PREPAID AND NONPREPAID ITEMS
So far, we've discussed one-time charges you may incur when buying your condo, co-op, or townhouse, but there will also be costs you'll see over and over again that you'll need to know about. They are called “prepaid” charges.
Closing costs are divided into two categories: prepaid or nonprepaid, sometimes called “recurring” and “nonrecurring” fees, respectively.
Nonrecurring, or nonprepaid, fees are the one-time costs for an appraisal or attorney. Recurring, or prepaid, costs are things such as property taxes, insurance, and even interest that is prepaid when you go to the closing.
You will continue to pay these fees over and over again for as long as you own the property. If you have escrow or impound accounts — where you pay a portion of your annual tax bill each month so that you'll have automatically paid your taxes by the time they come due — you'll need to set those up when you go to closing. Your lender will collect three months worth of property taxes at closing to set up the escrow account. The two extra months worth of taxes are a reserve just in case property values increase and your tax bill at the end of the year is higher than anticipated.
If your annual property tax bill is $1,200, that means one month's taxes equals $100. Three months of taxes to establish an escrow account means you will be coming to the closing table with $300, in addition to the nonprepaid items mentioned earlier.
Finally, prepaid interest will be collected at your closing. Prepaid interest is determined by the number of days up to the following month multiplied by the daily interest that accrues.
For instance, if you dose on the 20th of the month, the lender will collect interest from the 20th to the 30th (or 31st). This acts as your first mortgage payment; you're just paying it early.
Mortgage interest is paid in arrears, which means that each time you make a mortgage payment on the first of each month you're paying for the number of days you owned the property in the previous month. It's the opposite of rent, which you pay ahead of time.
Some people may tell you to close toward the end of the month because it saves you money. They're talking about accrual of interest. If you closed on the last day of the month you would only need to bring in one day's worth of interest instead of 10 days worth, had you closed on the 20th.