Mortgage Myth: Skipping a Payment

Mortgage Myth:  “Skipping a Payment” when Refinancing

One of the most common myths in the mortgage world is an oft-misunderstood aspect of refinancing when it comes to the first payment date of a newly originated/refinanced loan.  Many times consumers and loan officers alike are confused by the timeline of having one loan paid off and payments begin to take place on a new loan.  Due to this misunderstanding, the term “skipping a payment” or “skipping 2 payments” is often tossed around without any real explanation or understanding of how “skipping” a payment works.

The easiest place to start to understand how the process works is to understand that mortgage interest, unlike a lot of other types of financial interest, is paid in arrears.  That means that when a payment is made on a mortgage loan, the interest portion of the payment is actually the interest due for the month before the payment is made.  For example, a May mortgage payment includes a portion of principal, plus the interest accrued for April, the month prior to the payment due date.
In addition to interest being paid in arrears, the other piece to the puzzle is in the form of “per diem” interest that shows up on a borrower’s closing disclosure (CD).  On the CD, per diem interest is charged from the date a new loan funds through the end of that current month.  For example, if a new loan funds on the 15th of a 30 day month, one of the charges on the CD will be 15 days worth of interest.
Now let’s look at an example of calendar days, closing days, and how that magic “skipped” month happens.  We’ll use a loan closing June 15th as an example.  A loan funding June 15th will have a first payment due date of August 1.  Since there’s no payment in July, you skip a month, right?!  Not quite.  On the closing statement, per diem interest will be collected from June 15th through the end of the month.  On August 1, the payment made will cover interest for the entire month of July, since mortgage interest is paid in arrears.

In some instances, “you can skip 2 payments!” is pitched as a benefit of a refinance.  In reality, this is never the case.  This is typically done by closing a loan early in a month.  We’ll stick to our example of a refinance loan closing in June.  If a customer doesn’t pay their current lender for June’s payment, and we refinance their loan with a first payment date of August, technically no monthly payment is made for June OR July.  But does that mean 2 payments are “skipped”?  Not really.  Take our previous example into consideration, and we already know that July’s interest is paid with the August 1st payment.  The remainder of June’s interest is paid in “per diem” interest at closing, and the “extra month” is really just interest added to the current lender’s payoff – or in this case, just being transferred to the new loan.

So when it comes to “skipping payments”, refinancing doesn’t ever accomplish that.   That said, borrower’s do not have to physically make monthly payments the month following signing closing documents, but it’s important to remember that the interest is always paid one way or another.  All of the interest on the loan being refinanced is wrapped into the payoff and closing figures on the new loan, and the new loans interest is paid in full beginning with per diem interest on the closing documents, and continuing to be paid with payment #1.

This mortgage myth is one of the more complex issues, and for that reason, consumers AND many mortgage professionals are often confused when discussing “skipping payments”.  The correct wording to use for what’s really happening is “deferring interest” or “including more interest in a payoff”.   So the next time you see someone advertising or telling you you can “skip a payment!”, rest assured you know better – and then make the decision on when to close your refinance loan based on reality.