Closing costs are payments needed to finalize a home loan, separate from the down payment. Discover the purpose of closing costs, how to pay them, and more by clicking on the information below.
What Happens at the Closing?
The “Closing” is the final step in buying and financing a home, where the property is officially transferred from the seller to you. During this process, you and all other parties involved in the mortgage loan transaction sign the necessary documents.
Who is Present at Closing?
Closing may include various entities such as real estate agents, your attorney, the seller’s attorney, lender’s representative, title and escrow firm representatives, clerks, secretaries, and other staff. This process can take anywhere from one hour to several hours, depending on contingency clauses in the purchase offer or any escrow instructions needing to be executed.
The Role of Professionals
Most of the paperwork during closing or settlement is handled by attorneys and real estate professionals. Your involvement in some closing activities may vary based on who you are working with.
Final Inspection
Before closing, you should conduct a final inspection, or “walk-through,” to ensure requested repairs have been completed and agreed-upon items, such as drapes and lighting fixtures, remain with the house.
Settlement Process
In most states, a title or escrow firm completes the settlement. You provide all materials, information, and the appropriate cashier’s checks or bank wire to the firm, which then makes the necessary disbursements. Your representative will deliver the check to the seller and give you the keys.
What are Statutory Closing Costs?
Statutory closing costs are expenses you must pay to state and local agencies, even if you buy a house with cash and don’t need a mortgage:
Transfer Taxes
Some localities require transfer taxes to move the title and deed from the seller to the buyer.
Deed Recording Fees
These fees cover the cost for the County Clerk to record the deed and mortgage, and to update the property tax billing information.
Pro-Rated Taxes
Property taxes may need to be divided between the buyer and seller since they are due at different times of the year. For example, if taxes are due in October and you close in August, you would owe taxes for two months, and the seller would owe for the other ten months. Pro-rated taxes are usually calculated based on the number of days, not months, of ownership. Some lenders may require you to set up an escrow account to cover these bills. If not, setting one up yourself can ensure you have funds set aside for these important expenses.
State & Local Fees
Other state and local mortgage taxes and fees may apply, depending on the location of the property.
What are Third-Party Costs?
When purchasing a property, there may be expenses paid to third parties such as agents, attorneys, inspectors, or insurance firms, even if you pay cash for the property:
Attorney Fees
Hiring an attorney when purchasing a home can be beneficial. They typically charge a percentage of the selling price, often up to 1%, or may work on an hourly basis or for a flat fee.
Title Search Costs
Your attorney usually performs or arranges for a title search to ensure there are no obstacles, such as liens or lawsuits, regarding the property. Alternatively, you may work with a title company to verify a clear property title.
Homeowner’s Insurance
Most lenders require prepayment of the first year’s premium for homeowners insurance, sometimes called hazard insurance. Proof of payment must be shown at closing to ensure the investment is secured even if the property is destroyed.
Real Estate Agent’s Sales Commission
The seller typically pays the real estate agent’s commission. If one agent lists the property and another sells it, the commission is usually split. The commission is negotiable between the seller and the agent.
What are Lender Charges?
When obtaining a mortgage, various lender charges may apply. Here’s a breakdown of the common fees you might encounter:
Origination Fee
This fee is for processing the mortgage application. It can be a flat fee or a percentage of the mortgage loan amount.
Credit Report
Most lenders require a credit report for you and your spouse or an equity partner. This fee is often included in the origination fee.
Points
One point equals 1% of the loan amount. Points can be paid when the loan is approved, either before or at closing. These points can be negotiable and shared with the seller. Financing points adds to the mortgage cost, but paying them upfront makes them tax-deductible in the year they are paid. Different rules apply for second home loans.
Lender’s Attorney’s Fees
These fees cover the attorney’s work in drawing up documents, ensuring the title is clear, and representing the lender at closing.
Document Preparation Fees
Lenders may charge for preparing documents throughout the home-buying process, from application to closing. These fees might be included in the application or attorney’s fees.
Preparation of Amortization Schedule
Some lenders provide a detailed amortization schedule for the full mortgage term, usually for fixed or adjustable mortgages.
