Understanding Closing Costs

Avoid surprises! Be prepared for closing costs when it's time to finalize your loan.

Closing costs (or settlement costs) are the costs associated with the sale of a home or the refinancing of a mortgage. These costs generally range from 3% to 8% of the total loan amount. Usually, the costs are lower with a refinance and, as with a purchase, many of the costs can be rolled into the loan. Although some fees and taxes associated with a purchase are required by law to be paid by the buyer, you may be able to negotiate with the seller to split the cost of others, such as points. The lender may also be willing to negotiate some of these fees. Be sure to comparison shop several lenders. Don't forget to take advantage of our debt management calculators, which are very helpful in determining the costs of financing a home, including the total cost of settlement. Some typical closing costs are:

• Property Taxes (Pre-paid Escrow)

  • Pre-paid escrow costs are the pro-rated portion of the funds you will need to have on deposit with your mortgage company so, when it's time make the annual disbursement, there will be sufficient funds in your escrow account to cover the payments. Mortgage insurance and homeowner's insurance are also considered pre-paid escrow items.

• Generally, the annual property taxes are divided over a 12-month period, and you will be required to place two - three months in an escrow account to cover the annual expense. For more information about escrow and other settlement costs, see the U.S. Department of Housing and Urban Development (HUD) Settlement Cost Booklet.

• Mortgage Insurance (Pre-paid Escrow)

  • This insurance protects the lender in the event you don't make your loan payments, and the lender is forced to sell the house through foreclosure for less than you still owe. You may be able to finance the cost of certain mortgage insurance policies.

• If you are putting less than 20% as a down payment, you may be required to take out private mortgage insurance, commonly referred to as PMI. The premiums for PMI vary depending upon the amount, type, and terms of the mortgage. The U.S. Federal Reserve Board (FRB) explains mortgage insurance and more in the FRB Consumer's Guide to Settlement Costs.

• If your loan is insured by the Federal Housing Administration (FHA), you will be required to carry FHA Insurance, usually referred to as MIP. There is usually an up-front fee of 2.25% of the purchase price and a monthly fee of .50% for the life of the loan. For more information about mortgage insurance premiums, see HUD's webpage about FHA Single Family Home Insurance Premiums.

• Homeowners Insurance (Pre-paid Escrow)

  • The lender will require that you have a policy in effect at the time of closing, and several months' payments will probably need to be held in escrow. This can also be paid outside of closing (POC). The State of Arizona's Insurance Department has A Consumer's Guide to Homeowner's Insurance as well as an online Homeowner's Insurance FAQ.

• Loan Origination Fee

  • This is the fee a lender charges for work in preparing the loan. It is often expressed as points. One point is equivalent to 1% of the loan amount.

• Loan Discount Points

  • This is a fee, also expressed as points, paid to the lender to buy down the interest rate. This means that in exchange for paying points up front, the lender will reduce your interest rate. On average, one point will typically reduce the interest rate on a 30-year mortgage between .25% - .50%. This can vary between lenders. It could be beneficial if you plan to stay in your home for a number of years. Here's an example of how much interest you would pay over a two-year period vs. a 15-year period on a 30-year mortgage with and without points:

In this example, after allowing for the $1,000 (one point) paid up front to reduce the interest rate, you would pay $247 more after two years on the 30-year loan with points, but $4,716 less interest after 15 years. This pattern also holds true paying two points. This demonstrates that it makes sense to consider paying discount points only if you plan on staying in your home for a number of years. To compare mortgage loan payments with and without points, you can use the CareOne Credit home financing calculators. For information on mortgage shopping, read the Federal Trade Commission information about Looking for the Best Mortgage.

• Appraisal Fee

  • This pays for the independent appraisal that estimates the market value of the property. This is often required to be paid at the time of application and would appear on the settlement sheet as "POC" or "paid outside closing." Ask for a copy for your files. Expect to pay between $300 - $1,000, depending on the size and location of the property.

• Credit Report Fee

  • This pays for a comprehensive mortgage credit report that often combines information from the three major credit reporting agencies, Equifax, Experian, and Trans Union. The information contained in your credit report will be used by the lender to determine if you qualify for a loan and for what rate you are eligible. This, too, is often POC. This can range from $25 - $100.

• Title Search and Title Insurance

  • A title search and examination needs to be completed to prove that the seller actually owns the house. A title search also discloses whether there are other claims, judgments or liens on the property. Title insurance protects the lender against any ownership claims that may arise due to errors in the title search. The title insurance will probably be 0.2%-0.5% of the loan amount. The title services can range from $200 - $500. For more information, see the State of Washington's factsheet about title insurance.

• Interest

  • Typically, the amount of interest accrued between the closing and the first mortgage payment will be collected.

• Survey

  • A survey will be required to ensure that there are no discrepancies over boundaries with neighboring properties. This can range from $150 - $400, depending on the size and location of the property.

• Home Inspection

  • This is another fee that is typically POC. The home inspection is not required like an appraisal, but it is advisable to have one done if you are buying a home so you can anticipate any faults or potential repairs that may be needed. The inspection would typically be done after a contract or purchase agreement is signed, so it is important to include a clause in the contract that makes the sale contingent upon a satisfactory home inspection. This clause should spell out the terms to which both the buyer and seller are responsible. For more information, see the article on Home Inspections. This usually ranges from $150 - $500, depending on the size of the house and how extensive the inspection is.

• Other Fees

  • These can include fees for processing, document preparation, document stamp taxes, recording the new deed with the courts, couriers, loan assumption, survey, home inspection, flood plain certification, underwriting, wire transfers, and attorney fees. Helpful articles about closing costs can be found at FannieMae and GinnieMae.

The lender is required to provide you with a "Good Faith Estimate" within three days of your application that outlines the anticipated fees that will be associated with your loan. You should go over this document very carefully and get clarification on any fees you don't understand. Also, you should bring this document to the closing to make sure there are no major discrepancies between the estimate you were given and the actual costs that were incurred. The homebuyer's rights in relation to closing costs are protected by the Real Estate Settlement Procedures Act (RESPA). See the HUD website for more information about RESPA. You can also read the RESPA text here.

Take control of your finances with our debt help tools. Use our calculators and budget planner to help you manage your money.

Related Mortgage Articles:

• Is a Fixed Rate Mortgage Your Best Bet? The fixed-rate mortgage is the most commonly chosen. The longer the term, the lower the payment, and each month the payment is the same. If the amount of your debt management does not exceed 30% of your income you may be a good candidate for a fixed-rate mortgage, which come in terms of 15, 20, 30, and even 40 years.
   

• The Power of Preapproval - Part of smart debt management is knowing how to bargain or negotiate a better deal to pay less. While a prequalification is an estimate of what the lender thinks he can lend you, a preapproval is a statement from a lender showing you what they will indeed lend you. This comes from an actual application and credit report being run. By getting preapproved before shopping for a house, you stand out among other buyers who may be offering more than you but cannot show upfront that they are guaranteed to get the financing.
   

• An Adjustable Rate Mortgage May be Perfect for You - While an ARM mortgage can sound scary at first, they can be perfect for homebuyers with blemished credit or a lot of debt. Interest rates for ARM loans are lower, which means a lower monthly payment. The interest rate for the ARM is fixed for a certain time period before it begins to adjust up or down in accordance with the market. ARMS come in several fixed options; you can choose a 1, 3, 5, 7, even 10-year ARM, which means the rate is fixed for up to 10 years before it begins adjusting. There are other reasons to get an ARM loan, but you are hurt on the credit side, it may be perfect for you.