Everything You Need To Know About Mortgage Closing Costs
13-minute readAugust 13, 2021
*As of July 6, 2020, Rocket Mortgage is no longer accepting USDA loan applications.
When it comes to buying a home, the cost everyone immediately associates with the transaction is the down payment. While this is usually the most substantial upfront cost, it’s not the only thing you have to save for.
This article will make you ready for closing costs so you’re more prepared and educated when it comes time to seal the deal and get the keys. Although a lot of these costs have to do with buying a home, many apply equally if you happen to be refinancing your mortgage. Keep on reading to get a full breakdown.
What Are Closing Costs?
Closing costs are fees paid when you close on a real estate transaction. If you’re buying your real estate with a mortgage like most people, that’s going to be a significant portion of the costs. However, there are also fees associated with taxes and the title.
In fact, when most people think of a closing, they think about closing on a mortgage. But traditionally, closing has referred to taking the title and deed on a real estate transaction regardless of the mechanism for financing.
What Are Closing Costs?
While the definition of closing costs is relatively simple, you should know what’s included in them so you have some idea of what you can expect to pay. We’ve included some of the most common closing costs below.
This one is pretty obvious, and it’s often thought of separately from the rest of the closing costs associated with the mortgage. But if you’re buying a home this is going to be the lion’s share of your expenses on closing day.
There was a time when conventional wisdom dictated you needed 20% down to buy a home. Although there are still advantages to a sizable down payment (among them better interest rates and potentially avoiding mortgage insurance payments), you only need a down payment of anywhere between 3% – 5% to purchase a primary property.
Another thing to be aware of at this point is if you’re in a particularly competitive market but the appraisal comes in a bit below asking price. In this case, your mortgage lender can only give you a loan for what the property is worth according to the appraiser because it serves as collateral for the loan. Ideally, this doesn’t happen. But in the event you default on your loan, your lender might eventually have to sell the property and get whatever they can for it.
If the appraisal comes in low, when you close you’ll have to bring your down payment in addition to the difference between the loan amount and purchase price. This can be avoided if the seller is willing to renegotiate, but that’s not always the case.
There are special loans where no down payment is required.
USDA loans are for clients looking to purchase in eligible rural areas or on the outskirts of suburbia. In addition to geographic restrictions, the client is required to make no more than 115% of the median income in the area in which they plan to purchase a home.
VA loans offer a no-down payment option for eligible active-duty servicemembers, reservists, veterans and surviving spouses of those who passed in action or as a result of a service-connected disability.
When calculating the down payment amount you need to bring to closing, you’ll be able to subtract any earnest money deposit you may have made when you put in your offer. This is meant to go toward your down payment or other closing costs.
Nowadays, loans are backed by a major mortgage investor before being sold on the bond market. This bond market investor gets the interest payments and the originating lender doesn’t see much of that money. Therefore, an origination fee is a big part of the lender’s profit on the loan. It can be a flat fee but is more often charged as a percentage of the loan amount.
Sometimes a lender will have one or both of the fees we’ll discuss in the next section (processing and underwriting fees) in place of or in addition to their origination fee. This is very important when comparing lenders. If a lender is charging you low or no origination fee, make sure you also look at the processing and underwriting fees. If the costs are similar to or higher than another lender who’s charging you a higher origination fee but not the other fees, you may not be getting as good of a deal as you think.
Processing And Underwriting Fees
If you were to break down what a lender does when they originate a loan, a lot of the work comes down to processing and underwriting. This is everything from collecting the paperwork and handling scheduling to making sure you actually qualify for the loan (based on your personal financial profile and the characteristics of the property you’re buying).
If a lender doesn’t charge an origination fee but instead charges processing and underwriting fees, these are similar enough that you can use them to compare loan estimates.
Real Estate Agent Commission
Although they can be paid via a flat fee, real estate agents typically work on commission. The most common deal is that the buyer’s agent and seller’s agent split commission equal to 6% of the purchase price.
This fee is typically paid by the seller, but since everything can be negotiated we’ve included it here just in case.
This is a fee that may be charged for the delivery of such documentation as your loan estimates and closing disclosure. This is one of the smaller fees, but it’s worth mentioning.
Credit Report Fee
Lenders need to be able to pull your credit report to get a look at your score and any existing debts you have in order to determine whether you qualify for any particular loan option. This fee is typically no more than $30. Along with the appraisal, this is one line item that may be included in your deposit or closing costs depending on the procedures of the lender you go with.
The main purpose of an appraisal is to determine the value of the property. This is done by comparing your property with recent sales of similar properties in the area. This gives a lender the value of the collateral for the loan. It’s also for the buyer’s protection against overpaying.
The appraisal serves a second purpose of making sure the property is move-in ready and safe to live in. Although it’s not a home inspection, an appraiser does have to check to make sure it’s safe to move into the property. They’re charged with making sure the utilities are turned on and that there are no hazardous conditions like holes in the roof and exposed floorboards.
