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Understanding Closing Costs

One of the most common mistakes by new home buyers is underestimating the amount of cash (closing costs) needed to move into the home.  Most people wrongly assume all they need is the down payment.  Unfortunately, they do not consider the hard and soft closing costs of the services required throughout the home buying and mortgage qualifying process.  These items can quickly add up to a substantial amount, and if not planned for, ruin the transaction.

While each deal is unique, home buyers should be aware of and plan for the following cash outlay items when purchasing a home:

Non-Recurring Closing Closts

Non-recurring closing costs are those one time costs associated with the home buying and mortgage qualifying process.  These closing costs only occur once at the close of the transaction.  Typical non-recurring closing costs include Mortgage Points, Title, Escrow, Appraisal, Credit Report, Document Preparation, Property Inspection, Termite Inspection, Underwriting and other miscellaneous charges. 

Except for title and escrow, these charges are fixed and will not vary with the size of the transaction.  For a typical $200,000 purchase price, you should expect to spend between $1,700 and $2,000 for non-recurring closing costs PLUS any mortgage points you choose to pay.

  • Application Fee & Credit Report
    Imposed by your lender, the application fee covers the initial costs of processing your loan request, and usually includes a credit report check. The application fee with a credit report can range from $400 to $525. If it is handled separately, the cost for your credit report will be about $75 to $150. If you are self employed, you will also need a business report that costs between $50 and $100.
  • Appraisal Fee
    This fee covers an independent appraisal of the home you want to purchase. The lender requires this estimate of the market value of the house in order to make the loan. The appraisal fee varies depending on the purchase price and size of the home. For a $100,000 home, the minimum fee would be approximately $275.  
  • Documentation Fees
    Some lenders charge miscellaneous fees for various services, such as underwriting, processing and documentation preparation, which usually total under 1 percent of the loan amount.
  • Home & Pest Inspections
    A home inspection by a qualified engineer and pest inspection by a pest control specialist offer assurance that the home you are purchasing is structurally sound and free of termites and any related damage. The costs for these services vary depending upon the location and size of the property, and the professionals you choose.
  • Loan Origination Fees & Discount Points
    The origination fee is charged for the lender's work in evaluating and preparing your mortgage loan. Discount points are prepaid finance charges imposed by the lender at closing. Essentially, paying points is a means for the borrower to pay down the interest rate. Paying points can save thousands over the long term, so if you plan to be in your new home five years or longer and you have the cash up front, it's certainly an option to consider. One point equals one percent of the loan amount. For example, one point on a $75,000 loan would be $750. In some cases - especially with refinances - the points can be financed by adding them to the loan amount.
  • Survey
    At a minimum, the lender will require an independent verification from a surveying firm that no additional structures have been added to the lot since the last survey was conducted on the property. The lender may request a complete survey to ensure that the house and other structures on the property meet legal codes and regulations. Depending on the size of the property and the state you live in, surveys can cost between $250 to $450.
  • Title Fees
    In order to purchase a property, you must establish the seller's ownership and transfer ownership from seller to buyer. The following fees are required by a title search company to complete this process:
  • Document Preparation Fee
    This is usually a flat fee paid to the title company which can range from $50 to $200.
  • Title Search & Title Insurance
    It is necessary to prove to the lender that the seller owns the property you wish to purchase in order to get a loan. The title search provides this proof. The title search involves reviewing public records in local government offices, including recorders of deeds, county courts, tax assessors and surveyors. Records of deaths, divorces, court judgments, liens and contests over wills (all of which can affect ownership rights) must also be examined. The title search assures you and your lender that there are no claims against the property. The cost for a title search is based upon the purchase price, and may cost approximately $300 to $600. In addition to the title search, title insurance protects you and the lender from an error in the title search. Such an error could mean that the lending institution loaned you money to buy a house from someone who didn't own it in the first place. Lenders' title insurance is approximately .2 percent to .5 percent of the loan amount, paid by the purchaser. Owner's title insurance protects you from title search errors, and usually ranges between .3 percent and .6 percent of the purchase price of the home.
  • Government Fees
    Government-imposed fees are usually the most costly fees you will incur at closing. These include city, county and state transfer taxes, recording fees and prepaid property taxes.
  • Recording Fee
    This fee, which is paid to the title company, involves recording the transfer of title with the county clerk's office. Recording fees vary from state to state and county to county, however, each county sets a fixed price per page which is usually about $50.
  • Taxes
    Most states require that four to eight months' taxes be collected at closing and held in an escrow account. An escrow account is a reserve account set up by your lender in which you deposit enough money to cover the first few months of mortgage insurance, hazard insurance and property taxes. The purpose of the escrow account is to ensure that sufficient funds are available to cover these expenses once you've purchased your home.

