The term closing costs generally refers to all the costs associated with closing a home purchase or refinance. A more accurate term to reflect these costs is settlement costs. Settlement costs include 4 categories: lender fees, third party fees, prepaid items and taxes/government fees. Let's discuss each of these categories separately.
These are fees which are charged directly by the lender.
In order to process a mortgage application, a lender would and still may charge a flat upfront fee, or a percentage of the mortgage loan. This was previously referred to as a stand alone Origination Fee. Under the new Quailifed Mortgage lending guidelines set by the Consumer Financial Protection Bureau, an origiantion fee is any and all fees a borrower could incur when financing or refinancing a home even if the borrower won't incur such fee. These fees include (but are not limited to) underwriting, processing, and applicable attorneys fees. Origination fees are paid at the time of closing.
In order to lower your interest rate, you might want to consider paying discount points. One point is equal to 1% of the loan amount and is payable at closing. On a refinance, some lenders will let you finance the points, which means the points will be added to the mortgage cost and be part of the amount borrowed. The points may be tax deductible in the year in which they are paid (please consult a tax professional for more information).
Lenders will verify whether or not the property is in a flood zone. This fee is typically nominal and is charged at the time of close
Fees charged by companies other than the lender.
The buyer, the seller and the lender may each be represented by an attorney in a real estate transaction or they may waive representation. Fees are paid to the attorney(s) for preparing the official documents. These fees are typically paid at closing.
During the mortgage closing process, there are several documents and papers that must be prepared and you will occasionally see fees for this. These fees are typically paid at closing.
There are two forms of title insurance: an owner's policy and a lender's policy. They both provide the same protection, but the insurance benefits different parties. Title insurance is issued after a thorough investigation is done into the chain of title. It covers legal fees and any losses in the event that someone files a successful claim against the ownership rights to the property. In other words, it protects the owner or lender in case the home was not legally the property of the person it was purchased from. Owner's policies are optional when no liens are attached and remain in effect for the time the buyer or their heirs own the property. Lenders' policies are required by the lender to protect their investment and are good only for the life of the loan, hence new policies are required on refinances as well. Both premiums are paid at closing. During a purchase transaction, an owner's title policy will be disclosed on the good faith estimate even in the event the seller is paying the fee at closing.
Most lenders require that an appraisal be performed as a condition of the loan, often to verify that the selling price of the financed property is equal to or less than the fair market value or to determine the final loan to value when issuing a refinance. The appraisal fee is paid by the buyer or property owner and is almost always paid upfront. The lender may require a deposit for this fee at the time of application, after which it is held in escrow until given to the appraiser.
Lenders will pull a credit report as part of the qualification process both at the time of applicaiton and again prior to closing to determine. This is done to insure no harmful changes to credit or debt have occurred. This fee may be charged up front.
Some lenders require inspections (e.g. termite inspection) to make sure that the property is in excellent condition. In many rural areas a water test may be required to ensure the well and water system will maintain an adequate water supply to the house. This is necessary to ensure that the property will retain the required collateral to secure the mortgage loan.
You may make the purchase offer contingent upon satisfactory completion of more inspections: structural, water quality, radon tests, among others. Inspection fees are typically paid at the time of inspection.
Lenders may require that the property be surveyed to inspect for encroachment and confirm lot size and dimensions. This fee is typically paid before the time of closing.
Prepaid interest is exactly what it sounds like, interest that is paid in advance. Mortgage payments are paid in arrears, meaning that you pay the interest in the month after you use the money (i.e. February's interest payment pays January's interest). Since it isn't practical for you to make a partial monthly payment only days after you purchase or refinance your home, the lender will charge a small interest payment at closing. This is why most loans are not due until the second month after closing (note, this is not always the case). Prepaid interest is figured by multiplying the interest rate by the loan amount, dividing by 365 days, and then multiplying by the number of days left in the month when the loan closes. This is paid at the time of closing.
Homeowners insurance, also called hazard insurance, is required to be paid in advance. On a purchase, you will pay one year's premium up front at the time of closing. If you have chosen to escrow your insurance with your lender, you will also be required to set up a cushion for that escrow account, usually two month's worth of the annual premium. The cushion is there in case the premium rises and you need to cover the missed mortgage payment. On a refinance, you will be required to escrow a certain amount of your premium depending on when the next payment is due. These monies are collected at closing.
Property taxes up until the time of closing are almost always the responsibility of the seller, so the seller must cover a portion of the next tax bill due. This is shown as a credit at the closing from the seller to the buyer. However, a new homeowner who is escrowing their property taxes will need to set up a new escrow account with enough cash to cover the next property tax bill. This account will typically be funded with the seller's credit, plus a two month cushion from the buyer. Much like the homeowners insurance cushion, this is to cover the one month that the buyer may be skipping a mortgage payment plus a little extra to cover rising property taxes or any underage.
Fees paid to local or state agencies.
These fees may be paid by either party and are charged by a governmental entity for entering an official record of the change of ownership of the property. The fee is required by the government for recording the deed and is charged at closing.
Statutory closing costs are expenses you would have to pay to state and local agencies even if you paid cash for the house and did not need to take out a mortgage. They include the following:
Most of these fees can be negotiated into the contract for the seller to pay. It is not uncommon for a seller to issue a closing cost credit for either a specific item or just a general lump sum. Talk to your real estate agent for more information regarding seller paid closing costs.
Also, on a refinance, you may be able to choose a loan option in which the lender pays many of the fees listed above. However, you will have to pay a higher interest rate than if you paid the fees yourself. Please consult a reputable local loan officer for more information on these fees.
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