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DON'T LET CLOSING COSTS
BE A SURPRISE

Updated:         June 3, 2018

Many buyers are most often concerned with the amount of down payment that will be required for their proposed purchase. It is easy to forget or under-estimate the amount of closing costs that will also be required. These expenses mount up quickly and can be a shock to the buyer. If these costs have not been anticipated, they can result in the cancellation of the purchase . . . simply for the lack of sufficient funds. So, here are the costs that need to be considered in a purchase transaction.

1. ORIGINATION FEE: This represents the lender's charge for making the loan . . . commonly called "points". One point represents 1% of the loan amount. The origination fee reflects the lender's "income" in the loan. New rules eliminate the practice, prevalent in the sub-prime loan era, of charging more points if the borrower's credit scores are low (because of blemished credit) or some other "greater than normal" risk factor exists. Today's "no points" or "no cost" loan is simply the acceptance of a higher interest rate in exchange for "rebate pricing" with which the fees are paid. (There is more information regarding rebate pricing found at this webpage in tip sheet entitled “risk Based Pricing”.)

The ability of borrowers to use this option to reduce closing cost fees has been severely impacted by the newly enacted regulations. (see the explanation of Yield Spread Premium a the end of the article

2. DISCOUNT POINTS: These are mostly connected to what are called "buy downs" and are a reflection of the yield anticipated by the investor who will ultimately purchase the loan. A buyer can "buy down" the interest rate via the payment of discount points. For example, instead of accepting a 5.25% interest rate loan at a 1% loan cost, the buyer could choose a 5.125% rate at a 1.5% loan cost. The additional one-half percent loan fee would enable the buyer to acquire a one-eighth percent lower interest rate. Before deciding to buy-down the rate, buyers are encouraged to discuss the savings vs the cost factors with their mortgage lender. The decision to pay additional points will depend upon a number of factors including, how long you intend to own the property, the actual cost of any buy-down and who is actually paying the fee.

3. LENDER/ADMINISTRATION FEES: While these can vary depending upon the type of loan, typical lender fee costs are between $850 and $1200 and include:
- Tax Service Fee
- Wire Transfer Fee
- Loan Documents Preparation
- Underwriting
- Flood Certification

In addition, a processing fee of between $450 and $600 is usually charged by the lender/broker. Many real estate authors point to these costs as the “garbage” fees and encourage that they be “negotiated” and/or eliminated in the transaction. The reality is that the fees have to be paid and they will either be fully disclosed or “hidden” within the pricing structure. Know that the fees will be paid and opt for full disclosure.
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4. TITLE INSURANCE:  The payment of title fees is determined via contract agreement and is usually guided by “what is common for the area”.  There are two title insurance fees usually involved in a purchase transaction. The ALTA is often paid by the buyer and the CLTA can be paid exclusively by the seller but is can also be split between buyer and seller. The more costly CLTA fee is to assure the transfer of "clear title".  the buyer is charged an additional fee to insure "extended coverage". The ALTA fee is additional “extended coverage” required by the lender and results in a typical cost to the buyer of between $300 to $500 in most transactions. (Note: Make sure you understand title insurance coverage when you ultimately purchase).

5. ESCROW FEE: This fee is most often split equally between buyer and seller. The buyer's expense is most often between $350 to $500 in the average transaction. In VA loans, the seller was in the past charged the total escrow fee the fee is now paid via the terms agreed upon in the purchase contract.

Additionally, estimate $350 for such items as recordation fees, federal express charges and other miscellaneous escrow costs as recordation fees have increased substantially.

6. HOMEOWNER'S INSURANCE: The buyer is required to purchase a one year homeowner's insurance policy paid for in escrow, with the average cost between $600 - $800, depending upon the home value and coverage acquired.

7. TAX PRO-RATIONS: Buyers and sellers will be assessed their appropriate portion of the existing property taxes to be "pro-rated" in escrow. Depending upon the date of close of escrow (COE) and the assessed taxes, this can be a significant sum. While not a closing cost required in escrow, buyers will want to educate themselves as to the impact of "supplemental" taxes that will likely come due 90 to 120 days after close of escrow.

8. IMPOUND ACCOUNTS: When a loan represents a sufficient risk (typically above an 80% LTV), the lender imposes an "impound" requirement. This means that the monthly payment will include an amount for taxes and insurance as well as the normal principal and interest payment. There will be an initial assessment to "start the impound account". This amount will vary depending upon the month in which the loan closes escrow.

9. INTEREST ON NEW LOAN: Loan payments are due on the first day of each month. The interest owed on the loan is always paid in arrears (i.e.; the payment made on June 1st is in payment for the use of the money in May). This necessitates a pro-ration of interest on the new loan from the day it funds to the end of the month. The first loan payment is then due (in this scenario) on July 1st. Depending upon the day of the month the loan is "funded", this amount can be substantial.

10. APPRAISAL & CREDIT REPORT: These fees are typically paid at the time the loan application is submitted. New rules around appraisals now require ordering them via the borrower’s credit card. Credit reports are often acquired initially via the lender but the expense between $35 - $50 (including the required FICO credit scoring) will be reimbursed by the borrower in escrow. Appraisal fees are currently $500-$650 for conventional and $500 for VA loans. Conventional loans for non-owner occupied type loans are more expensive. 

While this is not intended as an exhaustive list of loan costs, it does represent the basic fees. The costs can become rather substantial depending upon the loan circumstances. To avoid surprises you may find it beneficial to discuss the type of loan you wish to acquire and secure an estimate of the closing costs from your lender early in the loan process.

The closing costs for refinance transactions differ somewhat but are still often more than borrowers anticipate. Again, it is advised that you thoroughly investigate the estimated closing costs before proceeding with your loan. And, make sure you acquire an accounting of “all the expected costs”. Refinancing can be expensive so it is usually not a good idea to enter into a loan option that will automatically require you to refinance within a couple of years.

Asking sellers to pay all of some of the buyer’s closing costs has become more frequent in recent years. Most loan options allow a seller to pay buyer’s closing costs, at least up to 3% of the purchase price. This has become a popular way to assist buyers who may be short of cash for closing costs.

As with any financing arrangement, to avoid unwelcome surprises, meet with your trusted mortgage loan officer and make certain that you understand the process completely.

We mentioned Yield Spread Premium (YSP) in the Origination fee discussion above. When a lender acquires a loan at an interest rate above the market rate, a rebate is generated that can now be used by the borrower to help pay closing costs. During the sub-prime era, YSP was often abused by “steering” buyers into higher interest rate loans in order to generate more income for lenders. YSP can be used in some instances to pay the lender origination fee but new rules have made this less likely. Any generated rebate today is more likely to be used to offset buyer closing costs. Buyers are urged to ask their mortgage lender about YSP and how it might be used for the borrower’s benefit.