Prepaid Expenses and Escrow Expenses—What the Heck Are Those?

My name is Evan Kaufman, your VA loan originator, here to help explain.

When you get an initial loan disclosure, you’ll receive a loan estimate. On that loan estimate, there are two sections—F and G—that break down prepaids and initial escrow payments.

Later, when you get your closing disclosure (towards the end of the loan process or somewhere in the middle), it refines those numbers further, but you’ll still see sections F and G detailing prepaid expenses and escrow expenses.

Now, you might look at these and wonder, “what the heck are those?” You might notice costs for title and lender fees, which make sense, but then see prepaids and escrows and wonder what those mean.

Let’s start with prepaids.

Prepaids are, as the name suggests, expenses you’re paying in advance.

The main example here is insurance.

For instance, when you get a quote for home insurance, say $1,500 per year, you need to pay for the first year upfront. You’ll see that amount listed under prepaids unless you choose to pay for it separately.

If you pay it on your own, just make sure to provide us with an invoice or receipt so we can account for it.

However, if you’d like to include it in your closing costs, we can handle that too, and you’ll see the insurance amount in that section.

In addition to insurance, you’ll generally see prepaid interest and possibly prepaid taxes.

Taxes aren’t always listed right away, as they depend on the tax cycle, but if there’s a tax bill due, it may appear later in the process.

The key item here, though, is prepaid interest.

Prepaid interest covers the prorated interest from the time you close until your first payment.

Let’s say you close on October 30. Your first payment won’t be due November 1—it’ll be due December 1. But you’re still responsible for covering the interest for those final days in October. So, we’ll calculate a prorated amount for that period.

If you close earlier in the month, there will be more days to cover, and your prepaid interest amount will be higher. For example, closing on October 5 would mean you’re covering 25 or 26 days, so the amount will be larger. But remember, your first payment still won’t be due until December 1, covering the full month of November. This prepayment covers only the prorated days of ownership in the closing month.

To summarize, in section F (prepaids), you’ll usually see insurance, some prepaid interest, and possibly taxes, depending on the tax bill cycle.

Now, let’s look at escrows, which appear in section G on your loan estimate and final closing disclosure.

Escrows are an account we set up to build a cushion, covering taxes and insurance.

Typically, we’ll include about three months’ worth of payments for each, though it may be higher for taxes if there’s a large bill coming due. Think of escrow as a cushion—if you ever stop making payments, the lender or servicer has extra funds to cover taxes and insurance.

Fun fact: In most cases, you can waive your escrow account.

For VA loans, we can often make this request for you.

Waiving escrow means you won’t need to build up that cushion at closing, which reduces your initial cash needed. However, you’ll still be responsible for paying taxes and insurance on your own, and we’ll still need proof of a year’s worth of insurance, which we discussed in the prepaid section.

When you hear people say, “are you escrowing your account?”, they generally mean your mortgage payment includes principal, interest, taxes, and insurance in one payment.

We, as your lender or servicer, collect that payment, add it to your escrow, and then pay your tax and insurance bills as they come due.

The escrow on your closing statement usually reflects about three months’ worth of payments as a starting cushion.

If you sell or refinance your home in the future, whatever is left in your escrow account will be refunded to you within 30 days.

For those refinancing rather than purchasing, prepaids may differ. For example, the insurance prepaid amount may or may not be required, depending on where you are in the insurance cycle.

Prepaids and escrows can be a significant cost on your initial loan estimate and final closing disclosure. Sometimes, people are surprised by the size of the escrow account if their insurance policy is large, which can impact cash due at closing.

That’s why it’s essential to work closely with us to get an accurate idea of your prepaids and escrows. We can review your financials and give you an idea of what to expect for these costs.

My name is Evan Kaufman, and I hope this helps clarify prepaids and escrows. I’m here to help you win a home with your VA loan. Take care!