I had just borrowed about a quarter-million dollars and my question was simple: "How do I pay you back?"
The woman on the other end of the phone, however, couldn't tell me. Ten days had passed since I signed the papers to refinance my home and, with the holidays approaching, I was worried my first payment would be late. She tried to soothe me with perhaps the most misunderstood phrase of the refinancing process: "Don't worry. You get to skip a payment."
Had I listened to her, it would have cost me thousands of dollars. And if you are one of the millions of homeowners who will refinance in 2013, it could cost you, too.
If your new year’s resolution is to save money or get control of the family budget, refinancing remains a really good option. But the idea that “skipping” the first payment can be pain free, financially speaking, is a myth, repeated over and over by loan officers like mine. Sometimes they are lying, sometimes they are misinformed and sometimes they are just trying to get an annoying borrower like me off the phone. But with rare exception, they are giving bad advice. (News flash: Whenever a bank seems to be doing you a favor, it probably has a hand in your wallet.)
Real estate transactions are already confusing enough. There are questions surrounding when you make your last payment on the old loan, when you make your first payment on the new loan, how many extra days of interest you pay toward both your old and your new loan, and when you are paying for both loans. We'll get to those tricky issues in a moment, but the priciest mistake you might make in a refinance is also the simplest one to correct.
You've heard this before, but this time, it's probably true: mortgage interest rates are at historic lows, and there may never be a better time to refinance. It's hard to imagine rates going any lower than the 3 percent range they are at now, but it's easy to imagine that, at the first signs of a real economic recovery or real inflation, they will climb sharply during 2013. The low interest rates that the Federal Reserve has imposed to boost the economy have been punishing for many, notably savers, who can barely earn 1 percent interest on their bank accounts and certificates of deposit. The one perk for consumers from the Fed’s interest rate policy is the ability to get cheap home and auto loans. If you haven't refinanced your mortgage in the past 24 months or so, you are missing out.
Fortunately, many American homeowners have gotten the message. According to the Mortgage Bankers Association, mortgage holders engaged in $1.3 trillion worth of refinancing in 2012. In fact, more than four out of five new mortgages in 2012 were refinanced loans, not home purchases.
I wish there were a way to know how many of those borrowers chose to skip that first payment.
'Can I get that in writing?' 'No'
My loan officer was lazy, I believe, and -- knowing that my loan had closed and all the commissions were guaranteed -- just wanted me off the phone as soon as possible. My call was unusual. I am always overly cautious when I set up any kind of new loan payment, as the chances for error are great: a wrong loan number on a check, a bad address, etc. So I always make the first payment early to make sure nothing goes wrong. That good habit proved profitable this time.
When I signed my loan papers, there were no payment instructions in my closing documents (not terribly unusual). My loan officer said I would receive payment coupons later. But when 10 days passed, and I heard nothing, I called. She sent me to the bank's customer service line, where I was informed that there was no record of my loan. (Did that mean I didn’t have to pay it back? Sadly, No.) Customer service transferred me back to my loan officer. She assured me that their computers would catch up to my urge to pay the loan, and I’d get payment information soon. Incredulous that they seemed not to want my money, I persisted. She tapped a few keys on her keyboard, made me wait a minute, then told me that my loan had funded on Dec. 5, so I didn't have to make a payment until Feb. 1.
"But my documents say repayment begins Jan. 1," I said. "So you're saying there will be no late fees if I don't pay Jan. 1?"
"Yes," she said.
"Can I get that in writing.?”
"No. I can't do that."
At that point, I did what any mature consumer would do: I laughed. And then I muttered something about the 100 pieces of paper they just made me sign, with innocuous documents putting the finest point on everything you can imagine, like the form I initialed in multiple places agreeing that, yes, I am known by Bob, Robert, Bobby, Robby and various other nicknames. Yet I couldn’t get the bank to put something in writing saying when I should make my loan payment?
My loan officer didn't laugh, but eventually she put me on the phone with a supervisor who sounded very grave. She'd done additional research, she said, and found out that the reason customer service couldn't find my loan was because it had already been sold to another bank. We called that bank together and found out my loan actually funded on Nov. 30, so my first payment was indeed due on Jan. 1. And I would have been liable for about an $80 late fee if I had listened to my loan officer. The manager profusely apologized.
