Can I Skip Any Payments (IRRRL)?
Chances are, if you’re asking this question, there are two possible reasons. Either A) your loan officer said something about not having to make a couple payments and kept talking before had a chance to ask what he or she meant, or B) you are remembering how a month or two of payments was included in closing costs when you bought your home, and you have some high-interest credit card debt you’re itching to throw a couple thousand dollars at to pay it down. Either way, we’ll answer this question here and try to also anticipate further questions that you might have after getting the answer to this one.
The word “skip” in regards to refinancing with an IRRRL is not accurate. You’re not skipping any payments, you’re just changing when and how you pay them. To be more specific, you have the option of rolling your next two payments on your old loan into your new loan. This is a popular option because it gives you two months to build up your savings, pay off other things, or go on your dream vacation, and does not significantly impact your monthly payments when they start up again. Sound too good to be true? It’s not; by doing this, you are technically adding thousands of dollars to your loan amount, which will now have interest charged on it along with the rest of the loan. Since, depending on how far along on your previous loan you were when you refinanced, likely over half of that is interest being paid on the principal to the old lender, you’re essentially paying interest on interest. Consider the following example:
Your monthly payment on your old loan is $1,500. You get an IRRRL and elect to defer 2 months of payments, which equals $3,000. Those two payments are made up of principal and interest that you would have been paid to the old lender. Let’s say that, at this point in the loan, half of your monthly payment is paying off interest, and half principal, so of the $3k, $1,500 of it is interest that you were being charged on the old loan principal. Remember, you’re only paying interest because you haven’t paid off all the principal yet. However, all $3k of the two monthly payments (including the interest) gets rolled into the new loan, becoming part of the principal in the new loan that you will start getting charged interest on. It’s interest getting charged interest. I suppose you could call it interest-ception.
That being said, we’re talking about relatively small amounts of money here. As mentioned earlier, the added amount from the two deferred payments ($3000 in the above example) does not significantly affect the amortization schedule or increase your monthly payments by very much. In most cases, the benefits of deferring the payments far outweighs the cost. In fact, there are many cases where it’s financially beneficial to defer your mortgage payments. The most obvious example here is if you have credit card debt that you need to pay off. Credit cards invariably charge much higher interest rates (especially on past-due accounts) than houses, especially VA loans. Using the $3000 to pay off a 12% APR credit card will save you more money than having to add $3k to your loan amount will cost you.
Here are a few less obvious examples: I blog for a living, and I would have a hard time blogging without a laptop. If I have an old laptop that’s started to have some problems, I could use one of those mortgage payments to buy a new laptop, which will enable me to work faster and with fewer problems, allowing me to make more money. The same could be said of a college or perhaps a high school student. Perhaps you’ve got an investment opportunity, and $3000 is just enough to get you in on the ground level. Paying 4.5% on an extra $3k is probably penny change to what your new investment will bring you. Like everything to do with mortgages and investments, it’s a numbers game. Compare the numbers, and there will always be a clear winner, though there are more considerations (e.g. quality of life, happiness, necessities, etc.) than just money.