Prepaid interest charged by a mortgage company is the daily interest your lender collects at closing to cover the gap between the day your loan funds and the start of your first regular billing cycle. On a $300,000 loan at 6.5%, that charge runs roughly $54 per day, so closing mid-month can add several hundred dollars to your settlement costs. The exact amount depends almost entirely on what day of the month you close, and it appears as a separate line on your Closing Disclosure under “Prepaids.”
Why Lenders Collect It at Closing
Mortgage payments are collected in arrears. A payment you send on June 1 covers the interest that built up throughout May, not June. That backward-looking schedule creates a problem whenever a loan closes on any day other than the first of the month: interest starts accruing the day the loan funds, but no regular payment is scheduled to catch those first partial-month days.
Prepaid interest fills that gap. The lender collects daily interest from your closing date through the last day of the month, all at once, at the settlement table. Without it, you’d get a short window of interest-free financing the promissory note never allowed. With it, your loan drops into a clean billing cycle so your first regular monthly payment picks up exactly where the prepaid period left off.
How the Amount Is Calculated
The math starts with a daily rate, called per diem interest. Your lender takes the annual interest rate, multiplies it by the loan amount to get the yearly interest cost, then divides by the number of days in the year. That last step matters: some lenders divide by 365, others use a 360-day “banker’s year.” The 360-day method produces a slightly higher daily rate because the same annual interest is spread across fewer days.
A concrete example. On a $300,000 mortgage at 6.5%, annual interest is $19,500. Divide by 360 and per diem comes to roughly $54.17. Close on the 20th of a 30-day month and you owe interest from the 20th through the 30th, which is 11 days. Multiply $54.17 by 11 and the prepaid interest charge is about $595.87 at closing. Using a 365-day year, the per diem drops to about $53.42 and the 11-day total is roughly $587.67. The difference is small on a short stretch, but worth checking on your Closing Disclosure so you know which method the lender applied.
How Your Closing Date Changes the Cost
Because prepaid interest covers every remaining day in the month after closing, the date you choose has a direct effect on how much cash you need at the settlement table. Close on the 2nd of the month and you’re paying nearly 28 or 29 days of per diem interest upfront. Close on the 28th and you might owe only two or three days’ worth. On the $300,000 example above, that’s the difference between roughly $1,500 and $160.
Closing late in the month is a common strategy for buyers who want to keep immediate out-of-pocket costs low. It doesn’t save money over the life of the loan, since total interest paid works out the same either way, but it can ease the cash crunch during a move when deposits, moving costs, and utility hookups all hit at once.
When Your First Payment Is Due
The prepaid interest period also sets when your first monthly mortgage payment is due. Lenders generally move about 30 days past your closing date and then land on the first of the following month. Close on March 12, and 30 days forward puts you at April 12, so your first payment would be due May 1. That May 1 payment covers April’s interest. Close near the end of a month and the first payment can be pushed roughly 60 days out, giving you extra breathing room.
Where to Find the Charge on Your Closing Disclosure
Your Closing Disclosure is the document to review. Federal regulations require lenders to provide it at least three business days before your scheduled closing, so you have time to check the numbers. Prepaid interest appears on Page 2 in Section F, labeled “Prepaids,” alongside items like homeowner’s insurance premiums and property taxes collected in advance. The line breaks out the daily interest charge, the date range it covers, and the total dollar amount.
That total feeds into the “Cash to Close” figure on Page 1 of the same form, so you won’t receive a separate bill for it later. If a number looks off, compare the per diem rate against your own calculation using your loan amount and interest rate. Lenders who get these figures wrong face civil penalties under federal consumer financial law, and borrowers may be entitled to restitution. Mistakes still happen, and catching one during the three-day review window is far easier than fixing it after closing.
Is Prepaid Interest Tax-Deductible?
Prepaid interest collected at closing is generally deductible as mortgage interest, but only for the tax year the interest actually covers. Because the prepaid amount at a typical closing spans just a handful of days in the same calendar year, most buyers can deduct it on that year’s return without any special allocation. If you close at the very end of December and the prepaid interest crosses into January, you’d split the deduction across both tax years.
To claim the deduction, your total mortgage debt must fall within the federal limit: $750,000 for most filers, or $375,000 if married filing separately, for loans taken out after December 15, 2017. Older mortgages may qualify under the previous $1 million cap. You also need to itemize deductions rather than take the standard deduction, which means the write-off only helps if your total itemized deductions exceed the standard deduction threshold.
What Happens When You Refinance
Refinancing involves prepaid interest on both sides of the transaction. Your old lender’s payoff statement includes interest through the day the old loan is paid off, so you’re covering every accrued day on the outgoing mortgage. Your new lender then collects prepaid interest on the refinanced loan from the funding date through the end of the month, just like a purchase closing. You effectively pay daily interest on two loans for a brief overlap, even though the old loan is being retired.
Closing earlier in the month means fewer days at the old rate but more days of prepaid interest on the new loan. Closing later reverses that trade-off. In practice, the daily savings from a lower rate over a handful of days are usually too small to justify rearranging your schedule. Focus on whether the overall rate reduction justifies the refinance costs, and treat the prepaid interest timing as a minor detail.