We receive a lot of questions from borrowers regarding the prepaid items that go into their escrow reserves. Where do these prepaid items come from, and how will they affect your bottom line at closing? Here’s an explainer that addresses these and other questions.
Prepaid Items and Escrow Accounts
Escrow accounts are a common source of confusion among home buyers, as well as homeowners who are refinancing their homes. People usually want to know three things, above all else: What are prepaid items? How are they calculated? How much will I have to pay at closing?
Let’s start by defining some of the terms being used here.
- Escrow: An escrow account is basically a fund that is held for future payment. Specifically, these funds are used to pay for the homeowner’s property taxes and insurance premiums. They are typically funded each month, when the borrower makes the monthly mortgage payment.
- Prepaids: In a mortgage context, a “prepaid” item is exactly what it sounds like. It’s when you prepay money into your escrow account for a specific purposes. For example, a borrower might have to prepay a year’s worth of home insurance premiums. This is a prepaid item that goes into the escrow account.
You can think of an escrow account as an easy way to manage (and pay) the property taxes and homeowners insurance premiums associated with your home. Basically, you’re setting money aside for these real estate-related expenses ahead of time, so you don’t even have to think about it when they become due. When you make a monthly mortgage payment, part of it goes to the principal and interest that are due for that month — and the rest is used to fund the escrow account for taxes and insurance.
What Will I Need to Pay at Closing?
Prepaid items are different from other closing costs because you’re essentially paying for something that hasn’t happened yet — but will happen. But prepaids are paid on closing day in most cases, so you’ll want to prepare for them in advance.
Which leads to another common question: “How much money do I need to come in with at closing, to cover my prepaid items?”
This will partly depend on where you’re buying a home. The tax rates and other costs associated with prepaids can vary from one state to the next. If you work with Sammamish Mortgage, you can rest assured that we’ll give you a detailed list of prepaid items and other closing costs, well in advance.
The escrow account is usually set up when the home buyer closes on the mortgage loan (or possibly before that). The initial amount needed to fund the account will depend on the property taxes, the insurance premiums, and other factors.
Property Taxes Can Vary by State
Property taxes are one of the prepaid items that go into the escrow fund. They’re usually included within the monthly mortgage payment, and paid into escrow to cover future payments. These prepaid items can vary by location due to differences in tax laws and rates.
Here’s a look at the property taxes paid by homeowners, as a percentage of the home value: *
- Colorado: 0.59%
- Idaho: 0.75%
- Oregon: 1.01%
- Washington: 0.96%
* These numbers were obtained from the Tax Foundation in June 2018.
Learn more: Please let us know if you have questions about prepaid items for escrow and closing in Oregon, Washington, Colorado or Idaho. We can even present you with a closing cost estimate so you can plan accordingly.