What are Prepaid Expenses?

When you obtain a home loan, there are several categories of prepaid expenses you will need to plan for.

Prepaid expenses include prepaid interest, prepaid property taxes and prepaid homeowners insurance.

Prepaid Interest:

When you pay your monthly rent, you are paying for future use – that is you write a check on the 1st of July for use of the premises for the month of July. When you pay your mortgage payment on the 1st of July, the interest that is included in your payment is for June’s usage of your loan money.

When you obtain a mortgage, the mortgage loan is likely to close on a date other than the 1st of the month. For example, if your loan closes on June 15, then your closing costs will include interest on the loan money from June 16-30 and you will not make a mortgage payment on July 1 – your interest has been prepaid for the portion of the prior month as part of the loan transaction.

Prepaid Property Taxes:

Property taxes in California are set up with a July 1 – June 30 assessment period. One-half of the property tax assessment is due and payable on November 1 of the assessment year, and the final half of the property tax assessment is due the following February 1 of the assessment year.

If your loan closes on 6/15, you are 15 days away from the end of the property tax assessment period and the prior homeowner has paid the property taxes for this period. If you have an impound account, you will see a calculation for 6 months of property taxes that are prepaid and deposited into your impound account to ensure that the funds are available in the account when the 1st half of your property tax bill becomes due on November 1.

Prepaid Insurance:

Two forms of homeowner’s insurance payment will be collected as part of your closing costs – the total premium due for the first year of insurance plus the equivalent of 2 months insurance cost.

The 2 months of insurance is prepaid into your impound account to ensure that when the renewal bill comes due the following year, sufficient funds will be available to allow the bank to pay the premium.