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Understanding Closing Costs

The time has come to buy your first home. It has taken years to save up an amount of money that you feel will cover a down payment. Thinking you have shown great foresight and responsibility, you now begin looking at homes and find one that you like and think you can afford.

You and your real estate agent visit a lender, where you must offer up all your personal information so that you can be checked out to see if you are loan-worthy.

You go home feeling confident that there will be no problem. Then, like a thunderbolt, you are handed the "Good Faith Estimate," which estimates your closing costs and fees. Your confidence slips away as you peruse a seemingly endless list of charges you will be required to fulfill at closing.

Most first-time home buyers and many second and third-time home buyers don't realize how much money they will need to contribute above and beyond the down payment. The term "closing costs" is vague. Many buyers are shocked when they find out the truth about what they must spend in order to move into that home.

Generally, your closing costs will run between 3% to 5% of the loan amount

It is important to keep "closing costs" in mind as you look at houses. Mentally add several thousand dollars onto the final cash cost as you determine whether or not you can afford the purchase.

When you shop for the best lender, don't make your decision on the interest rate alone, although that, too, is important. Federal law mandates that you must be provided a "good faith estimate" within three days of the mortgage application. Generally, your closing costs will run between 3% to 5% of the loan amount, although the figures can be higher in higher-tax areas.

When you get this good faith estimate, you can begin to process what the lender is going to charge you above the down payment, beyond the interest rate.

Because this equals a lot of money, take the time to shop for the best lender. Get good faith estimates from at least three different lenders. Compare what each one will charge you. If you prefer to go with a particular lender, ask if they will meet that lowest bid. Each lender can be different.

The worst news is that a good faith estimate is not a binding number. The amount you have to pay can change between the time the good faith estimate is offered to you and the time you close.

In fact, some lenders deliberately draw up a very attractive and reasonable good faith estimate to lure in your business, then change the amounts drastically in the final days before closing, counting on your emotional attachment to that home and your desire to get moved in as quickly as possible.

Closing costs you pay only once

These are fees and costs that are paid once and never again:

  • State, city, and county transfer taxes
  • Escrow
  • Notary fees
  • Attorney fees
  • Recording fees
  • Endorsement fees
  • Title fees
  • Wire fees
  • Home inspection fee
  • Courier fees
  • Home protection plans
  • Natural hazard disclosure fees

Closing costs you prepay and will pay on a regular basis

  • Property insurance premiums
  • Flood insurance (if required)
  • Prepaid interest
  • Property taxes
  • Mutual or private mortgage insurance premiums

There are serious costs and fees to consider before deciding upon the purchase of a home

Breakdown of closing costs

  • Loan origination fees: Your lender will charge you an origination fee. This pays for the lender's evaluation and preparation of your loan.
  • Discount points: The discount points are actually prepaid finance charges your lender will require you to pay at closing. Paying discount points is another way of saying that you are paying down the interest rate. If you hope to stay in your new home for a long period of time, say at least five years, it will benefit you to pay discount points, because this will save you money long-term. This only works, of course, if you have the ready cash to do it. One point equals 1% of the loan, so on a $100,000 home loan, one discount point would cost $1000. Sometimes, the points can be added to the loan amount. This is true especially with refinancing.
  • Application fees: The application fee pays the initial costs of processing the home loan application. The pull of your credit report is often included in this cost, and the cost for both runs about $400- $500
  • Credit report check: Alone, the credit report check costs about $75-$150. This is necessary to see if you have paid your debts on time in the past and to check your credit score. If you are self-employed, the lender might require a business report, which will cost you about $50-$100.
  • Documentation fees: Not all lenders charge these fees. They cover such items as: processing, underwriting, and the preparation of documents. Typically, these fees will be less than 1% of the loan.
  • Inspections: Most lenders will insist on a home inspection and pest inspection. This ensures that the home is free of termite damage and the building is sound. You, the buyer, can generally choose the inspection company. The costs will vary by company.
  • Appraisal fees: The home will have to be appraised before the lender can proceed with the loan application. The appraisal determines the market value of the house. Fees for this service will vary according to the cost of the home, the location, and the size of the house. Count on $200 or more.
  • Homeowner's insurance: This cost protects the house, and you, against damage by wind, fire, hail, vandalism, etc. It does not include flood damage. This fee is usually considered mandatory and must be paid before closing can take place. The price, of course, will vary according to the value of the home, the location, and what company you choose.
  • PMI, or mortgage insurance: This fee can kick in when you contribute a down payment of less than 20% of the home's value. In some states, the insurance is mandatory. This insurance protects the lender in case you do not make your loan payments. The premiums are usually set up to be paid annually through the escrow account, or can be paid in full at closing. The escrow account is a reserve account, which holds the funds you have contributed and pays them as they are due.
  • Attorney fees: Sometimes the buyer will want to have an attorney represent him or her during the buying process. Generally, an attorney charges a fee based on the cost of the home and how complicated the sale becomes. Additionally, the title insurance companies, real estate brokers, lending institutions, escrow companies, etc. all may require the assistance of attorneys to complete the settlement of the purchase. The buyer usually pays these costs, which can range up from a low of about $600.
  • Taxes: In most states, the buyer will be required to contribute four to eight months' of taxes at the time of closing. These funds will be put into the escrow account and paid out when they become due.
  • Daily rate of interest: This fee, calculated by your closing date, takes care of the loan interest from the day of closing through the end of the first month. It is paid to your lender.
  • Document preparation: Ranging from about $50 to $200, this fee goes to the title company.
  • Survey costs: Lenders often require a survey, which makes certain that there are no new structures added to the property since the last survey. The survey also makes sure the buildings on the property meet legal codes. This fee can run between $200 and $500.
  • Title fees: These fees include the title search and insurance. First, the title company verifies that the seller actually owns the property being sold. The title search can be complicated, and makes sure there are no contests or claims against the property. $300 to $600 is generally the cost of the title search.
  • Title insurance: This insurance protects you and the lender from any mistakes made by the title company during the title search. Lender title insurance runs about .2% to .5% of the loan, and is usually paid by the buyer.
  • Recording fees: This fee, charged by the title company, covers the cost of recording the transfer of the title at the county clerk's office. A recording fee will probably vary state to state.

Consider all the costs involved in buying a home

As you can see, there are serious costs and fees to consider before deciding upon the purchase of a home. After saving up your down payment, it would be a good idea to save another $5000-$6000. This might not cover all the closing costs, but it will be a good start.

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