When buying a new house, we often don't know (or forget) about all the additional costs with closing. It is smart to plan & budget early so you have fewer surprises during the process.
Actual closing costs will vary mostly due to local property taxes, home value, and mortgage rates. Here's the 80/20 on the Buyer's closing costs.
Closing Costs & Fees will typically range from $10-15k.
Includes: Property Taxes; Home Insurance; Loan Processing Fees; First Month's Interest; Appraisal; Title Costs; and HOA Transfer Fees.
Excludes: Down Payment; Mortgage Interest Discount Points; and Seller Contributions.
Note: Property taxes are the greatest variable to closing costs and can vary significantly based on locale.
80/20 Next Level Details
Once you engage a mortgage lender, they will provide an official Disclosure Form of closing costs. Below is an example of the most common items. In our example, we are purchasing a $500k home, closing Aug 8th, $50k down payment, $450k mortgage at 3%, and 1 mortgage point. All numbers are rounded for ease of example.
Line-Item Explanation:
Security/Earnest Deposit: It is common to put 1% of the purchase price as a security deposit on the home. If the Buyer is unable to close (except for common contingencies like home inspection, mortgage qualification, and appraisal), the deposit goes to the Seller. When the Buyer does close, the deposit will be credited to the Buyer. In our example, we are counting this deposit as part of the down payment. (Note: For conventional mortgages with less than a 20% down payment, the Buyer will have an added PMI fee added to their monthly payment.)
Mortgage Interest Discount Points: This option is paying upfront interest at closing to obtain a lower long-term monthly interest rate. A point represents 1% of the loan amount. The Buyer should do an analysis (points cost / monthly interest savings) to determine how many months it takes to break-even. Rates & points vary by lender.
Prepaid Escrows: Mortgage payments usually have escrow amounts built-in to fund payment of annual home insurance and property taxes. The Buyer will need to start these escrows with a cushion since the actuals costs could be higher.
Home Insurance: This is based on your policy's coverage amounts and the value of your home. Commonly, 3 months is used to initially fund the cushion. In our example, we will assume annual costs of $1,800 and therefore $450 at closing.
Property Taxes: This varies widely based on your local area and it can be a bit difficult for the Buyer to research & calculate. Commonly, it ranges from 0.75%-3.5% (but can be more) of the value of the home (e.g. Texas 3%, Tennessee 0.75%). At closing, the Seller is responsible for paying for the months they lived in the home and the Buyer funds for the months they will live in the home. In addition, the Buyer needs to start a cushion amount for the escrow. For this example, we will assume 1% property tax, payable in October for the upcoming calendar year, with Buyer responsible for 5 months (Aug-Dec) plus 3 added months of funding.
Alert - When comparing lenders, be sure to check how many months they are estimating to fund the escrows. Some mortgage companies may default a lower number of months required to fund escrows.
Seller Contribution: If it's a Buyer's market or if the home is not selling, the Buyer can negotiate for the Seller to contribute to closing. This may be a request to help cover general closing costs, an allowance to update the home, or cover items found in the inspection.
First Year Home Insurance: Since the home needs to be fully insured on the first day of closing, the Buyer pays for a full year of homeowners insurance. In our example, we are assuming an annual cost of $1,800.
Loan Processing Fees: The mortgage lender will charge the Buyer fees for processing, underwriting, credit reports, and document preparation. These fees can range from $1,000-$1,750 and vary somewhat between Lenders.
First Month Prepaid interest: Once you close, interest starts being charged on the loan. So, at closing the Buyer prepays the first month's interest from the date of closing to the end of the month (e.g., from Aug 8-Aug31). This is because you will not have a payment due the first month (e.g., Sept 1) since the mortgage company needs time to set-up your loan. Your first payment (e.g., Oct 1) pays for the second month's interest (e.g., Sept), a portion of principle, and your escrow contributions. This amount varies based on the interest rate, loan amount, and days remaining in the month.
Appraisal Fee: Since your home will be collateral on the loan, the mortgage lender will require an appraisal to ensure the home is valued more than the loan amount. An appraisal can range from $500-$1000 based on the appraiser. (Note: Ask the mortgage company for an appraisal waiver if you have a large down payment.)
Title Fees: To transfer the home's title from the Seller to the Buyer, there are certain fees that apply (e.g. Title insurance, Courier Fee, Doc prep, recording fee, escrow fee, etc.) which can range from $750-$1,250 and vary between closing attorneys.
Title Insurance: This insurance protects the Buyer and mortgage lender from unexpected title search errors that could occur during the title review (e.g. missing heir, unknown court proceeding, survey errors, etc.). A Lender's policy is required for all mortgages and covers the loan amount. The Owner's policy is optional and protects the Buyer up to the purchase price. Both policies together can cost around 0.5-1.0% of the home purchase price.
HOA Costs: If the property is part of a Home Owners Association there are additional costs to consider.
Annual Fee: Most HOA's have an annual fee and the amount can vary significantly based on what they cover. The Seller typically pays this at the beginning of the year. So at purchase, any remaining months the Seller already paid will be paid back to the Seller by the Buyer. If the annual HOA expense is $1,200, in our example, the Buyer would reimburse the Seller roughly 5 months ($500) for the remainder of the year. Note: HOA fees are not part of the monthly mortgage payment and are paid by the homeowner directly to the HOA.
Transfer Fee: Some HOA's charge a transfer fee to the Buyer, Seller, or both. These fees are set by the HOA and can vary significantly. For our example, we will assume a $100 transfer fee paid by the Buyer.
80/20 Takeaway
There are a many line-item costs associated with closing on a home and there is variability in each number based on the purchase situation, seller preferences, and buyer preferences. However, Buyers need to initially plan on closing costs of $10-15k, then work with your lender to fine tune their final costs.
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