You’re ready to buy your house and you’ve saved enough for a down payment. However, there are key players in a home purchase transaction that perform duties that require the addition of closing costs in order to finalize your purchase which can be surprising to some buyers who had not planned on that expense. Let’s explore what mortgage closing costs are, why they need to be collected, some typical closing costs are, and how best to compare them.
What are Mortgage Closing Costs and Why Do I have to Pay them?
In short, closing costs are the items that need to be paid in order to complete the purchase of your home. Most buyers will the need the services of certain professionals in order to finalize the sale of their house, and the duties they perform constitute the closing costs. For instance, a Lender needs to hire qualified Loan Originators, Processors, Underwriters and Closers. A Title or Settlement Company will conduct a search to ensure you can legally buy the property and conduct the settlement, an Appraiser will ensure the price you’re paying is justified in the marketplace. Local Governments will collect a tax on the transfer of the property. Those services/items result in fees – Closing Costs.
Typical Closing Costs
Let’s take a look at the most significant and typical closing costs in Maryland, Virginia, DC, and Pennsylvania to gain a general idea of what they are, and what they could cost. This is by no means exhaustive, but rather a look at the major Closing Costs you may come across:
Lender Fees ($800 – $1200): It may not seem like it, but a Lender has to hire a tremendous amount of staff in order verify your information, process & underwrite your loan (and ultimately arrange for the funding of your loan). Whether they’re called Administrative fees, Processing / Underwriting fees it all boils down to this – it’s the cost to get your loan approved.
Discount Points; “Points” (Optional): This is the fee you may elect to pay for a lower rate than the market rate. 1 point = 1% of the loan amount.
Appraisal ($400 – $550): An Appraiser is used to complete a report to ensure that the price you are buying it for is justifiable in the marketplace. Appraisers are trained to look at similar homes that have recently sold to make sure that the collateral that’s backing up the loan (the home) is worth what you’re buying it for.
Title / Settlement Company Fees ($700 – $1100): Just like the Lender, a title company is hired to conduct the settlement, hire staff to do a title search to make sure there are no liens or items against the property which would hinder the transfer of ownership to you. They prepare settlement papers and oversee that funds are transferred to correct entities. This may be broken down into many sub categories such as Abstract, Title Examination, Title Commitment, Document Prep, Notary Fee, Attorney Fee or they could be wrapped into one all encompassing “Settlement Fee”.
Title Insurance (Dependent Upon Purchase Price / Loan Amount) – In short, Title Insurance protects against undiscovered liens or if someone challenges the rightful ownership of the property. There are two types – Owner’s Title Insurance which protects you as the Owner if an issue arises, and is not mandatory (although I highly recommend). There is also Lender’s Title Insurance which as you might guess protects the Lender if an issue arises and is almost universally required when you are obtaining a mortgage to buy a property.
Transfer Taxes & Recording Fees (Dependent Upon Purchase Price & Jurisdiction)- Government will always get it’s piece of the pie. The local City, County and/or State collects a transfer tax based upon the purchase price of the home. The Recording Fee is the cost to record the transfer of ownership with the local jurisdiction.
Miscellaneous (less than $100) – Other smaller fees are typically collected such as a Credit Report fee, a Flood Certification to verify whether the home is in a flood zone or Employment Verification which some employers charge to the Lender in the course of verifying where you work.
While you don’t need to understand the nuances of each of these items, it’s good to have a general understanding of what these typical closing costs are – if for no other reason than to be aware that they need to be paid. Credits in the form of a Lender Credit (for accepting a slightly higher rate) or a Seller Credit can help offset these items.
Comparing Closing Costs
It can seem daunting to compare two loans against each other, however I would like to offer up what I believe is the easiest way to compare loans.
First, disregard items on a Good Faith Estimate which will not vary – regardless of which lender is chosen. In short, those are Government fees (Transfer Taxes & Recording Fees). No lender has a special relationship with the State or County that would change the amount of transfer taxes or recording fees you would pay so any small differences should be disregarded.
Second, disregard Escrow items & Interim Interest which are not Closing Costs to begin with. This would be the amount of Property Taxes & Insurance needed to be held by a Lender – again, these are not dependent upon the lender. Certainly your Tax Bill won’t go down or up if you choose Lender Y or Lender Z, so these items are not good barometers for comparing two offers.
Finally, make sure you are comparing the exact same scenarios – Same Purchase Price, Loan Amount, Program (Conventional, FHA, USDA…), and Interest Rate. If you can confirm those items are identical, simply add up the remaining costs and compare them against each other. What should also be considered is Customer Service you’ve received from the Lender and their reputation – will a $100 savings in Closing Costs matter if your settlement date is pushed due to a Lender’s error; or worse if they cannot deliver the loan promised?
For my next blog: Escrows Explained!