Published: October 15, 2015 • Last updated: June 23, 2024 at 14:29 pm

Demystifying Interest Adjustments when closing a home

Sometimes first-time buyers are confused by an extra closing cost they may not anticipate, called an Interest Adjustment. As a mortgage broker, clients ask me this sort of question all the time.

“I wanted to know from when I need to start making my mortgage payments. Based on the schedule you provided earlier, the first mortgage payment has to be made on the 1st of June, Correct? If that is the case, how come my first payment date isn’t in May, given that the closing date happens on the 28th of April. I am a little confused by this period of time. Let me know when you have a moment.”

Here is how I answered the question:

“Unlike your rent or cell phone bill, which you pay each month in advance, your mortgage payment is made after the fact. In other words, on June 01, you might make your first mortgage payment for the month of May.”

In this scenario specifically.
April 28th: Closing Date

May 1st: Interest Adjustment Date

June 1st: First Mortgage Payment

What does interest adjustment mean?

You will prepay a few days’ interest on your closing date – it is called an interest adjustment (to address the stub period between closing on April 28th and May 01). Your lawyer should explain all that when you go into sign papers.”

How do interest adjustments work?

When your mortgage funds mid-month, you have to prepay a few days’ interest on your closing date – it is called an interest adjustment, and it’s to address the period of time between the closing date and the beginning of the following month.

Is interest calculated on the closing date?

Regardless of your mortgage product, variable rate mortgage, a fixed-rate mortgage, or what the prime rate is currently at, you will owe interest at your decided rate for the days leading up to the interest adjustment date.

Rate changes might affect your future monthly payments, but your interest adjustment is calculated on the closing date and is due either on the closing date or the interest adjustment date.

What is the date for interest adjustment?

It depends on your specific lender and how they approach this interest adjustment date (IAD).

Some mortgage lenders will set your first payment exactly one month after your purchase completion date. In that case, the stars align perfectly — no Interest Adjustment for you.

Other lenders prefer to collect from you on the first day of the month. And in this case, unless your purchase date is also on the 1st, there will be a partial month’s interest your lawyer will collect from your bank account to adjust things until your payment period aligns perfectly.

How do you calculate interest adjustment?

When your closing date is not on the first day of the month, you will need to pay the interest accrued on the number of days between the closing date and the first day of the next month.

Your lender can opt for prepayment on the interest adjustment amount in your closing costs, or they can set up an interest adjustment date on the first day of the next month to make the payment.

To determine your interest adjustment amount, first calculate the amount of interest you accrue per year: your mortgage loan (not purchase price) X mortgage interest rate. Next, find the amount of interest you pay daily by dividing it by 365. Then take this amount of interest, and multiply it by the number of days on the statement of adjustments.

Let’s walk through a scenario: You have an adjustable-rate mortgage loan of $500,000. The number of days between your closing date and interest adjustment date is 15. You have a mortgage rate of 4%.

($500.000 X 4%) X 15 Days = $821.92
365
On your interest adjustment date, the amount of interest you will owe is $821.92. Your regular payments will begin one month from this date unless you have opted for bi-weekly payments.

This is also an excellent way to know how much interest you pay over the mortgage term. That’s the simple fact of real estate amortization; you pay interest on the amount until your maturity date.

Are Mortgage Payments Made in Advance?

It’s easy to see why there can be confusion about this topic. The timing of when a payment is due—whether in advance or in arrears—depends on the nature of the payment.

For instance:

• When you finance a car purchase, your payments are made in arrears. However, if you lease the same car, your payments are made in advance.
• Your cell phone contract and most insurance products require advance payments.
• Mortgage payments, on the other hand, are typically made in arrears.

Another point of confusion with mortgages is the mortgage adjustment date we discussed above. Often, there’s a one-time adjustment made on the day your mortgage is funded, which can add to the confusion.

If you’re unclear about any of this, it’s best to consult with your lender or real estate lawyer. They can help you determine the correct timing for your payments.

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• Rising Interest Rates and Your Mortgage
• Higher dollar means higher interest rates

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