Understanding Closing Costs

Background

The purpose of this article is to help you understand the costs associated with closing your home loan. This article covers general information regarding closing costs, including lender credits, which some lenders offer to offset the closing costs. In addition, there is a general overview of pre-paid charges that will be paid at the time of closing.

What You Need to Know

Closing Costs

Closing costs are the customary expenses one can expect when completing a residential lending transaction. Typical closing costs Include the following:

• Appraisal: A third party fee for having a certified appraiser determine the market value of the subject property
• Origination Fee: A fee charged by the lender for the processing, underwriting and closing of your loan
• Credit Report Fee: A third party fee for retrieving a credit report
• Tax Service Fee: A third party fee to assure your property taxes are paid on time and no tax liens are attached to your property
• Attorney Fee: A third party fee for closing attorney’s work related to the loan which may include preparation of a purchase & sale agreement, title examination and closing your loan.
• Title Insurance:
  • Lender’s Title Insurance – Mandatory insurance that protects the lender in the event a title issue is discovered after the closing. This is included in purchase and refinance transactions.
  • Owner’s Title Insurance – Optional insurance that protects the borrower in the event a title issue is discovered after the loan closing. This is typically only obtained in purchase transactions.
• Recording Fee: A third party fee charged by the local registrar of deeds to formally record your mortgage instrument

Discount Points (“Points”): A fee paid by the borrower to the lender at closing in exchange for a lower interest rate. The borrower is paying money at closing to get a lower interest rate over the life of the loan. This is referred to as “buying down” the rate.

A point is equal to 1% of the mortgage amount or $1,000 for every $100,000. For example, one point on a $200,000 loan is $2,000. Assuming the interest rate on a loan is 5.125% and a point lowers the interest rate by .25%, the rate would drop to 4.875%. Paying points only makes sense if the borrower is certain he/she will stay in the mortgage long enough to realize the savings from a lower interest rate. Here is the hypothetical example in greater detail:

HYPOTHETICAL EXAMPLE (not including taxes and insurance)

0 Points

1 Points

2 Points

Cost per point

$0

$2,000

$4,000

Interest rate

5.125%

4.875%

4.625%

Monthly payment

$1,088.97

$1,058.42

$1,043.29

Monthly payment savings

$0

$30.55

$45.68

Break even

N/A

65.4 months

87.5 months

Total Savings over the life of a 30 yr loan

$0

$9,000.70

$12,444.54

Lender Credits: A Lender Credit or Closing Cost Credit is a credit provided by the lender to offset some or all of the closing costs. Borrowers who receive closing cost credits receive higher interest rates than borrowers who do not elect closing cost credits because the lender “bakes in” the credit into the interest rate.

If a lender credit is issued by the lender to cover all of the above referenced costs (excluding Owner’s title insurance, which is a cost paid for by the borrower), the loan is referred to as a “no cost” loan.

Prepaid Charges: Prepaid charges are expenses that the homebuyer pays at closing, before they are technically due. Since mortgage payments are made in arrears, interest through the end of the month is always included as a prepaid item. In addition, if the borrower is escrowing taxes and insurance, they are required to create an escrow account or to adjust the seller’s existing escrow account. In addition to interest, prepaid charges may include taxes, hazard insurance, private mortgage insurance or other special assessments.