Prepaid items vs. closing costs--

What's the difference?

There's no doubt that mortgage closing disclosures can be confusing.

There are very few instructions to explain the forms, and the documents bear some, but little, resemblance to the Loan Estimate.

The areas that can be most confusing to homebuyers are in Sections F and G known as:

• "Prepaids"

• "Initial Escrow Payment at Closing"

What does prepaid mean?

Prepaid items are exactly what the name implies - payments made in advance of the monies due to obtain your new loan.

These amounts are often necessary to fund what's known as an "escrow" or "impound" account for property taxes and insurance. Lenders often require homeowners, especially those with less than 20 percent down, to have escro accounts associated with their mortgage loan. This means homeowners pay an additional amount each month to an account administered by the lender.

An escrow account on behalf of the lender lowers the its risk by making sure the home is protected. No liens for missed taxes should occur, and property insurance coverage protects the lender's collateral.

What are prepaids on a mortgage?

When it comes to mortgage loans, there are several different types of prepaid items, the most common are:

• Homeowners insurance premium paid up front as well as into an escrow account

• Real estate property taxes paid into an escrow account

• Mortgage interest (also known as per diem interest) that accrues between the closing date and month-end

Prepaid items: taxes and insurance

Typically, one full year of homeowner's insurance is collected and prepaid to your insurance company at closing. Alternatively, some homeowners choose to pay this amount prior to closing.

An additional cushion for homeowners insurance, along with property taxes, are collected and placed into an escrow account. This is so your new lender can build reserves and have enough to pay those bills when they come due.

Prepaids: mortgage interest

Mortgage interest is collected as a prepaid item so the lender can apply it to your first mortgage payment. This way, no matter which day of the month you close, the lender has at least 30 days to enter your data into its system, and issue your first statement.

The amount of interest required varies depending on what time of the month you close your loan. Some homeowners close at the end of the month so that it reduces the interest accrued in advance of your first monthly mortgage payment.

A common misnomer is "skipping a payment." The feeling of skipping that first payment comes because you've paid the first payment at closing, in advance of it actually coming due.