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What Are Closing Costs?
Closing costs are the costs associated with finalizing a real estate transaction. They include costs associated with the loan, title, and legalities of the deal. Costs may include title searches and insurance, taxes, deed recording fees, credit report charges, appraisal fees, origination fees, discount points, and more. The exact closing cost inclusions will vary depending on the state where the real estate is located.
The closing costs are implemented when the title is transferred to the buyer. Typically, homebuyers will pay between 2 percent and 5 percent of the purchase price. However, the closing costs can legally be paid for by either the buyer or the seller.
The law requires lenders to give a loan estimate that states the closing costs on the property as well. This loan estimate must be provided to the borrower within three days of the loan application being taken by the lender. Also, at least three days before the closing, the lender should always give a disclosure statement that outlines all of the closing fees. The fees may have changed and the final fees will be provided on the disclosure statement.
Origination fees are the fees that a bank charges in order to create the loan. Usually, the origination fees will be around 1 percent of the mortgage. In addition, if your down payment is less than 20 percent of the purchase price, you will have to pay an additional fee for private mortgage insurance.
Title insurance will protect the lender from any claims against the house. It also protects the buyer from past contractors making claims. Lenders will typically also require an appraisal. Local governments have recording fees and taxes. These fees by the local government are issued so that they can record the real estate transaction. The transfer taxes differ depending on the state.
The application fee is another one you can expect to see on the disclosure. This is charged by the lender so that they are able to process your application for the mortgage. You may also see an attorney fee. This is the fee that is charged by a real estate attorney for reviewing and preparing the real estate transaction agreements and contracts. Not every state requires an attorney for a real estate transaction. You may also notice that there is an escrow fee, also called a closing fee. This is paid to the title company, escrow company, or attorney that handles the closing of the real estate transaction.
The credit report fee and courier fee are also typical for a real estate close. The courier fee helps to expedite the transportation of paper documentation. You will not have to pay a courier fee if you are closing on the property digitally. Some lenders also require a deposit that covers two months of mortgage insurance and property tax. This will be called the escrow deposit.
You will also have to pay homeowner’s insurance and homeowner’s association transfer fees. A lender often requires the homebuyer to pay the first year for the homeowner’s insurance premium at the closing of the deal. If you are purchasing a townhouse, condominium, or a property in a planned development you have to join the homeowner’s association and pay a transfer fee at closing. This transfer fee is associated with the costs of switching the ownership of the property.
Finally, you will have fees associated with the title. There will be an upfront fee paid to the title company that protects the lender from ownership disputes. There is also owner’s title insurance which is often optional, but recommended because it protects the homebuyer if someone challenges your legal ownership of the property. Title search fees will be charged for the analysis of property records. They do this to ensure there are no discrepancies about the ownership of the property like liens or disputes.
Who Pays Closing Costs?
Generally the buyer will pay the bulk of closing costs, but the seller will contribute to the costs as well.
Buyer
The buyer is responsible for all of the costs that are related to the loan itself. They are also responsible for the property costs and any insurance policies that may be required. It is common for a fee to be associated with the mortgage process. This fee will also be the buyer’s responsibility.
In addition, the buyer will be responsible for property costs like the appraisal, home inspections, pest inspections, and prorated taxes and homeowner’s association fees. The buyer also pays for the prorated property tax. Keep in mind that most property taxes are tax deductible on your federal income tax. Check with a professional tax advisor to learn how to take advantage of these types of deductions.
Finally, if the buyer provides a down payment that is less than 20 percent of the purchase price, they will be required to pay for private mortgage insurance, or PMI. Typically, the provider will make you provide an annual premium upfront with the other closing costs. If you have an FHA, USDA, or a VA mortgage, you will have to put 1.75 percent down and then pay a monthly mortgage insurance premium instead.
Seller
The seller will typically cover any local taxes and fees on their end of the real estate deal. In addition they commonly pay part or all of other closing costs including the agent commission, transfer tax, title insurance, seller attorney fees, as well as any escrowed money that was initially promised to the buyer.
