What are Prepaid Costs When Buying a Home?
6 minute read
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July 20, 2022

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There are numbers everywhere when buying a home. 

It always feels like you’re paying for something. And with that, it’s easy to second guess yourself. 

Prepaid costs are something to think about upfront. 

The more you learn about these early in the process, the less chance there is that they will cause confusion or financial stress as you move toward closing on your new home.

So, what are prepaid costs?

Prepaid costs are things that you pay for in advance at closing. 

Examples include but are not necessarily limited to:

  1. Home insurance: Once you know you’re buying a home, contact several home insurance companies for quotes. 
  2. Property taxes: You’ll pay a portion of property taxes upfront as prepaid costs when buying a home. 
  3. Mortgage interest: Prepaid mortgage interest is collected so that the lender can put it toward your first payment regardless of the day you close. 

What is the difference between prepaid costs and closing costs?

Many people mistake prepaid costs for closing costs and vice versa. There are several differences between the two. 

Prepaid costs are upfront costs associated with your monthly mortgage expenses. Closing costs, on the other hand, are related to things such as origination, title insurance, and the administration of closing a mortgage loan.

Another detail to consider is that closing costs can be covered by the seller, but that’s not the case with prepaid costs. 

When you add the two, you end up with the total amount that’s due at closing. 

How to calculate prepaid costs

When calculating prepaid costs on your own, you’ll end up with estimates. The numbers you crunch are likely to change by the time your closing day arrives. Even so, it always helps to have a general idea of what you’ll pay. 

1. Calculating home insurance

Contact several home insurance companies for quotes. Premiums vary based on a variety of factors such as location, weather, age, condition, and previous claims. 

Once you have an estimated amount, you can work with your lender to determine the prepaid cost. In the future, you can make home insurance payments directly to your provider through your escrow account. 

2. Property taxes

This is likely to be your largest prepaid cost. Start by calculating or requesting the value estimate of the home you wish to purchase. While it can change from lender to lender, most request a minimum of two months of property taxes upfront to build a reserve. This way you have enough money in your escrow account to pay when the taxes come due. 

3. Mortgage interest 

The primary thing to remember with mortgage interest is that it’s calculated using the first day of accrued interest on your mortgage balance.

Generally speaking, the closer you close to the end of the month the less you’ll pay in prepaid mortgage interest. 

Do prepaid costs affect my mortgage?

Prepaid costs do not have any effect on your mortgage payment. 

The money that you pay upfront is used to ensure that you have enough money in your escrow account to cover expenses when they come due. 

For instance, if you don’t pay prepaid taxes, it’s likely that there won’t be enough money in your escrow account to pay your taxes when the first bill arrives. 

Can I get a mortgage without prepaid costs?

You may see some mortgage lenders advertise “no closing cost loans.” While this results in a higher monthly mortgage payment, it does save you money upfront. 

Typically, lenders don’t offer to pay prepaid items and roll them into the balance of the loan. However, it’s not out of the question.

If you’re seeking help paying prepaid costs, talk to your lender about your options. They may be able to offer assistance with closing costs, but not prepaid items. Or they may allow you to add both of them to the balance. 

Getting a mortgage without prepaid costs is determined on a case-by-case basis. 

Your lender will carefully review your finances, such as your down payment. A larger down payment, such as 20 percent or more, increases the likelihood of having some or all of your prepaid costs fronted by the lender.

Prepaid costs: frequently asked questions

The best way to learn more about prepaid costs is to discuss them with your lender. Ask questions, discuss your options, and make decisions based on the information and guidance you receive. 

What prepaid costs are you responsible for? 

This typically includes home insurance, real estate property taxes, and mortgage interest. 

How much are prepaid costs? 

Things such as the value of the home, cost of insurance, and amount of money borrowed can impact this. 

Are prepaid costs and closing costs the same thing? 

They’re both paid at closing, but as noted above they’re not one and the same. Learn the difference between the two and what’s included in each category. 

Are prepaid costs the same as escrow? 

They’re not the same but they’re definitely related. Prepaid costs are put into an escrow account for future use. 

Are prepaid costs the same with every mortgage company? 

Every lender makes estimates, but in the end, you’ll pay pretty much the same in prepaid costs. When comparing lenders, it’s better to focus on closing costs and interest rates. 

As you answer these questions, expect others to move to the forefront. You should address those, too.

Summary: prepaid costs and home buying

If you’re ready to buy your first home or your next home, apply for preapproval on our website. 

We can answer all your questions related to a conventional purchase (or refinance), while also providing guidance related to prepaid costs. 

There’s a lot to consider when buying a home, but we’re here every step of the way. 

If you ever need live help, call us at (844) 897-2265 Monday through Friday from 8:00 am to 8:00 pm EST. One of our experienced loan officers can help!

Photo by Kindel Media

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