As we discussed in our previous article, we often find that there are many misconceptions that surround the home buying process. One of the most common topics that we discuss with clients is the down payment options on their home purchase. We often find that the home buyer thinks that at closing, the only cash they need to provide is the “down payment.” The purpose of this article is to help clients to better understand that this is not the case.
Imagine… you have worked your way through the home buying process. You’ve reviewed a lot of estimates with your lender – different programs, different down payments, and rate buy down scenarios. You know how important the down payment is and are focused on gathering your funds. But wait. You are a little over a week away from closing, and suddenly you notice the all-in cash to close number. Why is this more than the down payment?
It’s a rude awakening, and one that we recently experienced with a client. Despite knowing we had explained the closing costs to our client, the overall focus on the down payment had blinded her to the total cash needed to close. We helped that client close on their dream home, but it showed us that we need to be more clear about the bottom line on closing costs. These costs are a major factor in mortgage loans and understanding them upfront is an important part of the process. The total costs of your mortgage loan are broken into two categories – “closing costs” and “pre-paid items.” We believe that it is important to know where the fees come from so that if you are shopping between lenders, you have a clear understanding of what you are shopping for.
While it is possible to negotiate a seller concession or lender credit to help you with your closing costs, you’ll never know what to ask your realtor to negotiate if you don’t understand the bottom line.
What are the different categories of closing costs?
1. Lender costs:
POINTS… look out for them! The interest rate is one of the most important aspects of the cost of your mortgage loan. It is almost always the first thing you will look for when reviewing an estimate from your lender. Often, lenders will charge “origination and/or discount points” for the purpose of offering you a reduced interest rate. A “point” is when you, the client, pay more upfront money to reduce your mortgage interest rate. These “points” are not a required cost of your loan. We find that many lenders do not point this out or discuss this as an optional cost of your loan. It is important to know your options and how these points are affecting your rate. You may learn that this cost is not worth the rate reduction based on your specific scenario and goals.
Your lender will typically charge a fee to provide service on your mortgage loan. Each company may use a different term for these costs, but look out for something like “document preparation fee”, “application fee.” These fees are probably a requirement for working with your lender, so take note when shopping around.
2. Title company cost:
It is best to think of your title company costs as a required cost of your mortgage loan. The title company will provide services that are required on a mortgage loan, like conducting a title search to ensure that no one else has an ownership interest in the property. While you can choose the title company that you work with, most buyers work with the company recommended by your real estate agent to ensure that the transaction is handled in a timely and professional manner. The title company will charge a fee for providing services. This will often be referred to as a “title services fee.”
Title insurance is also a necessary protection – both for your lender and yourself. You’ll see both lender’s title insurance and owner’s title insurance on your estimate. This protects both the client and the lender from any claims on the property that could jeopardize ownership.
Finally, you will see transfer taxes as a cost of your loan. States, counties, and municipalities impose transfer taxes when a property changes ownership. These fees will vary based on where the property is located.
3. Third Party Costs:
There are a variety of services that are performed by third parties on your mortgage loan. These items are listed on the estimate and paid directly to the vendors providing service at closing. Some of these items include an appraisal on the property, credit report, IRS tax transcripts, property inspection, and flood certification. These are typically required costs, but look closely at the estimates and ask questions to your lender, so that you know what to expect at closing.
What about those pre-paid items?
Pre-paid items refer to the money that is collected at closing and placed into your escrow account for real estate taxes and homeowner’s insurance that are due at different dates throughout the year. An escrow account is an account that holds money that is due later. The purpose of this account is that instead of sending three different payments each month (principal + interest to the lender, taxes to the city/state, and insurance to your insurance provider) you send one – keep it easy. Each monthly payment made after closing will include the principle and interest, homeowner’s insurance, real estate taxes, and any applicable mortgage insurance. The lender/servicer will deposit the funds for taxes and insurance into your escrow account. Making these payments each month ensures that there are sufficient funds in your account to cover payments for taxes and insurance when they come due at various points throughout the year.
When reviewing estimates with your lender, be sure that you are clear on what is being collected from you at closing. Because the amount collected is based on the closing date of your loan, it is important to understand which costs/items are set in stone and which may fluctuate throughout the process.
The bottom line? Know the bottom line.
We believe it is important for buyers to have a strong team of trustworthy people who are providing clear information in a timely manner, working with them on their mortgage loan. It is critical to understand the cost that goes into your loan, in addition to your down payment options. When you are reviewing estimates with your lender, be sure that you are clear on what is being collected from you at closing and which of these fees are optional. Ask your lender which costs are set and which ones may fluctuate depending on the closing date of your loan.
This is a part of the upfront conversation with your lender as you discuss how much you are comfortable contributing to your mortgage loan. There should be NO surprises once you find your dream home and decide to move forward.
COMMUNICATION IS KEY!
We believe that one of the qualities that make us your lender of choice is our willingness to communicate clearly and ensure that our clients feel empowered and educated throughout the loan process. Give us a call and let us know how we can help you!
