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Prepaid fees refer to fees that are paid in addition to other closing costs at the time of purchasing a home. The borrower makes this payment to the lender; the prepaid fees are then held in an account, and used to pay items such as hazard insurance, homeowners insurance, or private mortgage insurance. These represent recurring fees, rather than the other costs that are only incurred at the time of closing. Not all home buyers will be required to make these payments; generally, people who represent more of a lending risk, or who do not put at least 20 percent down will be required to pay.
The purpose of prepaid fees is to ensure that the new homeowner has enough money to pay his or her additional, recurring bills related to home ownership after making the purchase. Beyond simply the mortgage payment and taxes, it is necessary to add insurance such as homeowners and/or hazard insurance. In addition, anyone who did not put 20 percent down on the home is generally required to pay private mortgage insurance until the equity in the home reaches that important 20 percent mark. These fees can get costly over the first year, or few years, of ownership.
When prepaid fees are collected at closing, they are put in an account by the lender, and then used for paying the above mentioned bills. The required amounts can differ among lenders, and can also vary based on the cost of the house and the mortgage, but generally the prepaid fees will be covered for nine months to a year. It is in the best interest of both the borrower and the lender to make these prepaid fees part of closing, even though they can significantly increase closing costs.
This is because any borrower who does not put 20 percent down on the home, or who has a questionable credit score, represents a lending risk to the bank. Collecting prepaid fees, which may sometimes be referred to as prepaid items, helps to make sure that the new homeowner does not go into foreclosure. Ideally, it will not take long to get to 20 percent equity in the home, and at that point it will no longer be necessary to pay private mortgage insurance. Homeowners insurance is generally still required as long as there is a mortgage on the home, as well as property taxes and other expenses, so anyone purchasing a home should be sure to take these into account, even if the bank doesn't require prepaid fees.