It’s relatively easy to figure how mortgage interest works on an FHA loan. An FHA lender will loan money and expect a given rate of return, based upon the interest rate. If a 30 year FHA mortgage has a 3.50% rate assigned to it, that’s profit to the lender in return for issuing money to buy and finance a home. But there are a couple of details about FHA mortgage interest that will help you understand it better.
First, mortgage interest is paid in arrears. That means each day you own the home, interest accrues daily each month and is due and payable on the first of the following month. It’s the complete opposite of rent. When you make a rental payment, you’re paying for the month you’re about to live in the property, with a mortgage, your payment is for the previous month.
If you’ve ever refinanced a mortgage, your new FHA lender will request a payoff from the existing lender. In addition to the outstanding balance, there will also be interest that has accrued but not yet paid. If the loan closes on the 20th of the month, the payoff will include the outstanding principal balance plus 20 days of accrued interest. But not all mortgage interest is paid in arrears. Sometimes it’s prepaid.
When obtaining an FHA mortgage, whether for a refinance or a purchase, there will be a line item for prepaid interest. Prepaid interest is the interest that will accrue up until the first of the following month and is paid at your initial closing, not on the first of the next month. If you close on the 20th, your lender will collect 10 days of interest up to the first of the month. This prepaid interest is indeed your first mortgage payment but since it was paid for at the closing and you don’t write a check for it on the first of the following month, it sort of feels like you’re “skipping” a payment. You’re not because you already paid the prepaid interest charge at your closing. The following month? That’s when you’ll pay a full month’s of interest.