Some costs are paid in advance. These are costs that you must pay at closing that are prepaying things in advance. For example, the first year of homeowner’s insurance must be paid one year in advance.
Many of these items are put into an escrow account that cover the initial costs of expenses, such as private mortgage insurances, hazard insurance, taxes and special assessments. The purpose of having pre-paid items is to pay for the items on a certain date that they are due. These are charges that the lender requires you to pay at settlement, such as accrued interest. They are purchases in advance of their due dates. If you close the loan right before the month’s end, there will still be a few days left of mortgage interest.
The reason this happens is due to the fact your first mortgage is not due immediately after you close it. Mortgage interest is paid in arrears, so you are always paying the interest a month behind. For example, your August payment would cover the interest for the month of July.
Prepaid items and escrow accounts are alike. Escrow accounts are made to ensure the lender that property taxes, mortgage insurance and homeowners insurance will be paid smoothly. Also, the amount a lender collects depends on when the closing will take place. However, escrow accounts and prepaid items serve completely different purposes. The term “Closing costs” is a general term which is used to describe all the fees or charges. As for the term “Prepaid” this means you are paying for something in advance. Basically, you are paying for something you are going to use later or in the future.
Your mortgage lender may ask you to prepay a couple of things as well. The most common and important items that will need to be prepaid are things such as mortgage interest, real estate taxes, homeowner’s insurance, hazard insurance, and private mortgage insurance (PMI).