Closing costs are the actual "hard" costs associated with obtaining financing:
- All lender or broker fees
- Loan processing fees
- Appraisal fees
- Title fees such as title insurance, courier fees, release fees, closing fees, etc.
- Government taxes and recording fees
Pre Paids are fees that are either paid in advance and/or placed in an escrow account to be paid on their anniversary due dates. There are generally only 3 items that fall into this category and they are:
- Home owners insurance premiums and/or escrows
- Property tax bills and/or escrows
- Pre Paid Interest
Pre paid items are not considered a true closing cost because you have to pay them whether or not you get a new loan. You will have to pay insurance on your house and pay your property taxes regardless of whether or not you obtain new financing.
Pre paid items do factor into your bottom line when obtaining financing, because you will have to setup a new escrow account for your new loan, or at least make sure they are current if you are not going to escrow them.
In the case of refinancing, you setup a new escrow account for your new loan, but you also receive a refund from your old lender for any funds left in your old escrow account. Therefore, for taxes and insurance, these items ultimately end up being a "wash" or break even. You are just transferring those funds from one escrow account to another, so it doesn't cost you anymore than it would if you kept your old loan with your old escrow account.
Explanation of pre paid interest:
Interest starts on your new loan the day your loan funds. Pre paid interest refers to the interest due on your new loan starting from loan funding day until the end of the current month. It is called "pre paid" because you are "pre paying" that interest at the closing table, whether you finance it into your new loan or pay it out of pocket. Your first mortgage payment picks up where pre paid interest leaves off.
For Example, if you close 5 days before the end of June, you will have 5 days of pre paid interest due at closing, you will skip your July 1st payment, and your first mortgage payment due on August 1st will include all the interest for the month of July. Interest on mortgages is paid in arrears, so your current payment always includes the interest due from the previous month.
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