Understanding Closing Costs
Don’t let the variable, like PMI, snowball into sticker shock
Tracey C. Velt
California Real Estate
Sept. 2005
Sticker shock. It’s the term best used to describe the feeling right before closing when you learn that your mortgage payment and closing costs are higher than anticipated. Whre did you go wrong? If you’re like many homebuyers, you’ve discovered that an online mortgage calculator didn’t give you the full picture. There are many variables in calculating your closing costs and mortgage payment, including the day of the month that you close escrow and the amount of your downpayment.
As the saying goes: To be forewarned is to be forarmed. Here’s a primer that will help you make sense of the costs involved in buying a home.
Calculating Your Monthly Mortgage Payment
Many more factors besides the obvious – the amount borrowed and the interest rate – factor into your monthly payment. These factors include: duration of the loan (a 30-year loan versus a 15-year loan), how much you put down (a downpayment of less than 20 percent of the loan amount will usually require the homebuyer to pay private mortgage insurance[PMI]).
PMI insurance protects the lender if you default on the loan. In many cases, if you’re current on your loan, you may terminate theis additional insurance cost when you reach 20 percent equity in your home, based on the original property value.
According to the Mortgage Bankers Association (MBA), the lender may also require you to pay money into a special escrow account to cover homeowner’s or flood insurance, property taxes and PMI, if applicable. This is the element of the monthly payment that can fluctuate even in a fixed-rate mortgage. Together, says the MBA, these elements comprise PITI (Principal-Interest-Taxes-Insurance).
Ask your lender or mortgage broker if you will be required to set up an escrow account for taxes and insurance payments. Think of it as a forced savings program. Rather tha set the money aside on your own each month, the terms of your mortgage may require that money to be part of your monthly payment. Remember though, it’s not always required.
A word about escrow. Escrow is the period of time that occurs after your offer on a home has been accepted and you actually sit down at the closing table. During this time, documents and money are held or safeguarded by a neutral third party. The fees charged for escrow vary from county to county but range from $750 to $2,500, depending on the sales price.
Considering all this, it’s always advisable to have a tax professional (an accountant or certified public accountant) guide you through the process when trying to calculate your monthly payment.
Your Settlement Costs
There are three basic categories of charges and fees in settlement or closing transactions, according to the Federal Reserve Board publication, Consumer’s Guide to Mortgage Settlement Costs. Certain costs are traditionally paid by either the seller or buyer, although this si generally negotiable.
The three categories are:
- Charges for establishing and transferring ownership.
These include title search, title insurance, related legal fees, and fees for conducting the settlement. A title search is a search of the public records that establishes that the owner has clear title and ensures that there are no claims of ownership against the property you’re buying. A title company or a lawyer usually performs this search. Typically, estimate $150 to cover such items as notary and document recordings and endorsements, etc.
- Amounts paid to state and local governments.
These include city, county and state transfer taxes, recordation fees, and prepaid property taxes. These are the fees involved in handling and recording the paperwork for your home purchase as well as your property taxes. A city transfer tax or municipal tax can be imposed within the corporate limits of some cities. The cost is $3.30 per $1,000 of selling price. The Department of Veterans Affairs (VA) does not allow the veteran buyer to pay any portion of this cost.
- Costs of getting a mortgage.
These costs include survey, appraisals, credit checks ($50-$60, but consumers can obtain one report annually at no cost), loan documentation fees, notary charges, loan origination, commitment and processing fees, hazard insurance, interest prepayments, and lender’s inspection fees. How much you pay depends on the time of the month you close, as these fees are calculated daily and are either prepaid or prorated.
The costs of getting a mortgage may be imposed by your lender as early as when you apply for your loan, according to the Department of Housing and Urban Development (HUD).
Mortgage-related closing costs, as gathered from the Federal Reserve Board and HUD, include:
· Application Fee. Imposed by your lender, this charge covers the initial costs of processing your loan request and checking your credit report.
· Appraisal Fee. Many lenders require your home to be appraised (which is an opinion or estimate of market value) to ensure the value of the home is not less than the loan amount. Budget $300 to $500 for an appraisal, according to Orange Coast Title Company.
· Survey. At a minimum, the lender will require an independent verification from a surveying firm tha your lot has not been encroached upon by any structures since the last survey conducted on the property. Alternatively, the lender may insist upon a complete (and more costly) survey to ensure that the house and other structures legally are where the seller says they are.
· Loan Origination Fees and Discount Points. The origination fee is paid to the lender for costs incurred in evaluating and preparing your mortgage loan. Discount points are fees paid to a lender at closing in order to lower the interest rate on your home loan. One point equals 1 percent of the loan amount. For example, one point on a $55,000 loan would be $550. Government regulations allow only a 1 percent origination fee on FHA or VA loans. Conventional loan fees can vary from -1 to 3+ points, plus other costs.
· Mortgage Insurance. Buyers who make a downpayment of less than 20 percent (and in some cases 30 percent) of the value of the house may be required by lenders to take out mortgage insurance. The policy covers the lender’s risk in the event the buyer fails to make the loan payments. Premiums are typically paid annually from an escrow or reserve account, or in a lump sum at closing. A buyer, whose mortgage is insured by Federal Housing Administration (FHA) or guaranteed by the VA, will have to pay FHA mortgage insurance premiums or VA guarantee fees.
· Homeowner’s and Hazard Insurance. This is a form of protection against physical damage to the house by fire, wind, vandalism and other causes. Your lender will expect you to have a policy in effect at closing.
According to Orange Coast Title, other inspection fees that buyers may incur are:
· Property inspections that usually cover the foundation, electrical, plumbing and overall construction: $300-$400.
· Roof inspections: $74-$125
· Geological reports: $100
· Septic: $200-$400
· Radon: $50-$100
· Pest inspection fee: $75-$175
· Asbestos: $75-$125
According to HUD, a federal law called the Real Estate Settlement and Procedures Act (RESPA) requires, among other things, that when you apply for a loan, the lender or mortgage broker give you a Good Faith Estimate of settlement service charges you’ll likely have to pay. If you don’t receive the Good Faith Estimate when you apply for the loan, the lender or mortgage broker must mail or deliver it to you within the next three business days. Remember, this is an estimate, not an exact calculation, but the amount should be close. Changing market conditions can affect prices. Keep your Good Faith Estimate so you can compare it with the final settlement costs and ask the lender about any changes.
Just knowing to expect the unexpected can keep you from experiencing sticker shock when it comes to buying a home.