Homeownership is the culmination of the American Dream provided a chance to provide a better life for ourselves and our families. The process of becoming a homeowner is therefore very exciting for first-time buyers. With this excitement it is also important to understand the responsibility. There are many costs associated with home buying, like prepaids and closing costs, that some new home buyers may not thoroughly understand. So, what is the difference between the two?
Here is what you need to know.
Prepaid items refer to upfront taxes and insurance due at closing. The following is a list of prepaids that borrowers should expect to pay upon closing:
- Homeowner’s Insurance: Homeowner’s insurance is vital for you to be able to protect your investment against unforeseen challenges. The cost is built from several factors, including size of the house you buy, the cost to rebuild or even items like your deductible. Although homeowner’s insurance covers the majority of damages, the insurance does not account for destruction caused by flooding, earthquakes, and poor maintenance. You must purchase separate policies to be covered by earthquakes and flooding. The first premium of homeowner’s insurance is typically paid at closing.
- Flood Insurance: If your home is located in a high-risk flood zone, your lender will likely require you to purchase a flood insurance policy. It protects two types of property: your home and your contents. The type of coverage you select will dictate your deductible and limit. You may even want to consider flood insurance if you are located in a preferred (rather than high-risk) flood zone. Discuss your options with your insurance agent to see if this option is right for you.
- Escrow deposits: An escrow account for your mortgage is used to make payments on your behalf for real estate taxes and premiums for insurance. To make these payments, the lender will collect escrow funds as part of your monthly mortgage payment. At the end of every 12 months, the account will have the full balance to renew or pay your property taxes and insurances for the next year. At closing, you typically put 2 months’ payments into that escrow account because your first payment skips a month before you are required to pay. In order to make up for that skip, the escrow account starts with 2 months so it has a sufficient balance to pay when the bills come due in 12 months.
Basically, closing costs are fees associated with your home purchase, but separate from the price of the property itself. As the title states, these costs are paid at closing, or when the title of the property is transferred from the seller to the buyer. When you close on your mortgage, the closing costs you can expect to pay include:
Items payable in connection with the loan:
- Appraisal fee, credit report, and flood determination are 3rd party charges that you can typically pay your lender, who will then pay the vendor.
- Doc prep, processing, and underwriting are the lender fees you will owe your lender upon closing.
- Title items, which will be charged by the title attorney for closing.
- Loan discount points, which essentially refer to prepaid interest that can lower your interest rate for the life of the loan. One point is frequently the same as one percent of the loan amount.
- Origination fee, which is a lender fee charge for processing and gathering of all documents for a selected loan program.
Additional settlement charges:
- Recording fees are necessary to record the sale of the property. You will be charged by the title attorney to make this payment.
- Title insurance is optional. It serves the purpose of protecting you, the title owner, from previous contractors making claims against your property.
As both prepaids and closing costs are due at closing, it’s important to understand what each payment entails so your home buying process is as quick and smooth as possible. For more information about the difference between prepaids and closing costs, or to learn more about the costs associated with home buying, contact one of our mortgage specialists and download our eBook today.