Why You Don’t Actually Skip a Mortgage Payment When Refinancing
Homeowners are often allured by refinancing advertisements that offer the chance to skip their mortgage payment for one month. It almost seems too good to be true. And unfortunately, it is.
People refinance their homes for myriad reasons, from the possibility of securing a better interest rate to the potential for a lower monthly payment.
But if your reason for refinancing is to skip a monthly payment, you might want think before you act, as you’re not actually saving any money.
Do you actually skip a mortgage payment when refinancing?
In short, the answer is no. Although you skip the physical act of making a payment, you’re still paying for the skipped month in other forms.
“In the technical sense, do you skip having to physically make a payment? Yes. But are you saving any money by skipping that payment? No, not at all. Not one penny,” said Demond Johnson, sales manager at Guild Mortgage in Arlington, Texas.
When you refinance your mortgage, you do not make a payment until the month after you close. For example, if you closed on May 10, you wouldn’t make a mortgage payment until July 1. However, the payment that would be due in June still gets paid for by the borrower.
“From a practical standpoint, they don’t have to make a payment in June,” said Alex Margulis, vice president of Mortgage Lending at PERL Mortgage, Inc. in Chicago. “That does not mean, however, that the interest for the month of June is not being paid for by the borrower.”
Why can it appear that you skip a payment?
Because no payment is due the month after a refinance closing, many consumers believe they’re saving an entire month’s worth of a mortgage payment. In reality, they’re still paying for that month later on.
Refinancing a mortgage works in this way simply because of how the amortization of loans works: Interest is always paid in arrears, or a month behind. Take the example above, in which someone closes on their refinance on May 10. On May 1, he or she would have paid the interest for their mortgage in April. Because of the timing of their closing, the first payment on their refinance wouldn’t be due until July 1.
“Mortgage companies charge you in arrears,” Johnson said. “So there’s no way to charge you in advance for the interest. We have to wait until July 1 in order to charge you for June.”
Though no physical payment was made in June, you’re still paying for the month of June in July. Josh Weinberg, executive vice president of compliance at First Choice Loan Services, Inc. in Chicago, said one way to think of it is as if you’re deferring June’s interest until July.
Another thing to keep in mind when refinancing a mortgage is how the days between the closing and the first month of the new refinance will be paid. (In the example above, this would be May 10 to May 31.) How exactly are these days paid for? These days are paid for in the form of prepaid interest at closing. What you’re doing is paying interest on the new loan from today until the end of the month.
Why do companies advertise skipping a mortgage payment?
The nuances associated with refinancing are why some companies will advertise the chance to skip one month of your mortgage payment.
“Why the consumer would like that concept of ‘skipping the payment’ is because they don’t have to actually pay out of pocket for the month,” Margulis said. “But in all reality, they’re still paying for it. It’s just delayed by one month, as far as interest paid for that mortgage.”
Some companies will even go so far as advertise that you can skip two payments, which is also misleading. Let’s say you closed on May 10, as in the example above.
“Even though your payment was due May 1, it’s not technically late until the 15th of the month,” Johnson said. “If you can refinance and fund your loan before the 15th without having a late payment, then technically you don’t have to make May’s payment.”
However, you still aren’t skipping two payments, as this amount is going to be part of your payoff. It’s all included. You don’t miss two minutes of interest. But I think it’s a warm-and-fuzzy feeling to clients, because they feel as though they’re not physically having to make a payment and for some reason, they feel that they’ve saved something.
Is there any benefit to the monthly payment deferral that occurs when refinancing?
If you have a large expense in the interim month between refinancing, you might reap a small benefit.
“There is a benefit to ‘skipping the payment’ because it is a true relief to the consumer of not having to pay out of pocket for that intermediate month,” Margulis said. “It does not mean that you’re not paying interest for that month on your new loan, it just means that it’s delaying the payment for the interest by one month.”
How to find the best refinance offer
If you’re interested in refinancing, there are a number of best practices to keep in mind.
Inquire with the mortgage company that originated your loan. Oftentimes, consumers who went through a mortgage lending company will go to the bank providing their loan instead of the original mortgage company who helped them secure the loan.
“It’s in the borrower’s best interest to check in with that mortgage company instead of going back to the loan servicing bank that they’re making their payments to, because that mortgage company can give them an array of options and price out the best banks to choose from for their refinance,” he said.
Find your break-even point. Take a look at how long you plan on staying in the property. Although refinancing can give you a lower monthly payment and/or lower interest rate, there are costs to refinancing that might offset those savings. For example, saving $100 per month won’t be beneficial if the bank fees, appraisal fees and title fees associated with your refinance are in the thousands, and you plan on moving in five or six years.
Consider asking your lender to premium price the loan. When refinancing, people tend to focus only on interest rates. But in some situations, it can be more beneficial to ask the lender to premium price the loan, which means you take a higher rate, the lender makes more profit and then the lender gives you that profit in the form of a lender credit to offset the closing costs.
The rate on paper won’t look as pretty, but now you don’t have to worry so much about your break-even point down the line, now your savings are true savings.
Compare offers on LendingTree. Compare various loans using an online resource like LendingTree to ensure you are getting the best offer possible. Though a .25% or .5% difference in an interest rate might not seem like a lot, it actually is in the long term. For example, recent research showed that someone who got a mortgage rate that was 0.63% lower than their competition saved nearly $30,000 on a $300,000 loan over the course of 30 years.
Think about how long you’ll be in your home. Often what you’re doing by lowering your payment with the refinance is not just getting a lower rate, but extending the term of your loan. Refinancing might not be the best option for people looking to pay off their loan as quickly as possible unless they are shortening the term of their loan.