Additionally, the escrow fees are usually split evenly between the buyer and the seller. Escrow accounts are overseen by a third party. This third party will hold onto the buyers and sellers financial deposits until the property official changes ownership. This occurs at the closing. Then the escrow funds will be paid to the appropriate party or parties. The payment of escrow fees will be outlined in the purchase agreement. Sometimes, the fee is set as a flat rate while other times it is a percentage of the purchase price. The escrow fees cover the cost of the money transfers and other administrative costs.
How to Reduce Closing Costs
Closing costs can be expensive, but there are ways to limit the amount that you have to pay. These methods can help you focus on different aspects of the closing costs and address any costs that can possibly be reduced or even removed.
It is good to know which fees are negotiable and which are set in stone. Any fee that the government charges will be firm and non-negotiable. Some of the non-negotiable fees include tax service fees, stamp fees, recording fees, transfer taxes, property taxes, tax service fees, appraisal fees, and flood determination or certification fees. Conversely, the types of fees that are negotiable include homeowners insurance, title insurance, discount points, origination fees, and real estate commissions.
Loan Estimate Form
The loan estimate form is given to the borrower by the lender. It has to be given within three days of the completion of the mortgage application. However, you may be able to get it sooner than that, especially if you ask for it.
The loan estimate form will have a list of specific costs. It will include the amount on the loan, the interest rates, and the monthly payment amounts. Page two will include a section titled, “Services You Can Shop For.” This section will cover things like the pest inspection, survey, title search fees, settlement fees, and more. The loan estimate form includes the lender’s suggested vendors to use for these services.
However, you do not have to use these recommended vendors. In fact, you should at least compare other vendor’s prices, services, and fees before deciding whether or not to use the preferred vendors on the loan estimate form. Doing adequate research into additional vendors could potentially save you hundreds, or even thousands, at the closing.
Lender Fees
Lenders charge loan costs that are typically assessed at the closing of the real estate transaction. This will include origination and underwriting fees. You can try to negotiate with your lender to reduce these fees. Asking for a discount never hurts anything and it could save you money at the closing.
Furthermore, you may also save money by comparing more than one lender. Try to get estimates before the application is submitted. Compare multiple loan estimates from different lenders to compare.
Include Closing Costs in the Mortgage
A lot of homebuyers do not have the extra cash to pay for the closing costs, especially if they plan to use that money for moving costs, furniture, appliances, and more. If this is the case, you may want to ask your lender about different options. Many lenders will be able to include the closing costs as a part of the mortgage.
This will cost you more money in the long run because interest will be charged on the increased loan amount. This will also drive up your monthly payment even if it is only slightly more. However, for many homebuyers, this is a great option since they are already getting a loan for hundreds of thousands of dollars.
Close at the End of the Month
This may not always be convenient or even possible, but if you are able to close at the end of the month you could potentially save a lot of money on your first mortgage payment. This works by reducing the number of days on which the per diem interest is assessed before the first mortgage payment is due. Usually this payment is due at the beginning of every month.
To calculate the amount you would be able to save, take your interest rate. For example, if you have a 4 percent interest rate, you would use .04. Take this amount and multiply it by the total amount financed. This will be your annual interest expense. Now, divide this number by 365 to get daily interest. Multiply this number by the number of days remaining in the month. That would be the amount you would have to pay so of course the lower the number of days, the lower you will be charged.
Homeowners Insurance
Typically, you will have to pay at least 6 months worth of homeowners insurance when you take out a mortgage. It is a good idea to shop around for the best rates on the homeowners insurance. You could potentially save by bundling your homeowners insurance with your car insurance as well.
Discount Points
Discount points are a fee that you will pay upfront in order to lower your interest rate on the mortgage loan. .Generally, the points cost one percent of the loan amount. For example, a point for a $200,000 loan would equal $2000. You can buy these points to pay a higher fee upfront and secure lower monthly payments due to a decreased interest rate.
