Prepaids in a mortgage closing are upfront payments you make at the closing table to cover future recurring homeownership costs — mainly the mortgage interest that accrues before your first monthly payment, a full year of homeowners insurance, and your share of property taxes. They generally add 2% to 5% of the purchase price on top of your down payment and one-time closing fees. On a $350,000 home, that works out to roughly $7,000 to $17,500 for prepaids alone, and the number moves with your closing date, your property’s location, and your loan type.
How Prepaids Differ From Closing Costs
Both prepaids and closing costs land on the same document and both demand cash at closing, which is why first-time buyers mix them up. Closing costs are one-time fees for services that make the transaction happen: the appraisal, the title search, the lender’s origination charge. Once the deal closes, you never pay those again. Prepaids cover expenses you would owe anyway as a homeowner. You are paying them early so the lender knows the property is insured and the tax bill is current from day one.
The Closing Disclosure keeps the categories separate. One-time loan costs sit in Section F. Prepaids and initial escrow deposits sit in Section G under “Other Costs.”1Consumer Financial Protection Bureau. 12 CFR 1026.38 – Content of Disclosures for Certain Mortgage Transactions (Closing Disclosure) If a line item is in Section G, the money is going toward a recurring bill rather than a professional service. Discount points, which buyers sometimes confuse with prepaids, are not prepaids at all: they are an origination charge in Section F that permanently reduces your interest rate.
What Sits Under the Prepaids Line
Four categories make up almost everything you will see listed as a prepaid. Each one exists because the lender wants the property protected and current on its obligations before it funds the loan.
Prepaid Interest
Your first mortgage payment is not due until the first of the month after a full month has passed. Close on March 10, and your first payment is due May 1, covering April’s interest. That leaves 21 days in March where interest accrues but no monthly payment covers it. You pay that gap at the closing table as prepaid interest, sometimes called per diem interest.
The lender calculates the daily rate by dividing your annual interest rate by either 360 or 365 days, depending on the lender, then multiplying by the days remaining in the closing month. On a $300,000 loan at 7%, the daily charge is roughly $57 to $58. Close on the 5th and you owe about 26 days of interest, around $1,500. Close on the 28th and you owe three days, roughly $170. This is the most controllable prepaid on the entire disclosure, because you can shift it just by choosing a later closing date.
Homeowners Insurance Premium
Lenders require a full year of homeowners insurance to be paid before they will fund the loan. The logic is straightforward: if the house burns down in month two and the insurance has lapsed, the lender is holding a loan secured by rubble. Paying twelve months up front guarantees continuous coverage through the first year.
The premium depends on the carrier, the property’s location, the home’s age, and the coverage limits you choose. If the property sits in a designated flood zone, federal regulations separately require flood insurance to be escrowed for the life of the loan, which adds both a prepaid premium and ongoing escrow deposits.2eCFR. 12 CFR Part 339 – Loans in Areas Having Special Flood Hazards
Property Taxes
Property tax proration divides the current tax bill between seller and buyer based on the closing date. If taxes run on a calendar year and you close on September 1, the seller owes roughly eight months and you owe four. How that translates to dollars depends on the local tax cycle. Some jurisdictions collect twice a year, others quarterly, and a few still bill annually. Whether taxes are paid in advance or in arrears also matters. In an arrears jurisdiction, the seller may owe for months they lived in the home but have not yet been billed for, and the closing agent credits you for that amount rather than charging you.
The number to check is the daily tax rate the closing agent derives from the most recent assessed value. If a reassessment is pending, the actual bill could come in higher than the proration estimate, which is one reason lenders also collect escrow reserves on top of the prorated amount.
Mortgage Insurance Premiums
If your down payment on a conventional loan is less than 20%, the lender will require private mortgage insurance, and the initial premium often appears as a prepaid. FHA loans carry a separate upfront mortgage insurance premium of 1.75% of the base loan amount, paid at closing or rolled into the loan balance.3HUD.gov. Appendix 1.0 – Mortgage Insurance Premiums On a $300,000 FHA loan, that is $5,250, a significant prepaid charge buyers sometimes overlook when estimating cash to close.
