Closing Costs
Closing costs are the costs associated with purchasing a home. The amount of closing costs will vary depending on several factors. Let’s scratch the surface to help you understand what the closing costs are and how the costs can be paid in a transaction.
First, we’ll take a look at a quick breakdown of closing costs you can expect to see on your quote or Loan Estimate (LE) from your Loan Specialist.
Origination/Lender costs
These costs will vary from company to company. Possible line items you may see are for origination, underwriting, processing, application fee, and/or other various fees. There are several types of fees that can be listed under the lender costs. These costs are one way loan companies make their money. I call them the upfront costs because this is what is shown to the consumer upfront. Any discount points (charges for a lower interest rate) will also be disclosed in this section.
Do not be fooled if these costs show $0 though. It does not mean a company is better priced. It is impossible to accurately shop for a loan by simply asking what is your rate? Or by asking how much are your closing costs? Or how much are your origination or lender fees? This is because loan companies are also paid through a cost within the interest rate called backend pricing. Very rarely will a loan company discuss or show the backend pricing with their consumers. I will write a blog explaining this more in the future.
Services You Cannot Shop For
Third party costs are associated with getting a loan. These are not paid out to the loan company, but are required services for the loan. For example, one of these costs may be for an appraisal. The appraiser is paid for their service. It is not a borrower’s choice in who does the appraisal; therefore, you can’t shop for it. These services and charges can vary from company to company. The costs will also vary depending on the type of loan program you use.
Services You Can Shop For
Borrowers have the ability to decide on these third party charges. In most cases, the realtor or loan specialist will recommend a company for the services, but the decision is ultimately up to the client. Most common fees in this category are related to title fees. The cost of those fees will vary from title company to title company.
Government fees
These costs are associated with the costs of recording documents with the county in which the property is in. Each state and county can differ in their costs. These costs should be the same in each county regardless of who helps you with your transaction. You will also find charges for transfer taxes, if they apply in your state.
Prepaids and Escrow
These costs are also going to be the same in a transaction, regardless of what company you use for your loan. These costs include prepaid interest, escrow reserves, as well as any costs that need to be paid upfront to homeowner insurance companies or taxes. Prepaid interest will vary depending on the day of the month you close. This will cover the interest charges for the remainder of the month, since your payment will not be due until the 1st of the following month.
For example, if you close with 5 days remaining in the month of March and the daily interest charge is $20. You will pay $100 ($20X5) for the interest for the rest of the month. Your first payment would then be due May 1st. There are scenarios when that can vary.
Escrow accounts are accounts that hold funds from your monthly payment to pay for taxes and homeowner’s insurance when they become due. There are occasions when these accounts could be waived, but most homeowner’s who hold a mortgage will place these funds in an escrow account. The initial escrow account is established when closing a loan. When the taxes or homeowner’s insurance become due, the servicer will payout the payment from your escrow account so you don’t have to fork out all the money at once.
The annual taxes and insurance can change each year, so there are a few more months added into the account in case the costs in the escrow account don’t cover the full amount due. These are called reserves. Servicers try to have 2-3 months of reserves in your account.
These are the basic costs of getting the loan and establishing your escrow account. For detailed costs in your scenario, please reach out and we can get you a detailed quote of what to expect. Keep in mind rates do change on a daily basis so the costs will likely fluctuate each day depending on market conditions.
So who pays closing costs when purchasing a home?
The basic answer to this question is the buyer is ultimately responsible for closing costs. However, do not be discouraged if all you have saved is enough for a down payment. There are other ways to get the closing costs paid for. A very common way to have closing costs paid for is to ask the seller to pay for the closing costs. This is done when negotiating a contract and purchase price. During the covid pandemic, seller paid closing costs were not common as many sellers were receiving multiple offers above asking price. Now things have slowed down and shifted the market.
This has placed homebuyers in a position to have more negotiating room to ask for seller paid closing costs, also known as seller concessions. Some sellers will pay for all closing costs, some will negotiate and meet somewhere in the middle, and some will flat out say no. It all depends on the market, the seller, and the offer.
Closing Costs in Negotiation
The following are possible common scenarios to help explain how closing costs can be paid for:
Doug and Jane are first time homebuyers. The young couple has finally saved enough for a 3% ($15,000) down payment on a $500,000 home. They talk with a loan specialist and are preapproved to purchase a home. Their realtor starts helping them shop for a home. Doug and Jane find a home that is listed for $500,000 and decide they want to make an offer on the home, but need to figure out a way to pay for closing costs.
The loan specialist lets them know the estimated closing costs are $7,000 based on their scenario. This includes all costs associated with purchasing the home. They make a full asking price offer of $500,000 and ask the seller to pay for $7,000 in closing costs.
Here are 3 of the most common ways I see this scenario unfold:
1. The seller can accept the offer and pay for the $7,000 in closing costs. These costs would be paid through the sellers proceeds at closing. The loan specialist would get the contract and finish the loan with Doug and Jane paying only the 3% down payment of $15,000 at closing. The seller would then receive $7,000 less in proceeds upon selling their home.
2. The seller is not willing to pay for the closing costs out the $500,000 purchase price offer and counters the offer at $507,000. In addition to countering for a higher purchase price, the seller would agree to pay for the $7,000 in closing costs. The seller would then use the extra $7,000 in purchase price to pay for the closing costs so it doesn’t take away from the seller’s original equity. In this scenario, and most all scenarios, the appraisal does need to come in at the agreed upon price. If it doesn’t, the contract would need to be renegotiated or terminated.
3. The seller is willing to pay for half of the closing costs. This would result in the seller and buyer having to come in with $3,500 to cover the closing costs. The buyer would have the option to come in with the funds in addition to their down payment. If they did not have enough money for the additional $3,500, they could look into increasing their interest rate to get a lender credit to cover the remainder of the closing costs. This would result in a higher interest rate, which does mean a higher monthly payment. This would also allow them to not have to bring in extra money they do not want to spend upfront. Debt-to-income ratios would need to remain within tolerance of loan product guidelines.
There are multiple other ways that this scenario could play out. Hopefully this gives you a better idea of how you can expect to to pay for closing.
Conclusion
These are the basic closing costs that you should expect to see when purchasing a home. The types and amounts of fees do vary from state to state and from lender to lender. The rates and costs will also vary from day to day depending on the market conditions. You will want to get a detailed quote with the same interest rates on the same day to see the differences between closing costs when shopping for a loan. These costs can be paid by the buyer or the seller. The way they are paid will depend on the buyers scenario and the contract. Please reach out with questions and follow Grizz’s Home Loans on Facebook or Instagram for more education and tips that will save you money!