Are Prepaids and Closing Costs the Same Thing?

When you look at your Closing Disclosure for your home purchase, you may notice a special category called “prepaids.” It might be tempting to assume these are just more closing costs, but prepaids and closing costs are not the same thing. And understanding the distinction can help you better plan for your mortgage expenses. 

Before October 2015, when updated mortgage disclosure rules were introduced, prepaids might have been listed as “Items Required by Lender to be Paid in Advance” or “Reserves Deposited with Lender.” Regardless of terminology, it’s important to know what these charges are and why they matter.  

What Are Closing Costs? 

We use "closing costs" as the umbrella term for all fees associated with finalizing your mortgage. 

These include charges for services like title searches, loan origination, appraisals, recording fees, and more. These costs pay the various professionals and institutions involved in getting your loan approved and processed. Depending on your loan program, some of these costs can potentially be covered by the seller as part of your negotiation, too.  

What Are Prepaids? 

As the name suggests, prepaids are payments made in advance for certain homeownership-related expenses. 

Think of it like other services you prepay: your cable bill, car insurance, or a lawyer’s retainer. In the context of homebuying, lenders collect prepaids at closing to ensure there are funds available to pay expenses like property taxes and insurance when they come due.  

Common Prepaid Items 

Some of the most common prepaid items in the homebuying process include: 

• Mortgage interest: Paid upfront for the period between your closing date and the end of that month. 

• Real estate taxes: A portion collected in advance to fund your escrow. 

• Homeowners insurance: Lenders often require the first year’s premium paid in full at closing. 

• Private mortgage insurance (PMI): If applicable, some portion may be prepaid. 

• Initial escrow account deposit: To establish your escrow for future tax and insurance payments. 

• Special assessments: Typically tied to property taxes for improvements like sidewalks or street lighting. 

Expert Tip

These payments don’t go to your lender as profit; They’re your own money set aside to cover future bills.

Do Prepaids and Closing Costs Vary by Loan Type? 

The short answer? Yes. For example: 

• FHA and VA loans require escrow accounts and limit how much sellers can contribute toward costs. 

• Conventional loans may allow you to waive escrow if your loan-to-value (LTV) ratio is 80% or lower. 

• Certain loans might have higher prepaid insurance requirements based on property location or borrower profile. 

How Prepaids Affect Your Monthly Mortgage Payment 

Prepaids directly relate to your escrow account, which covers ongoing costs like property taxes and insurance. Each month, a portion of your mortgage payment goes into this account. At closing, your lender collects enough to start that account off strong – and keep all parties protected should disaster strike your home, or you can’t make your mortgage payments. 

If your lender doesn’t collect enough, or if costs rise later, your monthly payment could increase to make up the difference. That’s why prepaids matter: they help ensure your escrow is sufficient from day one. 

How Is Prepaid Mortgage Interest Calculated? 

Your mortgage payment includes both principal and interest. Interest is paid in arrears – that is, your June payment covers May’s interest, for instance. But when you close mid-month, there’s a gap that needs to be filled. 

For example, if you close on April 15, your first mortgage payment might not be due until June 1. That June payment covers May’s interest. But what about April 15–30? That’s where prepaid interest comes in. You’ll pay the interest for those remaining April days at closing. 

To reduce how much prepaid interest you pay, many buyers choose to close near the end of the month. 

Can the Seller Pay for Your Prepaids? 

The short answer? This time, it depends. 

If your purchase contract says the seller will cover "closing costs," that doesn’t automatically include prepaids. To ensure prepaids are covered, your contract must explicitly state "closing costs and prepaids." 

However, loan programs often place limits on how much the seller can contribute: 

• FHA: Up to 6% of the home’s price 

• VA: Typically 4% 

• Conventional: Ranges from 3% to 9%, depending on down payment size 

Always confirm with your lender to ensure seller-paid amounts align with your loan program. 

How To Estimate Your Prepaids and Closing Costs 

While your lender will provide a Loan Estimate early in the process, you can start estimating based on a few factors: 

• Your closing date (affects prepaid interest) 

• Local property tax rates 

• Homeowners insurance premiums 

• Whether your loan type requires PMI or funding fees 

Some online calculators can help you approximate, but, trust us, nothing replaces a personalized estimate from a Mortgage Banker. Ask for a closing cost worksheet to give you an estimated breakdown of everything you’ll pay, line by line. 

Bringing It All Together 

Buying a home is one of the biggest financial decisions you’ll ever make, and understanding where your money is going can help you feel more in control throughout the process. 

So, knowing and feeling confident in, the difference between prepaids and closing costs (plus how they affect your monthly payment and overall budget) you’ll be better prepared to navigate the closing table with confidence. 

If you're unsure about any part of your loan estimate or closing disclosure, don't hesitate to reach out to your lender for guidance. After all, informed decisions lead to smoother closings and smarter homeownership.