What do prepaid expenses include when setting up an escrow account?

Prepaid expenses in the context of an escrow account typically include costs that will be required in the future but are paid in advance by the borrower. Taxes and insurance are essential components of these prepaid expenses, as they protect both the lender's and borrower's interests.

When setting up an escrow account, lenders generally require borrowers to contribute a portion of their property taxes and homeowners insurance premiums upfront. This ensures that these obligations are met in a timely manner and that there are adequate funds available when these payments are due. By collecting these amounts as prepaid expenses, the lender can manage and disburse the funds appropriately, ensuring that property taxes are paid to the local government and insurance premiums are paid to the insurance provider without default.

Other options such as outstanding debts, closing costs, and property appraisals do not typically classify as prepaid expenses within the escrow context. Outstanding debts do not relate to future payments required by the escrow, while closing costs are one-time costs incurred at the time of closing rather than ongoing or future expenses. Property appraisals are also a one-time cost incurred prior to closing and do not represent prepaid expenses that would be managed through an escrow account for ongoing obligations like taxes and insurance.