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What We Talk About When We Talk About Real Estate is a blog that I created where I researched what is trending in Google about REAL ESTATE and share them with you!
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Prepaids -- Just another closing fee?
When you look at your Closing Disclosure for your home purchase, you may notice a special category called “prepaids.” You may think, “Oh, those are just some additional closing costs.”
FACT >> Prepaids are different from Closing Costs
Closing costs is the general term used to describe all of the fees or charges for actions or items related to originating and closing on your mortgage. These can include payment to title companies, government offices, or even the mortgage lender itself. People involved in your loan need to get paid and that happens through closing costs. Depending on the type of loan you get, you may be able to get the seller of the property to cover some or all of the closing costs during your sales contract negotiation (not very likely during 2020-21 seller's market ).
As the term suggests, you are paying in advance for something. At some point in your life, you’ve probably been asked to pay in advance for a service. Most cable providers require payment in advance for the next month of usage. Your car insurance premiums are paid in advance. If you need an attorney, you may be asked to pay a retainer for their services. You get the picture – you prepaid for something you were going to be using later. Your mortgage lender asks you to prepay a few things as well.
So, what are you prepaying when you get your mortgage?
Mortgage interest, real estate taxes, homeowner’s insurance, hazard insurance, private mortgage insurance, and any special assessments (usually related to real estate taxes) are the most common items you’ll see listed as prepaids. In order to create an escrow account, your lender needs money to place in the account. At closing, you’ll be asked to pay a portion of your taxes and insurance, including private mortgage insurance if applicable, as prepaids for this purpose. Depending on when you close, you may not have a payment due for another 30-45 days which would delay your lender being able to fully set up your account in their system. Including a portion of these items in your closing allows them to have your account ready for future deposits and disbursements before your first payment is made. Going forward, all of these items are collected as part of your regular mortgage payment. “There is a regulated amount that can be put into this account at closing. The amount collected at closing along with the monthly payments will combine to be sufficient to pay the taxes and insurance when they come due. Escrows are required on FHA and VA loans. They may be waived on a conventional loan if the LTV is 80% or below,” explains Bob Dineen, Regional VP and Branch Manager, at Atlantic Bay.
>>>“Prepaids are not a closing cost or a fee. They are the borrower’s own funds being put into an escrow account for the purpose of paying taxes and insurance.”
Look at Section F (Prepaids) and Section G (Escrows paid at closing). Your Closing Disclosure (formerly HUD-1) will also show prepaids and escrows in sections F and G.
Homeowner's Insurance Premium (Hazard Insurance)If a mortgage is involved, homeowners insurance fees are required to be paid at closing. On a purchase, you will be asked to prepay an entire full year of insurance premium before you can close. Why? Because your lender does not want to risk having your house burn down right after closing and you haven’t paid your insurance.
With insurance on a purchase, you not only have to prepay a full year, but you also have to escrow (i.e., pay) anywhere from one to two month’s worth of insurance payments at closing for a cushion. A cushion is basically what it sounds like – extra money you have to lay aside so your servicer has something extra in case you don’t make your mortgage payments and they still have to pay homeowner’s insurance and property taxes.
Prepaid mortgage interestYour mortgage payment consists of principal and interest. Principal is applied towards your loan amount and interest is paid to the lender for giving you the loan. Here’s where it gets a little tricky – interest is paid in arrears. When you make your mortgage payment, the interest is for the previous month. When you make June’s mortgage payment, you’re paying May’s interest. However, when you close, there may be a short period of time that needs to be covered and you’ll pay that as prepaid interest. For example, if you close on April 15 and your first payment is due on June 1, your June payment will cover all of May’s interest. But, what about the interest from April 15 – May 1? You’ll pay that at closing as a pre-paid. In order to reduce the amount of prepaid interest, you’ll probably be like most people and try to get a closing as near to the end of a month as possible. Your lender can help you estimate the amount you’ll need in prepaids so that you can make sure to have the funds available.
In Texas, Property Taxes are due early October and homeowners have until January 31st to pay the bill before considered late. Taxing authorities will only accept one payment for the full amount and the responsibility lies with whoever owns the home at the time the taxes are due. Therefore, when you sell or buy a home the property taxes will be prorated at closing so that each party pays their portion of the year's taxes. If the taxes aren’t due at the time of closing, the buyers will be responsible for making the full year’s worth of property tax payment when the bill is due. Conversely, if the property taxes are due at the time of closing, the seller will pay for the full year of taxes and the buyer will then reimburse the seller for the prorated time they’ll own the home. (Hmm, a bit confusing, just read it again -- it totally makes sense!)
So, is there a rule of thumb for how much prepaids can cost? Yes, on a purchase:
- Six to 12 months of homeowners insurance premiums, plus two months for escrow reserves
- Two months of property taxes as set by your local government (for example, if your annual property tax bill is $12,000, you’d prepay $2,000 into an escrow account)
- Any interest that accrues on the loan from the closing date through the end of the month.
(some parts of the Article courtesy of Atlantic Bay Mortgage)
If you need more detailed information about this topic, please email me and we can talk more or I can introduce you to my preferred lender who will guide you every step of the way!