Closing Cost Basics
What happens at closing?
Statutory Costs and Taxes
Statutory costs are expenses you would have to pay to state and local agencies even if you paid cash for the house and did not need to take out a mortgage. They vary by state and county. They include the following: Transfer taxes are required by some localities to transfer the title and deed from the seller to you. These will vary by locale. Recording fees for deed pay for the county clerk to record the deed, mortgage, note and change the property tax billing so that it is updated. This is done for home purchase and refinance transactions Pro-rated taxes such as school taxes and county taxes may have to be split between you and the seller because they are due at different times of the year. In California there are mello roos taxes that are based on the city and county. Other states have their own version of such taxes that differ by locale. In the case of state taxes, if taxes are due in October and you close in August, you would owe taxes for 2 months while the seller would owe taxes for the other 10 months. Prorated taxes usually are paid based on the number of days (not months) of home ownership that has transpired. Impound Account requirements vary by lender and program. Escrow or impound accounts are created to insure that insurance and tax bills are collected. Whether impound accounts are required or not is based on the requirements of the loan. Not all loans require them, but a rate change may take place if they are not taken. If your lender does not require an escrow account, you may want to set up a special account on your own to make sure you have money set aside when “lump-sum” tax and insurance bills arrive. Other state and local fees can include mortgage taxes levied by states as well as other local fees that may be induced by local authorities..
Third-Party Closing Costs
Third-party closing costs are expenses paid to others such as appraisers, title insurance companies, or escrow companies. These expenses are required even if you pay cash for the house. Examples of third-party costs are as follows: Attorney fees: Attorney requirements vary by state. Most states do not require attorneys. Attorneys usually charge a percentage of the selling price (three-fourths or 1 percent), but some may work for a flat fee or on an hourly basis. If attorneys are required in your state, your realtor should have information that will help you answer your questions. Title search costs: The title company or your attorney will arrange for the title search to make sure there are no obstacles or encumbrances (liens, lawsuits) on the property. This is how the owner of the property is verified. Nothing could be worse than buying a home from somebody that didn’t actually own it! Home owner’s insurance: Most lenders require that you prepay the first year’s premium for home owner’s insurance (sometimes called hazard insurance) when you purchase a home. This helps to insure that their investment will be secured, even if the house is destroyed. Refinance transactions do not have this requirement. You will prepay some insurance if you set up impounds, but that is it in a refinance loan. Real estate agent’s sales commission: The seller pays the commission to the real estate agent. If one agent lists the property and another sells it, the commission usually is split between the two. It’s important to keep in mind that even the commission is negotiable between the seller and the agent.
Finance and Lender Charges
Most people associate closing costs with the finance charges levied by mortgage lenders. The charges you pay will vary among lenders, you may have to pay the following charges depending on your lender.: Origination or application fees: These are fees for processing the mortgage application and may be a flat fee or a percentage of the mortgage. You will pay points only if you are buying down your rate. Inspections (termite, water tests): In most purchase scenarios, a termite inspection is required. In many rural areas, lenders will require a water test to make sure the well and water system will maintain an adequate supply of water to the house (this is usually a test for quantity, not a test for water quality). Points: A point is equal to 1% of the loan amount borrowed. Points can help you buy the rate down and get a lower rate. Points are typically tax deductible, but different deductibility rules apply to second homes. Your tax adviser can clarify these points for you. Document preparation fees: You will see an amazing array of papers, ranging from the application to the acceptance to the closing documents. This fee covers the cost of drawing docs. Preparation of amortization schedule: This is not common practice anymore. Land survey: Some lenders will require that the property be surveyed to make sure that no one has encroached on it and to verify the buildings and improvements to the property. This is only used under special circumstances as an appraisal is usually enough for most lenders. Appraisals: This is how the value of the home is verified. Recent comparable sales from local homes are used to gauge your home’s value. Credit report: A credit report is required on all purchase and refinance transactions. This is how the lender gauges your creditworthiness. Private Mortgage Insurance: If your down payment is less than 20%, many lenders will require that you purchase private mortgage insurance (PMI) for the amount of the loan. This way, if you default on the loan, the lender will recover lost monies. These insurance premiums will continue until your principal payments plus down payment equal 20% of the selling price, but they may continue for the life of the loan. Release fees: If the seller has worked with a contractor who has put a lien on the house and who expects to be paid from the proceeds of the sale of the house, there may be some fees to release the lien. Although the seller usually pays these fees, they could be negotiated in the purchase offer. Escrow account: An escrow account or impound account is a fund into which you will make monthly payments for taxes, homeowner’s insurance, and PMI (mortgage insurance, if required). These monies are collected on a monthly basis and will pay your insurance and tax bills when they come due every six month. The goal is to have these monies put aside in small amounts every month versus having a large lump sum bill come due every six months. Prepaid interest:Your first regular mortgage payment is usually due about 6 to 8 weeks after you close (for example, if you close in August, your first regular payment will be in October; the October payment covers the cost of borrowing money for the month of September). Interest costs, however, start as soon as you close. The lender will calculate how much interest you owe for the fraction of the month in which you close (for example, if you close on August 25, you would owe interest for 6 days). In some cases this is due at closing. In a refinance transaction you will also owe monies to your old lender. In the previous example you would owe 25 days to your old lender. In a refinance you are typically paying about one month’s worth of interest in the transaction every time you refinance. This is offset by the first month gap in which you will NOT make a mortgage payment immediately after refinancing.