What does prepaid mean?

Prepaid items are exactly what the name implies – payments made in advance of the monies due to obtain your new loan.

These amounts are often necessary to fund what’s known as an “escrow” or “impound” account for property taxes and insurance. Lenders often require homeowners, especially those with less than 20 percent down, to have escrow accounts associated with their mortgage loan. This means homeowners pay an additional amount each month to an account administered by the lender.

An escrow account on behalf of the lender lowers the its risk by making sure the home is protected. No liens for missed taxes should occur, and property insurance coverage protects the lender’s collateral.

What are prepaid items on a mortgage?

When it comes to mortgage loans, there are several different types of prepaid items, the most common are:

Homeowners insurance premium paid up front as well as into an escrow account

Real estate property taxes paid into an escrow account

Mortgage interest (also known as per diem interest) that accrues between the closing date and month-end
Prepaid items: taxes and insurance

Typically, one full year of homeowner’s insurance is collected and prepaid to your insurance company at closing. Alternatively, some homeowners choose to pay this amount prior to closing.

An additional cushion for homeowners insurance, along with property taxes, are collected and placed into an escrow account. This is so your new lender can build reserves and have enough to pay those bills when they come due.

Prepaid items: mortgage interest

Mortgage interest is collected as a prepaid item so the lender can apply it to your first mortgage payment. This way, no matter which day of the month you close, the lender has at least 30 days to enter your data into its system, and issue your first statement.

The amount of interest required varies depending on what time of the month you close your loan. Some homeowners close at the end of the month so that it reduces the interest accrued in advance of your first monthly mortgage payment.

A common misnomer is “skipping a payment.” The feeling of skipping that first payment comes because you’ve paid the first payment at closing, in advance of it actually coming due.

There is a difference between prepaid items, closing costs and fees. Prepaid items are not closing costs. They are monies that would have been paid anyway — new home loan or not.

Prepaid items, listed above, are figures on your Closing Disclosure unrelated to the process of getting a mortgage. The exception to this is upfront mortgage insurance premiums (MIPs) for Federal Housing Administration (FHA) mortgage loans.

Closing costs on the other hand, describe all of the fees or charges for actions or items connected to originating and closing a mortgage loan. Closing costs can include things such as:

Payments to title companies
Attorney fees
Governmental title recording fees
Lender fees

Some homebuyers’ wonder, “Is the inspection part of closing costs.” The answer is “typically not.” Generally the home buyer orders and pays for an inspection to gain a detailed understanding of the home’s condition. Sometimes, the home buyer is able to use the inspection report to gain price concessions from the seller or to negotiate certain repairs to the home. In cases where a home buyer doesn’t pay for the inspection fee promptly at the time of service, inspection fees could be handled at closing as part of the closing costs.

Closing costs and prepaid items factor into mortgage loan comparisons

Understanding what is included in closing costs for buying a house and the difference between prepaid items, closing costs and other fees associated with closing can help you shop for lower mortgage rates.

Prepaid items should be the same from one lender to the next. They are separate from your mortgage closing costs, rate and terms. As such, you can remove them from your cost comparisons.

Separating closing costs and prepaid items should make comparing mortgage rates easy. If you’re unsure about whether a certain item is included in closing costs or prepaid items, just ask yourself a simple question: “Is this a charge that I would have if I wasn’t borrowing to buy the house?”

If the answer is “yes,” it’s a prepaid item.


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