This may be fully or partially covered by your deposit. If that’s the case, you’d only be responsible for whatever the deposit doesn’t cover at the time of closing.
Because your home itself serves as the physical backing collateral behind the mortgage, your lender has a vested interest in making sure your house can be fully repaired or rebuilt in the event of damage. For this reason, before you close on your home you’ll be required to source homeowners insurance that (at minimum) covers any scenarios involving damage.
Homeowners insurance policies may also provide extra benefits like theft and liability protection as well as coverage of other structures on the property. As a result, it can be worth shopping around and getting the best deal on the coverage you want.
It’s not uncommon for a lender to want you to pay for a full year of homeowners insurance premiums up front when you close. This is something to be prepared for.
If you make a down payment of less than 20% on a conventional loan, you’ll be required to pay for mortgage insurance in one form or another. However, one of the things you can do is take a slightly higher interest rate and opt for lender-paid mortgage insurance (LPMI) to avoid a separate monthly fee. But there’s also something referred to as single-pay mortgage insurance. While this is LPMI, you pay for the entire cost of the policy up front at closing. In doing so you get the same rate as you would if you didn’t have LPMI and you’d also avoid the monthly fee associated with borrower-paid mortgage insurance (BPMI).
FHA loans have an upfront mortgage insurance premium of 1.75% of the loan amount. This can be built into the cost of the loan if you don’t have the money for it right away.
USDA loans have an upfront guarantee fee that functions like mortgage insurance. The upfront fee is 1% of the loan amount and can be built into the loan balance if necessary.
VA loans don’t have mortgage insurance, but they do have a funding fee. The amount of this funding fee can depend on the size of your down payment, the amount of equity you have, whether you served active-duty or as a member of the reserves, the type of loan you’re getting and how many times you’ve used a VA loan in the past. In any case, the funding fee is usually anywhere between 2.15% – 3.3% of the loan amount. If it’s a VA Streamline, also known as an interest rate reduction refinance loan (IRRRL), the funding fee is 0.5%. You’re exempted from this funding fee if you receive VA disability, you qualify as a surviving spouse, or you are a Purple Heart recipient serving in an active-duty capacity.
Title Search And Insurance
When you get a mortgage to buy a home, you’re required to have a title search done to make sure no one other than the seller has a claim to the property you’re buying. As part of this, the title company insures against future claims.
You’re required to purchase a lender’s title policy which indemnifies the lender and protects their investment if a long-lost relative makes a legitimate claim to the property 5 years down the line. You can shop around for the least expensive company that does the title search and insurance, but the cheapest we were able to find was $425.
Owner’s title insurance isn’t required, but it’s a very good idea. While the lender’s policy protects the mortgage lender’s investment, you’re still out of luck. You’d lose the house without any real recourse. If something is missed in the title search and you have to find a new home after someone else comes back to claim the property, with an owner’s title policy you’d get money to help you purchase a new home. An owner’s title policy also varies in price, but the lowest we saw was $645.
Setting Up An Escrow Account
An escrow account is a requirement of many mortgages to make sure your taxes and homeowners insurance are properly paid when they’re due. Even if you don’t have to have one, many people prefer to keep an escrow account because you don’t have to pay taxes and homeowners insurance payments in a massive chunk.
In order to set up an escrow account, your lender will likely require you to have a couple of months’ worth of property tax and homeowners insurance payments up front. In case your taxes and insurance adjust upwards, this also provides a cushion to ensure you never have less than you need in the account when it comes time to make the payments.
If you were ever short, your lender would pay off the difference and raise your mortgage payment in the future to cover the gap. That said, having the cushion helps keep your payments consistent.
Mortgage Discount Points
In addition to having a good credit score and a bigger down payment, another way to control your interest rate is to buy mortgage discount points, also known as prepaid interest points.
Mortgage discount points allow you to buy down your interest rate. One point is equal to 1% of the loan amount. They can be bought in increments as low as 0.125%. Whether or not you should buy discount points comes down to a math problem that looks at how much you’ll be saving in comparison to how long you plan to stay in your home.
Here’s a quick example. Let’s say buying two points on a $200,000 home saves you $50 per month on your payment. The cost of the points in this example is 2% of the loan amount ($4,000). If we divide that by the amount saved per month, we see that the breakeven point here is 6 years and 8 months (4000/50 = 80 months). If you plan on staying in the home for a longer timeframe than that, you save money. Otherwise, consider buying fewer points if you do choose to look at buydowns.
Tax Service Fee
Your lender has another vested interest in making sure your property taxes are paid on time so you don’t lose the property due to a tax foreclosure, which would jeopardize the lender’s investment. There’s a small fee paid for a service which alerts the lender of any liens due to unpaid taxes.