Recurring Closing Costs

As the name implies, Recurring Closing Costs are those costs of homeownership that will recur over time.  While there will be an initial, upfront charge when the transaction closes, these items can be expected to continue in the future. 

Typical recurring closing costs include Prepaid Interest on the mortgage, Homeowners Insurance Policy, Real Estate Tax & Homeowners Fee Proration, and Mortgage Insurance Premiums.

Recurring Closing Costs vary widely depending on the size and timing of the transaction.  Typical costs on a $200,000 purchase with a $180,000 loan would run between $500 and $2,500.

  • Homeowner's & Hazard Insurance
    Homeowner's and hazard insurance offer protection against physical damage to your new home by fire, wind, vandalism and other causes. Most states require that the annual premium on your homeowner's insurance be paid in advance and put into effect at closing. Prices for homeowner's insurance vary depending upon the value of the home, the location and the insurance agency. For example, homeowner's insurance for a $200,000 property could cost between $600 to $700 annually.
  • Interim Interest or Daily Rate of Interest
    This cost is based upon your closing date and covers loan interest from the day you close through the end of the month. Therefore, it can range from 0-30 days' interest, payable to the lender.
  • Mortgage Insurance (PMI)
    Buyers who make down payments that equal less than 20 percent of the value of the house may be required by lenders and, in some states, by law to take out mortgage insurance. The policy covers the lender's risk in the event the buyer fails to make loan payments. Premiums are usually paid annually from an escrow or reserve account, or in a lump sum at closing. A buyer whose mortgage is insured by FHA or guaranteed by VA will have to pay FHA mortgage insurance premiums or VA guarantee fees.

Impound Accounts

In California, lenders are allowed by law to require you to set up an impound account if you put less than 20% as a downpayment.  Most will only require it if you put 5% or less down.  An impound account is an account that is set up with the lender to pay real estate taxes, home owners insurance and mortgage insurance.   The account is initially funded with up to 8 months of taxes, 14 months of homeowners insurance and 14 months of mortgage insurance.  You would then pay an amount into your account each month with your house payment equal to 1/12 of these charges.   In theory, the lender would always have 6 months reserve with which to pay your taxes and insurance. 

The amount of the impound account varies widely by the size and timing of the transaction and by the type of insurance you obtain.  On a typical $200,000 purchase with a $180,000 loan, impounds could range from $1,000 to $4,000.

Move In Costs

Move in costs are the closing costs associated with moving your belongings and setting up your new household.  Typical move in costs include moving vans, moving services, window coverings, painters, carpet cleaning, deposits for utilities and new household items.

Cash Reserves

It is very important that you feel you have a comfortable cash reserve upon moving into your new home.  Most lenders will require you to have between 2 and 6 months of house payments in liquid reserves when you close your transaction.

Summary of Cash to Close

Below is a "typical" list of cash items to close on the purchase of a $200,000 home with a 10% downpayment.  The mortgage is a 9.00% 30 Year Fixed rate mortgage that costs 1.0 points.

Down Payment $20,000
Non Recurring Closing Costs $2,000
Mortgage Points (1.00%) $1,800
Recurring Closing Costs $2,500
Impound Account $3,000
Move in costs $1,000
Cash Reserves (4 months) $6,500
TOTAL MOVE IN CASH $36,800

As you can see, the costs can quickly add up.  If they are not understood and planned for, they can ruin your dream of home ownership.

Minimizing Cash to Close

There are many "tricks of the trade" used to minimize the bite of cash to close.  Typical tricks include seller paid credits to the buyer, using mortgage service release premiums to pay for closing costs, timing the close properly and utilizing special home buyer programs. 

It is VERY important that you choose highly experienced mortgage and real estate professionals when you are purchasing a home.  A skilled mortgage professional can structure your transaction so as to minimize the above items.   In many cases, you can limit your cash outlay to the downpayment plus some incidental costs.

 


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