When it comes to closing on a home, first-time buyers often encounter a seemingly unexpected expense known as an “Interest Adjustment.” This question comes up a lot and it’s essential to demystify this aspect of the home-buying process.
The Timing of Mortgage Payments:
One common source of confusion is when the first mortgage payment is due. Unlike monthly bills such as rent or cell phone payments, where you typically pay for the upcoming month in advance, mortgage payments work a bit differently. Let’s clarify this with an example:
April 28th: Closing Date
May 1st: Interest Adjustment Date
June 1st: First Mortgage Payment
Here’s the key point: You’ll prepay a few days’ worth of interest on your closing date, which is known as an “interest adjustment.” This adjustment addresses the brief period between your closing date at the end of April and the start of the new month in May. Your lawyer should explain this detail when you go in to sign the paperwork.
Understanding Interest Adjustments:
Interest adjustments come into play when your mortgage funds mid-month or you have opted for a specific payment frequency. For our purposes, we will use a monthly payment frequency.
In this scenario, you are required to prepay interest for the days leading up to the interest adjustment date, which typically falls on the first day of the following month.
Regardless of the type of mortgage you have—whether it’s a variable rate or fixed-rate mortgage—you owe interest based on the rate you agreed upon for the days between your closing date and the interest adjustment date. While future monthly payments may be affected by interest rate changes, the interest adjustment itself is calculated and due on the closing date or the specified interest adjustment date.
Determining the Interest Adjustment Date:
The exact date for the interest adjustment depends on your specific lender and their approach to this process. Some lenders set your first payment to occur precisely one month after your purchase completion date, aligning perfectly with the calendar and avoiding an interest adjustment.
However, other lenders prefer to collect payments on the first day of each month. In such cases, if your purchase date doesn’t align with the 1st of the month, your lawyer will collect a partial month’s interest to adjust the payment schedule accordingly.
Calculating the Interest Adjustment Amount:
To calculate the interest adjustment amount, you need to consider the number of days between your closing date and the first day of the following month. Here’s a step-by-step breakdown:
- Calculate the annual interest by multiplying your mortgage loan amount (not the purchase price) by your mortgage interest rate.
- Find the daily interest by dividing the annual interest by 365.
- Multiply the daily interest by the number of days between the closing date and the interest adjustment date.
For example, if you have a $500,000 adjustable-rate mortgage loan at 4% interest and 15 days between the closing date and the interest adjustment date:
($500,000 x 4%) x 15 Days = $821.92 / 365 = Daily Interest
On your interest adjustment date, you will owe $821.92 in interest. After this date, your regular monthly payments will commence, unless you’ve chosen a different payment schedule like bi-weekly payments.
Understanding interest adjustments not only helps clarify your initial mortgage expenses but also sheds light on the amount of interest you’ll pay over the entire mortgage term. It’s a fundamental aspect of real estate amortization: you’ll continue paying interest on the principal amount until the loan reaches its maturity date. It’s also the date a lot of lenders will consider to be the starting date of the mortgage.