Closing Costs 

What to Expect And How to Pay for Them

I regularly council people that wish to purchase a home and the topic of closing costs must be mentioned in the process. Many times, people are somewhat shocked when all items are added up and they see the bottom line. Here are the categories of costs to expect:

·        Costs associated with the loan

·        Third party fees

·        Prepaid items

Loan costs

Also known as points and fees. A point is 1% of your loan amount (e.g. for a $500,000 loan, 1 point will equal $5,000). Paying points, or a fraction of a point, can reduce your interest rate and thereby reduce your monthly mortgage payment. This is an option I always present when it comes time to lock the rate. I also run a break-even analysis so show the borrower how long it will take to recoup the upfront cost of the point(s) paid. This option is best in a low-rate environment, however. If rates are at historical highs, you may well refinance before you break-even, rendering the money you spent for rate reduction “as tossed out the window.”

All lenders impose an underwriting fee. This can be paid by the borrower or financed into the rate. If you finance it, you will take a higher interest rate for the life of the loan, probably not the best idea. When bankers offer to “finance” something, who do you think benefits the most? Probably not you.

Beware of "junk fees." This can be an administrative fee, a processing fee, or something named a “miscellaneous” fee. America’s Home Loans has none of these but read your Initial Loan Estimate carefully. These will usually appear on page two at the top left. 

Third Party Fees

If an appraisal is needed, the appraiser will charge you an appraisal fee. The fee will depend on the property and area where the property is located. This fee can vary wildly and be anywhere from $600 to over $2,000. 

Title and escrow fees are another third-party fee. There is lender’s title insurance, an escrow fee, an owner’s title insurance policy, a notary fee and a recording fee. There are also some small items that get added such as an environmental protection lien. When all of these are added up, this category can easily surpass $3,000 or more on a purchase transaction. Be prepared. 

Lastly are pre-paid items

You will secure hazard insurance for your home and pay up front for the first year’s coverage. Because of recent disasters in California, an insurance policy may run anywhere from $1,500 per year to over $10,000 depending on location and approximate cost to rebuild the structure. When a client is looking at a property and wishes to make an offer, I strongly recommend that they consult with their insurance representative before going any further. This cost can be a real gotcha if you wait until the end of the home buying process.

Pre-paid interest is next. Depending on when your escrow closes, your lender will collect interest on the mortgage from close of escrow through the last day of the month in which it closes. You will not make a payment typically on the 1st day of the next month, but  on the 1st day of the next month since mortgage payments are always “in arears” or you pay for the prior month that you owned the property. 

Property taxes are next. If you elect to have impounds (property taxes and insurance as part of your monthly payment), then your lender will collect sufficient property tax and insurance reserves up front and put them into an account on your behalf and continue placing money each month into that account so that there will be sufficient funds to pay your property tax bill and your insurance when they come due in the future. If you elect not to have an impound account, your closing costs can be significantly reduced—but you’ll have to pay your property taxes on your own which are due in November and February of each year and your annual insurance premium for a full year on the anniversary of the purchase of your home. 

Paying for these can be done in a few ways. 

·        You pay them

·        You get a seller credit to pay for them

·        Your lender can provide a credit to help 

If you pay them yourself, expect these fees to be part of your funds to close (Downpayment + Closing Costs).

A seller credit can be asked for when you make an offer (e.g. your realtor places into your offer a clause that states “seller to credit buyer 2% of purchase price for closing cost”). Remember, you can always ask.

A lender credit can be obtained as well. This will mean taking a higher interest rate at close in exchange for a sum of money credited to you at close of escrow. There is no magic formula to calculate this since it changes on a day-to-day basis. You need to discuss and negotiate this with your loan originator when you lock your rate.

You can also mix and match any of the above to help with the initial costs of buying a home.

Knowing what to expect before you start the home-buying process is massively important and often overlooked. Many loan officers fail to bring the subject up at all and simply hope for the best. I prefer the educational route to bring my clients fully up to speed and make certain they understand every element of the home buying-process before they start looking at houses.

If you need any clarification, give me a call

Scott