Understanding Closing Costs
When you buy or refinance a home, you incur closing costs. Lenders also require you to pay certain costs of homeownership upfront. Here’s what you can expect to see on your closing statement.
- Lender charges
- Other closing costs
- Prepaid homeownership costs like taxes and insurance
You can reduce your out-of-pocket costs for these items by having the seller or lender cover them. The tradeoff may be a higher purchase price or mortgage interest rate.
What Are Closing Costs?
Closing costs are fees that cover services and products associated with a home purchase or a mortgage refinance. You pay them to the mortgage lender or third party providers like an appraiser (for an appraisal) or the county (for recording the transfer of title and the mortgage lien).
List of Closing Costs
There’s a long list of closing costs, all of which are itemized on the standard Loan Estimate form. But the main (most expensive) fees to be aware of are:
- Origination fee or broker fee (0-1% of loan amount)
The lender or broker charges an origination fee to cover processing, underwriting, courier services, loan officer pay, and more.
- Mortgage points or “discount points” (0-1% of loan amount) —
This fee is an OPTIONAL amount that you can pay to lower your mortgage rate.
- Processing and/or underwriting fee ($300-$900 each)
Some lenders separate out these fees instead of including them in an origination charge. The fee covers loan processing paperwork and underwriting services.
- Title search and title insurance ($300-$2,500+)
Title companies charge to check historical records and make sure the property can be legally transferred to you and to insure your title.
- Escrow fees ($350-$1,000+)
A third-party escrow company administers the funds, oversees the final signing and facilitates the legal property transfer and recording of liens.
- Home appraisal ($500-$1,000+)
Fee for an appraiser to evaluate the home’s fair sale price or refinance value.
Government-backed mortgages also require an upfront insurance premium or ‘guarantee fee.’ This covers all or part of the cost for the federal government to insure your loan.
- FHA loan — Upfront mortgage insurance premium (1.75% of loan amount)
- VA loan —VA funding fee (1.4% to 3.6% of loan amount)
- USDA loan — Upfront mortgage insurance fee (1% of loan amount)
These premiums are technically part of your closing costs on an FHA, VA, or USDA loan. But you’re allowed to roll them into the loan balance (even on a home purchase loan) and most borrowers choose this route to avoid the extra upfront charge.
Most people include prepaid items in their closing cost total. However, these are not technically closing costs paid to the lender or anyone else for services.
They are the costs of homeownership. Anyone who owns a home pays property taxes and homeowners insurance (if they are smart) and HOA dues if applicable.
However, a mortgage lender does require you to pay some of these upfront when you have a mortgage. That’s to ensure that they do get paid and that the lender is protected. It does not want to see your home burn down without insurance because you will probably not pay the mortgage and the lender will have no house to sell.
Normal prepaid items are one year of homeowners insurance premiums and two property tax installments (that usually covers six months of taxes).
The Down Payment Is NOT a Closing Cost
The down payment is an amount that goes toward the purchase of the home. If you put down 10%, you get equity in the amount of 10% of the home value. So you are not paying a fee; you are just paying money for equity of equal value.
Closing costs are moneys paid for services or products, like your mortgage and title insurance, so you can buy or refinance a home. You don’t get a tangible asset in exchange for those expenses, althoughthey are necessary.
Prepare for Closing Costs
Piotr Bieda of GCA Mortgage Group and an expert in helping first-time homebuyers said the following:
The sooner you start to budget and put money away, the easier it will be to cover your closing costs. Some buyers find it helpful to utilize budgeting apps such as Mint to keep track of spending habits and are making their finances work for them.
There are ways to reduce or eliminate out-of-pocket closing costs.
- Shop for costs you can control.
- Get the lender to cover them.
- Ask the seller for concessions.
Note that you’ll pay more for your loan and probably for your home to offset this. But your out-of-pocket costs can be managed.
Each loan program allows sellers concessions by home sellers to cover buyer’s closing costs. Most of our borrowers at Gustan Cho Associates do not have to come out of pocket for closing costs. It is normally covered with a seller’s concession by the home seller.
Here is the amount of sellers concessions allowed:
- HUD allows up to 6.0% sellers concession for FHA loans
- The VA allows up to 4.0% for VA loans
- USDA allows up to 6.0% for USDA mortgages
- Fannie Mae and Freddie Mac allow up to 3.0% for owner-occupied properties and 2.0% for investment homes
- Non-QM loans allow 2.0% to 6.0% seller’s concessions
It should not matter to a seller if you ask for 5% in concessions or a 5% price reduction. As long as the appraisal supports the selling price, the lender should have no issue with it.
Another source of closing cost help is your lender. Lenders can cut or eliminate your out-of-pocket closing costs with rebate pricing. Rebate pricing involves taking up the interest rate a bit so that the lender can afford to pay your closing costs and perhaps even your prepaid items for you.
For instance, it might cost you a 1% origination fee to get a 3% interest rate on a 30-year mortgage, and zero to get a 3.125% mortgage rate. But what if you’re willing to pay 3.5% or even 4%? The lender might be able to rebate 3% back to you for closing costs. Note that you can’t get your rebate as cash; your lender will apply it toward closing costs and prepaid items only.
Ask an Expert
If you’re worried about affording your home closing costs, ask your lender. At Gustan Cho Associates, we are experienced in helping borrowers minimize closing costs and get into their first home.