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Understanding Closing Costs

January 24, 2018

Most homebuyers know there are more expenses than just the mortgage – like mortgage insurance, homeowners insurance, taxes, and remodeling costs, but one vital expense that often gets overlooked is the cost of closing a mortgage loan.

Closing costs are the various charges associated with the mortgage transaction that are above and beyond the purchase price of the property or loan amount. Sellers have to pay some closing costs too – they usually pay a commission to the real estate agent, which is a percentage of the total sale price.

Buyers’ closing costs, on the other hand, can involve a variety of different fees including:

  • Title work – This means a title company will do a bit of research on the title – making sure there are no liens, claims, etc. Once the title company confirms there are no encumbrances, they will issue a title policy.
  • Appraisal – An appraisal is a written estimate of a property’s market value and is based upon what other properties are selling for in an area, the property’s condition and features such as the size, number of rooms, and architectural features.
  • Home inspections – A home inspector visually inspects a home for immediate or potential problems. The inspector will provide a report detailing any issues with the property and recommendations for further evaluation.
  • Credit reports – This is a detailed report of an individual’s credit history.
  • Recording fees – These are fees charged by a government agency for recording or registering a real estate transaction, so the sell/purchase becomes a matter of public record.
  • Origination fees and points – No one works for free. As a mortgage lender, we charge to cover the cost of processing the loan.
  • Title insurance – There are two types of title insurance policies – owner and lender. Just as lenders require fire insurance and other types of insurance to protect their investments, nearly all institutional lenders also require title insurance [a loan policy] to protect their interests.
  • Reserves for taxes and homeowners insurance – Reserves are extra money lenders require a homebuyer to have in the bank at closing. For example, if a lender says a buyer needs three months’ reserves, they are usually saying they need three months of mortgage payments in the bank.

That said, the total closing costs for your home loan will vary depending on your situation and your state or municipality. You won’t know exactly what these costs will be right away, but within three business days of application you’ll receive a Loan Estimate, which includes an estimated amount of closing costs.

The total amount of closing costs will be provided by your lender at least three business days before your closing. This information will be included in your Closing Disclosure, which is similar to the Loan Estimate but contains additional details on the costs associated with your mortgage.

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During this three-day window before your closing, you’ll have time to ask your lender any questions you may have about your mortgage and closing costs. Typically, a buyer pays all of the closing costs associated with a transaction. Depending on your state laws, however, the seller may end up paying a portion of the buyer’s closing costs.

If you are looking to save on closing costs, or don’t want to or cannot pay closing costs out of pocket, you may have a few other options:

  • You could negotiate a “credit” with the seller, stipulating the seller pay some of the buyer’s closing costs.
  • You may qualify for a credit through the lender. In this case, the lender will help cover your closing costs, but this may result in a higher interest rate.
  • You may qualify for Down Payment Assistance (DPA), which is a down payment and closing cost assistance program that helps qualified homebuyers close on their mortgage loans. Both the buyer and home being purchased must be eligible.
  • You may be able to utilize a Mortgage Credit Certificate (MCC) designed to help first-time homebuyers offset a portion of their mortgage interest on a new mortgage as a way to help qualify for a loan. As a tax credit, not a tax deduction, a MCC helps you reduce your annual taxes dollar for dollar. The mortgage credit allowed varies depending on the state or local government issuing the certificates, but is capped at a maximum of $2,000 per year by the IRS. MCCs can often be used alongside another down payment program.
  • If you’re a first-time homebuyer, your lender may offer you a first-time homebuyer credit.

So, long story short, you can either pay the closing costs up front, or pay them as part of your mortgage. In many cases, it’s best to speak to a loan professional to discover which option is best for your unique situation and loan type.

Also, it’s important to keep in mind you will need to pay closing costs when refinancing your mortgage. Many homeowners overlook this cost when planning for their refinance.

In total, your closing costs typically range from 2 to 4% of your mortgage loan amount. But while closing costs are a necessary step to achieving homeownership, you can rest assured your money will be invested wisely – because you will begin building equity that will benefit you and your family in the future.