Explaining Closing Costs
What Are Closing Costs?
By Liz Clinger Updated on 11/22/2013
The term closing costs generally refers to all the costs associated with closing a home purchase or refinance. A more accurate term to reflect these costs is settlement costs. Settlement costs include 4 categories: lender fees, third party fees, prepaid items and taxes/government fees. Let's discuss each of these categories separately.
Lender Fees (fees charged directly by the lender)
Origination Fee
In order to process a mortgage application, lenders may charge a flat upfront fee, or a percentage of the mortgage loan. This is referred to as the Origination Fee. Some lenders may not charge an origination fee. Origination fees are paid at the time of closing.
Points
In order to lower your interest rate, you might want to consider paying points. One point is equal to 1% of the loan amount and is payable at closing. On a refinance, some lenders will let you finance the points, which means the points will be added to the mortgage cost and be part of the amount borrowed. The points may be tax-deductible in the year in which they are paid (please consult a tax professional for more information).
Application Fee
Some lenders charge a fee at the time of application in order to prepare the documentation for the next step in the process. This may or may not include the deposit for the credit report fee and appraisal fee (discussed in Third Party Fees below). The application fee is typically due at the time of application and may be non-refundable. Be sure to ask for detailed descriptions of each application fee before paying them.
Underwriting/Processing Fee
Some lenders charge a fee at the time of closing for the underwriting or processing of your loan. These fees typically cover the administrative costs of approving the loan. Some lenders will simply add these fees to the origination fee as a lump sum total.
Flood Certification Fee
Lenders will verify whether or not the property is in a flood zone. This fee is typically nominal and is charged at the time of close
Third Party Fees (fees charged by companies other than the lender)
Attorney's Fees
The buyer, the seller and the lender may each be represented by an attorney in a real estate transaction, or they may waive representation. Fees are paid to the attorney(s) for preparing the official documents. These fees are typically paid at closing.
Document Preparation Fees
During the mortgage closing process, there are several documents and papers that must be prepared, and you will occasionally see fees for this. These fees are typically paid at closing.
Title Insurance
There are two forms of title insurance: an owner's policy and a lender's policy. They both provide the same protection, but the insurance benefits different parties. Title insurance is issued after a thorough investigation is done into the chain of title. It covers legal fees and any losses in the event that someone files a successful claim against the ownership rights to the property. In other words, it protects the owner or lender in case the home was not legally the property of the person it was purchased from.
Owner's policies are optional and remain in effect for the time the buyer or their heirs own the property. Lenders' policies are required by the lender to protect their investment and are good only for the life of the loan, hence new policies are required on refinances as well. Both premiums are paid at closing.
Appraisal fees
Most lenders require that an appraisal be performed as a condition of the loan. This is to verify that the selling price of the financed property is equal to or less than the fair market value. The appraisal fee is usually paid by the buyer and is almost always paid upfront. The lender may require a deposit for this fee at the time of application, after which it is held in escrow until given to the appraiser.
Credit Report
Lenders will pull a credit report as part of the qualification process. This fee may be charged up front around the time of application or at the time of closing. Some lenders will include the credit report fee in the application fee they charge up front.
Inspection Fees
Some lenders require inspections (e.g., termite inspection) to make sure that the property is in excellent condition. In many rural areas a water test may be required to ensure the well and water system will maintain an adequate water supply to the house. This is necessary to assure that the property will retain the required collateral to secure the mortgage loan.
You may make the purchase offer contingent upon satisfactory completion of some other inspections. These inspections might include structural, water quality and radon tests. Inspection fees are typically paid at the time of inspection.
Survey
Lenders may require that the property be surveyed to inspect for encroachment and confirm lot size and dimensions. This fee is typically paid before the time of closing.
Prepaid Items
Prepaid Interest
Prepaid interest is exactly what it sounds like, interest that is paid in advance. Mortgage payments are paid in arrears, meaning that you pay the interest in the month after you use the money (i.e., February's interest payment pays January's interest). Since it isn't practical for you to make a partial monthly payment only days after you purchase or refinance your home, the lender will charge a small interest payment at closing. This is why most loans are not due until the second month after closing (note, this is not always the case).
Prepaid interest is figured by multiplying the interest rate by the loan amount, dividing by 365 days, and then multiplying by the number of days left in the month when the loan closes. This is paid at the time of closing.
