Pre-paid costs when buying a home

Pre-paid costs when buying a home are the expenses you pay upfront at closing. While the exact amount will vary depending on your loan and property location, pre-paid costs typically include homeowners insurance, property taxes, mortgage interest and an initial escrow deposit. If you live in a community with a homeowner association, they may also include HOA dues.

In addition to closing costs, expect to pay the following pre-paid costs regardless of your lender.

1. Initial escrow deposit: A mortgage escrow account, also called an impound or trust account, allows borrowers to manage the costs associated with owning a home. If you have an escrow account, your monthly mortgage payment includes part of your expected property tax bill and hazard insurance premium. This ensures that when each payment is due, there are funds in your account to cover them. The advantage of an escrow account is that it allows you to spread out your tax and insurance bills into monthly installments rather than worrying about paying a large sum annually.

   An initial escrow deposit is what you’ll pay at closing to start your escrow account if one is required.

2. Homeowners insurance: When you take out a home loan, you must carry homeowners insurance to protect your property against losses and damage. Homeowners insurance is also sometimes referred to as “hazard insurance.”

   You get to choose your insurance company. The Consumer Financial Protection Bureau recommends you “comparison shop to find the insurance policy you want and to learn if the amount the lender estimated is accurate for your specific situation.” Expect to pay the first six to 12 months of homeowners insurance premiums at or before closing, plus two- or three-months’ payments in advance to set up an escrow account.

3. Pre-paid interest: Interest paid in advance is known as pre-paid interest. When you close, this charge covers the cost of borrowing money between the date your home sale closes and the first day covered by your first monthly mortgage payment.
4. Real estate property taxes: Property taxes on real estate are used to pay for public services like roads, schools and libraries.

   When homeownership transfers to you, so does the responsibility for paying property taxes. If the seller pre-paid the entire year of property taxes, you’ll likely need to pay a prorated portion for the remainder of the year.

5. HOA dues: If you’re looking to buy a new home, there’s a good chance it will be in a community with a homeowners association (HOA). When purchasing a home with an HOA, you’re responsible for paying monthly or annual HOA fees. In exchange for fees, HOA management will provide services for the upkeep of common areas and building maintenance. Common areas may include parks, tennis courts, elevators and swimming pools.

   According to HOA Management, homeowners associations usually gather dues monthly in advance. Therefore, your pre-paid cost when buying a home will be prorated based on the number of days you own the home in the month of closing.

Although sellers may cover some closing costs, you’re responsible for all pre-paid expenses as the homebuyer. A third party, like your title company or escrow agent, will collect and deposit them in your escrow account.

A mortgage loan estimate (LE) is a complimentary service that we provide, giving you an idea of what to expect if you decide to move forward with your home loan. You’ll find a list of pre-paid costs in your LE along with your loan amount, the interest rate, APR, closing costs and a ballpark figure of your monthly mortgage payment.

Here are some ways to get a rough estimate of what your pre-paids may be before you make an offer on a home:

Initial escrow deposit: The types of mortgage loan programs that require a home escrow account are government-backed loans such as FHA loans, USDA loans and VA loans. Typically, Conventional loans with down payments less than 20 percent also require an escrow account. With an escrow account, expect to pay three months of homeowners insurance plus three months of property taxes at closing.

Homeowners insurance: The cost of homeowners insurance can vary significantly depending on various factors, including the location and value of your home and your coverage options. Consult with an insurance professional or use an online insurance calculator for an estimate based on your situation.

Pre-paid interest: How much interest you’ll pay depends on how many days between when you close your home and make your first mortgage payment. To determine your daily interest or “per diem interest,” follow these steps:

1. Divide the annual mortgage rate by 365 to get your per diem interest amount.
2. Multiply your per diem interest amount by your home loan amount for the cost per day.
3. Take the cost per day and multiply it by the number of days you’re required to prepay interest.

Property taxes: Local governments set property tax rates. In general, to calculate the amount of property tax you’ll owe each year, multiply the property tax rate by the sale price of your home.

Prorated HOA fees: HOA fees can range from a few hundred to a few thousand dollars. The location, type of home and amenities all affect how much you’ll pay. To ensure you’re prepared financially before making an offer on a home, ask the homeowners association board how much the monthly or HOA fees are and what they cover.

Do you have questions about how to estimate your home loan closing and pre-paid costs? Connect with a loan officer in your neighborhood.