A notary for a mortgage closing serves as a required witness to the transaction and also makes sure all the proper procedures are followed. You pay for this as part of your closing costs. In some states, the person in this role is required to be an attorney. If that’s the case in your state, the cost for this may be higher than in other states.
Flood Insurance Checks
Depending on whether you live near a body of water, your lender may need to check if flood insurance is necessary. If it’s necessary, you’ll have to get it before you can get a mortgage on your property because regular home insurance doesn’t cover this without an extra rider.
Similarly, those who live in a forest area may need fire coverage in case of wildfires. You should also consider getting wind coverage if you live in a plain prone to high gusts.
Property ownership is a public record filed with the county clerk. When you close on your house, there’s a fee in order for you to properly file this record with the county. The amount will vary depending on where you live.
Although there are exceptions carved out in the laws, in most states you’ll have to pay some sort of transfer tax when property changes hands. Typically, you’ll have to pay X amount for every Y amount of property value. Some states charge both local and state taxes.
How Much Are Closing Costs?
Closing costs can vary based on whether the transaction is a purchase or refinance, the type of loan you’re getting and the amount of the loan, among other factors. That said, it’s possible to give some estimates.
For home buyers, average closing costs are anywhere between 3% – 6% of the purchase price in addition to your down payment. Closing costs tend to be lower on a refinance for a couple of reasons, the first being that title work usually isn’t necessary. Additionally, an appraisal may not be necessary depending on the loan you’re getting.
Can Closing Costs Change?
When you apply for your loan, you’ll receive an initial loan estimate within 3 business days of your completed application. A completed application can happen fairly quickly on a refinance. On a purchase, your application is considered officially complete until you’ve found a property and sent a completed purchase agreement to your chosen lender. An initial loan estimate will give you an initial look at your closing costs among other important details.
You’ll receive a closing disclosure 3 business days before you close on your mortgage. This will give you your final closing costs. Lending costs such as origination, processing and underwriting fees are very limited in terms of how much they can change. However, third-party fees for things like appraisals and title insurance can change by as much as 10%. If you have any questions or see something out of whack with your numbers, it’s a good idea to call your lender immediately and talk things through.
Understanding The Importance Of Annual Percentage Rate (APR)
Your APR is an extremely important thing to understand when comparing closing costs between several lenders. When you shop for a mortgage, you’ll see two interest rates with every loan option you look at. One will be lower. This is the amount of interest being charged by the lender in exchange for giving you the loan. The second and higher rate is your APR.
APR factors in the interests you’re being charged in addition to the closing costs (as if these were being paid off over the term of the loan). The bigger the difference is between the base interest rate and the APR rate, the more you’re being charged in closing costs.
There are a couple of cautionary points to understand when you go about comparing loans this way. You want to make sure you’re comparing apples to apples. This means that if you’re looking at a 30-year fixed conventional loan at one lender, you need to compare it to 30-year fixed conventional loans at other lenders. You should also make sure you’re looking at similar amounts of discount points for any given rate.
Who Pays Closing Costs?
The only closing cost a buyer is typically required to pay for is their down payment. Everything else is negotiable up to a point. While seller concessions are one way of keeping your closing costs down, lenders and mortgage investors place limits on how much a seller can pay for. We’ll get into this a bit below.
Sellers are typically responsible for paying for the real estate commission for the agents. There may be other fees that are paid by the seller depending on local customs.
Ways To Keep Closing Costs Down
There are typically two ways of keeping closing costs down: seller concessions and lender credits. Let’s run through these below.
Seller concessions happen when a seller agrees to cover part of the closing costs for the buyer. Asking for concessions works best if you have a motivated seller or if the property has been on the market for a while and they’re just looking to unload it (even if it means cutting into their profit margins).
The drawback here is that every loan option generally has limits as to how much the seller can contribute. For instance, the limit is 3% of the loan amount when purchasing a primary residence with a conventional loan and a down payment of less than 10%.
If the appraisal comes in higher than the agreed upon purchase price, another way to get the seller to agree to concessions is to offer them more money if they’ll cover a certain amount of your closing cost. In this way you’re essentially building in your closing costs to be paid off over the life of the loan.
The other way to keep closing costs at bay is to get your lender to cover some or all of them (except the down payment) in exchange for a higher interest rate. This is the reverse of discount points. By doing this, your closing costs are paid for over the term of the loan rather than being fully covered up front at closing.
Hopefully this blog post should give you some insight into closing costs so you’re more prepared for your mortgage transaction. If you’re ready to apply, you can get started with Rocket Mortgage®1 or give one of our Home Loan Experts a call at (888) 452-8179.
1Rocket Mortgage® and Rocket HQSM are separate operating subsidiaries of Rock Holdings Inc. Each company is a separate legal entity operated and managed through its own management and governance structure as required by its state of incorporation, and applicable legal and regulatory requirements.
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