What are Prepaids When Buying a House and How Do They Work?

Buying a house involves more than just saving for a down payment - you'll need to plan for prepaid expenses too. I've found that many first-time homebuyers are caught off guard by these upfront costs, so let's break down exactly what prepaids are and how they fit into your home purchase.

Prepaids: Prepaid expenses are costs that must be paid in advance at closing, typically including property taxes, homeowners insurance premiums, and mortgage interest. These items are usually collected and held in an escrow account by the lender to ensure timely payment of recurring housing-related expenses.

Types of Prepaid Expenses

Let's look at the three main types of prepaid expenses you'll encounter during your home purchase:

Property Taxes

Property taxes make up a significant portion of your prepaid costs. Your lender will collect enough money to cover several months of property taxes upfront. The exact amount depends on when your taxes are due and your location's tax schedule. For example, if you close in June but property taxes aren't due until December, you'll need to prepay six months' worth of taxes.

Homeowners Insurance

You'll typically pay your first year's homeowners insurance premium at closing. Your lender requires this coverage to protect their investment (and yours). You get to choose your insurance provider, but the coverage must meet your lender's minimum requirements. Shopping around for insurance rates before closing can save you money.

Mortgage Interest

This prepaid cost covers the interest on your mortgage from your closing date until your first monthly payment begins. If you close on March 15th, you'll prepay interest from March 15th through March 31st. Your first regular mortgage payment would then start May 1st, covering April's interest.

Understanding the Escrow Account

Your escrow account acts like a savings account managed by your lender. They deposit your prepaid funds here and use them to pay your property taxes and insurance when they're due. Each year, they'll review your account to make sure they're collecting enough money monthly to cover these expenses.

If they've collected too much, you'll get a refund. If they haven't collected enough, you'll need to pay the difference or accept a higher monthly payment to make up the shortage.

Common Questions About Prepaids

• Prepaids aren't part of your down payment - they're separate closing costs

• Most lenders won't let you roll prepaids into your loan amount

• Prepaids differ from reserves - reserves are extra months of payments required by some lenders

• Your tax and insurance payment schedules determine how much you'll need to prepay

Financial Planning for Prepaids

Start planning for prepaids early in your home-buying process. Request a loan estimate from your lender to see approximate prepaid costs. You might save money by:

• Timing your closing date to minimize prepaid interest

• Comparing insurance quotes from multiple providers

• Asking the seller to cover some prepaid costs

Prepaids vs. Other Closing Costs

Unlike other closing costs such as appraisal fees or title insurance, prepaids aren't one-time expenses - they're advance payments on recurring costs you'd pay anyway. Some closing costs can be negotiated with the lender, but prepaid amounts are fixed based on tax rates, insurance premiums, and interest calculations.

Regional Variations

Your location affects your prepaid costs significantly. Different states have varying:

• Property tax rates and payment schedules

• Insurance requirements based on natural disaster risks

• State-specific escrow regulations

Tips for Home Buyers

Make your home-buying process smoother by:

• Getting prepaid estimates from multiple lenders

• Starting your insurance shopping early

• Learning your local tax payment schedule

• Building a relationship with your loan officer

Common Mistakes to Avoid

Don't fall into these common traps:

• Forgetting to include prepaids in your home-buying budget

• Assuming all lenders calculate prepaids the same way

• Missing the chance to shop around for better insurance rates

• Not preparing for possible escrow adjustments after the first year

Taking the Next Step

Understanding prepaids is just one part of the home-buying process. Bellhaven Real Estate's agents guide you through every step, from estimating your closing costs to finding the perfect home. Ready to start your home-buying journey? Reach out to Bellhaven Real Estate for personalized guidance through the entire process.