How Mortgage Payoff Works in a Refinance
Failing to understand process can cost borrowers
BY JACK GUTTENTAG, MONDAY, OCTOBER 24, 2011.
A reader asked her loan officer for an explanation of the process by which her existing loan was paid off when she refinanced. The note shown below is the loan officer's written response:
"Basically, the way mortgage companies do payoffs is we take your payoff amount off your credit report plus one month of payment. The reason we do that is because when you make your upcoming October payment, you are paying principle for October, but you're paying September's interest. So when you close this loan -- say, in November -- you still have to account for that monthly interest payment you missed.
"So that's why we roll in the whole loan amount, then at closing we net out the principle and escrow portion of it and just make it the interest only. That's why your payoff is showing up higher than the $219,000. But the way that is computed is you will skip one month of payments all together. So (if) you close in November, you will skip December altogether, then start in January."
The reader found this answer completely incomprehensible, as did I, and immediately suspected that the loan officer was trying to "pad his profit." The borrower, wary about the loan officer's response, decided to look elsewhere.
There are many problem areas in the mortgage process that can result in a borrower overpaying, making a poor selection decision, or both -- but the payoff process associated with refinances is not one of them. That's why I have never written about it before.
But some borrowers do have anxiety about the process because they don't understand how it works and fear that it could be one more place where they can be ripped off. For the most part, this is not a danger, but the process has a few features that can cost borrowers money if they don't understand it.
When you apply for a refinance, one of the documents the new lender will require you to sign authorizes it to request a payoff statement from your existing lender. This is the case even if you are refinancing with the same lender. The new lender should give you a copy of the statement when it gets it. If the loan officer quoted above had simply provided the statement, he could have avoided arousing the borrower's suspicions by spouting gobbledygook.
While no two payoff forms are exactly alike, they all provide the same basic information. The bottom line is the total amount the borrower has to pay the lender on a specific payoff date to eliminate the borrower's debt. Assuming the payoff date is Oct. 7, and that the borrower has not yet made the payment due on Oct. 1, the payoff amount consists of the following:
- The loan balance as of the end of September;
- Plus interest for the month of September (which would have been in the payment due Oct. 1;
- Plus interest for the first six days of October;
- Minus current escrow balance;
- Plus payoff fees;
- Plus other unpaid debts.
If the borrower had made the mortgage payment due Oct. 1, the loan balance would be reduced by the amount of the payment that constituted principal, and the only interest due would be for the first six days of October.
The daily interest covers the period until the payoff date, except on FHA mortgages, where the payment covers the entire month. Evidently, the Federal Housing Administration's accounting system can't deal with days, only months. That means that it is a good idea for borrowers refinancing out of an FHA mortgage to close as close to the end of the month as possible.
Not all lenders deduct the escrow balance from the payoff amount, and there is no requirement that they do so. In such cases, the borrower will receive a check some weeks later. That is a deplorable practice because during that period the borrower is in effect maintaining two escrow accounts. This is important for the borrower to know about.
The payoff fee will be called different things by different lenders, and there could be two of them, but the amounts are small -- on the order of $50 or so.
Any unpaid debts due the lender will also appear on the payoff statement. The most common are late charges, which in some states are difficult for lenders to collect if the borrower refuses to pay them. They can't refuse at payoff if they want the refinance to go through.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania.