Home Ownership Made Easier, an extension publication of the Department of Consumer Economics and Housing, New York State College of Human Ecology, Cornell University, Ithaca, NY, 14853
Buying a home involves time, energy, and, most of all, money. In addition to committing yourself to mortgage payments for 15 to 30 years, you need quite a bit of money “up-front” to close the transaction that will make the house yours. There are several types of closing (or settlement) costs and other up-front costs you should be prepared to pay. An estimate of the magnitude of these costs is in the table below, called Examples of Home Purchase Closing Costs
One of the major up-front costs in buying a home is the investment time. The average household spends about 4 months house hunting and looks at an average of 20 houses before closing a deal. In addition to shopping for a home, you also spend time trying to find the best mortgage terms and an attorney who will assist you with the legal issues in purchasing a home.
How much time you spend looking for a home, a mortgage, and an attorney depends on your location. You will spend less time if you know what you want in a house and know much you can afford, and working with real estate agents will help narrow the choices. How many mortgage lenders are in your area? You can reduce time costs in mortgage shopping by keeping an eye on advertisements. Many newspapers run a summary of current mortgage interest rates offered by local lenders which you can follow up with a phone call and then a visit. How many attorneys are willing and able to help you close the deal on a home? You may want to ask friends, neighbors, or financial advisers for referrals to attorneys.
Financial closing costs are paid by both the buyer and the seller. In some areas, custom or tradition calls or the seller to pay for certain expenses and the buyer to pay for others. One way to minimize closing expenses is to negotiate some of them as part of the purchase offer. Some fees are set by law, and therefore are not negotiable. Others are set by the local real estate and financial markets and may be more flexible.
What Happens at Closing
Much of the paperwork involved in closing (or settlement) is done by attorneys and real estate professionals. You may be involved in some of the closing activities and not in others, depending on local customs and on the professionals with whom you are working.
Before you close on the house, you should have a final inspection, or walk-through, to make sure any repairs you requested have been made and that items which were to remain with the house (drapes, light fixtures) are still there.
At the closing, ownership officially is transferred from the seller to you. It may involve you, the seller, the real estate agent, your attorney, the lender’s attorney, representatives from the title or escrow firm, and a variety of clerks, secretaries, and other staff. It is possible to have an attorney act on your behalf if you cannot attend the meeting (for example, if the house is in another state). Closing can take as little time as an hour to sign all the forms and transfer ownership or it can take several hours, depending on the contingency clauses in the purchase offer (and any escrow accounts that may need to be set up).
In some states, settlement is done by a title or escrow firm to which you forward all the materials and information along with the appropriate cashiers’ checks and the firm will make the necessary disbursements. The real estate agent or another representative of the title company will deliver the check to the seller and the house keys to you.
Statutory costs are expenses you would have to pay 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:
are required by some localities to transfer the title and deed from the seller to you.
Recording fees for deed
pay for the county clerk to record the deed and mortgage and change the property tax billing.
Other state and local fees
can include mortgage taxes levied by states as well as other local fees.
such as school taxes, municipal taxes may have to be split between you and the seller because they are due at different times of the year. For example, if taxes are due in October and you close in August, you would owe taxes for 2 months while the seller would owe taxes for the other 10 months. Prorated taxes usually are paid based on the number of days (not months) of ownership. Some lenders may require you to set up an escrow account to cover these bills. If your lender does not require an escrow account, you may want to set up a special account on your own to make sure you have money set aside for these important, and large, bills.
Third-party costs are expenses paid to others such as inspectors or insurance firms. You would have to pay many of these expenses even if you paid cash for the house. Examples of third-party costs are as follows:
You will probably want to work with an attorney when buying a home. Attorneys usually charge a percentage of the selling price (three-fourths or 1 percent), but some may work for a flat fee or on an hourly basis.
Title search costs.
Usually your attorney will do or arrange for the title search to make sure there are no obstacles (liens, lawsuits) to your owning the home. In some cases, you may work with a title company to verify a clear title to the property.
Most lenders require that you prepay the first year’s premium for homeowner’s insurance (sometimes called hazard insurance) and bring proof of payment to the closing. This insures that their investment will be secured, even if the house is destroyed.
Real estate agent’s sales commission.
The seller pays the commission to the real estate agent. If one agent lists the property and another sells it, the commission usually is split between the two. It’s important to keep in mind that even the commission is negotiable between the seller and the agent.
Finance and Lender Charges
Most people associate closing costs with the finance charges levied by mortgage lenders. The charges you pay will vary among lenders, so it pays to shop around for the best combination of mortgage terms and closing (or settlement) costs. You may have to pay the following charges:
Origination or application fees.
