I think what you describe is what you see on a Truth-in-Lending disclosure (TIL) that you have received. TIL calculations compute the “amount financed” by taking the loan amount and subtracting the “pre-paid finance charges.” Then the amount financed in combination with the payment stream over the term of the loan is used to calculate the Annual Percentage Rate (APR). For all practical purposes APR is nothing more than a statistic used to disclose to consumers the cost of credit. APR is the interest rate on the loan plus the loan’s closing costs in one number (APR).
Note: Pre-paid finance charges do not include escrows for taxes and insurance. That is a different use of the term “pre-paids.” The pre-paid finance charges are a very specific subset of closing costs defined in the TIL act. Not all closing costs are prepaid finance charges.
Often when a lender is paying your closing costs they may include the closing costs they are paying in the pre-paid finance charge when calculating the APR. While this may be technically incorrect and could overstate the APR, an overstated APR is not a regulatory problem. An understated APR is.
The good news is that including the closing costs paid by the lender in the pre-paid finance charges used in calculating the APR does not result in you paying the fees twice. It just results in a slightly overstated APR. The amount you should pay at closing is the actual fees less the fees paid by the lender. Then, after closing, you pay interest on the unpaid balance of the loan at the rate and terms included in your note…not at the APR.