Your First Mortgage Payment Explained
07 August 2015, by Design A House Sign
It can be confusing when taking out a mortgage, to know exactly how it works and when your payments are due. It is first important to understand that a mortgage is a type of amortisation. This means that your loan will have equal monthly payments of principal and interest over a specified period of time. This means that an amortised loan will be completely paid off at the final payment. Basically, the amount you haven’t paid is calculated again every month and accounted for in your next payment. This means that your first payments are also likely to be higher than your last.
Paying in Arrears
You may have heard the phrase before but did not know what it actually meant. Unlike most things that you pay for, a mortgage is paid in arrears, which mean you pay for your mortgage after the fact. For example, if you were to rent a property your payment would be made in advance. If you started renting a property on September 1st, then your rent would be due on the same day because you pay for the month of September in advance. This is why it can be confusing as to when you actually start paying your mortgage. You will not make your first payment until at least a month after your closing date.
When is my first payment due?
When you decide to buy a home and take out a mortgage, the agent who closes the deal will collect interest from you. You can find this interest on your closing statement and it will be charged as a closing cost. Any mortgage payment consists of two parts, which includes the mortgage interest and the mortgage principal. You will always pay interest 30 days in arrears and the principal part reduces your mortgage balance for the due date. If the day you close is on September 15th for example, you will receive a charge of interest for the 15 days up until October 1st. Your first payment will then be due on November 1st as you will be charged the interest for that month. You may want to check the proration clause in your contract before signing.
How to calculate your first payment
For the reasons listed above it can be hard to work out exactly how much you need to pay on your first payment. Let’s say that you are borrowing £300,000 at 5% interest. Your monthly payment will be £1610.46, payable in equal monthly instalments for 30 years. Your daily interest rate charge is worked out by taking £300,000 times the interest rate of 5%. This is then divided by 12 months (£1249.99) and again by 30 days. Your daily interest rate is, therefore, £41.67. You will then owe 16 days of interest from March 15th that will stand at £666.72 and will be charged on your closing statement as a closing cost. When you make the first payment on November 1st that mortgage payment will pay the interest as follows; £1610.46 minus £1249.99 interest for October equals £360.47 principal reduction.
Although it can seem like you’re getting a free ride and not paying for a mortgage from when you close, this isn’t actually the case. Interest is paid in arrears so you will always be charged for the interest you have accrued. Make sure you are aware of these things before you have to make your first payment so that you know exactly what you owe.