What Are Pre-paid Expenses And Escrows & What Do They Have to Do with Closings?

There are several intimidating definitions when it comes to real estate.  PMI, FHA, VA, closing costs and amortization are just a few of the acronyms and terms that create clouds of uncertainty for homebuyers and sellers.  However, as intimidating as these terms may seem, their explanations are relatively simple.  Most of the time, it just takes a quick call to your realtor to understand how these terms fit into the crazy labyrinth known as a real estate deal.  William Tierney, an agent in our Scituate, MA office, discusses a few important real estate terms-specifically, Pre-paid Expenses and Escrows and how they both fit into the closing process.  Read on…

Closing costs typically refer to fees charged by lenders and third parties. Pre-paid expenses and escrows are also included in closing settlement statements and are frequently referred to as closing costs, although they are actually a separate category.

Pre-paids

Pre-paid expenses are items that must be paid at closing but actually cover a future time frame.  Common pre-paid items are insurance and interest. Homeowners insurance has a 12-month premium that must be paid in advance. Some buyers submit payment for the amount directly to the insurance company in advance of the closing, while others do so at the closing.  Interest is another pre-paid item.  Mortgage payments are commonly paid in arrears, meaning that they cover a past month.  For instance, if you buy real estate January 15th, your first mortgage payment would be due on March 1st, and it covers the month of February.  So there is no payment covering January 15th-31st.  The interest for that period is charged at closing as pre-paid interest.

Escrows for Home Purchases

Escrows are payments placed in a holding account, known as an escrow account, and disbursed when needed. They are set up to cover regularly billed expenses such as private mortgage insurance (PMI), real estate property taxes, and property insurance. Each month, as part of the monthly mortgage payment, a certain amount is placed into the escrow account. When PMI, taxes, or insurance payments are required, the appropriate amount is removed from the escrow account. This serves two purposes. First, it removes the hardship of borrowers having to budget for the large fees. Secondly, the lender ensures that the bills are paid, which preserves their interest in the home. Escrows are not offered by all mortgage companies, but it is common for mortgages with small down payments.

The cost of pre-paid expenses and escrows may vary based on the season or time of month. Closing close to the end of a month will minimize pre-paid interest. Pre-paid taxes and escrows will depend on the municipality and when tax bills are issued. If minimizing funds required for closing is critical, discuss the time frame with your real estate broker and mortgage broker. For additional information or guidance on the above, check out Bill Tierney’s  website and blog at http://williamtierney.net/ or email at William.Tierney@Raveis.com.

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