Does Your Closing Date Make A Difference?

Question: I have recently signed a contract to purchase a home. I would like to settle in the first week of December but my real estate agent says that I should settle at the end of November because I can save a month's interest by settling at the end of the month. I'm all for saving a month of interest but it doesn't sound right. Why would a lender give you an interest-free month?

Answer: Lenders don't lend any money for free. It seems that there's a common belief that you can "save" a lot of interest by settling at the end of the month. Not true. Your real estate agent is confusing "saving" interest with pre-paid interest. Let me explain.

All mortgage payments are paid in arrears. This means that any mortgage payment covers the interest owed for the preceding month. It's the opposite of rent payments, which are due in advance.

Since mortgage payments are paid in arrears, your first mortgage payment will always be due at the end of the first full month you took out the loan. So if you settle in early December, your first full month will be January and your first mortgage payment will be due February 1st -- almost two months after settlement.

If you settle at the end of November, your first full month will be December and your first payment will be due January 1st -- about one month after settlement.

Your real estate agent is referring to the interim interest that must be pre-paid at the time of settlement. If you settle in the beginning of any month, you will be required to pay the interim interest from the day you settle to the end of the month.

If you settle of the tenth of the month, you would pre-pay roughly 20 days of interest to cover the period from the tenth to the end of the month.

If you settle on the 30th, you wouldn't pre-pay any interest but your first mortgage payment would be due in one month's time.

So, settling at the end of the month doesn't "save" you any money. However, if you are short of cash, it will reduce the amount of funds required at the settlement table.

I hope I have answered your question. But now that we're on this subject, let me also talk a little bit about loan payoffs.

Millions of Americans are taking advantage of lower interest rates and refinancing their mortgage. For those folks who have FHA (Federal Housing Administration) loans, it's important to know that FHA collects the entire month's interest when the loan is paid off.

Basically, this means that if you pay off your FHA loan on the first of the month, FHA will charge you interest for the entire month. So for folks who are refinancing their FHA loan, it's best to settle at the end of the month. With any luck your loan officer will already know this and have you scheduled to close at the appropriate time.