I’m Looking At My HUD-1 Settlement Statement: What Is A Closing Cost and What Is A Prepaid Item?

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Signing mortgage paperwork can be unsettling for people. No matter how many times a person has signed a HUD-1 Settlement Statement in their lifetime, there's something about that form that makes them mentally drop on the deck and flop like a fish.

Settlement statements are confusing, no bones about it.  And for good reason:

• The HUD-1 is cryptic. It doesn't come with line-by-line instructions like an IRS form
• The HUD-1 bares no little resemblance to its "preview" -- the Good Faith Estimate
• Most people never see HUD-1 Settlement Statements  but for their own closing(s)

However, the settlement statement section that repeatedly confuses homeowners the most is the one known as "Prepaid Items".  A "prepaid item" is exactly what its name implies -- a payment related to the mortgage, collected before the payment's actual due date.

There are 10 types of prepaid items, listed in Sections 900 and 1000 of the settlement statement. The most common ones are:

• Advance mortgage interest paid from the closing date to month-end
• Real estate taxes paid into an escrow account
• Homeowners insurance paid into an escrow account
• Dues paid to a condo or homeowners association

More simply, prepaid items are home-related costs that would have been due anyway -- new home loan or not.

Prepaid items on a settlement statement are costs not related to the process of getting a mortgage. This is what distinguishes them from closing costs on a settlement statement.  By contrast, closing costs are fees assigned by lenders, title companies and governments.  They are incurred only because of the new home loan.

For rate shoppers, this is an important distinction. It simplifies comparisons.

Because prepaid items are paid irrespective of lender choice, Sections 900 and 1000 of a Good Faith Estimate can be specifically excluded from your comparisons.  In addition, excluding Sections 900 and 1000 has the secondary impact of thwarting loan officers that understate their prepaid items on purpose to make their respective GFEs look "cheaper".  If you ignore prepaid items anyway, sales tactics like that won't fool you.

Settlement statements won't get simpler for the layperson but separating closing costs from prepaid items may.  Just ask yourself: "Is this a charge that I would have to pay anyway, even if I wasn't starting a new mortgage?"

If the answer is "yes", the charge is a prepaid item.