The most intimidating part of the home buying process for most buyers is closing. Rather than approach the entire shopping process dreading the finish, let’s break down closing costs and demystify the process.
Ignoring closing costs can lead to the two most common mistakes buyers make when trying to get a handle on the cost of a home: focusing exclusively on mortgage rates, or choosing a rate based on a verbal estimate of closing costs instead of asking for a “Good Faith Estimate” breaking down closing costs in writing. To avoid these mistakes associated with mortgage closing costs, you need to have a firm grasp of all the costs associated with closing.
Closing costs are an umbrella term for the fees associated with the buying or selling of a home. Some fees are automatically assigned to either the buyer or the seller; other costs are either negotiable or dictated by local or state law. Closing costs generally are not included in your loan amount.
It’s important to understand that closing practices differ widely from one place to another. In some localities, buyers and sellers are free to negotiate certain fees. In most states, buyers can cut costs by shopping around among providers of some of the settlement services.
This guide will provide you with information about the various types of closing costs charged by mortgage lenders so you know just what to expect on a Good Faith Estimate.
1. Mortgage Fees
At closing, you will deposit money into an escrow account. These funds often are called “impounds” and are used to pay your hazard insurance, mortgage insurance, and property taxes when they come due. Your escrow account will grow each month as you make your mortgage payments because a portion of your mortgage payment will be deposited into escrow. When your yearly insurance or taxes are due, your lender will then be able to pay the amounts with the money available in your escrow account.
Pre-Paid Interest: You will owe your lender interest for the number of days that you utilize your mortgage in the first month of ownership. For example, if you were to close on the first day of April, you would owe the lender 30 days of interest. The daily amount of interest is based on your interest rate. If your schedule allows, try to close at the end of the month in which you purchase, and you can minimize pre-paid interest costs.
Mortgage Insurance Premium: Lenders require Private Mortgage Insurance (PMI) where the loan amount is over 80% of the home's purchase price. The policy covers the lender's risk in the event the buyer fails to make the loan payments. A mortgage insurer, typically selected by the lender, determines the actual premium amount, which can cost you between $50 and $200 per month, depending on the balance of your loan and your PMI rate.
When you buy a new home, your lender will look at the amount of your down payment compared to the sales price to determine your loan to value ratio. So if you purchase a home for $200,000 and put $20,000 down, your loan to value ratio is 90% and you’ll be required to pay PMI.
2. Title Searches & Insurance
When a lender agrees to issue a mortgage for a piece of property, the lender must receive a guarantee that the property is indeed owned by the seller. Title fees pay the lender for the costs associated with determining the current owner of the property and legally certifying that the title information is correct.
Title Search: This is a fee charged by the title company or another party to search public records to determine if there are any liens on the property being financed. When it comes to houses, providing clear title is not a simple process.
In many parts of the country, public records affecting real estate title are spread among several local government offices, including recorders of deeds, county courts, tax assessors, and surveyors. Records of deaths, divorces, court judgments, liens, and contests over wills also must be examined.
Title Insurance: In addition to the formal title search, your lender is likely to require a title insurance policy to protect it against an error in the title search. Errors are rare, but they do occur.
The cost of the policy, usually a one-time premium, is usually based on the loan amount, and is typically paid by the buyer, although a split with the seller sometimes can be negotiated.
The title insurance required by the lender protects only the lender. To protect yourself against unforeseen title problems, you may also want to take out an owner's title insurance policy. Normally the additional premium cost is only a fraction of the lender's policy.
Make sure you shop around for title insurance, as premiums and the scope of coverage can vary widely. As a rule, look for a policy with the least exclusions from coverage as possible.
Title Exam: This fee, typically around $300, is charged by the closing attorney to examine the title to determine if there are any title issues such as breaks in the chain of title, or any unsatisfied mortgages, liens or judgments which have been recorded. Examinations also review the history of ownership, including all trusts, will and deeds associated with the property in the past. This is called reviewing the chain of the title, and inspects whether the property's ownership may be legally tied to anyone other than the current buyer and seller. The title examination fee goes toward the search, clearance of items, payoff ordering, title opinion and order processing.
Attorney Fees: In addition to the title exam fees, you may also be assessed attorney’s fees. This fee covers the attorney’s time spent resolving any title issues and preparing closing documents as well as the actual time spent conducting the closing. Expect to pay around $300-500 in attorney fees.
3. Lender Fees: Lenders charge different fees for assisting you in obtaining a mortgage. These fees vary widely from lender to lender, and some lenders may include all the fees listed or only a few. This list is a comprehensive view of all potential lender fees, which you can use to compare with your actual Good Faith Estimate.
Origination Fee: A fee charged by lenders to procure your mortgage loan. Most lenders charge an origination fee because it is an important source of income for the lender and helps to cover operational costs. The industry standard is 1% of the loan amount, but can vary.
Discount Fee: Discount fees, also known as “points,” are prepaid finance charges imposed by the lender at closing, to increase the yield to the lender beyond the stated interest rate on the mortgage note. One point costs one percent of the loan amount. In some cases the points can be added to the loan amount. You also can choose to pay them upfront to “buy down” your interest rate. The more points you pay, the lower the interest rate.
