Buying a first home is simultaneously exciting, stressful and confusing. Once you have scrutinized open house listings, scraped together the dough and performed the required inspections, there is still the down-and-dirty business of transferring the home from seller to buyer.
Even the most seemingly mundane details of buying a new home have consequences. That includes the day of the month you choose to close.
Title agents and mortgage brokers often steer homebuyers toward the earlier days of the month. But cash-strapped first-time homebuyers might find that closing on the first day of the month is a bad move. Here is why.
Prepaid Interest Costs Are Higher
Mortgage interest is paid in arrears, after the month has ended. This is an unexpected change for many renters, who are accustomed to prepaying their housing expenses. Because mortgage interest is calculated based on the outstanding principal mortgage balance, it is more accurate for a mortgage lender to calculate interest at the end of the month.
How does this affect a new homebuyer’s closing costs? To get a new homebuyer up to date with the current month’s interest payments, a mortgage lender asks a borrower to prepay the first month’s worth of interest, and includes that first mortgage payment interest in the overall mortgage loan closing costs.
“If you close on a home at the end of the month, you can take advantage of the prorated costs. From a cash-flow perspective, your out-of-pocket costs would be lower,” said Andrew McCrea, account executive with PMBC Group in Beverly Hills, Calif.
When the time comes to close on a mortgage, borrowers are expected to pay accrued interest from the time they close through the last day of the month. “Therefore, the closer to the end of the month that you close, the less interest you will have to pay,” McCrea said.
For example, assume you have a loan of $240,000 and an annual interest rate of 4.5 percent. The daily interest rate in this example would be 0.012329 percent (4.5 percent divided by 365 days). Multiply the daily interest rate by the principal loan balance and you will end up with the amount you will pay in interest per day: $29.60.
If you close on the first of the month, you will pay daily interest on the loan for every day within the month. If there are 30 days in the month, you will pay $888 in prepaid interest at closing. If you close on day 30 of a 30-day month, you will pay interest for one day, or $29.60.
You will see this number reflected on line 901 of the HUD-1 settlement form. For a new homebuyer, it can make a sizable difference to have that extra cash in hand.
You Will Pay a Higher Share of Real Estate Taxes and HOA Fees
Mortgage interest is not the only closing cost that is dependent on settlement date:
“Real estate taxes and homeowners association or condominium association dues are prorated between buyer and seller at the time of closing,” said Brad Chandler, CEO and co-founder of Express Homebuyers USA in Springfield, Va. “If the amounts are prepaid by the seller, the buyer needs to reimburse the seller for the buyer’s portion of the payment from the settlement date through to the end of the period for which a payment was made.”
For example, if HOA fees are $600 per month, the buyer must reimburse the seller about $20 per day to cover the period from the date of settlement through the end of the month. If closing happens on the 29th, the buyer will pay just about $60 in prorated HOA fees. If closing is on the 7th, the buyer will pay substantially more — about $500. If you are buying your first home, that cash cushion could be the difference between buying a dining room table and eating dinner on the floor in front of the television.
You Might Double Up on Rent and Mortgage Interest
Closing costs are not the only payments to consider when selecting a settlement date. For those making the transition from renter to homeowner, there is rarely a need to pay rent while simultaneously making a first mortgage payment.
“If the buyer is buying his or her first home, closing near the end of the month could mean less overlap with an existing rental lease,” said Chandler. “By limiting overlap, the buyer can further reduce the amount of out-of-pocket expenses required at the time of closing.”
Is the First of the Month Ever a Good Idea?
The day of the month when settlement occurs can have an impact on the closing costs you will incur, but you get what you pay for. That first mortgage payment interest is due only for the days you actually own the home. If it is more convenient to move at the beginning of the month, the increased settlement costs are a reflection of the greater number of days during which you will occupy the home.
“While the day of the month does impact how much prepaid interest you will have to pay at closing, this is really only a very short-term issue,” said Daniel Price, president, co-founder and CEO of OneTitle National Guaranty Company in New York. “By the time you make your first mortgage payment at the beginning of the second full month, it will all equal out, regardless of when you closed. The day of the month you close does not affect the total amount that you will end up paying on your mortgage.”
Still, the vast majority of settlement transactions occur at the end of the month. This is when title agents and mortgage brokers are their busiest and, consequently, when mistakes are made and service is rushed. If holding on to the upfront cash is not an issue for you, you could survive a much smoother transaction by coming to the closing table earlier in the month.
In short, a late-month settlement will have an effect on your mortgage loan closing costs, but not on your overall monthly mortgage payment. When it comes to daily mortgage interest, you get what you pay for.