Furthermore, you may want to research lender credits. These are the opposite of discount points because they reduce your closing costs and increase your interest rate. You can use discount points and lender credits to adjust the terms of the mortgage. However, you need to be aware of the increased interest rates as you do so.
Origination Fees
These fees are associated with the process of the underwriting. The name of the fees may be different depending on the lender. This is the fee that is paid to a mortgage broker or loan officer for bringing the lending institution the borrowers business. Usually these fees are around one percent of the requested loan, but this does vary depending on the lender as well. The fee will be listed on the upper left hand corner of the second page on the loan estimate form.
It is possible to negotiate a lower origination fee. If you have a great or even a good credit rating, then it will be easier to get the origination fee reduced. In addition, you could also ask for a loan-processing fee that is set at a flat-rate. Sometimes, however, the lender will only accept a lower origination fee for a higher interest rate so be careful during your negotiations. Ask your lender if any of the aspects of the origination fee can be reduced or waived. You may also want to ask whether the lender bundles in the application fee with the origination fees. Some lenders do this while others do not.
Real Estate Commissions
Usually the real estate transaction will involve real estate agents on both ends of the deal. Usually, homebuyers do not have to pay for the real estate agent out of pocket. Usually these commissions are paid for by the seller.
Negotiating Closing Costs
So you know what costs can and cannot be negotiated, but you still need to know how to negotiate the fees in the right way. Never assume that you are getting the best deal without negotiating. There are some ways to help you in your real estate negotiations.
Compare Lenders
First, before you make any offer, you should always shop around for rates from multiple lenders. Then, you will have more knowledge that will help you gain leverage in the negotiation of the loan. Let the lenders know you want the best rates available, but are also considering the closing costs. This can help them match the rate with flexible pricing and closing costs. This does not involve negotiating the exact terms of the mortgage, but will help you see which lenders meet your qualifications when you are ready to make the offer down the line.
If you have a solid understanding of home loans, you will be in a better position to negotiate with lenders. You may even want to take a homebuyer’s education course. This can help you learn the entire process from start to finish. The Consumer Financial Protection Bureau is a great place to research information. They have mortgage interest rates for each area that you can compare with any lenders.
Credit Score
Your credit score is possibly the best tool for negotiation when you are buying a house. Lenders will even compete for the business of someone with a high credit score. Conversely, a low credit score does not give you much bargaining power. Improving your credit score is a fantastic first step to becoming attractive to lenders, but some people do not know how to adequately improve their credit score quickly. In addition to paying off all outstanding credit card debt, always avoid taking any new loans before the mortgage loan. Obtain a free copy of your credit report and set up plans or pay off anything that is listed.
Don’t Rush
Good negotiation takes a lot of time so you never want to hurry through the process. You may even want to take a day off of work to research and negotiate with the lender. Always be sure to leave yourself extra leeway between your offer and the targeted closing date. This will provide you with time to negotiate and respond to counteroffers before the deal needs to be finalized.
Junk Fees
Junk fees are sometimes high, but they may not have to be. It is a good idea to ask about them if they seem absurdly high. This may result in them being reduced or waived altogether. These types of fees include the underwriting fee, the application fee, mortgage rate lock fee, loan processing fee, and the broker rebate.
Estimate Your Closing Costs
To estimate your closing costs, you may want to check out the average percentage of the purchase price that closing costs make up in your state. Check out this spreadsheet for that information.
Typically, homebuyers pay somewhere between 2 and 5 percent of the purchase price in their closing costs. Therefore, for every $100,000, you will pay somewhere between $2000 and $5000 in closing costs. However, it is important to note that this amount can be drastically more or less depending on a number of factors such as location, loan value, lender, and more.
The closing costs are broken down into two categories. The property-related fees cover all the expenses that are incurred by the lender when they are evaluating the property. The mortgage-related fees are for administration and processing your application for the mortgage.Make sure that you speak with your lender about what you should be expecting to pay well before the closing.
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