What Are Closing Costs in Mortgage

What Are Closing Costs?

The total cost of a home mortgage is much more than just the monthly mortgage payments. Once a sales contract is signed, the closing process begins. As part of the closing, the deed and title are transferred to the buyer, title insurance and financing documents are exchanged and copies are delivered to the county recorder. Since the closing is a legal process, it often involves an attorney or at least a third-party escrow holder. All of these processes and professionals cost money, adding up to a surprisingly large sum known as the closing costs.

The amount of money you'll have to pay in closing costs varies a lot by region. If you live in a highly taxed area, for example, your closing costs will be higher. Also, realtors, lenders and attorneys have differing fee scales depending on the markets they work in. Typically, you will pay anywhere from 3 to 6 percent of your total loan amount in closing costs -- that means $3,000 to $6,000 if you get a $100,000 loan. You can and should shop around and negotiate the fees. The Real Estate Settlement Procedures Act requires lenders to provide you with a good faith estimate of closing costs within three days of receiving your application. As you can see from the list covering the next few pages, there are a lot of fees that you might be able to convince the lender to lower or drop. You may also be able to negotiate for the seller to pay some of the closing costs.

The fees for services involved in closing a mortgage fall into three categories: the actual cost of getting the loan, the fees involved in transferring ownership of the property and the taxes paid to state and local governments.

List of Closing Costs, Part I

Here are some of the major fees included closing costs:
  • Processing fee --This is what the lender charges to cover initial loan processing costs. It includes the application and credit report access fees. These charges are usually around $400 to $550. Something to watch for when comparing lenders: Sometimes the credit report fee will be listed separately from the processing fee.
  • Appraisal fee -- Because the lender wants to make sure the property is worth what you are paying for it, it requires an appraisal. An appraisal compares the value of the property to similar properties in the same neighborhood. These services are performed by independent appraisers and usually cost around $250 or more depending on the price of the property.
  • Origination fee -- In addition to the application or processing fee, the lender may also charge an origination fee. This covers the additional work the lender has to do when preparing your mortgage. The charge may be a flat fee or a percentage of the mortgage. If the fee is a percentage of the loan, then it is typically considered a "discount point" in disguise. This changes the tax implications and your costs, so be sure to ask the lender about this fee.
  • Discount points -- Buying discount points means that you're buying "down" the interest rate you'll be paying. One discount point equals 1 percent of the loan amount. These points are paid either when the loan is approved or at closing. Buying points can save a lot of money in interest payments over the life of the loan, so investigate it when you're shopping around. Some lenders will let you add the cost of the points to your mortgage, or you may have the option of paying for them up front. You can also deduct those points from your federal income tax. For more information about what is tax deductible, click here.
  • Document preparation fee -- This charge may be included in the application or attorney's fee. It pays for the preparation of the mound of documents that have to be prepared and is usually a flat rate, but can also be charged as a percentage of the loan amount -- usually less than 1 percent

List of Closing Costs, Part II

  • Attorney fees -- Both you and your lender will incur attorney fees. This charge ensures that your lawyer draws up the necessary documents and sets everything up properly for the closing. Your own closing attorney will represent your interests and may be present at, or may facilitate, the closing itself. The closing attorney collects all fees, transfers the deed to the buyer, pays outstanding taxes and utility bills, pays himself and all other closing costs and gives all remaining money to the seller. The attorney fees may range from $500 to $1,000 or more, depending on the purchase price of the property and the complexity of the sale.
  • Home and pest inspections -- Your lender will probably require that the home be inspected to make sure it's both structurally sound and free of termites and other destructive insects. You may also have to have the water tested if the property uses a well rather than city tap water. In some areas, the water test means checking only the quantity of water available to the house, rather than the quality. If this is the case, you may want to have your own water quality test done.
  • Homeowner's and hazard insurance -- You'll have to have these policies in place (and the first year's premium prepaid) at the time of the closing in most states. This insurance protects your (and the lender's) investment if the house is destroyed.
  • Private mortgage insurance (PMI) -- If your down payment is less than 20 percent of the value of the house, you may be required to purchase mortgage insurance. This protects the lender in case you fail to make your mortgage payments. Premiums will usually be a part of your monthly mortgage payment and will be transferred into the same escrow account your taxes and homeowner's insurance fees are paid into. You have to pay these PMI premiums until you reach the 20 or 25 percent requirement -- or, they can go on for the life of the loan. (See the next section for more details on PMI.)
  • Surveys -- Many lenders will require that the land be independently surveyed. This is just to ensure that there haven't been any changes, like new structures or encroachments on the property, since the last survey. These usually run $250 to $500.

List of Closing Costs, Part III

  • Prepaid interest -- Although your first payment won't be due for six to eight weeks, the interest starts accruing the day you close the sale. The lender calculates the interest due for that fraction of a month before your first official mortgage payment. It's a good strategy to plan your closing for the end of the month to reduce the amount of prepaid interest you'll owe.
  • Deed recording fees -- These fees, usually around $50, pay the county clerk to record the deed and mortgage and change the billing information for property taxes.
  • Title search fees -- A title search ensures that the person saying he or she owns the property is the legitimate owner. A title company closely examines public records such as deeds, records of death, court judgments, liens, contests over wills and other documents that could affect ownership rights. This is an important step in closing your loan because it assures that there are no outside claims against the property. The fees charged for title searches, usually between $300 and $600, are based on a percentage of the property cost.
  • Title insurance -- If the title company misses something during the title search, you'll be glad you have title insurance. Title insurance protects you from having to pay the mortgage on a property you no longer legally own. Lenders require title insurance to protect their investment, but you may also want to get your own policy. Title insurance has only a onetime fee that covers your property for the entire length of time you or your heirs own it (usually 0.2 to 0.5 percent of the loan amount for lender's title insurance, and 0.3 to 0.6 percent for owner's title insurance). It's also one of the least expensive types of insurance. If the previous owner of the property owned it for only a few years, you may be able to get title insurance at a "re-issue" rate, which is usually lower than the regular rate.
  • Closing Taxes -- Depending on the state you live in, you will have to pay anywhere from three to eight (or more) months' taxes at the closing, or place the money in an escrow account for later payments throughout the year. These include prorated school taxes, municipal taxes and any other required taxes. In some cases, you may be able to split these taxes with the seller based on when they are due. For example, you would only pay taxes for the months following the closing date up until the date the taxes had to be paid. The seller would have to pay for the months up until the closing date.

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