Closing Costs Explained

It is a common misconception that a down payment is the only expense when buying a home.  There are additional expenses paid at closing commonly referred to as “closing costs”.  When buying a home, the closing costs need to be paid by the buyer or negotiated to be paid by the seller.  Whether or not the seller is willing to pay the closing costs will depend on market conditions.

If you are doing a refinance, depending on your lender, it may be possible to roll the closing costs into the loan amount and pay them over time as part of your mortgage payment.

Closing costs will typically be 2-6% of the home’s purchase price depending on where you live. Some areas have higher taxes or recording fees that drive up the closing costs. Other areas may be in a flood zone or high-risk area which increases the amount of homeowner’s insurance needed to be paid. You may even choose to pay “discount points” to reduce the interest rate on your loan.

Typical Closing Costs

Home appraisal

Third-party report that determines the market value of the home you want to purchase.  This will determine the value that the bank uses for the home.  Based on your loan type, the most you can borrow as a mortgage is 95-97% of the appraised value.  If the appraisal is lower than what is needed for your mortgage, a new sales price must be negotiated, or any difference must be paid by the buyer.  Most appraisals cost about $600 but will vary depending on your location.

Home inspection

Third-party report that checks for any repairs that need to be made to the home.  You can ask the seller to make the repairs or discount the home price to compensate for the items on the inspection.  The number of repairs or amount of compensation is typically negotiated between the buyer and seller.

Credit report

The credit bureaus charge a fee for the lender to pull your credit.  The lender pays this during the application process and then charges it back to you at closing.  Credit report fees are around $50.

Origination fee

This is the fee for the lender to process and underwrite your loan, also called “points”.  Your origination fee is typically 1% of the loan amount.

Discount points

Each discount point is equivalent to 1% of the loan amount and is used to buy down the interest rate.  It is also known as prepaid interest.  The longer you plan to live in your house, the more it will make sense to use discount points.  The discount on the interest rate will vary by loan program.  Have your loan officer show you the breakeven point to determine if discount points make sense in your scenario.

Title Search

This is paid to the title company for doing the research to determine if the current owner is the actual owner and to make sure no one else has a claim on the property.  Any issues on title are extremely rare.

Title Insurance

Lender’s title insurance protects the bank in case there is a claim on the property in the future.  If you want to protect yourself if there is a future title claim not found during the title search, you can purchase optional owner’s title insurance.

Recording fees

These fees are charged by your local government to record the deed and deed of trust (mortgage) in their records.  This is typically small is most counties.

Transfer Tax

This is charged by your local government similar to a sales tax.  This can vary greatly by county and range from several hundred dollars to several thousand dollars.

Escrows

If you have your bank pay your homeowners insurance and taxes, they hold reserves so they can make the payments.  As you pay your mortgage each month, it will increase the reserves so the full amount can be pulled out of your escrow when due.  When you sell or refinance your home, any remaining balance in your escrow account will be returned to you.  If you refinance don’t spend it too quickly, they will basically take it back to establish a new escrow account.

Homeowner’s insurance

This is paid to the homeowners insurance provider.  Most insurance providers require 1 year to be paid in advance.  The amount coming from your escrows pays for the next year in advance.

Conclusion

This is designed to give you the basic definitions of closing costs to help you understand these industry specific terms.  If you have any questions about your specific situation, you should consult with your mortgage loan officer.  You can also check out DubbleUpp to see if you qualify for a no money down and no closing cost loan.