- The Washington Times - Wednesday, October 25, 2006

Q:I am a first-time home buyer and have signed a contract to buy a condominium in Rockville. I have been renting for the past 10 years and have saved enough money for a 20 percent down payment. I have applied online with a mortgage company because they had the best interest rate. The problem is that I have not had much contact with them, so my real estate agent explained the Good Faith Estimate of charges.I was told that all the fees are customary and I accept that, although I don’t really know what they are for. The only real question I have is about the prepaid interest. We scheduled our settlement for the last day of the month because my agent says I save a month’s interest costs that way. I firmly believe that nothing is free, but my agent wasn’t able to explain how I can get an interest-free month by settling on the last day. An explanation would certainly be appreciated.

A: This is a question that consistently has come up during the many years I’ve written this column. It’s no surprise that the very simple concept of prepaid interest is misunderstood, thanks to the misinformation, intended or not, floating around. Inexperienced real estate agents often schedule closings at the end of the month because the buyer will, indeed, pay little or no prepaid interest. Does this mean the buyer receives a “free” month? Of course not.

Worse yet, many homeowners who read this column have undoubtedly received a refinance solicitation in the mail touting that refinancing will allow the homeowner to “skip” a mortgage payment, suggesting an interest-free month.

Such tactics are shameful.

Here’s the true scoop: Lenders amortize loans by the month. A 30-year fixed-rate loan will charge a principal and interest (P&I) payment each month for 30 years. Each payment is due on the first day of each month, with the last payment due on the first day of the 360th month. Each payment covers the interest for the previous month. Closing on the last day of October, for example, means that the first mortgage payment would be due on Dec. 1, which would cover November’s interest charges.

Now, let’s say you close on the new home on Nov. 5. Your first P&I payment can’t be due on Dec. 1st because every P&I payment is the same, and the bank would be overcharging you because you didn’t have use of the money for the entire month of November.

The first P&I payment is always due after the first full month. With a Nov. 5 settlement, the first payment would be due Jan. 1, which would cover only December’s interest.

But a Nov. 5 closing would give you the use of the money and access to your new home 25 days before December. You owe the bank interest charges from the period of Nov. 5 to Nov. 30. To keep square, the bank will charge this interest at settlement. Aptly named, this is prepaid interest.

Here’s where agents get mixed up: Settling at the end of the month decreases the amount of cash required at settlement, but it doesn’t give you a break on interest charges. Your first mortgage payment is due earlier. An Oct. 31 settlement means that the first payment will be due on Dec. 1, one month later. In contrast, a Nov. 1 settlement would require a month’s prepaid interest at the settlement table, but the first payment would be due Jan. 1, two months after settlement.

It all comes out in the wash. There’s no free lunch.

A quick comment on your mortgage process: While I don’t make it a habit of bashing Internet mortgage companies, it’s not a good sign that a first-time home buyer has not been satisfactorily informed of each and every charge on the Good Faith Estimate by the loan officer.

This is not the real estate agent’s job. Beware of any mortgage company, in cyberspace or not, that you cannot freely contact to receive full explanations on the entire mortgage process. A lack of initial understanding breeds two things: getting ripped off or having last-minute surprises, or both. You want neither.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).

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