Application Fee: A fee which can vary in price up to $500, imposed by your lender to cover the initial costs of processing your loan request and checking your credit report. If the application fee includes the cost of the credit report, make sure you are not also being charged an additional credit report fee.
Processing Fee: A fee, generally around $300, to cover the costs of processing your loan. This fee covers preparing all of the information for your application, verifying information, creating documents to the lender’s specification and facilitating closing between the loan under writer and title when necessary.
Underwriting Fee: A fee, generally around $500, charged to determine if the lender is willing to lend you money based on your application for a mortgage. If you’re going to be using a mortgage broker, you shouldn’t need to pay this fee, because the broker isn’t doing any underwriting on your loan. This fee might be warranted, but only if you are getting a loan through a bank that underwrites loans.
Administrative Fee: This also is a fee, which varies widely from lender to lender, designed to cover the expenses of processing your loan. If you already are being charged for a processing fee, challenge any administrative fees, as they may arguably be duplicative.
Document Preparation Fee: Lenders will prepare some of the legal documents that you will be signing at the time of closing, such as the mortgage, note, and truth-in-lending statement. This fee, which can range widely, is charged by some lenders and covers the expenses associated with the preparation of these documents. It’s often waived though, so make sure to challenge this fee if it appears on your Good Faith Estimate.
Courier Fee: A fee, typically around $20, to cover the cost of sending your loan documents to different parties.
Wire Transfer Fee: Mortgage lenders generally wire the funds to the escrow company handling the loan closing. Funds are wired through the Federal Reserve System and done through commercial banks that are members of the Federal Reserve Bank. Usually, banks charge mortgage lenders a fee between $25 and $100 for the wire transfer service.
4. Third Party Fees
The lender will require some additional items that are paid to third parties. These can include the following:
Appraisal Fee: An appraiser will evaluate your home to determine its fair market value, and the fee is paid to the appraiser for the production of this report. An appraisal is an independent written opinion that identifies the property’s market value. This document is generally required by the lender’s regulator. The fee can vary widely depending on the type and location of the property, but you can count on paying as little as $300.00 or as much as $750.00. Depending upon market conditions, you might be able to get the seller to pay for an appraisal or split the cost with you. Make sure you ask for a copy of the appraisal report for your files.
Credit Report Fee: Your lender will order a credit report to determine your creditworthiness. A fee, typically $20-$25, is paid to the credit service agency to obtain the report.
Tax Service Fee: A tax service fee, typically around $50, is collected and paid to an outside source that monitors your tax account and alerts the lender to any unpaid tax bills. This fee is often waived by lenders so make sure you ask before paying.
Flood Certification Fee: A fee, typically less than $15, charged to obtain the government-required document used to determine whether the subject property is located in a flood plain. If a flood certification determines that your property is located in a "flood zone," an area in high risk of flood damage, then you’ll have to pay for that certification, and your lender will require you to purchase flood insurance.
Survey Fee: A licensed surveyor will conduct a survey of the property to make sure that your lot has not been encroached upon. At a minimum, the lender will require an independent verification from a surveying firm that your lot has not been encroached upon by any structures since the last survey conducted on the property. This more straightforward survey typically costs around $250. Sometimes the lender may insist upon a complete, and more costly, survey to ensure that the house and other structures legally are where you and the seller say they are.
Home Inspection Fee: This is a fee you actually want to pay, as having a thorough, professional home inspection prior to purchase is a must. The inspector will examine all the systems and structural features of the property. This includes checking the home’s roof, chimney, porch and any decks or other exterior features. The inspector will look for structural cracks in foundation walls and floor problems, will inspect the home’s wiring and electrical system as well as the heating and air systems and will examine all the major appliances in the kitchen and laundry rooms.
This means paying a bit more -- $300 or so – for a detailed inspection that takes several hours and is complete with a typed report and pictures, but it’s a great investment because it can head off much more expensive issues.
5. Recording Fees
When you purchase a home, the local government requires the changes resulting from the transaction to become public record. The government also collects the appropriate taxes.
Recording Fee: After closing, your mortgage and property transaction is recorded with the appropriate county. The county charges a fee to record the mortgage or deed of trust, typically around $50.
Intangible Tax: This tax, charged only in a handful of states, is typically paid by the borrower and is based on the mortgage loan amount at a rate set by state law. An intangible tax is imposed on the value of intangible assets such as mortgages, stocks, bonds, money market funds, and bank account balances.
Property Tax: This tax rate is dependent on the county where your property is located. Property tax is prorated between the buyer and seller at the closing.
6. Broker's Commission
Like many other people in the sales business, mortgage brokers work on commission. You can expect to pay 1% of the loan amount in commission, but remember that everything is negotiable. For example, you might explore taking a bit higher interest rate on your mortgage in exchange for your broker removing a commission charge, but only consider that if the math works in your favor.
Whew! That is a lot of fees. They certainly add up: as a general rule of thumb, closing costs will be about 3% of the price of the home, or in some relatively high-tax areas, 5% to 6%. You can chip away at some settlement costs by shopping around for the services and negotiating with the seller, your lender, and your attorney or settlement agent. Question everything, and once you have your Good Faith Estimate, go through it line by line with you realtor.