Wealth Informatics

In 2010, we decided we will be buying a home in a couple of years. As a first time home buyer, all I knew was there would be a mortgage and a down payment.  We started with figuring out how much house we can afford and set up a goal to save at least 20% for the down payment. So far, so good. Now, we want this year to be the year we actually pull the plug on buying a home. So I have been attending some real estate seminars and reading more about the buying process.

I started hearing the phrase “closing cost” thrown around a lot. When I asked the folks teaching the seminar what exactly it was, all I got was “Oh it is a bunch of one-time costs you pay when you close the house, sometimes you pay the entire thing, sometimes if the seller is motivated they will pick up the costs”. Books and online articles were a little more helpful in refining the closing costs, but even then I couldn’t get an estimate on how much more these costs will be? How much should I save over than the down payment? Some sites said $1000 whereas some quoted 3-5%. That is quite a big range! I don’t want to get close to finding the house we like only to realize we don’t have enough money to close. So I decided to get as specific and possible.

(Update: We got pre-approved for a loan. During the pre-approval process we were asked to show proof that we can pay the 20%+Closing cost on our own to get the conventional loan. Good thing I had taken the time to figure out a ball park and save it along with the down payment. Otherwise it would have really complicated the process. So if you are planning to buy a home but are not planning to bundle the closing costs in the mortgage, know what the ballpark closing costs are.)

Here is a laundry list of costs that are all bundled together as simply “closing costs”.

Image source: Brianac37

Conventional loans closing costs explained

Part 1: Costs associated with the loan

• Origination fee: Fee charged by the bank to give you this loan. This fee covers charges like lender’s attorney fee, notary fees and document preparation fees.
• Processing fee/underwriting fee: Usually if they charge the origination fee, the processing fee and the underwriting fee is included in that. Otherwise, the processing fee is charged by the bank to process all your information for this loan. Underwriting fee is again, charged by the bank for researching whether they should approve this loan for you. Sometimes origination fee, processing fee, administrative fee and underwriting fee are used interchangeably.
• Discount points: To reduce the interest rate of your loan, some loans come with discount points. These are essentially prepaid interest. For example, if you pay 1% of your loan now, they will reduce the mortgage interest rate by 0.5%. This might be worth it if you are going to keep the house for the entire length of the loan.
• Loan application fee: Again, another fee to process your application. If you are paying an origination fee, negotiate this one away.
• Appraisal fee: The property you are buying has to be appraised to make sure the lender is not lending you more than the property’s worth.
• Document preparation fee: Another processing fee, to prepare the documents related to the mortgage. If you are paying an origination fee, this is probably included in that fee.
• Credit report fee: To get your credit report. Sometimes this fee is included as part of the application fee, some lenders charge this even before you apply for a loan.
• Flood certification fee: Fee charged by the lender to hire a third party to check if your property is in a flood zone. If the property is in a flood zone, along with the hazard insurance (the general home owner’s insurance), you will also have to purchase flood insurance before closing. This flood insurance cost is additional.
• Survey fee: This fee is charged to survey the property lines, shared fences, etc.
• Broker fee: If you are using a mortgage broker to shop for rates, the broker will probably add a fee for his service.

Part 2: Prepaid charges

• Daily interest charges: Partial monthly interest rate for the month you close. For example, if you close on May 15. You will have to pay prorated interest for the 16 days left in May. Your first payment will be in July.
• Private mortgage insurance: If you put less than 20% down, the lender will require you to get private mortgage insurance (PMI). The PMI protects the lender in case you default on your loan.
• Home owner’s insurance: To cover any damage to your home.

Part 3: Escrow/Reserves

If you put less than 20-25% (some lenders will waive the escrow at 20%, some will want the escrow until you have 25% equity) lenders will want to establish an escrow account. This escrow account will hold your property taxes, PMI and home owner’s insurance payments. The monthly payments are bundled together with your mortgage payment. But to start the account, they will want some buffer amount, which is usually 6 months worth of payments.

• X months (usually 6) worth of property taxes
• X months (usually 6) worth of mortgage insurance
• X months (usually 6) worth of home owners insurance
• Settlement/closing fees: Fees paid to the settlement or escrow agent to establish your account.