Homeowner's Insurance
Homeowner's insurance, also called hazard insurance, is required to be paid in advance. On a purchase, you will pay one year's premium up front at the time of closing. If you have chosen to escrow your insurance with your lender, you will also be required to set up a cushion for that escrow account, usually two months' worth of the annual premium. The cushion is there in case the premium rises and you need to cover the missed mortgage payment. On a refinance, you will be required to escrow a certain amount of your premium depending on when the next payment is due. These monies are collected at closing.
Property Taxes
Property taxes up until the time of closing are almost always the responsibility of the seller. As such, the seller must cover a portion of the next tax bill due. This is shown as a credit at the closing from the seller to the buyer. However, a new homeowner who is paying their property taxes through escrow will need to set up a new escrow account with enough cash to cover the next property tax bill.
This account will typically be funded with the seller's credit, plus a two-month cushion from the buyer. Much like the homeowner's insurance cushion, this is to cover the one month that the buyer may be skipping a mortgage payment plus a little extra to cover rising property taxes or any underage.
Taxes & Government Fees (fees to paid to local or state agencies)
Recording Fees
These fees may be paid by either party and are charged by a governmental entity for entering an official record of the change of ownership of the property. The fee is required by the government for recording the deed and is charged at closing.
Statutory Closing Costs
Statutory closing costs are expenses you would have to pay to state and local agencies even if you paid cash for the house and did not need to take out a mortgage. They include the following:
Most of these fees can be negotiated into the contract for the seller to pay. It is not uncommon for a seller to issue a closing cost credit for either a specific item or just a general lump sum. Talk to your real estate agent for more information regarding seller paid closing costs (see below).
Also, on a refinance, you may be able to choose a loan option in which the lender pays many of the fees listed above. However, you will have to pay a higher interest rate than if you paid the fees yourself. Please consult a reputable local loan officer for more information on these fees.
The term closing costs generally refers to all the costs associated with closing a home purchase or refinance. A more accurate term to reflect these costs is settlement costs. Settlement costs include 4 categories: lender fees, third party fees, prepaid items and taxes/government fees. Let's discuss each of these categories separately.
Lender Fees (fees charged directly by the lender)
Origination Fee
In order to process a mortgage application, lenders may charge a flat upfront fee, or a percentage of the mortgage loan. This is referred to as the Origination Fee. Some lenders may not charge an origination fee. Origination fees are paid at the time of closing.
Points
In order to lower your interest rate, you might want to consider paying points. One point is equal to 1% of the loan amount and is payable at closing. On a refinance, some lenders will let you finance the points, which means the points will be added to the mortgage cost and be part of the amount borrowed. The points may be tax-deductible in the year in which they are paid (please consult a tax professional for more information).
Application Fee
Some lenders charge a fee at the time of application in order to prepare the documentation for the next step in the process. This may or may not include the deposit for the credit report fee and appraisal fee (discussed in Third Party Fees below). The application fee is typically due at the time of application and may be non-refundable. Be sure to ask for detailed descriptions of each application fee before paying them.
Underwriting/Processing Fee
Some lenders charge a fee at the time of closing for the underwriting or processing of your loan. These fees typically cover the administrative costs of approving the loan. Some lenders will simply add these fees to the origination fee as a lump sum total.
Flood Certification Fee
Lenders will verify whether or not the property is in a flood zone. This fee is typically nominal and is charged at the time of close
Third Party Fees (fees charged by companies other than the lender)
Attorney's Fees
The buyer, the seller and the lender may each be represented by an attorney in a real estate transaction, or they may waive representation. Fees are paid to the attorney(s) for preparing the official documents. These fees are typically paid at closing.
Document Preparation Fees
During the mortgage closing process, there are several documents and papers that must be prepared, and you will occasionally see fees for this. These fees are typically paid at closing.
Title Insurance
There are two forms of title insurance: an owner's policy and a lender's policy. They both provide the same protection, but the insurance benefits different parties. Title insurance is issued after a thorough investigation is done into the chain of title. It covers legal fees and any losses in the event that someone files a successful claim against the ownership rights to the property. In other words, it protects the owner or lender in case the home was not legally the property of the person it was purchased from.
Owner's policies are optional and remain in effect for the time the buyer or their heirs own the property. Lenders' policies are required by the lender to protect their investment and are good only for the life of the loan, hence new policies are required on refinances as well. Both premiums are paid at closing.
Appraisal fees
Most lenders require that an appraisal be performed as a condition of the loan. This is to verify that the selling price of the financed property is equal to or less than the fair market value. The appraisal fee is usually paid by the buyer and is almost always paid upfront. The lender may require a deposit for this fee at the time of application, after which it is held in escrow until given to the appraiser.
