Prepaid Interest
Definition and meaning of Prepaid Interest in real estate.
Prepaid interest is the interest charges a borrower pays at closing to cover the interest that will accrue on a new mortgage from the closing date until the end of that calendar month.
In more detail
Mortgage interest is typically paid in arrears, meaning a monthly payment covers the interest that accrued during the previous month. Since a new loan closing can happen on any day of the month, the lender charges prepaid interest daily for the remaining days of the closing month.
This aligns the billing cycle so that the first regular mortgage payment is due on the first day of the second full month after closing. Buyers can minimize this closing expense by closing near the end of the month, which reduces the number of days for which daily interest is charged.
Key facts
| Category | Mortgages & Financing |
|---|---|
| Typical timing | Paid at closing |
| Also known as | Interim interest |
| Who pays | The buyer |
If a buyer closes their loan on the twenty-fifth of a thirty-day month, they must pay five days of prepaid interest at closing to cover the period through the end of the month.
Frequently asked questions
How is daily interest calculated?
Daily interest is calculated by multiplying the loan amount by the annual interest rate, then dividing that figure by three hundred sixty-five days.
How can I reduce the amount of prepaid interest I owe at closing?
You can reduce this amount by scheduling your closing date as close to the end of the month as possible, which minimizes the days remaining in the month.