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Closing Costs on Buying a Home, Mortgage Rates are Only Part of the Expense

October 17, 2011

When you’re buying a home or refinancing a mortgage your main concern is where are mortgage rates today but that shouldn’t be your only concern. Yes, mortgage rates current are a big concern but closing costs are also something you need to pay attention to. The mortgage settlement process also known as mortgage closing can be confusing. A settlement may involve several interested parties and a variety of documents and fees.

I will help you understand the steps involved in the settlement process and finding a list of mortgage rates from many different lenders. Although the focus here is on settlements for home purchases, much of the guidance will also apply if you refinance a mortgage.

Settlement costs can be high, so it pays to shop around for settlement services and negotiate with the home seller, your mortgage lender, and your real estate attorney or settlement agent. The less you pay in settlement costs, the more funds you will have to get started in your new home. Negotiate the terms of your purchase. Thankfully interest rates are low right now on mortgages. If you are a net depositor you probably are aware how low interest rates are. The best CD rates available these days aren’t that high and probably won’t go higher until mid 2013.

Customs and practices during settlement often vary regionally, with buyers and sellers free to negotiate which party pays certain fees. In slow-moving real estate markets, for example, the seller may agree to pay certain settlement costs including points or fees usually assumed by the buyer. In fast-moving markets, the buyer may have to agree to pay more costs to close the deal as an incentive to the seller of a property in great demand.

Whatever you negotiate should be in writing and will become the basis of the sales contract. However, be careful: if some buyer’s costs are shifted to the seller, the price you pay for the property may increase if the seller wants to recoup those costs. You can reduce some costs by shopping around for settlement services. The more you know about the settlement process and related costs, the better your chances are for saving money at settlement time.

Because settlement practices vary significantly based on your locale, it is difficult to provide reliable estimates for costs that fit every settlement situation you may encounter. However, one rule of thumb for buyers is to figure that settlement costs will be about 3% of the price of your home. In some relatively high-tax areas of the country, however, 5% to 6% may be more common.

Some settlement costs, such as homeowner’ s insurance, private mortgage insurance, or points, can be more expensive if your credit rating is low, too. Knowing your credit score, therefore, can help you understand how lenders will evaluate your applications and how that score may impact the cost of your mortgage loan and help you to anticipate your settlement costs. Your lender is required to give you a copy of your credit score as part of the settlement process. Make sure you get a copy of your score.Understand the types of settlement costs.

Most people associate settlement costs with mortgage loan charges. These fees and charges vary, so it pays to shop around for the best combination of mortgage terms and settlement costs. Mortgage-related costs that may apply to your loan include the following items. Imposed by your lender or broker, this charge covers the initial costs of processing your loan request and checking your credit report.

The origination fee (also called underwriting fee, administrative fee, or processing fee) is charged by the lender for evaluating and preparing your mortgage loan. This fee can cover the lender’s attorney’s fees, document preparation costs, notary fees, and similar charges.

Points are a one-time charge that may be negotiated with the lender, usually to reduce the interest rate you pay over the life of your loan. One point equals 1% of the loan amount. For example, one point on a $100,000 loan would be $1,000. In some cases–especially in refinancing–points can be financed by adding them to the amount that you borrow.

However, if you pay the points at settlement, they are deductible on your income taxes in the year they are paid (different deduction rules apply when you refinance or purchase a second home). In your purchase offer, you may want to negotiate with the seller to have the seller pay all or a portion of the points.

Lenders want to be sure that the purchased property is worth at least as much as the loan amount. An appraisal fee pays for a determination of the value of the home and lot you want to purchase or refinance. Some lenders and brokers include the appraisal fee in the application fee; you can ask the lender for a copy of the appraisal. If you are refinancing and have a recent appraisal of the property, some lenders may waive the requirement for a new appraisal.

Lenders may require a termite inspection and an analysis of the structural condition of the property by an engineer or consultant. In rural areas, lenders may require a septic system test (if applicable) and a water test to make sure the well and water system will maintain an adequate supply of water for the house.

