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Home Warranty

Home Matters Blog

What are Prepaid Costs When Buying a Home?

You were aware buying a house would take quite a bit of your savings, but you didn’t realize how much money you would need upfront. Closing fees. Down payments. Home inspection fees. Prepaid closing costs. Buying a house is an expensive—and incredible—investment, but many new homeowners may be overwhelmed by the number of charges and deposits required before they’ve even had the chance to make their first mortgage payment.

But don’t worry! Although there are several prepaid costs when buying a home, they are all part of the typical home buying process. American Home Shield is here to help break down the estimated prepaid items at closing, along with other initial costs of buying a home, so you can plan ahead and feel prepared. Here are the answers to some common questions soon-to-be homeowners have.

What are prepaid costs when buying a home?

Prepaid costs act as a safety net for lenders. The money they require you to prepay is usually for taxes, interest, and insurance. You give it to them in advance, and it goes into a prepaid escrow account. They then use that money to pay for those items. Placing the money for prepaid closing costs in an escrow account assures them these important payments will be met because failure to pay prepaid items could cause a foreclosure.

So, what specifically do these prepaid closing costs entail? Most consist of:

Prepaid interest on a mortgage: This is the interest that arises between your closing date and the end of the month. The amount you pay for prepaid items for your mortgage depends on how much you’re borrowing and at what interest rate. Of course, how early in the month your closing date falls on plays a huge factor. To cut down on how much interest you’re prepaying, pick a closing date closer to the end of the month, if possible. (If you ever need to refinance your mortgage down the line, learn about the advantages of home equity loans.)
Prepaid property taxes at closing: When it comes to property taxes, the seller has to pay for the taxes they owe while owning the house. On closing day, you sign on the dotted line, and the rest of the year becomes your responsibility. Lenders have you prepay for property taxes from your escrow account.
Prepaid homeowners insurance at closing: Most lenders want you to pay up to one year of premiums in advance to cover homeowners insurance. That way, if anything happens to your new home in that first year after move-in, the lender can be assured that repair costs will be taken care of so you can keep on making your mortgage payments. Just like car and health insurance, homeowners insurance rates can vary. Learn more in our Home Warranty vs Insurance blog post.
Initial escrow payment at closing: Some lenders may not require this prepaid escrow deposit (also known as earnest money or a good faith deposit), as it’s usually on top of prepaid closing costs. It acts as a cushion for future homeowners insurance or property tax payments. This money is kept in the escrow account as a security to your lender that you’re serious about purchasing the house and can usually be applied to closing costs and down payment once the purchase is finalized.

This process may sound a little complicated, but these are costs you’ll end up paying for anyway. Prepaid costs can be beneficial for buyers because you’ll have the responsibility of all these essential payments off your plate. You’ll have enough on your homeowner checklist to take care of before moving day, so having someone else handle those required payments can come in handy. Sure, it means more money down, but it streamlines the process instead of paying for each item individually and at different times.

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What’s the difference between closing costs and prepaids?

Prepaid costs when buying a home, or prepaids, are expenses that you would pay for anyway—you’re just paying for them early. Closing costs are fees for services rendered during the closing of your home. All of those friendly people who helped you through each step of the process (even behind the scenes)—lawyers, title companies, lenders, appraisers, etc.—get paid from your closing costs.

We do have a home buyer tip when it comes to closing costs, as you have a potential opportunity here to save a little money. Sometimes you may be able to get lenders to pay for closing costs or give you better rates for how much they charge. In some cases, the seller will pay for the closing costs. It never hurts to shop around and find the best deal.

Finding a better deal doesn’t apply to prepaid closing costs, though. You will be paying for them no matter what, and it’s a standardized part of the home buying experience.

Final Thoughts

Owning a home can be a worthwhile investment, but there are some important things—like the initial costs of buying a home—to be aware of as you start out on your home buying journey. American Home Shield is here to support you every step of the way. We have great advice for first-time home buyers, like how to find a real estate agent and what to expect during the mortgage approval process.

Be sure to communicate with your real estate agent throughout the transaction process to make sure there are no surprises with prepaid costs when buying your home. Once payments are made, approvals are given, and contracts are signed, you’ll be moving into your new home in no time.