These are fees for processing the mortgage application and may be a flat fee or a percentage of the mortgage.
If you are making a small down payment (usually less than 25%), most lenders will require a credit report on you and your spouse or equity partner. This fee often is a part of the origination fee.
A point is equal to 1% of the amount borrowed. Points can be payable when the loan is approved (before closing) or at closing. Points can be shared with the seller–you may want to negotiate this in the purchase offer. Some lenders will let you finance points, adding this cost to the mortgage, which will increase your interest costs. If you pay the points up front, they are deductible in your income taxes in the year they are paid. Different deductibility rules apply to second homes.
Lender’s attorney’s fees.
Lenders may have their attorney draw up documents, check to see that the title is clear, and represent them at the closing.
Document preparation fees.
You will see an amazing array of papers, ranging from the application to the acceptance to the closing documents. Lenders may charge for these, or they may be included in the application and/or attorney’s fees.
Preparation of amortization schedule.
Some lenders will prepare a detailed amortization schedule for the full term of your mortgage. They are more likely to do this for fixed mortgages than for adjustable mortgages.
Most lenders will require that the property be surveyed to make sure that no one has encroached on it and to verify the buildings and improvements to the property.
Lenders want to be sure the property is worth at least as much as the mortgage. Professional property appraisers will compare the value of the house to that of similar properties in the neighborhood or community.
Lender’s mortgage insurance.
If your down payment is less than 20 or 25%, many lenders will require that you purchase private mortgage insurance (PMI) for the amount of the loan. This way, if you default on the loan, the lender will recover his money. These insurance premiums will continue until your principal payments plus down payment equal 20 or 25% of the selling price, but they may continue for the life of the loan. The premiums usually are added to any amount you must escrow for taxes and homeowner’s insurance.
Lender’s title insurance.
Even though there is a title search for any obstacle (liens, lawsuits), many lenders require insurance so that should a problem arise, they can recover their mortgage investment. This is a one-time insurance premium, usually paid at closing; it is insurance for the lender only, not for you as a purchaser.
If the seller has worked with a contractor who has put a lien on the house and who expects to be paid from the proceeds of the sale of the house, there may be some fees to release the lien. Although the seller usually pays these fees, they could be negotiated in the purchase offer.
Inspections required by lender.
(termite, water tests) If you apply for an FHA or VA mortgage, the lender will require a termite inspection. In many rural areas, lenders will require a water test to make sure the well and water system will maintain an adequate supply of water to the house (this is usually a test for quantity, not a test for water quality).
Your first regular mortgage payment is usually due about 6 to 8 weeks after you close (for example, if you close in August, your first regular payment will be in October; the October payment covers the cost of borrowing money for the month of September). Interest costs, however, start as soon as you close. The lender will calculate how much interest you owe for the fraction of the month in which you close (for example, if you close on August 25, you would owe interest for 6 days). In some cases this is due at closing.
Lenders will often require that you set up an escrow account into which you will make monthly payments for taxes, homeowner’s insurance, and PMI (mortgage insurance, if required). The amount placed in this escrow account at closing depends on when property taxes are due and the timing of the settlement transaction. The lender should be able to give you a close approximation of these costs at the time you apply for your mortgage loan.
Other Up-Front Expenses
The major portion of other up-front expenses is the deposit or binder you make at the time of the purchase offer and the remaining cash down payment you make at closing. In addition to the deposit and down payment, other up-front expenses can include the following:
(structural, water quality tests, radon tests) In addition to inspections required by the lender, you may make the purchase offer contingent on satisfactory completion of some other inspections. You and the seller will need to negotiate these fees.
Owner’s title insurance.
You may want to purchase title insurance for yourself so that if problems arise, you are not left owing a mortgage on a property you no longer own. A thorough title search (going back to 1900 if necessary) is often assurance enough of a clear title.
You may want to hire your own appraiser, either before you sigh a purchase offer or after seeing the results of the lender’s appraisal.
Money to the seller.
(for example, for fuel oil in the tank) You will need to pay for items in the house that you want and that were not negotiated in the purchase offer. Such items may include appliances, light fixtures, drapes, or lawn furniture and also fuel oil and propane left in tanks.
If you are changing jobs, your new employer may pay for your move. Otherwise, you must figure in the cost of moving, either truck rental and hired help or a professional mover. Shopping around for moving services can pay off. You will also need cash for utility deposits (phone, cable, and the like).
Escrow account funds.
(for example, for cleanup, radon mitigation, untested appliances) In the purchase offer, you can request that the seller set up an escrow account to defray any costs of major cleanup, radon mitigation procedures, house painting, or other items. Also, if you have not had a chance to try out some appliances (the furnace if you buy in the summer or the air conditioner if you buy in the winter), you may request an escrow account to cover repairs if necessary.
