Mortgage borrowers of the world! It’s time for some “real talk” about the true and actual benefits of refinancing a mortgage.
I often get clients who are excited about “skipping a payment” as a result of the refinance process. And I in no way want to pour any water on to the flames of excitement about the financial improvements one achieves through a refi, BUT- nobody actually skips a payment when they refinance.
Your daddy always told you there were no free rides in this life, and while I’m not going to say that he was “right”- I will say that daddy was right when it comes to the residential mortgage business. Indeed no one rides for free. Indeed no lender is “paying for your appraisal” or giving you a “no-fee” mortgage- YOU the borrower pay for everything every time, its just a matter of HOW.
But lets focus on the idea of “skipping a mortgage payment” during a refinance.
To be clear, you don’t skip a payment, but what you get is the “sensation” of skipping a payment. You get the sensation as a result of how mortgage interest is calculated and accounted for.
Mortgages are always paid “in arrears” with one exception: mortgage interest is PRE-PAID for the portion of the month in which a new mortgage is closed.
So here’s how it shakes out: You’ve got a mortgage, and you are faithfully making your payments. Since the interest is calculated in arrears, your January first payment actually is paying for interest in December (Feb 1st payment pays for January interest and so forth). But now you are embarked on a refinance! The new loan closes April 20th. You have made your April 1st payment already (which we now know pays for March). And the title company has ordered the official loan payoff. The Payoff is the amount required by the soon to be OLD mortgage that accounts for the current loan BALANCE OWED *PLUS* (in this example) 20 days of interest that you owe them for April (because that May payment will not be coming!).
The new loan will collect pre-paid interest for the remainder of April: 10 days (calculated at your new rate). And now you see- April is paid for: partly by the old mortgage (embedded in the payoff), and partly by the new mortgage (pre-paid interest line item on your HUD).
And when does May get paid for?
(all together now) JUNE 1st!
So you pay your April 1st payment, get a refi in April (roll all your fees and pre-paids into your new loan balance), and then you SKIP that May 1st payment. You’ve actually financed that payment. But hey- its OKAY- its a wonderful sensation, and has some great cash flow benefits.
I simply just don’t want you to think that you are actually getting a free month of mortgage. Wouldn’t that be amazing? The mortgage industry is just that charitable right? NOPE.
And also- if a mortgage person is trying to SELL you on the idea of refinancing with the “skipped” payment as one of the main benefits, I would seriously consider parting ways with that mortgage person. Skipping a payment in a refinance is a fine thing, but it’s simply a peripheral accounting sensation that elicits a not-so cheap thrill.