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.
