RateWatch #340 – Getting the Loan Amount Right When Refinancing
January 25, 2003 By Dick Lepre
Getting the Loan Amount Right When Refinancing
Since we believe that there will be refinancing opportunities this year I want to discuss the details of getting the new loan amount right. The devil is in the details.
The answer is best obtained by going to the end of the process - the escrow disbursement sheet and seeing where the money is going. Then you can figure where it needs to come from.
You will need to pay:
1) your old loan balance
2) per diem interest on your old loan
3) prepaid per diem interest on the new loan
4) non-recurring closing costs (title insurance, escrow fee, and all those damn things no one wants to pay but has to)
5) recurring closing costs (potential property taxes and insurance)
6) impounds if you are going to have tax and insurance impounds
1) The old loan balance is simple. Now the fun begins.
2) Remember that mortgage interest is paid in arrears. (That is, your September payment is for the use of the money on August.) Suppose that your new loan is going to fund on September 8 and that you have not yet made your September payment. You need to pay interest on your old loan from August 1 until the day that the old lender receives the payoff. This is usually 2 days after your loan funds. In this case you will pay interest on the old loan for 41 days - August 1 to September 10. The per diem interest is equal to the loan balance on August 1 times the interest rate (as a decimal) divided by 365. The escrow company will be told the per diem interest by the old lender and send 41 days of that along with the August 1 balance.
In this case, if you had made your September payment you need only to pay 10 days of per diem interest on the old loan. The prepaid interest is the interest that you are paying at escrow for the new loan for the remaining days in the month. In our case, you would be paying interest from September 8 to September 30 and then have no October payment.
The amount of prepaid interest depends on the first payment date of the new loan. If your loan is funding is the first few days of the month you can usually choose one or 2 "first payment dates." Suppose that your loan is funding on September 3. You can have a first payment date of October 1. In this case you should be credited at escrow for 3 days of prepaid interest (September 1 - September 3). Then in October you will pay one full payment. This is, in effect, interest from September 3 to September 30 plus the 3 days of per diem interest that you were given credit for at escrow.
When you are refinancing you almost always have to pay at least 2 days of "duplicate" interest. You pay the new lender from the day the new loan funds. You pay the old lender until the day they receive the funds from the escrow company. This is usually 2 days after funding. Consequently, you do not want your refinance to fund on a Friday. If it does you will have to
pay at least 4 days of duplicate interest.
Non-recurring closing costs are: title insurance, escrow, appraisal, credit report etc. If you are getting a "no cost" loan the broker will be covering these.
Other potential recurring closing costs are insurance and property tax, These are dependant on timing. In general, the new lender will want you to have at least 6 months of hazard insurance in place on the day your loan funds. You may have to make 6 months or 1 year's worth of insurance payment to escrow. This will go to your carrier.
Property taxes. This is one thing that gets confusing. In California, our property tax is due in 2 installments. The first is delinquent on December 10 and the second on March 10. Listen up: if your new loan is funding on October 20 and has a December 1 first payment date you will have to make the December property tax payment at escrow. (That's because you have until December 15 to make your mortgage payment. This is 5 days after your taxes are delinquent.) Since the very fabric of the universe would unfold if that happened, you are forced to make your payment early. The same thing is true with the second installment if you have an April 1 "first payment date."
If your first payment date is after April 10 and before December 1 this is not an issue. In some other states the taxes are due in quarters but the same principles apply. Impounds. This one is can get really confusing. Suppose that you either choose or are "forced" into a property tax impound
(in the case of a high loan to value loan).
Suppose that your "first payment date" is October 1. To understand what to do you must work backwards. In California the lender will need enough in the impound account on April 1 to have
made both tax payments. You will have made 6 payments Oct., Nov, Dec, Jan, Feb, Mar by April 1. Thus you will have to throw in - 12 minus 6 - or 6 months worth of taxes to the escrow to insure that you'd have enough in there on April 1. Some lenders may insist on 1 or 2 months "buffer" on top of that. If you have PMI you will usually need 2-4 months PMI payments in the escrow.
Also, if you are delinquent in your taxes or have liens, they also need to be settled at escrow.
So...the right loan amount is the sum of all of this stuff less what you are putting in "out of pocket." Some borrowers want to cover all of these costs with the new loan, some want to keep their loan balance the same and cover the costs themselves.
- coordinate with your loan officer the understanding of when the first payment date is.
- make sure that you don't make a payment on your old loan at the beginning of the month that does not have time to be credited by the day your escrow must close. Again, coordinate
this with your loan officer.
- if you elect to have impounds, be ready for the "seed money" for the impound account
- let your loan officer know when your insurance is coming due
Some points from my experience. If you don't have enough cash to bring to escrow the whole thing may get screwed up. You may lose your rate lock or have to pay a "redraw fee." If
you find that your new loan amount is too high you usually have the option of taking the excess from the escrow and using it to pay down your principle with the first payment. Your loan
balance will then be in line with expectations, your monthly payment will be slightly higher than it has to be, but you will be paying the loan off faster.
When refinancing, try to understand all of this and work with your loan officer to get "the right loan amount."