One of the necessary evils of buying a house are closing costs. The closing costs are just that, costs related to your mortgage and settlement with the seller.
Closing expenses are classified into three types: lender costs, third-party charges (businesses that offer services to the lender), escrow fees, and prepaid costs.
Closing expenses vary by state and even by county within a state.
Every lender will need an appraisal cost, flood certification, lender's title insurance, and recording fees.
Application fee (lender)
Some lenders will charge you an application fee. As the name implies, this fee is the cost to apply for the mortgage. The cost defrays the clerical expense to process the application. Some lenders choose to charge an application fee in place of the appraisal fee and credit report fee.
Appraisal fee (third party)
If you're purchasing a home with a mortgage, the lender will require an appraisal on the property. The home is the collateral against the property. If you default on the loan, the lender will sell the house to recapture the balance of the loan. The cost of the appraisal will vary due to location, sales price, mortgage program, and the number of units. Two to four-unit homes tend to cost more than single-family homes.FHA, VA, and USDA loans cost you more to appraise.
Attorney fee (third party)
In some states (i.e. New York), the buyer is represented by an attorney to ensure the buyer's interests at closing are protected. The cost of representation can be as much as $1,500... wow. Good work if you can get it.
Credit report (third party)
The lender will request a credit report on the applicant(s) from each of the three largest credit agencies. All three credit reports will be "merged" into one credit report. It is not uncommon for some credit history to be reported to one agency and not the others. For this reason, the applicant's credit history is combined into one integrated report.
Discount points (lender)
The mortgage interest rate can be reduced by "paying points". A discount point is one percent of the loan amount. For example, if you pay (or buy) one point and the loan amount is $100,000, the point will cost you $1,000 ($100,000 X 1% = $1,000). Pay two points, and you'll pay $2,000 ($100,000 X 2% = $2,000). So why would anybody pay points? The reason is that the interest rate is reduced by paying points. Read more about mortgage points
Flood certification fee (third party)
We have all seen floods on television and on the internet consume homes and businesses. Water can create immense damage. For this reason, the lenders need to know if the property resides in a flood-prone area. The lender obtains a flood certification to determine whether the home could be subject to a flood. If the home does reside in a flood area, the lender will require a flood insurance policy.
Some states charge a mansion tax on properties exceeding a certain amount, usually in excess of one million dollars.
Origination fee (lender)
The origination fee can be discount point(s), a collection of fees to process the loan or a combination of both. Fortunately, the new Loan Estimate breaks down the origination fee nicely.
Recordation tax/excise tax
The recordation tax is another name for the recording fee; however, the cost can be fixed or be based on a percentage of the sales price, mortgage amount, or both.
After all the papers are signed, the settlement company will “record” all the deed and mortgage paperwork at the city or county recorder’s office. The recorder’s office is the place that tells any interested party who owns the property in the county and if anyone has a lien against the property.
The charge by the attorney, settlement company, or title insurance company to handle the ownership transfer. The settlement company is usually responsible for recording the deed transfer, the payment of any recording taxes, and other documents registered with the recorders' office.
In some areas of the country or properties, it's easy to determine where your property boundaries are, but if you have 5, 10, or a thousand acres with mineral rights, you and the lender may want to know the property boundaries. You may also want to know if your neighbor’s fence is on your property or his.
Tax service fee
This fee is paid to a company to verify that the real estate taxes have been paid and/or to inform the lender of the current cost of the real estate taxes on the property.
Title insurance protects the lender and/or the property owner against ownership issues. For example, how do you know that the seller is really the seller and not an imposter? How would you feel if you handed over your down payment money to the seller and then find out he was a fraud?
Another common title (ownership) issue is undisclosed heirs. For example, the house passes to three sons by way of inheritance. Only two sons sell the house with the belief that the missing brother has passed away. Then, the missing son shows up at your door claiming ownership. In short, title insurance protects the “title” against ownership issues. The cost of title insurance is regulated in most states.
Some title companies/settlement companies charge a separate fee for searching the ownership history at the courthouse or county records.
Endorsements to the title policy are extra protections. A title endorsement could include covenants, conditions, and restrictions of the neighborhood.
Transfer tax (stamps)
Most states charge a real estate transfer tax when you buy a house. The transfer tax is a sales tax on real estate. The cost of the transfer tax varies from state to state and county to county. The recorder will usually affix postage stamps to the documents upon payment of the tax. Some states like Pennsylvania have a state transfer tax, a local transfer tax, and a school transfer tax. Ouch!
Underwriting fee (lender)
The underwriter is the approval person for the lender. He or she will make sure all the paperwork is complete and will determine whether the bank or mortgage company will approve the loan application.
Some expenses are "prepaid". For example, you (and the lender) want a homeowner's insurance policy in place when you close or settle with the seller. The cost of the homeowner's insurance policy is said to be "prepaid". A flood insurance policy, if required, is also prepaid.
Real estate taxes are also prepaid. Many home buyers are confused and some become angry over the property tax prepayment. Why should I have to "pre-pay" my taxes? Didn't the seller pay the taxes? The reason real estate taxes are prepaid is because there may not be enough money in the escrow account when the tax bills come due.
Let's use an example to help clarify this issue. Assume your $1,200 property taxes are due January 1st and you close your loan in July.
Your first mortgage payment is due in September (skip August). That means you will only make 4 mortgage payments toward your tax bill (i.e. September's payment = $100, October's payment = $100, November's payment = $100, December's payment = $100). The lender knows this, so the lender will collect the "missing" 8 months or $800 at closing.
With the prepaid taxes paid at closing and with the anticipated tax payments, September, October, November, and December, the lender will have enough money to pay the property taxes in January.
This is a generic explanation of the prepaid taxes and escrow. In some states, the property taxes are paid annually to the counties/municipalities and/or school districts, some counties have semi-annual taxes. No matter how the property taxes are paid, you are likely to pay something at closing so there is enough money in escrow to pay the tax bill(s) in full when they come due.
The word escrow is a fancy name for a savings account. If you’re purchasing a home with a mortgage, most lenders will require you to "escrow" your property taxes.
The lender will obtain the annual property tax cost from the tax collector. The lender will then divide the annual tax bill by twelve months and make the expense a part of your monthly mortgage payment. For example, if your annual tax bill is $1,200, the monthly cost of $100 is added to your mortgage payment. Each month, the lender deposits $100 into your escrow/savings account and pays the real estate taxes from your tax escrow. The government back loans, FHA, USDA, and VA, require lenders to escrow the property taxes and insurance.
Homeowner's insurance escrow
Like the property tax escrow, the lender will divide the annual homeowner’s insurance premium by 12 months and add it to the monthly mortgage payment. The lender will pay the homeowner's insurance premium when the policy renews.
Flood Insurance, like homeowner's insurance, will be escrowed and paid when the flood insurance bill comes due (if applicable). Read more
Frequently Asked Questions About Closing Costs
Q. How much are closing costs for a buyer?
A. Closing costs will vary from state to state and even county to county. Take California for example, the payment of the documentary transfer tax is paid by the seller in southern California, In northern California, the Buyer pays and In central California, it can be a combination of both.
Q. When are closing costs due?
A. Closing costs are paid at settlement
Q. Who pays closing costs, the buyer or the seller?
A. The home buyer usually pays for the title insurance policy and any fees that relate to the mortgage. It should be noted that by custom in many areas of the country, the seller pays for the owner's policy and the buyer pays for the lender's policy; if there is a mortgage. Transfer or excise taxes are paid by the buyer, seller, or split as stated in the sales contract.