Land Survey
A survey ensures the property hasn’t been encroached upon and verifies buildings and improvements. This may be required by the lender.
Appraisals
Professional appraisers compare the property’s value to recently sold neighborhood properties to ensure it’s worth the mortgage loan amount.
Lender’s Mortgage Insurance (PMI)
If your down payment is 20% or less, you may need Private Mortgage Insurance (PMI). This protects the lender if you default. PMI premiums usually continue until your principal payments and down payment equal 20% of the selling price, and may continue for the life of the loan. These premiums are typically added to your escrow account.
Lender’s Title Insurance
Despite a title search, many lenders require insurance to protect their investment. This one-time premium is usually paid at closing and covers the lender, not the homebuyer.
Release Fees
If the seller has a contractor lien on the house expecting payment from the sale proceeds, release fees might apply. The seller usually pays these fees, but they can be negotiated in the purchase offer.
Inspections Required by Lenders
Lenders may require specific inspections, such as a termite inspection for FHA or VA loans. In rural areas, a water test may be needed to ensure an adequate water supply. Additional inspections might be required depending on the sales contract and property type.
Prepaid Interest
Interest costs begin at closing, though the first regular mortgage payment is typically due 6-8 weeks later. The lender calculates the interest owed for this period, and it’s often due at closing.
Escrow Account
Lenders often require setting up an escrow account for taxes, homeowner’s insurance, and sometimes PMI. The amount deposited at closing depends on when property taxes are due and the timing of the settlement. The lender provides a cost estimate during the mortgage application process.
What can be some other Up-Front Expenses?
When buying a home, several up-front expenses may arise besides the deposit or binder you make at the time of the purchase offer and the remaining cash down payment made at closing. These can include:
Inspections
Lenders may require inspections, and you can make your purchase offer contingent on satisfactory completion of other inspections, such as structural, water quality, septic, termite, roof, and radon tests. These inspection fees can be negotiated between you and the seller.
Owner’s Title Insurance
Purchasing title insurance protects you against unforeseen problems, ensuring you’re not left owing a mortgage on a property you no longer own. A thorough title search helps confirm a clear title.
Appraisal Fees
You may want to hire an appraiser before signing a purchase offer or after reviewing the lender’s appraisal report.
Money to the Seller
Pay for items in the house you want that weren’t negotiated in the purchase offer, such as appliances, light fixtures, drapes, lawn furniture, or fuel oil and propane left in tanks.
Moving Expenses
If your new employer doesn’t cover relocation costs, consider expenses such as truck rentals, professional movers, and utility deposits like telephone, cable, electricity, etc.
Repair Expenses
In the purchase offer, request the seller set up an escrow account to cover major cleanup, radon mitigation, house painting, appliance repairs, etc. Depending on the purchase contract and contingency clauses, you may encounter these expenses upon moving in.
Example Scenario
If your purchase offer contract includes a satisfactory structural inspection clause and the house needs a new roof, you can negotiate with the seller. The seller might arrange for the work, delaying the closing date, or you may agree to a higher house price or share the repair costs. Alternatively, the seller might reduce the sale price, but you’ll still need cash for the roof.
Time Investment
Don’t overlook the time and expenses invested in house-hunting, which can take up to four months, plus the time spent searching for the best mortgage, real estate agent, attorney, and other related tasks. These activities require a significant time investment.
What is RESPA?
The Real Estate Settlement Procedures Act (RESPA) provides important information about the settlement or closing costs you may encounter when buying a home. Here’s what you need to know:
Loan Estimate
Within three business days of your mortgage application, your lender must provide a “Loan Estimate.” This document outlines the estimated settlement or closing costs based on their understanding of your purchase contract. It helps you understand how much cash you’ll need at closing to cover prorated taxes, the first month’s interest, and other settlement costs.
Purpose of RESPA
RESPA ensures transparency in the home-buying process, helping you understand the various costs involved. It aims to protect consumers by requiring lenders to disclose important information upfront, allowing you to make informed decisions about your mortgage and closing costs.