To understand how refinancing works when the loan closes, it’s important to understand how a purchase loan closes first. By comparing the two different processes,
Home Purchase: How it Works on Closing Day
The final settlement date for a purchase is listed directly on the sales contract. Once the contract is executed by both parties, there is a binding agreement between the buyers and sellers. The date of the contract signing and the settlement date provide enough time for the lender and various third parties to provide needed services and documents. If for some reason more time is needed and both parties agree, the settlement date can be moved. Buyers are also encouraged to close near or at the end of the month. Why? That’s due to prepaid interest and finance charges.
When a homeowner makes a payment each month, the payment actually applies to the previous month, not the current one. That’s referred to as ‘interest in arrears.’ Prepaid interest on the other hand is interest collected on behalf of the lender. When closing on the last day of the month, there is only one day of prepaid interest collected. Closing on the 20th of the month, there’s 10 days of prepaid interest collected, and so on.
Upon the first day of the following month, there is no mortgage payment that needs to be made because it was already paid at the settlement table in the form of prepaid interest. That interest represents the very first mortgage payment. When refinancing, that script is flipped.
Refinancing: The Benefits of Timing
When refinancing to a lower rate, it makes perfect sense to get that rate applied to the new mortgage as soon as possible. This accomplished two things- it starts saving money each month right away and reduces the amount of interest in arrears. With a sales contract, the closing date is determined by the contract but with refinancing, the homeowners have the choice of when to close. If there is a clear reason for refinancing to a lower rate it makes sense to lock that rate in as soon as possible.
Further, interest rate locks can be for a relatively short period of time, say 10 days or so, or longer. As much as 90-120 days for most programs. But with a longer lock comes higher fees. When a lender accepts a lock request, the lender is in essence pulling your mortgage out of its credit line. A rate lock for a standard 30 day fixed rate program might cost as much as a quarter of a discount point.
On a $300,000 mortgage, that equates to $750 additional dollars. Locking in a rate for 15 days typically doesn’t cost extra. Different lenders can have different policies but in general this is what you can expect. It’s easy to see how refinancing sooner rather than later has an impact on your pocketbook.
It’s also important to note what happens if your refinance doesn’t close within the lock period. For example, someone locked in an interest rate for 30 days and during that time rates tick a bit lower. The homeowner decides to let the rate expire and re-lock at the new, lower rates. However, most lock policies instruct the lender to accept a new lock at the higher of whatever was initially locked in and current market rates. Closing sooner rather than later avoids this situation.
If you’re thinking about refinancing, you’ll need to get current rate information. But don’t make this decision on your own. Let’s talk together and we’ll review your current situation and compare it with what a possible refinance would look like. Sometimes it just doesn’t make sense to refinance but either way it’s the numbers that will tell you which direction to take. If the numbers tell you refinancing is a good idea, then it’s prudent to move as soon as possible without delay.