In general most people think of their closing costs to obtain their mortgage and complete the purchase as the amount they pay above and beyond their down payment. If it is a refinance it would be thought of as the amount they add to their mortgage above their payoff amount. While this is a general way of looking at it I would like to explain further in a more technical way for you to understand closing costs.
I look at what most people consider closing costs in two parts.
Part one is the amount of total cost that you pay just to obtain the mortgage. These costs may include: an appraisal, credit report, title and escrow, origination fees, and possibly Discount Points (if you are buying your interest rate down) and lender fees (underwriting, tax service, flood certification, verification fees, and possibly a subordination fee if you are refinancing a first mortgage and leaving a 2nd mortgage in place.) Some items that you may also need to consider but are not required to be paid to get a loan to purchase a home are a home inspection and a home warranty.
Part two is what we refer to as your pre-paid items and reserves. You can think of Pre-paid items as those costs that you incur just to be an owner of a home. These items include: Home owners insurance, home owners association dues if there is an HOA, interest due to the lender for the number of days left in the month in which you close. The reserves are for your taxes and insurance to start your escrow account. Generally, most lenders will start this escrow with two months reserves for each. The pre-paid interest is calculated based on the interest rate and the loan amount of your loan. Interest is calculated per day and it is multiplied times the number of days that you will own the property in the month in which you close on your loan.
In both cases part one and part two some of the closing costs will vary depending on the sales price or the loan amount for your home. For example if you choose a loan with an origination fee or discount points that will be a percentage of the loan amount you intend to borrower. The appraisal cost may vary depending on the actual size of the home you are purchasing. Generally there is a standard fee for a particular loan type. Say the fee is $400 for a conventional loan and $450 for an FHA loan for a home up to 4000 sq. feet. After the appraisers pre-determined sq. feet amount where additional appraisal fees may be incurred you will need to receive a quote from the appraiser to determine the actual cost of the appraisal for that property.
The title and escrow fees will in most cases be charged on a sliding scale. The lenders title insurance fee is most often determined based on the loan amount and the escrow fee is determined from the sales price. Your property taxes will be determined in most cases by your county assessor’s valuation of your property so the more valuable the property the larger the tax bill.
Your home owner’s insurance amount may be determined by a number of factors. Some things that can determine this is the cost to rebuild your home, and thus the size of your home will be a factor, the zip code you are in, proximity to a fire station, and the company you choose to insure your home may be just a few of the items that can determine the cost of your home owners insurance.
Part one closing costs without paying any origination fees or discount points for an average sales price of $200,000 will generally be in the amount of $3,000 to $3,500. Part two pre-paid items and reserves should account for around $1500. So in total you should plan to have at the minimum in addition to the amount of your down payment is an additional $4500 to $5,000 for your closing costs, pre-paid items and reserves.
There are a few other options to get your closing costs paid other than from your pocket. If you are making a purchase you can try to negotiate for the seller to pay them for you. This works best when the market is in favor of the buyer (also known as a “buyers’ market”) when supply of homes for sale is above the normal average and homes take longer to sell. It does not work so great when it is a “sellers’ market” when supply of homes is short and competition for them is high.
The other potential way to finance some or all of your closing costs is doing a “low cost” or
“no cost loan.” This is where you agree to take a slightly higher interest rate and the lender will pay those costs up front for you. You must remember with a higher interest rate you will pay for them over the life of your loan. However, if you do not have the cash up front to pay for them it may be an option to get you into your home. Sometimes this is a good strategy to use on some refinances, depending on how long you are planning to keep the loan you are refinancing into.
Sometimes people will use a combination of these two strategies when purchasing their home.
If you are looking to refinance your loan you can in many cases add your closing costs into your new loan depending on the Loan To Value (LTV) which will be determined by an appraisal and the amount of loan you need to pay off your old loan and include your closing costs in the new loan. Sometimes people will also choose the “low or no cost” loan if they are not planning to keep the new loan they are putting in place with the refinance.
Here are some very IMPORTANT notes to this process. If you pay attention to these details in the links below it will make the mortgage process much less frustrating.
If you have any questions, please feel free to give me a call. Thanks for reading!