What Are Prepaid Costs When Buying A Home

April 28, 2022

Real Estate

What Are Prepaid Costs When Buying A Home

When you buy a house, it’s not just the down payment, monthly mortgage, and closing costs you have to put together. Don’t sleep on prepaid costs or mortgage prepaids when buying a home.

Before October 2015, homebuyers could find the terms “Reserves Deposited with Lender” and “Items Required by Lender to be Paid in Advance” in the Closing Disclosure. The equivalent of which are prepaid costs when buying a home.

“Aren’t they just prepaid closing costs?” Prepaid costs, closing costs, and escrow are separate expenses. What are prepaid costs when buying a home? Estimated prepaid items are: 

  • private mortgage insurance
  • hazard insurance
  • homeowner’s insurance premium
  • property taxes
  • mortgage interest rate
  • initial escrow deposit 
  • down payment
  • earnest money
  • any other special assessments typically related to real estate taxes
  • government recording and transfer fees 

You should find your exact prepaid items on Page 2, Section F of the loan estimate document that you will receive from the mortgage company, and you will pay these prepaids at closing. The payment for these common prepaid costs is deposited into an escrow account by your mortgage lender. 

Your first home loan payment and other bills won’t be due for another 30-45 days after your closing date. But your lender won’t wait until then to create the escrow account in their system. 

What Is Homeowner’s Insurance

One of the prepaid costs when buying a home is homeowner’s insurance or home insurance. Mortgage companies require homebuyers to acquire a homeowner’s insurance policy before taking out a home loan. Your lender will collect six to twelve months’ worth of homeowner’s insurance premiums at closing and then pay these on your behalf to the insurer. Other lenders will allow insurance premiums and other prepaid costs included in your monthly mortgage payments.

You can save on home insurance by comparing multiple quotes from several reputable insurance companies. Experts advise homeowners to continue having a homeowner’s insurance policy with liability and additional living expenses (ALE) coverage even after paying off their home loan to secure their house and finances.

Homeowner’s insurance protects the borrower, their home, and their belongings. Homeowners can file a claim when tools, sports equipment, clothing, and furniture need replacing. Home insurance can also cover stolen gifts and gadgets or destroyed landscaping.

When you have homeowner’s insurance, you won’t go into debt or, worse, bankruptcy when rebuilding or repairing your home in the event of hurricanes, tornadoes, fires, storms, and theft. Home insurance policies also cover damages to detached structures such as guest houses, gazebos, and storage sheds. 

You can benefit from liability coverage when visitors or neighbors get into accidents on your property. Homeowner’s insurance will pay for your attorney fees and the injured’s medical bills. 

Sometimes, you need to temporarily move out of your home when you have major repairs or pest problems. Additional living expenses (ALE) coverage can pay for hotels, Airbnbs, and even meals when your house is out of order.

What Is Mortgage Insurance?

Another prepaid item that a person buying a home needs to prepare for is mortgage insurance (also known as home-loan insurance or mortgage guarantee). Homebuyers with less than 20% of the sale price set aside for the down payment need to have mortgage insurance in order to gain approval from the lender. The good news is that you will likely qualify for the home loan after getting mortgage insurance, but the downside is that this will raise the overall cost of your loan.

The lender will receive compensation when the borrower fails to repay the mortgage or dies. Mortgage insurance can be either public or private mortgage insurance (PMI). 

Avoid confusing mortgage insurance with mortgage life insurance, as the latter’s function is to protect heirs if the borrower passes away while owing monthly mortgage payments. Depending on the policy terms, it may compensate either the lender or the heirs. 

What Are Property Taxes?

Property taxes fund neighborhood and local community features. Borrowers pay prepaid property taxes at closing. Lenders usually require two months’ worth of property taxes and make payments to the local government on the borrower’s behalf.

Property taxes are part of the initial escrow payment at closing, along with the additional two months of home insurance (remember: you will pay about one year’s worth of home insurance premiums, to begin with). Some home sellers will negotiate covering a percentage of the property taxes to entice a potential buyer. 

Borrowers may also have the option to make semi-annual or annual payments to tax authorities themselves as long as there is no risk of tax foreclosure. 

How do you calculate property tax?

To estimate your property taxes, you may use this formula: 

Assessed value × Tax rate = Property tax 

Let’s have an example:

$289,252 assessed value

x 1.80% average property tax rate in Texas

= $5,206 estimated annual taxes

You can confirm the appraised value of your home and your exact property taxes by contacting the Houston Appraisal District and Houston Tax Assessor/Collector here.

What Is Mortgage Interest?

One of the prepaid costs when buying a house is mortgage interest. Generally, it should be at least a month’s worth of mortgage interest to cover the period between the closing date up to the end of the month. Homebuyers prefer to close nearer the month’s end to lessen the prepaid mortgage interest needed.  

Monthly mortgage payments consist of interest and principal. You pay the mortgage interest to the mortgage company for granting you the loan, and you pay the principal towards your home loan amount. The mortgage company can provide an estimate of the mortgage interest you’ll need in prepaids. 

Prepaid vs. Initial Escrow

To differentiate prepaid and initial escrow payments from closing costs, let’s look at their meaning and sample costs. With all the necessary expenditures a home buyer must wrestle with, think of prepaid costs as a cash reserve to ensure the buyer can pay all of these expenses on time and with enough funds. Closing costs are charges for items or actions connected to originating and closing your home loan, like payments to the mortgage company, government offices, and title companies. 

An expert real estate agent from Happen Houston can discuss with you more what fees are associated with a mortgage.

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