Prepaid interest on a mortgage is the interest your lender collects at closing to cover the days between your loan’s funding date and the last day of that same month. It exists because your regular monthly payments start the following month, and the lender needs the interest clock to be current from day one. The amount depends on three things: your loan balance, your interest rate, and how many days are left in the month after you close.
How the Charge Is Calculated
The formula is straightforward. Divide your annual interest by 365 to get a daily rate (often called the per diem), then multiply by the number of days remaining in the closing month.
Take a $300,000 loan at 6.5%. Annual interest is $19,500. Divide by 365 and the per diem comes to roughly $53.42. Close on the 15th of a 31-day month and you owe 17 days, or about $907.14 at the closing table.
Most residential lenders use a 365-day year (366 in a leap year). Some use a 360-day denominator while still counting actual calendar days, which produces a slightly higher daily rate. Your loan documents specify the method, and your Closing Disclosure shows the exact daily figure so you can check the math.
How Your Closing Date Changes the Number
Because the charge only covers the remaining days in the month, the date you sign controls how big it is. Using the $300,000 example, closing on the 2nd of a 30-day month means 29 days of per diem, roughly $1,549. Closing on the 28th of that same month drops it to three days, about $160.
Scheduling a closing near the end of the month is a common way to reduce cash needed at settlement. It does not lower the total interest you pay over the life of the loan; it only shifts when you pay it. If your reserves are tight, a later closing date can free up several hundred dollars.
Why Your First Payment Isn’t Due for Almost Two Months
Mortgages are paid in arrears, which is the opposite of rent. A May 1st mortgage payment covers the interest that accrued during April. That creates a timing gap at the start of the loan.
If you close on June 10th, prepaid interest covers June 10th through June 30th. Your first full monthly payment is due August 1st, and it covers July’s interest. The stretch between closing and that first payment runs about seven weeks. Prepaid interest fills the partial first month so the loan stays current from the moment it funds.
Where to Find It on Your Closing Disclosure
The prepaid interest charge appears on page two of your Closing Disclosure under Section F, labeled “Prepaids.”1Consumer Financial Protection Bureau. TILA-RESPA Integrated Disclosure FAQs The line shows the daily interest amount, the rate used, and the number of days you’re being charged. The rate must match the interest rate shown on page one.2Consumer Financial Protection Bureau. 12 CFR 1026.38 – Content of Disclosures for Certain Mortgage Transactions
Compare the figures against your earlier Loan Estimate. If the daily rate or number of days looks off, raise it with your lender before you sign. Catching a mistake at this stage prevents a surprise increase in the cash you bring to the table.
Is Prepaid Interest Tax-Deductible
Yes, generally. Per diem prepaid interest collected at closing is treated as home mortgage interest in the year you close, since it accrues entirely within that year. To claim it, you have to itemize on Schedule A, the loan must be secured by a qualified residence, and your total mortgage debt cannot exceed $750,000 ($375,000 if married filing separately).3Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction The deduction sits under 26 U.S.C. § 163.4Office of the Law Revision Counsel. 26 USC 163 – Interest
Your lender reports total mortgage interest paid during the year — including the prepaid amount from closing — on Form 1098, which is required when you’ve paid at least $600 in interest.5Internal Revenue Service. About Form 1098, Mortgage Interest Statement You should receive it by the end of January following the year of your purchase. Confirm that Box 1 reflects both your monthly interest and the prepaid interest from your Closing Disclosure. If the total looks low, contact your servicer.6Internal Revenue Service. Instructions for Form 1098
What Prepaid Interest Is Not
Two other closing charges get confused with prepaid interest, and it’s worth separating them.
Discount points are not the same thing, even though the IRS sometimes describes them as a form of prepaid interest. Points are an optional upfront fee, usually 1% of the loan amount each, paid to permanently lower your interest rate. Per diem prepaid interest doesn’t change your rate or any future payment.7Internal Revenue Service. Topic No. 504, Home Mortgage Points
The initial escrow deposit is also separate. It appears on page two of the Closing Disclosure under Section G, and it funds the account your lender uses to pay future property taxes and homeowners insurance.8Consumer Financial Protection Bureau. Closing Disclosure Both charges are collected at closing, but they sit in different sections and cover different obligations.