You’ve been saving funds diligently, knowing how much you want to put down on a home – be it that minimum of 3% or trying to breach the non-mortgage insurance threshold of 20%. You’ve swallowed the reality of the cost of a home where you want to buy and then your mortgage person tells you, “oh yes and you have closing costs and prepaids on top of your down payment that are approximately another 3%.” WTH??? So that is the bad news. The good news is that there are ways to offset those thanks to provisions in regulations.
In a moment I will explain what the options are, but first let’s talk about what these mysterious charges are so you can better understand how they work.
Closing costs – these are one time charges associated with both getting a mortgage and purchasing a home.
Credit report and property appraisal: These are generally paid directly by you. You don’t get to choose who does them and they help the lender understand who and what they are lending on. Cost on credit may vary some if they have to update trades or re-issue the report multiple times to find the right program, those these are minor charges like just few dollars at a time. Appraisal costs vary by location and type of property. If you are buying multi unit property or acreage out in the sticks, the charges will be higher than a tract home in the city. If you have an unusual property, make sure you ask for a quote on the cost so that you are prepared.
Lender fees: there are a variety that crop up under this category including an underwriting fee, tax monitoring or tax service fee, flood certification and any number of small charges that are lender or area specific.
Services you may shop for: This includes things like home inspections, pest and dry rot inspections or roof inspections that might be desired by you or required by the lender should they view a possible deficiency from either the contract or the appraisal of the property. In some areas surveys are regularly required. The other big ticket items under the category of services you may shop for have to do with closing and title.
Title insurance ensures a clear transfer of the title from one owner to you the purchaser. Typically the seller pays for the main title policy, but if you are getting a mortgage, there are some extended coverages that will also be required by your lender that you will pay for. Additionally there is usually a settlement agent who charges for their services to watch over and orchestrate signing and funds being distributed after the closing occurs. Related to this is escrow. Some areas use an attorney’s office for this, in OR, WA, and CA escrow is the place for closing real estate transactions. Escrow is the disinterested third party that holds all funds and oversees the closing where the settlement agent works. The cost for Escrow and settlement is usually split evenly between buyer and seller. Sometimes the escrow company is independent and other times it is simply a branch of a title company. Other costs that fall under this are notary fees or cost for a mobile notary.
Other misc charges: These include local transfer taxes, recording fees and sales tax on other services purchased.
Prepaids – these are items paid in advance that you normally have to pay regularly when owning a home.
Prorated interest – interest is prorated from the day you close to the end of the month that you are in. Since mortgage interest is collected in arrears, it will be another month before you actually have a payment due. Example: If you close January 16th, you will pay 15 days of interest at closing and your first house payment will be due on March 1. If you are a renter, this will feel like skipping a payment though you really are paying interest for every day that you own the home, just not in advance like you do as a tenant.
Homeowner’s Insurance: When you purchase, the lender will require that you provide a policy that covers at least the loan amount or the cost to rebuild the structure should it be destroyed. They will require that a full year be paid for in advance and may also collect an extra 2 months worth to be sure there are enough funds to cover any adjustments to premium for when it comes due again if they will be paying it out of a reserve account.
Property taxes: How taxes are paid vary from place to place. Depending on when they are due and payable they will be prorated between you and the seller for amounts that are already paid. If you have a reserve account they will also collect an amount to ensure that when taxes are due and payable there is enough in the reserve account to cover the amount that is likely due. You may see this amount adjust from year to year on your reserve statement from the lender as tax amounts change within your local jurisdiction.
Mortgage Insurance: There are several ways this is paid. If you are not doing borrower paid monthly, they may collect an amount in reserve for a couple of months. If you are doing single premium or one other the other plans there may be a large amount due. Be sure to discuss the options though typically for most borrowers borrower paid monthly is the best bet.
HOA dues or other obligations related to the property: Anything that is a recurring charge related to the property like HOA dues, recreation centers, security fees and so forth will be prorated between you and the seller. This means depending on how they are paid, they may be giving you a credit or you crediting them back and/or paying an amount due to the organization.
How am I supposed to pay for all of that on top of my down payment? Good question! There are ways to offset these costs:
- Seller paid: When you make your property offer, you can include an allowance for the seller to pay your closing costs and prepaids up to a certain amount as part of your bargaining process. Check with your mortgage professional to find out how much is allowed for the seller to pay on your behalf for these items as it varies from program to program. Typically it runs from 3%-6% of the sales price. This is a great way to basically roll those costs into your loan amount. It’s also a way to buy down the rate to lower percentage. The only bugaboo is that the property will need to appraise out for the sales price of the property. If for some reason it doesn’t you may need to renegotiate.
- Rebate pricing: If you take a slightly higher rate, your lender will secure a rebate that will allow you to offset closing costs by the amount of the rebate. For example on a $400,000 loan, if a loan is priced where the rebate is 1.25% then that allows you to get a credit of $5000 toward those costs. If you also ask a seller to pay for $5,000 in costs then you will likely have covered the bulk of them between the two at a total of $10,000. A special note in that you want to be sure that you use all of the seller credit so don’t make it too much. If you don’t use it all, it will be forfeited.
- Community programs: I’ve talked about community programs before for down payment assistance, these also can often be used for closing costs and prepaids. You will need to check with your program to see what they will cover.
Have helped buyers of all types and financial levels and worked on 1000's of loans.
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