Part 4: Title charges

• Title services and lender’s title insurance: The lender wants to make sure they are the first lien holders in the property. So they will do a title check to make sure it is clear. They will also get the insurance, which you will have to pay for.
• Owner’s title insurance: Similar to the lender’s title insurance, this is for your own title protection.

Part 5: Recording and transfer charges

• Government recording charges: Fee charged by the local Government to record the sale of the property and the loan details.
• Transfer taxes: Taxes charged by the state and local Government on mortgage and sales. They can also be called real estate conveyance taxes, real estate excise taxes, mortgage transfer taxes, documentary stamp taxes and property transfer taxes. To find out how much tax you have to pay on the sales, check this list of transfer taxes by state.

Other fees paid during closing but not generally included as part of closing costs

• Buyer’s attorney fee: Not everyone will hire a real estate attorney. Some people want to make sure they are not missing anything in the hundreds (or even thousands) of pages of legalese, so they will hire a RE attorney.
• Home owner’s association transfer fee: To get into the new HOA, you will have to pay a transfer fee and all the back fees (if the seller has not kept his dues up to date).
• Home inspection fee: Home inspection is an absolute essential step in buying a home unless you are a licensed contractor and have the knowledge to inspect the home yourself.
• Pest inspection fee: It can be part of the home inspection, if not, the lender can require you get a pest inspection done.

Closing costs for FHA loans

The closing costs for FHA loans are similar to conventional loans. The only difference I could find was, there are a couple of extra closing costs (for >15 year loan term) –

• Upfront mortgage insurance premium (UFMIP): There are two parts to the FHA mortgage insurance, the first part is the upfront mortgage insurance premium. This one you pay when you close. The UFMIP is currently 1.75% of the loan value.
• Monthly mortgage insurance: This is similar to the PMI in a conventional loan, except, in case of an FHA loan, you pay this mortgage insurance for 5 years regardless of how much money you put for down payment or how much the property value changes AND the loan value should be less than 78% of the property. (If you are getting an FHA loan on/after June 3, 2013, the FHA monthly mortgage insurance will NOT cancel for loans starting with loan to value exceeding 90%. Translation: If you put less than 10% down, you pay this for ever. Even if you do put more than 10% down, you still have to pay the mortgage insurance for at least 11 years).

Closing costs for VA loans

Again, the basic closing costs are similar to the FHA/conventional loans. The additional fee that is unique for the VA loans is

• VA funding fee: This fee is established to offset the cost of the VA loan guarantee program. This fee can be paid at closing or included in the loan.

More information on VA loan closing costs.

Closing costs for USDA loans

The closing costs and fees for USDA loans are customary for the similar mortgage transactions (VA, FHA). The two additional fees that is unique to USDA loans are-

• Upfront guarantee fee: This guarantee fee is similar to the PMI, but paid up front. This can be paid by the borrower at closing or included in the loan. The current upfront guarantee fee is 2% of the loan value.
• Annual fee: This annual fee is applicable for the life of the loan. It is calculated based on the unpaid average balance and added to the monthly mortgage payment. The current rate for the annual fee is 0.4% of the unpaid balance.

More information on USDA loans.

Now that I know what these costs are, it is time to figure out how much each of these will cost me (buyer). Are any of these costs negotiable? Or can be passed off to the seller?

Estimate of closing costs + who pays and gets the money (buyer, seller, broker or lender)

The buyer pays all the closing costs. But depending on the loan, the seller is allowed to pay up to 3-6% of the closing costs. Some loans also allow the closing costs to be included in the loan (again, depending on the type of the loan and loan amount). The estimates are from my research. Make sure to get the Good Faith Estimate and the HUD-1 form from your lender for the exact cost you will be paying.

Also most closing costs are negotiable esp. if you shop around for a good mortgage deal.

It is best to shop around for a mortgage. Get at least 3 preapprovals and compare the rate & closing costs side by side. This is the closing cost worksheet we are using.

You can download the PDF of the worksheet here.

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