Understanding Closing Costs
Home buyers are generally responsible for making a down payment on a home as well as paying closing costs. These closing fees typically run between 2% and 5% of the home purchase price. Understanding more about what makes up these fees, will help you to compare rates and fees across lenders as well as minimize costs.
Closing costs have three different categories of fees. These include lender fees, third party fees and escrow fees.
Lender fees are costs the bank charges for underwriting the loan. Third party and escrow fees are not expenses the lender controls. Be aware that negotiating fees, could result in an increase in interest rate. If you only intend to stay in the home a few years, minimizing fees is the strategy that will save you the most money. If you plan to stay in the home for an extended number of years, then the lower interest rate is more valuable than lower fees.
Lender Fees that are common include:
- Origination fee is generally 1%. This fee can be negotiated but the rate will adjust to accommodate any adjustment. A par interest rate includes 0 points and a 1% origination.
- Discount points. This is the most negotiated fee. When you add discount points you are said to be “buying down the rate.” You can choose to have higher closing costs in order to secure a lower fixed rate. This can be a profitable strategy if you plan to stay in the home for a long time.
- Mortgage application fee. Sometimes the credit report fees are rolled into the application fee.
- Credit report fee is charged for gaining access to the three credit bureau reports
- Appraisal Fee is a third party fee, but lenders generally order the appraisal and you are not permitted to choose your own appraiser.
Third Party Fees are costs that are charged by someone other than the bank. You have the ability to compare prices among vendors, which gives you the ability to find the lowest cost.
Third Party Fees that are common include:
- Attorney Fees. Most loans must close with an attorney.
- Inspection Fees of the property. Common inspections include a home inspection which helps the buyer and bank evaluate the condition of the home and a pest inspection which looks for termites. This is generally required by the lender, but you can select your own inspectors.
- Survey which shows exactly where your property lines are. This may or may not be required by the lender, but is highly recommended to prevent property line disputes.
- Title insurance which protects the lender in the event there are issues with the title and is required by most lenders.
- Title search and filing fees. In addition to attorney fees you will be charged by the attorney for the title search, to ensure clean title, and filing fees which are paid to the city/county to record the deed in your name and secure the lien for the lender.
Escrow is a separate account that is established by the bank to pay your annual property taxes and home insurance. When the account is established they will generally collect money up front to establish the escrow and upfront payments.
Home Insurance is often paid a year in advance and then monthly payments are collected each month so when the next bill comes around there is enough in the account to cover the payment. You are able to compare rates among insurers and select the company you want to work with.
Property Taxes. The seller will be responsible for paying for the months they own the home and you will pick up the difference. The escrow account will collect a few months upfront and then will collect payments monthly to cover the taxes as they become due.
A base amount is collected at closing to establish the account. Lenders want several hundred dollars in the account above and beyond actual expenses because the amounts will fluctuate from year to year. Even if you have a fixed rate mortgage, the escrow payments may adjust depending on current rates.
If you choose not to establish an escrow account, most lenders will charge you a fee for waiving escrow.
Ways to Reduce Closing Costs
Ask the Seller To Pay. When negotiating the price of the home, you can request that the seller pay part of the closing costs. This can increase the sales price of the home, while reducing the amount you must have for closing.
Lenders will sometimes add the closing costs to the loan amount. To be successful the appraisal must be adequate to cover the sales price and closing costs, or have a large enough down payment.
A no closing cost mortgage is another option. In this case the lender will offer a higher interest rate, in exchange for closing costs. It will reduce the amount you need to close the loan but will cost you more in interest payments over the long run.
When you make an offer on a home, you must receive a Good Faith Estimate (GFE) within three days. As you look over the fees consider what numbers you have control over and which ones you don’t. This will help you more accurately compare rates across lenders and ensure you have enough funds available to close the loan.