Depending on the purchase offer contract and contingency clauses, you may find you have some expenses immediately upon moving in. For example, suppose your purchase offer contract has a clause making the purchase contingent on a satisfactory structural inspection, and the inspector determines that the house will need a new roof. You could negotiate to have the seller arrange for the work to be done, but this will probably delay the closing date–and you may have to agree to a higher price for the house or to cover some of the expenses of the new roof. Or you and the seller may be able to split the cost of a new roof, put on after you move in, using estimates from a contractor of your choice, each of you putting funds into an escrow account for the new roof. Or the seller may be willing to reduce the sale price of the house by an amount you think is fair. In either case, shortly after moving into your new home, you will need cash for a new roof.
The Real Estate Settlement Procedures Act (RESPA) contains information on the settlement or closing costs you are likely to face. Within 3 days of the time you apply for the mortgage, your lender is required to provide you with a “good faith estimate of settlement costs,” based on his or her understanding of your purchase contract. This estimate should give you a good idea of how much cash you will need at closing to cover pro-rated taxes, first month’s interest, and other settlement costs.
The act also requires lenders to give you an information booklet, Settlement Costs and You, written by the U.S. Department of Housing and Urban Development, which discusses how to negotiate a sales contract, how to work with various professionals (attorneys, real estate agents, lenders), and your rights and responsibilities as a home buyer. It also shows an example of the uniform settlement statement that will be used at your closing.
One business day before you close, you are entitled to see a copy of the Uniform Settlement Statement with your figures on it so you will know just how much the final costs will be.
Truth in Lending
Mortgage lenders are required to give you a truth in lending (TIL) statement containing information on the annual percentage rate, the finance charge, the amount financed, and the total payments required. For adjustable rate loans, the “total payments” figure is estimated as a “worst case” scenario. The figure represents the payments you would make if your loan adjusted upward to the maximum rate allowed by annual and lifetime caps and then stayed there for the duration of the loan.
The TIL statement may also contain information on security interest, late charges, prepayment provisions, and whether the mortgage is assumable. If you have an adjustable rate loan, it may outline the limits on the adjustments (annual and lifetime caps) and give an example of what your next year’s payment might be, depending on interest rates.
Negotiate Savings on Closing Costs
There are several ways to make sure your closing costs are as low as possible, and they all involve negotiation. First, negotiate with the seller to take over as many expenses as possible. Don’t let tradition or custom get in your way; just because the “buyer always pays for the survey” doesn’t mean the seller can’t pay for it in your case. Also, keep in mind that FHA and VA loans do not allow points; thus any points in financing these loans must be paid by the seller. Even if you are planning to use a conventional mortgage, see if the seller will pay for some points.
Second, shop around for the best mortgage terms. The firm with the lowest interest rates may also have the highest closing costs, so you will have to make some choices. By shopping around, you can compare the settlement costs as well as the interest rates. You may be able to negotiate with your lender to waive or reduce certain fees. In competitive financial markets, some lenders may be willing to cut some fees to get your business.
Third, negotiate with your attorney on his or her fees. Although attorneys may base their fees on a percentage of the price of the home, you may be able to negotiate to pay an hourly rate. Also, you may decide that you also need to rewrite your will now that you have a major asset in your estate. If you are equity sharing, you will need a legal contract to that effect. By packaging several legal services together (real estate closing, equity sharing contract, will), you may be able to get a reduced rate from your attorney.
Closing costs that are most likely to be negotiable, either with the seller or the lender, include application/origination fees, credit report fees, points, attorney fees (yours and the lender’s), document preparation fees, surveys, inspections, money to the seller, and escrow funds from the seller (for cleanup, radon mitigation, and the like).
Since closing costs can be high, it pays to shop around and negotiate with the seller, your lender, and your attorney. The less you have to pay in closing costs, the more you can invest in the down payment on your house, reducing your mortgage costs.
Written by Jeanne M. Hogarth, associate professor, Department of Consumer Economics and Housing, New York State College of Human Ecology, Cornell University, Ithaca, NY; with assistance from Kevin Berkley, vice-president, Citizens Savings Bank, and the following Cornell Cooperative Extension agents: Eileen Donahoe, Marjorie Keith, John Nettleton, JoEllen Saumier, Martha Shortlidge, and Madelene Umscheid.
Examples of Home Purchase Closing Costs
The following examples of closing costs are based on purchasing $55,000 and $165,000 houses with a 9% down payment ($5,000 and $15,000). A likely range of fees is given. Not counting the down payment, closing costs can range from 4.5% to 17% of the amount of the mortgage loan.