Prepaid items are amounts that are required by the lender to be paid at settlement, in advance of their due date. These may include taxes, accrued interest, association dues, mortgage insurance premiums and hazard insurance premiums.
Prepaid items contribute to the total amount of the loan’s closing costs and will have to be paid at closing. (See Closing Costs for more information.)
One of the prepaid items you are responsible for is accrued interest. This will vary depending on what time of the month you close your loan. One reason many people close at the end of the month is that it reduces the interest that accrues in advance of your first monthly mortgage payment.
If you close on the 15th of the month, for example, you will have to pay interest up front from the 15th to the end of the month. It’s a one-time charge: Once you have paid the portion of interest that accrued during the month of the purchase, your regular mortgage payments come due at the first of the month. The good news: If you close on the 15th of May, for example, your first mortgage payment isn’t due until July 1.
If your down payment was less than 20 percent, another prepaid item will be your first month’s premium for private mortgage insurance (PMI), which protects the lender in case you can’t make your mortgage payments.
You may also be expected to prepay the first few months of your hazard insurance premiums. The money goes into an escrow account, which is set up by a third party, and is paid to the insurance company by your lender. You will need a receipt to show that you have prepaid this item.
Another prepaid item that goes into an escrow account is an amount equal to the first few months of your annual property tax payment. The amount to be prepaid is based on the previous year’s tax bill. Because tax rates often change annually, and because the tax value of your home can change with periodic reassessments, your actual annual tax bill could be higher or lower. Your mortgage payments will be adjusted accordingly if you continue paying property taxes through an escrow account.
Depending on a number of factors – the date of closing, the value of your home and the amount of the loan – prepaid items could represent a significant cost. Your lender and your real estate agent can help you estimate these costs ahead of time so you can be prepared to come up with the money for these prepaid items.