Prepaid Costs   CONTENTS: What are prepaid costs? Interest formula How are Insurance, Taxes, Mortgage Insurance & Escrow Accounts figured? NOTE

Prepaid Costs are what trip up most people when they are making up their house buying budgets.

 

People are usually aware of the downpayment and closing costs, but are not so cognizant of prepaid costs. Since Prepaid Items can cost as much, if not more, than your Closing Costs you need to be very sure they are included in all your homebuying calculations.

 

You may have heard people talk about setting up an escrow account, it's basically the same thing as Prepaids. Your Prepaid costs are:

interest

insurance

taxes

mortgage insurance

top

INTEREST: When you are rent you pay BEFORE you use the product (rent). When you purchase you pay AFTER you use the product (the money you borrowed) This means your September payment is for the month of August.

You will owe interest from the day you close until the first of the next month and your house payment will not be due until the first of the following month.

This means that if you close on the 1st of the month you will pay more interest at closing, but will have 2 months without a house payment whereas if you close on the last day of the month it will be cheaper at closing but your house payment will be due in 30 days. Another way to say it is that if you close at the first of the month you get to skip a payment.

To calculate the interest due:

multiply your interest rate times the loan amount to get the interest per year (that's a tax write off for you)

8% X $100,000 = $8,000 per year

divide the interest per year by 365 to get the interest per day

$8,000 ÷ 365 = $21.92 per day

multiply the interest per day times the number of days till the first of the month. If you were to close on the 15th you would pay 15 days of interest

$21.92 X 15 days = $328.80

 

INSURANCE: You must buy a full year's Fire & Extended Cover insurance policy (this covers the dwelling - contents coverage is optional) and also pay 2-3 months worth of monthly insurance payments into escrow so that next year there will be enough money in your escrow account to buy a new insurance policy for the next year.

The choice of insurance companies and amount of coverage is totally under your control with these provisos: Coverage amount must be equal to at least the loan amount and your deductible cannot exceed 1% or $1,000 whichever is greater. You may change insurance companies at any time.

 

TAXES: The seller will pay taxes from Jan 1 until your closing date into your new escrow account. You will also pay 2-3 months tax payments so that there will be enough money in the account to pay the taxes next year when they are due.

 

MORTGAGE INSURANCE : Mortgage Insurance is required on most low downpayment loans. MI protects the lender against borrower default.

 

Some MI policies are paid in a lump sum up front, others are paid monthly. FHA makes you pay both upfront and monthly.

 

FHA requires the purchase of Mortgage Insurance no matter how large your downpayment, but Conventional loans only require MI if you put less than 20% down. With Conventional loans the larger the downpayment the less expensive the MI. With FHA you will pay MI both up front and monthly, but the upfront MI can be financed.

 

Talk to our Lending Partners, they have loans that don't require MI, although usually at a higher interest rate.

 

ESCROW ACCOUNTS : Some loan types allow you to pay your own taxes and insurances if you put enough money down, but most people like the convenience of having the taxes and insurances included in their monthly payments.

 

Expect to pay for the privelge of paying your own escrows because this increases the risk to the lender. Look at it from their viewpoint, what if you don't pay your insurance on time and your house burns or you don't pay your taxes?

top

A Lender cannot be as accurate in their Guesstimation of your Prepaid Costs as they can be with Closing Costs since many of the prepaids are not fixed costs and some are under your control. Mortgage companies cannot control how diligently you shop for a good price on your insurance. Many times accurate tax information is not available until a few days before closing. Changes in closing date also affect these figures. Ask your lender to calculate these on the high side. It is better to budget for more and need less.