If you’ve ever bought a home, or have been doing research for an upcoming purchase, you have probably run across the phrases ‘prepaids’ and ‘closing costs.’ Both of these are paid at the closing, so it is easy to think of them as the same thing, or at least similar. Let us tell you, the two terms don’t have much in common aside from referring to amounts of money owed and being paid at the same time.
Prepaids got their name because they are paid at closing, which is technically before they’re due. Prepaids are related to the actual home itself, not the real estate transaction. The three most common prepaids are property taxes, homeowner’s insurance, and mortgage interest.
Property taxes and homeowner’s insurance are collected at closing and placed into an escrow account. The money is collected ahead of time to ensure there is money for the bills to be paid when the time comes.
Mortgage interest is a little different than the other two. The amount collected at closing is the amount that will accrue between closing and the end of the month.
Often people feel as though the first month of mortgage interest is skipped. This is because mortgage payments are paid in arrears, which means it is paid after the month has occurred. This system is opposite of renting, where you pay for the month’s rent before it occurs.
Say you purchase a home on October 17. The amount of mortgage interest collected at the closing will account for October 17-31. Your first mortgage payment will be on December 1, to pay for November’s mortgage interest. It’s easy to see how people can think a month’s interest was skipped.
Closing costs are fees related to the real estate transaction itself. Included in the closing costs are payments to everyone who has worked on your loan from the underwriter to the appraiser. These costs are generally paid by the buyer, but sometimes the seller helps in paying them. It all depends on the arrangements made in the purchase contract.
As you can see, prepaids and closing costs are very different. However, with both it is important to be prepared to pay at closing. More often than not, people are surprised these costs are due and are not prepared to pay them.
We believe in educating homebuyers on every aspect of the homebuying process, in an attempt to avoid surprises like this. If you have any questions regarding prepaids or closing costs, or the mortgage process in general, please feel free to contact us.