When you close on a home, you’ll encounter not only the down payment and closing fees but also prepaid costs—monies you pay in advance for future expenses. Mortgage lenders collect these funds to ensure taxes, insurance, and interest are covered on time. When buying a home, the key prepaid costs include:
1. Prepaid Mortgage Interest
If you don’t close on the first day of the month, you’ll owe interest from the closing date to month’s end. This protects the lender because mortgage payments are made in arrears.
Example calculation: A $200,000 loan at 3.5% annual interest accrues roughly $19.18/day. Closing 10 days early adds ~$191.80 to your closing costs.
2. Homeowners Insurance Premium
Lenders typically require 6–12 months of insurance upfront to ensure the property is immediately protected. This can be bundled into your escrow account.
3. Property Taxes
You’ll prepay taxes from the closing date to the end of the tax period—often a full year, depending on local rules. Lenders often collect 2 months’ worth initially plus prorated taxes.
4. Mortgage Insurance Premium (if applicable)
With low down payments (<20%), lenders may require mortgage insurance. Conventional loans often need two months’ PMI upfront; FHA loans require an Upfront Mortgage Insurance Premium (MIP) of 1.75% of the loan amount.
5. Initial Escrow Deposit
Beyond prepayments, lenders also pad escrow accounts—typically 2–3 months of taxes and insurance—to cover future obligations. This “cushion” ensures timely payments even if monthly contributions temporarily lag.
Prepaids vs. Closing Costs ⚖️
Prepaid costs are often listed alongside closing costs but differ substantially:
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Closing costs pay for loan and purchase processing: appraisals, title searches, attorney fees, etc.
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Prepaids are held in escrow accounts and used for future, recurring obligations like taxes and insurance.
On the Loan Estimate or Closing Disclosure forms, prepaids appear in Section F, while closing costs are under different line items homelight.com.
Estimating Prepaid Costs When Buying a Home
Use the Loan Estimate to forecast prepaids. Typical calculations include:
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Interest: Daily rate × days until month’s end
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Insurance: Annual insurance × mortgage payment period
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Taxes: Annual tax ÷ 12 × months remaining in year
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Escrow cushion: Add two months’ worth of taxes and insurance.
Why Mortgage Lenders Require Prepaids
Prepaids protect lenders’ investments by ensuring insurance and taxes are current. Lapses can lead to claims, liens, or foreclosures
Case Study #1: Suburban Buyer Closing Early
Anna purchases a $300,000 home in early October.
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Loan amount: $270,000 at 4% interest
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Closing date: October 5
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Days until month-end: 26 → Interest due = 26 × ($270,000 × 4% / 365) ≈ $771
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Annual insurance = $1,200 → 12 months = $1,200
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Annual taxes = $3,600 → October–December = 3 months → $900
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Escrow cushion: 2 months tax ($600) + 2 months insurance ($200) = $800
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Total prepaids: $771 + $1,200 + $900 + $800 ≈ $3,671
Anna brings this sum in addition to her down payment and closing fees.
Case Study #2: Urban Buyer with PMI
Michael buys a $450,000 condo in mid-June.
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Loan: $405,000 (10% down) at 3.75% interest
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June 15 closing → 15 days interest = 15 × ($405,000 × 3.75% / 365) ≈ $626
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First-year insurance = $1,800 → $1,800
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Annual taxes = $6,000 → July–December = 6 months = $3,000
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PMI upfront: 2 months at $100/month = $200
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Escrow cushion: 2mo tax ($1,000) + 2mo insurance ($300) = $1,300
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Total prepaids: $626 + $1,800 + $3,000 + $200 + $1,300 = $6,926
Michael’s lender includes these funds in the escrow, which he’ll repay via monthly mortgage payments.
Tips to Manage Prepaids Closing Costs
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Schedule closing at month’s end – minimizes pre-paid interest.
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Shop insurance rates – lower premiums reduce prepaids.
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Understand doors to escrow account – initial cushion differs among lenders.
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Use seller or lender credits – closing credits can offset prepaids.
Summary
| Prepaid Cost | Purpose |
|---|---|
| Mortgage Interest | Covers days until first payment arrives |
| Homeowners Insurance | Pre-pay 6–12 months for lender security |
| Property Taxes | Pre-pay monthly or yearly tax obligations |
| Mortgage Insurance (PMI) | Paid upfront if <20% down on conventional loan |
| Initial Escrow Deposit | Cushion to guarantee future payments |
Prepaids aren’t optional—lenders require them to ensure taxes and insurance are covered. Though they add to your initial cash needs, they prevent financial mishaps post-closing. Careful planning and strategic timing can help reduce prepaids while keeping home purchase on track.
Prepaids are a critical—but often overlooked—part of home buying. Understanding them ensures you’re prepared, minimizing surprises at closing. Let me know if you’d like help estimating your prepaid costs or integrating them into your cash-to-close plan!
References
BankRate, A. C. (2023, August 17). Closing costs vs. prepaids: What’s the difference?
RefiGuide. (2024.). First Time Home Buyers Guide
Zillow. (2025, April). What are prepaid closing costs?