Steep penalty anyway
But I'm not writing to warn you about late fees. There's a much bigger culprit here you have to worry about. Had I followed my loan officer's advice and skipped a payment, even if the bank waived the late fee (which the manager said was likely), I would have paid a steep penalty anyway. You've probably guessed the punch line: there's no such thing as skipping a payment. In reality, homeowners are borrowing that money and extending the loan term for an extra month. The payment will be tacked onto the end of the loan, with interest. How much? If it's a conventional loan, that’s 30 years’ worth of interest. Effectively, you are borrowing one month's payment for 30 years. Ouch!
"Skipping is a misnomer. A better description would be ‘deferring with additional interest added,'" said Jack Guttentag, a professor emeritus at the University of Pennsylvania who also runs a consumer education website called MortgageProfessor.com.
Just how much extra interest can skipping that first payment cost you? There are too many variables to create a decent rule of thumb. But here's an illustration from Guttentag's site with deliberately round numbers. Skip the first payment of $500 on a $100,000 loan at 6 percent, and you will pay an additional $2,993 in interest during the 30 years.
Forget the $75 late fee. That's real money. As Guttentag puts it, "a payment that is miniscule to one is a fortune to another."
Some loan officers say they only won't offer the "skip-a-payment" option unless the refinance closes toward the end of the month, when the homeowner might have trouble coming up with the extra cash for closing costs and a fresh mortgage payment close together. Others say they offer it all the time.
To be clear: Most borrowers don’t actually complete their 30-year loans before moving or refinancing, so few would end up paying that high a penalty. Also, it's important to note that my bank didn't even hold the loan, so they weren't profiting from the “skip-a-payment” advice. I believe this is usually a lazy mistake, not a greedy one. Still, the basic truth holds. Don't be tempted to skip a payment when you refinance unless you really, really need the cash for some unusual expense (Christmas credit card bills are probably not the best reason.)
Skipped payments are not to be confused with other loan closing related interest payments, including:
*Your last payment on the old loan. You can't skip that, either. If your loan closes near the end of the month, you should still make the scheduled payment to your old bank. Why? Interest is actually paid in arrears, meaning you pay at the end of the month the cost of borrowing the money for that month. It's confusing, because mortgage payments are really two payments at once -- last month's interest and next month's principal. To keep it simple, if your loan closes on the Nov. 30, you will be paying November's interest with your Dec. 1 payment, along with December’s principal. You won't need to make the December principal payment if you refinance on Nov. 30, but most folks pay far more in interest than principal because they are early in their loan's term, so the overpayment won't be large. Just pay it to avoid late fees, and enjoy any refund that comes your way.
*Pre-paid interest. When your loan closes in the middle of the month, your new bank will make you pay up-front (as opposed to in arrears) daily interest for the remaining days of the month. If you close on the 20th, you'll pay 10 more days of interest payments. That's OK, it means you won't owe the money on the back end of the loan.
*Money for nothing: The three-day (or more) overlap. There's an odd quirk in most refinancing deals in which there are several days when the homeowner will be paying interest on the same loan to both banks. In most states, consumers have a three-day "right of rescission" after signing their refinancing papers, meaning they can cancel the new loan if they get buyer's remorse. Such regret laws are very consumer-friendly and are necessary because of nefarious loan officers who tricked consumers into bad deals in the past. But, in this case, the consumer-friendly law is also costly, as it means both banks have liability for the loan during that rescission period, and are both entitled to collect interest. Note: The regret period is usually three business days, so if your closing stretches over a weekend, the double-interest period can be even more costly.
It's important to keep all these quirky, refinance-related interest payments straight when talking to your loan officer, so you'll know what to do when he or she suggests you can skip a payment. None of this should scare you away from refinancing, which is really the only way you can make the recession work for you.
But remember, you are refinancing to save money, and you probably shopped around trying to save $50 here or $100 there on closing costs; don't lose thousands of dollars because of one false move after closing.
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First published January 1 2013, 4:34 AM