What Are Prepaids and Closing Costs?

What are prepaids?

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.

What are closing costs?

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. 

If you’ve ever bought a home or have been doing research for an upcoming purchase you have probably run across the terms ‘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. Aside from referring to amounts of money owed and being paid at the same time, the two don’t have much in common.

Prepaids

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.

One interesting thing we’ve learned from our clients over the years is that people often feel like 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 the 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

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. 

While many first-time buyers believe the seller is responsible for both the prepaids and closing costs, that isn’t the case. Buyers are responsible for paying both prepaids and closing costs. The only exception to this rule is when the purchase contract states the seller will help cover some of the closing costs. Even then, the buyer must pay the prepaids and often some of the closing costs.

So, before deciding to buy, remember that you don’t just need money for the down payment and monthly payments, but also the prepaids and closing costs. If you have any questions about prepaids and closing costs, get in touch! Ready to buy a house? Fill out our online application.