Prepaid interest (or per diem interest) is the interest charged to a borrower at closing to cover interest on the loan between closing date and the end of the month.

Example: If a loan funds on the 19th of the month, (and there are 30 days in the month) and the first payment is due on the first of the following month, the new lender will charge 12 days of prepaid interest. If the loan closes one day before the end of the month, then only 1 of interest is charged.

Note: When an FHA loan is refinanced, a full 30 days of interest is charged regardless of when the loan is paid-off. To accommodate for this, we will close our new loan at the end of the month so the borrower does not pay unnecessary double-interest.

Arrears is an interest payment made after its due. Interest is said to be paid in arrears since it is paid to the date of payment rather than in advance. For example, an October mortgage payment will pay for the Septembers interest.

Per Diem interest should not be viewed as a cost or fee. If the loan is not pursued,
interest still needs to be paid to the exsisting lender for that time frame.

Many people believe think that when you obtain a new mortgage you get to skip a month's payments; the payment is actually only deferred. The skipped payment will be made up at the end of the loan because mortgage interest is paid in arrears. This is one reason the payoff amount of a home is often higher than the loan balance.

Mortgage interest always being paid in arrears is why your loan balance never seems to go down, especially on 30 year mortgages. If you have a mortgage that is 100,000 dollars and your payment is 1,000 dollars and $900 goes towards interest and $100 goes towards principal, when you make your first payment your actual balance would be $100,900 on the date your first payment was due. When you make your first payment of $1,000, $900 will go towards interest which will bring your balance back down to your original loan amount of $100,000 and the other $100 will go towards the principal of your loan, which would bring your balance down to $99,900. This is how your mortgage loan balance works and why your balance seems to take forever to decrease. The above example is using generic numbers to help explain interest paid in arrears on a mortgage loan.

 

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