Jim Quist is the President and Founder of NewCastle Home Loans. Jim has worked in the mortgage industry for over 20 years. His goal is to help home buyers find the information they need to close on their home purchase with confidence.
Prepaid items are the homeowner’s insurance, mortgage interest, and property taxes that you pay when you buy a home.
You’re probably wondering how much money you’ll need to cover these closing costs. Well my friend, today you’ll have answers. After you read this post you’ll know:
- Where to find prepaid items on the Loan Estimate
- How much you’ll need for prepaid insurance, interest, and escrow
- How mortgage escrow accounts work
- Why your mortgage payment could increase
- How to compare prepaid items in loan offers from lenders
- When to waive the escrow
Not only am I about to give you simple answers, but I’m also going to show you a Mortgage Closing Cost Calculator that will make planning your home purchase a breeze. With all this home loan how-to, you should feel pretty good about your decision to buy.
Where to find Prepaid Items on the Loan Estimate
Let’s start by looking at the prepaid items on the Loan Estimate, the form the lender gives you after you apply for a mortgage. At the bottom of Page 1, the Estimated Closing Costs include “Other Costs.” The prepaid items - the insurance, interest, and taxes that we’re unraveling today are Other Costs.
Page 2 of the Loan Estimate divides the prepaid items into two sections, Prepaids and Initial Escrow Payment at Closing.
- Prepaids are the Homeowner's Insurance Premium and the Prepaid Interest.
- Initial Escrow Payment at Closing includes Homeowner's Insurance and Property Taxes.
Prepaid Homeowner’s Insurance Premium
Lenders require proof that you have homeowner’s insurance on the property. Homeowner’s insurance protects you and the lender in the event of an accident or disaster involving your home.
Before you purchase a home, you must buy insurance that covers the property for the next 12-months. In our example, the buyer paid $998 for insurance coverage from October of this year through October of next year.
To satisfy the lender's requirements for homeowner's insurance,
- Choose an insurance company. The lender does not.
- Pay the insurance premium for the next 12-months.
- Give the lender evidence of insurance and the paid receipt at least 1-week before you close.
Prepaid Interest for the Mortgage
Prepaid Interest is mortgage interest you pay to the lender from the day you sign the loan agreement through the last day of the month. For example, the buyer closed on October 28. She prepaid interest for the 4-days left in the month. At $31.17 per day, the prepaid interest cost her $125.
You can lower the amount of money you’ll need at closing by scheduling the closing date for the end of the month. If the homeowner in our example closed on October 1, she would prepay interest for 31-days, costing her $966. Instead, she closed at the end of the month, prepaid interest for 4-days, and saved $841.
Initial Escrow Payment at Closing
The initial escrow payment is the money you deposit with the lender that the lender will use to pay future homeowner’s insurance and property taxes. If you set up an escrow account, deposit 2-months of homeowner’s insurance and 2-months of property taxes when you close.
Initial Escrow Payment = 2-months of homeowner’s insurance + 2-months property taxes.
In the example, the buyer’s initial escrow payment is $895.
How Mortgage Escrow Accounts Work
An escrow account is a savings account that the lender sets up to manage your homeowner's insurance and property tax payments.
If you escrow, the payments you send to the lender each month includes insurance and taxes. The lender deposits the insurance and tax portions into the escrow account. When the bills are due, the lender withdraws money from the account to pay them.
Look at the Payment Calculation on Page 1 of the Loan Estimate to see if your loan requires an escrow and how much the lender plans to put aside each month for insurance and taxes.
Why your Mortgage Payment could Increase
Remember the initial escrow payment, the 2-months you deposit at closing? The lender calls it a cushion. It’s extra money that the lender holds in reserve. If your insurance or taxes increase, the lender would use the cushion to pay for it, and then increase the escrow portion of your monthly payments.
On the other hand, if by some miracle your insurance or taxes decrease, the lender would lower your escrow and your total monthly payment would decrease. Since lenders may not hold more than a 2-month cushion, you could get an escrow refund check.
How to Compare Prepaid Items in Loan Offers
As you shop for a mortgage, the prepaid items will be different on the Loan Estimates you get from competing lenders. In other words, the dollar amounts in sections F & G won’t match up. One lender’s estimate for homeowner’s insurance, prepaid interest, or property taxes could be much higher or lower than other estimates.
Don’t pick one lender over another just because their prepaid items are less. How much you actually prepay for insurance and taxes will end up the same no matter which lender you choose.
Lenders won’t know the insurance or tax amounts right after you apply for a mortgage. They give you approximate numbers using the information available at the time. After you select an insurance company and the seller provides the county property tax records, the lender verifies the exact amounts and sends you a revised Loan Estimate.
If you want the exact numbers now, get a quote from an insurance company. Ask your real estate agent for tax info or search the county treasurer's website.
Here are the county property tax portals in Chicagoland:
When to Waive Escrow
But you could ask the lender to waive the escrow for a conventional loan if your down payment is 20% or more and you can handle the lump sum payments for the annual homeowner’s insurance and property tax installments.
For instance, if you buy a place for $350,000 you could waive the escrow and manage the insurance and tax payments on your own as long as the Loan Type is Conventional and your down payment is at least $70,000, 20% of the purchase price in this case.
Lenders want to manage your insurance and tax payments through an escrow account. That’s because uninsured homes and delinquent property taxes increase the risk of loss from disaster and foreclosure.
The lender might charge you a fee to waive the escrow. The fee is typically 0.25% of the loan amount. So if your loan amount is $280,000, the lender might charge you a $700 fee at closing to waive the escrow.
Mortgage Closing Cost Calculator
People planning to buy homes want to know how much it will cost upfront. With today’s technology, there’s no longer any reason you can’t. Our Mortgage Calculator gives you a fair estimate instantly. It’s the perfect tool for planning your big purchase.
No dickering with salespeople or filling in mortgage applications that run down your credit score. All you do is enter basic info.
- Zip Code
- Purchase Price
- Down Payment
- Your Credit Rating
The calculator finds loans that meet your criteria and serves-up the numbers you’ve been looking for.
You get current mortgage rates, payments, and closing cost details - even the prepaid items.
Like what you see? Apply and get an Official Loan Estimate in about 15-minutes. We can prepare a Mortgage Pre-approval Letter on the same day to boot.
Prepaid items are the homeowner’s insurance, mortgage interest, and property taxes that you pay when you buy a home. These costs increase the amount of money you need at closing. To see how much, look at Page 2 of the Loan Estimate, the Prepaids and the Initial Escrow Payment at Closing sections.
The Prepaids are the homeowner’s insurance premium and mortgage interest. If you set up an escrow you’ll make an initial payment at closing. And your monthly payments to the lender will include insurance and taxes. The lender will deposit the insurance and tax portions of your payments into the escrow account and pay the bills when they are due.
The cost for prepaid items will end up the same no matter which lender you choose. That’s because you control these costs, not the lender. You select the insurance company, the rate and day you close, and the amount of your property taxes.
Nevertheless, you should know what to expect by requesting a Loan Estimate from a lender. Most lenders, however, will check your credit report before they give you a Loan Estimate. As you know, those inquiries could lower your score.
Our Mortgage Calculator will help you plan for your big purchase. You can see live rates, payments, and closing costs, including the prepaid items. These are the same numbers you would see on the Loan Estimate.