DON'T LET CLOSING COSTS
BE A SURPRISE
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
- 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.
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
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
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
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
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
As with any financing arrangement, to avoid unwelcome surprises, meet with
your trusted mortgage loan officer and make certain that you understand the
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.