Initial Escrow Deposits Are a Separate Line
Just below the prepaids on the Closing Disclosure is another group of charges labeled “Initial Escrow Payment at Closing.” These fund the same underlying bills as prepaids but do a different job. Prepaids cover costs already due. Escrow deposits build a reserve so your servicer can pay future tax and insurance bills on your behalf.
Each month, part of your mortgage payment goes into the escrow account. When the annual tax bill or insurance renewal comes due, the servicer pays it from that account. But the account starts at zero on closing day, and the first big bill might arrive before enough monthly deposits accumulate. To bridge the gap, the lender collects several months of escrow deposits up front. The exact number depends on when the tax and insurance bills fall due relative to your closing date.
Federal regulations also let the servicer collect a cushion on top of the minimum balance. That cushion cannot exceed one-sixth of the total estimated annual escrow disbursements, roughly two months’ worth.4Consumer Financial Protection Bureau. 12 CFR 1024.17 – Escrow Accounts The Closing Disclosure will show each escrow item as a separate line with the number of months collected and the monthly amount.
How Your Closing Date Shapes the Total
The biggest lever you have over prepaid costs is the closing date. Prepaid interest is the clearest example. Closing on the 28th of a 30-day month means two days of interest; closing on the 3rd means 28 days. On a $400,000 loan at 7%, that difference is roughly $2,000.
Closing later in the month does mean your first mortgage payment comes sooner. Close on September 28 and your first payment is November 1, barely a month away. Close on September 3 and your first payment is still November 1, giving you almost two months of breathing room. Neither approach changes the total interest over the life of the loan, so this is a cash-flow decision.
Property tax proration is less flexible. The closing agent uses the local tax rate and the assessed value as of the closing date. If the property was recently reassessed upward, your proration share will be higher. In an arrears jurisdiction, the seller’s share may appear as a credit to you rather than as an amount you pay out of pocket.
Reducing Prepaids With Seller Concessions
In many transactions, the seller agrees to pay part of the buyer’s closing costs and prepaids as part of the negotiation. The caps vary by loan type and are calculated as a percentage of the sale price or appraised value, whichever is lower.
- Conventional loans: The cap depends on your down payment. Buyers putting down more than 25% can receive up to 9% in seller contributions. Between 10% and 25% down, the limit drops to 6%. Below 10% down, the cap is 3%.5Fannie Mae. Interested Party Contributions (IPCs)
- FHA loans: Sellers can contribute up to 6% of the sale price toward closing costs, prepaids, and discount points.
- VA loans: The seller concession cap is 4% of the property’s reasonable value, and prepaid property taxes and insurance count toward that limit.
- USDA loans: Seller contributions are capped at 6% of the sale price and can cover eligible prepaid items and escrow funding.6USDA Rural Development. Loan Purposes and Restrictions
Seller concessions work best in a buyer’s market. In a competitive market, asking for 6% back on a conventional loan with 15% down is technically allowed but may make your offer less attractive than a competing bid with no concession request. A common middle ground is to negotiate a higher purchase price with a built-in seller credit, though the strategy only works if the appraisal supports the higher number.
What You Can Deduct Later
Not everything you pay at closing is deductible, and the rules differ by category.
Prepaid mortgage interest is deductible in the year you pay it, as long as the loan is secured by your principal residence and the interest was calculated as a standard per diem charge rather than disguised as an origination fee.7Internal Revenue Service. Topic No. 504 – Home Mortgage Points Discount points paid at closing, a separate line item from prepaid interest, are also deductible in the year of purchase if they were computed as a percentage of the loan amount and shown clearly on the settlement statement.
Property taxes paid at closing are deductible, but only the portion covering the period beginning on your purchase date. The IRS treats the buyer as paying property taxes from the date of sale forward, regardless of how the local jurisdiction assigns the lien.8Internal Revenue Service. Publication 530 – Tax Information for Homeowners For taxes held in escrow, you can deduct only what the servicer actually pays to the taxing authority during the tax year, not the total you deposited into escrow. State and local tax deductions, including property taxes, are subject to the federal SALT cap, which was raised to $40,000 (indexed for inflation) for tax years 2025 through 2029.
Homeowners insurance premiums on a personal residence are not deductible. The mortgage insurance premium deduction that previously allowed borrowers to deduct PMI and FHA mortgage insurance has expired and is not available for current tax years.9Internal Revenue Service. Publication 936 (2025) – Home Mortgage Interest Deduction