Do You Really Skip a Mortgage Payment When Refinancing?
This is an all too common phrase some lenders throw out when marketing their refinance programs or when speaking with a loan officer on the phone. A refinance replaces one loan with another and there are multiple reasons to refinance other than lowering an interest rate but skipping a mortgage payment isn’t one of them. A refinance makes sense when someone decides to get out of an adjustable-rate mortgage and into a fixed-rate loan.
Adjustable-rate mortgages, or ARMS, can be a good choice when the borrowers decide they may not keep the home for the long term because the initial rate for an ARM will be lower than prevailing fixed rates. Today, most ARMs issued are in the form of a hybrid mortgage which in essence is an ARM that can adjust every six or twelve months but is fixed for an initial period of time, say three or five years.
How To Refinance for a Better Mortgage Payment
Homeowners can refinance if they want to switch loan terms. Many times such transactions shorten the loan term to match up with their financial and retirement goals. Borrowers who plan on retiring in 15 years might want to refinance out of a 30-year loan into a 15-year term. Doing so saves on interest. There are also a few balloon mortgages still outstanding where borrowers must refinance before the entire loan comes due. But the most common reason people decide to refinance is in fact to lower the rate on their home loan.
Refinancing in the current environment has been picking up over the last several weeks as mortgage rates continue to fall. Recently, Freddie Mac reported the biggest weekly drop in rates that we haven’t seen in almost a decade. Whatever the reason to refinance, one reason is not to skip a mortgage payment. Let me explain.
Let’s say you and I decide a refinance makes good sense for your situation. You’ll complete an application and document the file much like you did the first time around. Or, depending upon whether or not you’re refinancing a government-backed loan and take the streamline route, there will be very little documentation needed at all. An appraisal will be ordered as will title work. An escrow will also be opened and a targeted settlement date will be set. We will also order payoffs from the existing lender.
How it Works
Unlike a purchase loan however, you’re able to roll closing costs into the new loan. It’s completely up to you whether or not to roll closing costs into your new mortgage but most do. I’ll give you a list of estimated charges you can expect to encounter at the closing table and, at your direction, add those charges to your new loan and calculate the new monthly payment. Yes, adding closing costs to your loan does increase the loan amount and monthly mortgage payment but not by very much. The advantage with rolling your costs into your new loan is preserving available cash. When you bought your home, you had to pay for closing costs out of pocket but when refinancing you have an option to roll all or some of those costs into the new mortgage.
When your existing lender provides us with a payoff amount, that amount will be a bit different than the current balance. It will also include interest, both prepaid and accruing. When you make your mortgage payment every month it includes an amount directed to the outstanding principal balance and the interest that accrues for the previous month. A mortgage payment pays the interest that accrues the previous month. But you’ll also pay prepaid interest to your new lender, just like you did when you first bought the home.
Let’s say your refinance will close and fund on the 15th day of the month. Your payoff amount will include your outstanding principal balance plus 15 days of interest accrued at the old rate. We will also collect 15 days of prepaid interest based upon the new rate and term of your new mortgage.
When you first closed on your home, you also paid prepaid interest based upon how many days were leading up to the following month. Remember, interest is paid in arrears. If you closed on the 20th, your new lender also collects 10 days of interest which is in effect your first mortgage payment. When the first of the following month comes up, there is no mortgage payment due because you prepaid it at the closing table.
When you’re told that you can skip a mortgage payment when refinancing, this is what’s being referred to. In reality, you’re not skipping anything because you already paid it.