This is usually a test for water quantity and not quality; your local health department may require a water quality test as well, but may do so outside the settlement process and with a separate payment. Keep in mind that such inspections are for the benefit of the lender; you may want to request your own inspection to make sure the property is in good/acceptable condition.

Your first regular mortgage payment is usually due about six to eight weeks after you settle (for example, if you settle in August, your first regular payment will be due on October 1; the October payment covers the cost of borrowing the money for the month of September). Interest costs, however, start as soon as you settle. The lender will calculate how much interest you owe for the part of the month in which you settle.

Private mortgage insurance (PMI). If your down payment is less than 20% of the value of the house, the lender will usually require mortgage insurance. The insurance policy covers the lender’s losses if you do not make the loan payments. Typically, you will pay a PMI monthly along with each month’s mortgage.

Your PMI can be canceled at your request, in writing, when you reach 20% equity in your home (based on your original purchase price) if your mortgage payments are current and you have a good payment history. By federal law your PMI payments will automatically stop when you acquire 22% equity in your home (based on the original appraised value of the house) as long as your mortgage payments are current.

Some lenders will pay for LPMI–or lender’s private mortgage insurance–and, in turn, charge a higher interest rate to you. Unlike the PMI that you might pay, with LPMI there is no automatic cancellation of the insurance charge once you acquire 22% equity.

 To eliminate LPMI, you must refinance the loan, which in turn means carefully considering market interest rates and settlement costs at the time to see if refinancing would be advantageous to you, rather than keeping your current mortgage and its attendant costs.

The Federal Housing Administration (FHA) offers insured mortgages and the Veterans Administration (VA) and the Rural Housing Service (RHS) offer mortgage guarantees. If you are getting a mortgage insured by the FHA or guaranteed by the VA or the RHS, you will have to pay FHA mortgage insurance premiums or VA or RHS guarantee fees.

As with PMI, FHA insurance premium payments will stop when you acquire 22% equity in your home. FHA fees are about 1.75% of the loan amount.1 VA guarantee fees range from 1.25% to 3.3% of the loan amount, depending on the size of your down payment (the higher your down payment, the lower the fee percentage).2 RHS fees are 2.00% of the loan amount.3

Your lender will require that you arrange for homeowner’s insurance coverage (sometimes called hazard insurance) at settlement. This insurance protects against physical damage to the house by fire, wind, vandalism, and other causes, and ensures that the lender’s investment in your purchase will be secured even if the house is destroyed. I

If you are buying a condominium, hazard insurance may be part of your monthly condominium fee; you may also want to secure insurance coverage for your home furnishings and valuables.

If your home is in a special flood hazard area where flood insurance is mandated, lenders cannot offer you a mortgage loan unless you buy flood insurance. Regardless, your lender may charge a fee to find out whether the home is in a flood hazard area. Flood insurance protects the lender if flooding damages or destroys your home.

Estimated cost: $10 to $16 for the search (This is not the cost for the flood insurance; flood insurance, if required, would be in addition to your homeowner’s insurance and may cost from $500 to $5,925 depending on location and property value and loan balance.4 )

Some lenders require that you set aside money in an escrow (or reserve) account to pay for property taxes, homeowner’s insurance, and flood insurance (if applicable). Lenders use escrow funds to ensure that these items/expenses are paid on time and to protect their interest in your home. With an escrow account, money is held by the lender or its agent, which then pays the taxes and insurance bills when they are due.

At settlement, you may need to provide funds for this account, depending on when payments will be due. For example, if you buy your home in August and property taxes are due the following January, you will need to deposit funds into your escrow account at settlement so that you can cover tax payments when they are due in January.

Lenders require a property survey to confirm the location of buildings and improvements on the land you are purchasing. Some lenders require a complete (and more costly) survey to ensure that the house and other structures are legally where you and the seller say they are.

Depending upon the location and type of property purchased–and the extra settlement services you or your lender request–you may also have to pay some of the following fees and assessments.

  
Prorated expenses between the seller and the buyer. In your purchase contract, you may agree to split some costs with the seller to cover your respective periods of ownership during the overarching calendar year or tax period, such as prorated property taxes.

