Maybe you’ve heard this and maybe you haven’t, but when someone asks when the best time is to close on a contract it’s typically at or near the end of the month. Why? Because it’s how mortgage interest is accrued. When someone makes a mortgage payment on the first of the month, the payment doesn’t apply to the month about to be lived in but instead it’s for the interest that accrued for the previous month. But at the settlement table when a purchase mortgage is taken out there are no previous occupied days, yet interest is still collected.
It's called prepaid interest and it’s an amount that includes interest on the first day of the new note up until the first of the following month. If a closing takes place on the 20th of the month, the lender will collect interest up to the first of the following month. In this example that would be 10 days. If on the last day of the month, there will only be one day’s worth of interest collected.
Then, there would be no mortgage payment on the first of the following month because it’s already been paid. So, with a purchase transaction, it makes sense to close as close to the end of the month as possible. Some like to give a little breathing room and close on the next to last day of the month just in case something happens to cause a delay.
The closing date on a purchase is clearly laid out on the first page of the contract. Closing must take place on or before that date. Any extension must be agreed to by both parties. There’s really no wiggle room about that. If the buyers can’t close on the specified date, they run into the possibility of losing their earnest money deposit.
On the other hand, there’s a bit of a difference as it relates to a refinance. When someone is refinancing to get a lower rate or adjust their loan term the homeowners dictate the closing date. There’s no contractual date that must be followed and no earnest money that needs to be considered. Yet when refinancing in this example it makes sense to close as soon as able in order to begin saving on monthly interest. Most lenders will lock in a loan before ordering closing papers in as little as 10 days but whatever the period, there needs to be enough time allotted for the various third parties to deliver the services and documents needed.
When refinancing, there will be interest in arrears for the number of days for the old mortgage plus prepaid interest collected up to the first of the following month. Again, because the interest has been prepaid, there will be no mortgage payment on the first day of the next month because it’s already been paid.
During a purchase transaction the closing date is established upon execution of the contract. When refinancing, it’s completely up to the homeowners not just whether or not it makes sense to refinance but setting a closing date.
