Monday, June 10, 2013

What Are Closing Costs?

Sometimes first-time home buyers are fortunate enough to have a twenty percent down payment, whether through savings or gifting. Most, however, rely on FHA's low down payment (3.5%) program. In either event, however, they'll hear the term "closing costs" tossed around by their lender, broker and others. And since changes happen, even seasoned buyers and sellers are often surprised at what they find at closing.

Closing costs are a very big deal for first-timers, though. That's because their cash reserves often are tight. FHA loans permit the seller to pay up to six percent of closing costs, so it's a no-brainer to ask for them in a purchase offer. 

From the seller's point of view, though, a buyer asking for closing costs amounts to a six percent discount (or whatever the buyer requests) off the asking price. And asking for closing costs may limit the buyer's ability to negotiate the price of the home, which adds stress in the current (in many places) seller's market. It's problematic to offer 95% of the asking price and ask for closing costs besides.

So, what are closing costs?

1. Lender loan fees, discount points, etc.: The first is the Loan Origination Fee, usually shown as a percentage of the loan amount. Sometimes, it's a flat fee. It varies by lender.

Next  are "Points." One point equals one percent of the loan. If you pay points upfront (discount points), it's because your lender is charging fees to give you a lower interest rate (also see YSP, below).

You should also see fees or or points charged by your mortgage broker, who has shopped your package to several places to try to find you the best program. Or should have, if he/she isn't lazy!

2. Other loan charges: If you didn't have to pay the appraiser up front, you will see an Appraisal fee. The lender will also charge a fee for obtaining your credit report. An inspection fee can appear, especially if there were repairs that had to be made before closing.

If you paid less than twenty percent down, you'll be required to have mortgage insurance. Some mortgage insurers require an application fee. Some don't.

You may also see an item on your HUD-1 closing statement saying, "Yield Spread Premium," or YSP. If your mortgage broker has matched you with a lender's program whose terms and conditions are higher than "at par," your broker receives compensation. You don't pay it directly, but it  must be disclosed. The term "at par" simply refers to the lender's interest rate at which it will neither pay YSP or require discount points.

A less common fee but one which will increase over time is the Assumption Fee, which is what a lender charges when a buyer assumes the seller's existing loan. With rates at historic lows, more seller loans will be assumed as interest rates rise.

3. Lender Prepaids: The lender requires you, the buyer, to prepay certain items at closing. These are the Mortgage Insurance Premium (MIP), loan interest from the day of closing to the end of the month when closing occurs, and Hazard Insurance (really, the home owner's insurance policy you'll buy anyway). Depending on where the home is located, there may be a charge for Flood Insurance.

4. Impounds: As a buyer, your monthly payment will include Principal, Interest, Taxes and Insurance (PITI). Your lender will set up what's called an Impound Account to disburse your payment to each of these. Property taxes and hazard insurance are generally paid once per year, so your lender may require some prepayment of these. Also look for HOA charges to show.

5. Title, Settlement and Related: Someone will act as the Settlement Agent, the person who has prepared the documents, calculated the charges for both sides and administers the closing. Often, this person is the Escrow Officer, but some states don't have escrow. In any event, this person or firm must be paid, and the fee will appear. Very often a fee for Document Preparation (you'll hear "doc prep") is also levied. Some documents have to be notarized, so you'll also see a Notary Fee.

Title: If Title seems complicated, that's because it is, and it's a topic for a separate post. You'll see charges for title search, which looks for recorded and unrecorded claims and exceptions that could affect clear title. You already will have been given a full Preliminary Title Report showing the results of this search. Sometimes, charges for this work are included in the Title Insurance Premium.

Title insurance: The Seller is required to insure title for the buyer, and the price is determined by the sales price. The buyer is required to insure title for the lender for the amount of the loan. Charges for both will appear on the HUD 1 for Buyer and Seller. Also, you may see charges for Endorsements that some lenders require which generally expand coverage. These vary widely, so ask for an explanation.

Less common are Attorney Fees, but sometimes, an attorney may act as the Settlement Agent. 

6. Other Fees: These could be Survey Fees, Inspection Fees, Recording Fees, Transfer taxes, and others. Most aren't very big, but $50 here and $75 there can add up. Sometimes, Homeowner Associations charge a fee when a property transfers to cover internal costs.

Some jurisdictions have Transfer Taxes, which is a tax required when title to real property changes from one person to another. This tax can be significant. The seller often pays, but not always, and it's a charge that may have to be negotiated. Surveyors aren't cheap, either, but whether or not there's a survey probably depends on local practices.

7. Real Estate Sales Commission: This item is likely the biggest charge for the seller and is usually  but not always, shown as a percent of the sales price. The disbursement to the buyer's agent and the seller's agent is shown. While it's true that  the payment of the sales commission is usually deducted from the seller's proceeds, buyers tend to think they aren't paying a commission. They need to think again. That purchase price is funded with the buyer's mortgage and down payment.

Buyers and sellers won't necessarily see all of these fees, but they might. They could also see charges not noted here, as local conditions vary and as rules and regulations are refined and created. But the above is a good snapshot and offers an insight into what closing costs are.

Details of specific charges to specific loans notwithstanding, there's a larger point, here: Shop around for a mortgage loan.

Thoughts or comments? Let me know!