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What are Prepaid Costs When Buying a Home?

You thought buying a house would require a significant portion of your savings, but you didn't anticipate the magnitude of upfront expenses. Closing fees, down payments, home inspection fees, and prepaid closing costs are just...


You thought buying a house would require a significant portion of your savings, but you didn't anticipate the magnitude of upfront expenses. Closing fees, down payments, home inspection fees, and prepaid closing costs are just a few examples of the many charges and deposits that new homeowners must face before making their first mortgage payment. However, fear not! While there are several prepaid costs associated with purchasing a home, they are all part of the standard home buying process. American Home Shield is here to help you understand these estimated prepaid items at closing and other initial costs, so you can plan ahead and feel prepared. Let's address some common questions that soon-to-be homeowners often have.

Understanding Prepaid Costs When Buying a Home

Prepaid costs act as a safety net for lenders. It usually involves prepaying for taxes, interest, and insurance. The money you provide in advance goes into a prepaid escrow account, which is then used to fulfill these financial obligations. Placing funds for prepaid closing costs in an escrow account ensures that these critical expenses are met, as failure to do so could result in a foreclosure.

So, what exactly do these prepaid closing costs entail? Here are the most common ones:

  • Prepaid interest on a mortgage: This refers to the interest that accrues between your closing date and the end of the month. The amount is determined by the loan amount, interest rate, and timing of your closing date. Selecting a later closing date in the month can help minimize the prepaid interest amount.
  • Prepaid property taxes at closing: The seller is responsible for paying the property taxes up until the closing day. Once you assume ownership, you are required to prepay for the property taxes from your escrow account.
  • Prepaid homeowners insurance at closing: Lenders often require you to pay for up to one year of homeowners insurance premiums in advance. This provides assurance that any potential damages or repairs during the first year of homeownership will be covered, ensuring you can continue making mortgage payments.
  • Initial escrow payment at closing: While not always mandatory, this prepaid escrow deposit serves as a security measure for future homeowners insurance or property tax payments. It demonstrates your commitment to purchasing the house and can often be applied towards closing costs and the down payment.

This process may seem complex, but these costs are inevitable. Prepaid costs actually work to your advantage as a buyer because they relieve you of the responsibility of managing these essential payments. With the numerous tasks on your homeowner checklist before moving day, having someone else handle these mandatory payments can be a welcome relief. It means more money upfront, but it also streamlines the process by combining these expenses and ensuring they are paid on time.

Closing Costs vs. Prepaid Costs

It's important to note the distinction between closing costs and prepaids. Prepaid costs are expenses that you would eventually pay for anyway; the only difference is that you pay for them early. On the other hand, closing costs are fees associated with the services provided during the closing of your home. These fees compensate the professionals involved in the process, such as lawyers, title companies, lenders, and appraisers.

When it comes to closing costs, you have an opportunity to potentially save some money. You can negotiate with lenders to have them cover the closing costs or offer better rates. In some cases, the seller may agree to pay for the closing costs. Shopping around and comparing offers can help you find the best deal.

However, with prepaid closing costs, you have no such flexibility. These costs are a standardized part of the home buying experience and will be incurred regardless. It is essential to be aware of them as you navigate through the process.

Final Thoughts

Purchasing a home can be a valuable investment, but it's crucial to understand the initial costs associated with buying a home. American Home Shield is here to support you every step of the way. We provide advice for first-time homebuyers, including finding a real estate agent and understanding the mortgage approval process.

Communicating with your real estate agent throughout the transaction process is vital to ensure there are no surprises when it comes to prepaid costs. Once all payments are made, approvals are given, and contracts are signed, you'll be ready to move into your new home in no time.