Some of these expenses may involve large amounts: for example, annual condominium fees, homeowners’ association fees, water bills, and other lump-sum service charges.

 Inspection costs/fees. As a buyer, if you make your purchase offer contingent on the results of a home inspection–such as testing for structural damage, water quality, and radon gas emissions–you will have to pay for these inspections.

Escrow account funds. In the purchase contract, you can request that the seller set up an escrow account to cover any costs for repairs, radon mitigation, house painting, or other items. For example, if you do not test all the appliances (for instance, if you buy in the summer, you may not test the furnace), you may request an escrow account to cover repairs if they are needed in the future.

The seller may agree to split the costs with you, in which case you would need these funds at settlement. Sellers sometimes offer home warranties in lieu of these arrangements and as an enticement to buyers. These warranties typically cover repairs or the replacement of plumbing and heating, major appliances, and other home systems not covered by other home insurance policies.

Fees paid to find a lender. As a borrower and buyer, you may work with a mortgage broker or other third party to secure a mortgage loan. For example, you may want to work with a broker to find a loan with nonstandard terms or conditions. Brokers arrange transactions rather than lend money directly; in other words, they find a lender for you. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they have contracted with you to act as your agent.

The goal of a title search is to assure you and your lender that the seller is the legal owner of the property and that there are no outstanding claims or liens against the property that you are buying. The title search may be performed by a lawyer, an escrow or title company, or other specialist.

Title searches can be time- and labor-intensive. Public real estate records can be spread among several local government offices, including surveyors, county courts, tax assessors, and recorders of deeds. Liens, records of deaths, divorces, court judgments, and contests over wills–all of which can affect ownership rights–must also be examined.

If real estate records are computerized, the title search can be completed fairly quickly. In some cases, however, the title search may involve visiting courthouses and examining other public records and files, which is more time-consuming.

Most lenders require a title insurance policy to protect the lender against an error in the results of the title search. If a problem arises, the insurance covers the lender’s investment in your mortgage.

The cost of the policy (a one-time premium) is usually based on the loan amount and is often paid by the buyer. However, you may negotiate with the seller to pay all or part of the premium.

The title insurance required by the lender protects only the lender. To protect yourself against title problems, you may want to buy an “owner’s” title insurance policy. Normally the additional premium cost is based on the cost of the lender’s policy, but it can vary based on your locale.

Some advice on keeping title insurance costs low: if the house you are buying was owned by the seller for only a few years, check with the seller’s title company. You may be able to get a “re-issue rate,” because the time between title searches was short. As well, if you are refinancing, you may be able to get a “re-issue rate” on your title insurance. The premium is likely to be lower than the regular rate for a new policy. If no claims have been made against the title since the previous title search was done, the insurer may consider the property to be a lower insurance risk.

Usually, you will have to buy title insurance from a company acceptable to your lender. However, you can still shop around for the best premium rates (which can vary depending on how much competition there is in a market area).

If you decide to buy an “owner’s title policy,” look for one with as few exclusions from coverage as possible. Exclusions are listed in each policy, and if a policy has many exclusions–that is, situations under which the insurer will not pay for your title problems–you may end up with little/scant coverage.

Estimated cost: The cost of title services and title insurance varies by state. For example, a lender’s policy on a $100,000 loan can range from $175 in one state to $900 in another. In some states, the price can even vary by county.

Settlements are conducted by title insurance companies, real estate brokers, lending institutions, escrow companies, or attorneys. In most cases, the settlement agent provides a service to the lender, and you may be required to pay for these services. You can also hire your own attorney to represent you at all stages of the transaction, including settlement.

In some regions, all parties involved in the sale–the buyer; the seller; the lender; the real estate agents; attorneys for the buyer, seller, and lender; and representatives from the title firm–may meet to sign forms and transfer funds. In other regions, settlement is handled by a title or escrow firm, which collects all the funding, paperwork, and signatures and makes the necessary disbursements. This firm delivers the check to the seller and the house keys to you.

Entry filed under: Homes. Tags: Closing Costs on Buying a Home, Mortgage Rates are Only Part of the Expense.