When you’re selling a home, money from the buyer is transferred into an escrow or settlement account. This money goes to pay fees and closing costs, including the existing mortgage payoff. When you pay off your mortgage, your lender will give you a prorated mortgage payoff, which will give you a breakdown of the fees.
Understanding Prorated Mortgages
The payment you made each month to your mortgage lender covered fees other than what you owed toward the loan principal. You also paid mortgage interest and possibly a portion of your property taxes, home insurance premium and mortgage insurance premium. If you pay them in advance, the statement will show a credit for the unused portion (like the time remaining on your home insurance policy). It will also show any prorated amounts for fees you owe that you already accrued (like interest).
When you secured your mortgage, there was likely a gap of a couple of months between the close of the loan and the due date of your initial payment. Your first month’s interest was likely paid at the close of your transaction but in the subsequent lapsed month your loan kept accruing interest. This interest is charged in the first monthly payment. Mortgage interest is then paid regularly in arrears, meaning you’ll pay for January’s interest with your February payment. When you receive your pay-off statement, you'll see the prorated interest amount you owe.
Property taxes are another universal fee included with home ownership. You might make these payments on a monthly basis with your mortgage payment, or your local government may charge you once or twice a year. It all depends on your lender’s requirements. If you’ve been paying them through a lender, the statement should show a prorated property tax fee or credit. You may be credited with the portion of taxes you no longer owe since you no longer own the property. You may be charged if your monthly payment didn't cover the entire tax debt accrued while you owned the home.
It All Adds Up
Depending on the type of loan and the property, you might see other prorations in the payoff statement. These could include credits or fees for homeowner association dues, credits or fees for unused or owed portions of home insurance and mortgage insurance premiums. Your HUD-1 Settlement Statement, which your lender will give you before closing the transaction, also lists these charges. If you’re selling, the HUD-1 will also include the amount of net cash you’ll receive once the mortgage and other fees and closing costs are paid.