Credit Report
Lenders will pull a credit report as part of the qualification process. This fee may be charged up front around the time of application or at the time of closing. Some lenders will include the credit report fee in the application fee they charge up front.
Inspection Fees
Some lenders require inspections (e.g., termite inspection) to make sure that the property is in excellent condition. In many rural areas a water test may be required to ensure the well and water system will maintain an adequate water supply to the house. This is necessary to assure that the property will retain the required collateral to secure the mortgage loan.
You may make the purchase offer contingent upon satisfactory completion of some other inspections. These inspections might include structural, water quality and radon tests. Inspection fees are typically paid at the time of inspection.
Survey
Lenders may require that the property be surveyed to inspect for encroachment and confirm lot size and dimensions. This fee is typically paid before the time of closing.
Prepaid Items
Prepaid Interest
Prepaid interest is exactly what it sounds like, interest that is paid in advance. Mortgage payments are paid in arrears, meaning that you pay the interest in the month after you use the money (i.e., February's interest payment pays January's interest). Since it isn't practical for you to make a partial monthly payment only days after you purchase or refinance your home, the lender will charge a small interest payment at closing. This is why most loans are not due until the second month after closing (note, this is not always the case).
Prepaid interest is figured by multiplying the interest rate by the loan amount, dividing by 365 days, and then multiplying by the number of days left in the month when the loan closes. This is paid at the time of closing.
Homeowner's Insurance
Homeowner's insurance, also called hazard insurance, is required to be paid in advance. On a purchase, you will pay one year's premium up front at the time of closing. If you have chosen to escrow your insurance with your lender, you will also be required to set up a cushion for that escrow account, usually two months' worth of the annual premium. The cushion is there in case the premium rises and you need to cover the missed mortgage payment. On a refinance, you will be required to escrow a certain amount of your premium depending on when the next payment is due. These monies are collected at closing.
Property Taxes
Property taxes up until the time of closing are almost always the responsibility of the seller. As such, the seller must cover a portion of the next tax bill due. This is shown as a credit at the closing from the seller to the buyer. However, a new homeowner who is paying their property taxes through escrow will need to set up a new escrow account with enough cash to cover the next property tax bill.
This account will typically be funded with the seller's credit, plus a two-month cushion from the buyer. Much like the homeowner's insurance cushion, this is to cover the one month that the buyer may be skipping a mortgage payment plus a little extra to cover rising property taxes or any underage.
Taxes & Government Fees (fees to paid to local or state agencies)
Recording Fees
These fees may be paid by either party and are charged by a governmental entity for entering an official record of the change of ownership of the property. The fee is required by the government for recording the deed and is charged at closing.
Statutory Closing Costs
Statutory closing costs are expenses you would have to pay to state and local agencies even if you paid cash for the house and did not need to take out a mortgage. They include the following:
- Transfer taxes - Required by some local governments to transfer the title and deed from the seller to you.
- Deed stamps - Some municipalities charge deed stamps to transfer title. This is basically another way to say transfer taxes.
- Other state and local fees - Some local and state agencies may have fees beyond those listed above.
Most of these fees can be negotiated into the contract for the seller to pay. It is not uncommon for a seller to issue a closing cost credit for either a specific item or just a general lump sum. Talk to your real estate agent for more information regarding seller paid closing costs (see below).
Also, on a refinance, you may be able to choose a loan option in which the lender pays many of the fees listed above. However, you will have to pay a higher interest rate than if you paid the fees yourself. Please consult a reputable local loan officer for more information on these fees.
Buyer and Seller Closing Costs
Although most costs involved in a real estate transaction can be negotiated between buyer and seller, there are a lot of costs that are traditionally paid by one party or the other. We have set forth below a list of these charges.
Typical Buyer's Closing Costs:
Negotiable Closing Costs:
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Typical Seller's Closing Costs:
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Mandatory Costs: FHA & VA
FHA and VA regulations require the seller to pay the following fees in an FHA or VA transaction, if applicable: assignment fee, flood certification fee, bringdown endorsements, document preparation fees, photo/inspection fees, tax service contract, warehousing fees, or any other loan cost or charge except the following: prepaid interest, impounds on new loan, loan origination, loan discount fees or appraisal. In addition, on a VA transaction the seller is required to pay the entire escrow fee.
Prior to closing, your loan officer will provide you with a Good Faith Estimate and your Escrow Officer will provide you with a Settlement Statement. It is recommended you
review both documents prior to closing.
review both documents prior to closing.
