What Are Prepaid Costs When Buying a Home?

Around 58% of home buyers save up to make the down payment for their mortgage. However, the down payment is only one part of the equation. Other expenses need to be considered as well, like prepaid costs, aka prepaids. But how well do you understand them? That means asking not only more questions but also the right questions. Let’s go through a few answers to what are prepaid costs when buying a home by starting with the basics.

What are prepaid costs?

They are upfront cash payments made to third parties involved in the process before any down payment. Lenders will outline these in a loan estimate document once you apply for a mortgage. An important point to understand is that these costs have nothing to do with your mortgage lender. These fees are required when closing on a home, regardless of whether you sign a mortgage or not,

What’s the difference between pre-paid costs and closing costs?

The difference can be confusing, especially since both of them are paid around the same time. Think of it like this – prepaids are simply paid during the closing process, while closing costs are paid for the services of closing on a mortgage. Closing services include those of attorneys and title companies, document drafting, and more.

What common prepaid costs can I expect?

Prepaid costs usually include the homeowner’s insurance premium, mortgage insurance premium (if applicable), property taxes, and prepaid interest fees. Mortgage companies must give you an estimate of these costs upfront. Keep in mind that they are simply estimates. In the end, you will choose the insurance provider and may have some flexibility on taxes based on local governance rules. Even your mortgage interest rate will vary depending on which part of the month you finalize the closing.

Are prepaids related to escrow?

Almost every time you ask what are prepaid costs when buying a home, an escrow account will come up in the answer. But the key here is that they are related, not the same. An escrow account is simply a bank account set up by your mortgage lender to avoid risks and ensure you will not falter on or miss your mandatory prepaid payments. A portion of your total mortgage payment will deposit your insurance premiums and property taxes at the beginning of each month. That way, when those bills are due, your lender will pay them out of there directly.

Explaining prepaid interest

Prepaid interest fees are part of your prepaid costs and can vary depending on when you finalize your mortgage. That is because the rate gets prorated based on how long it took you to close. The closer to the month-end you close, the less you’ll have to pay. The way to calculate your prepaid interest is first to take your annual interest rate and divide it by 365 days. Then take that number and multiply it by your home loan amount. This will give you your cost per day, which you can then multiply by the number of days that have passed between signing your mortgage and making your first payment.

Understanding the full picture behind prepaid costs and all the minute details of purchasing a home puts you in control of your finances. You can begin taking back the reins by downloading our free guide, Things to Consider When Buying a Home. Once you’ve mastered all that theoretical knowledge, reach out to an MBA Mortgage loan officer to get pre-approved for your mortgage. This way, you only look at properties you can afford, stand out in front of sellers, and close on your dream home faster.