Prepaid Insurance

Most mortgage lenders require homeowners insurance to be in place and active before they'll fund the loan. As a result, buyers are typically required to pay at least the first year of homeowners insurance at or before closing; this upfront payment is the "prepaid insurance."

In addition to the annual premium, lenders often collect an initial deposit into your escrow account at closing, typically a couple of months' worth of insurance premiums, to ensure the account has a buffer before monthly payments start flowing in. Both the annual premium and the initial escrow deposit may appear as separate line items on the Closing Disclosure.

The total amount depends on the insurance policy you choose and your lender's escrow requirements, not a fixed number.

Prepaid insurance can be one of the larger upfront costs at closing, particularly in markets where homeowners insurance premiums are higher. Unlike many closing costs that are set by the lender or government, the insurance premium itself is determined by the insurance company you choose, which means shopping for homeowners insurance is one area where buyers can directly influence their closing costs.

Make sure your policy is bound and your lender has proof of insurance well before your closing date. It's a common last-minute requirement that can delay closings when it's not handled early.

A buyer's annual homeowners insurance premium is $1,800. At closing, the full $1,800 is paid to activate coverage for the first year. The lender also collects two months of insurance ($300) into the escrow account as an initial cushion. The total insurance-related closing cost in this example is $2,100. Going forward, a portion of the monthly mortgage payment funds the escrow account to cover future annual renewals.

"Prepaid insurance and the escrow account are the same thing."

Prepaid insurance refers to the annual premium paid upfront to activate your homeowners policy. The escrow account is the lender-managed account that your ongoing monthly mortgage payment funds, which the lender uses to pay future insurance renewals and property taxes when they come due. Both may involve insurance-related charges at closing; the Closing Disclosure explains each separately.