Mortgage Closing Costs
So often, I hear people speaking in very vague generalities about closing costs, and/or what they believe are mortgage closing costs. What these costs actually consist of though, are a mystery to many people, and it shouldn’t be that way. The public is so used to hearing phrases like, “your closing costs should be “X” percent of your home purchase price.” Statements like these, are generally completely wrong, way over-generalized, and add to the confusion around closing costs/mortgage closing costs.
Further aggravating this problem, are the regulatory disclosure requirements for our industry. All lenders are required to issue cost disclosures in specific formats, dictated by government agencies. The “Good Faith Estimate (GFE),” used to be the primary, mandated document that covered closing costs. This has since been replaced by the “Loan Estimate (LE).” The “loan estimate” covers the same information as the GFE, but in a different format.
The problem is the organization of the GFE was incredibly convoluted. So much so, almost no borrowers were capable of deciphering how it arrvied at its final numbers. Because of this, all lenders continued to use their own “closing costs worksheets.” These closing costs worksheets, while not an “official” disclosure document, have always done a much better job of taking the same information found in the government documents, and presenting it in a much clearer format.
The loan estimate, that replaced the GFE as the official disclosure for closing costs/mortgage closing costs, does a little bit better job. However, it is still harder to follow than a closing cost worksheet, and in reality, most buyers still use it as a secondary resource.
Who Charges the Closing Costs?
First, let me say that I focus on Texas deals, and this is written with a Texas audience in mind. Some details will vary from state-to-state, however, I believe this is a good starting point, regardless of what state you’re in. With that being said, one of the primary things I clear up with my buyers first, is who charges closing costs.
The first thing I explain about what many people reference as mortgage closing costs, is that very few costs associated with closing on a home are charged by the lender. In reality, the bulk of the cash it takes at closing aren’t closing costs at all. In Texas deals, the bulk of the cash it takes to close can normally be attributed to what is more appropriately called “prepaids.” As far as actual costs, most of them are true 3rd party costs, charged by the other groups/companies that your lender and agent will work with to get your deal closed.
Actual Mortgage Closing Costs
The fee that the vast majority of lenders charge, will range between $800 – $1,200. This is classically referred to as the origination fee, and still is for official compliance purposes. However, within the industry, most of us explain these fees to buyers, simply as “bank fees.” That’s because many times the term “origination fee” is never explicitly listed. Most commonly, these charges will be listed as “processing fees,” “underwriting fees,” or some combination of the two.
The only thing buyers really need to know, is exactly what charges the lender is charging directly. If you ask your loan officer to point out their “bank fees,” they should know exactly what you’re talking about.
There can be a few variables from my example, but when you’re shopping mortgages, this $800 – $1,200 example should be in line with what you’re going to see 90% of the time, as far as actual mortgage closing costs. Almost everything else that a buyer pays in conjunction on closing a home are true, 3rd party costs.
True Closing Costs
In addition to bank fees, here’s a break-down of other fees, that are actual closing costs. Your lender will initially estimate these charges, based on market norms. While processing the loan, the lender will work with the title company, and other 3rd party service providers, to obtain their actual fee for the specific transaction. Lenders are not allowed to mark these services up. So what a buyer will see is the true cost the service provider is charging, and in some cases will pay this directly to the service provider.
Appraisal – Your lender will order your appraisal, through an “appraisal management company.” The appraisal is an opinion of value for the property. For Texas transactions, this averages between $400 – $600, depending on loan type, property value, and property location. Some lenders will pay this on behalf of the borrower, and recoup at closing. However, this is normally charged up-front. It can be collected by the lender, or sometimes paid directly to the appraisal management company. See Appraisals 101 for More Info
Survey – Sometimes confused with the appraisal, the survey is simply a “map” of the property. In Texas deals, if the seller has an existing survey, it can normally be reused. If they don’t have one, or it can’t be used for some reason, the contract will dictate whether the buyer, or the seller pays for this. For normal, Texas properties, these range between $350 – $650, normally.
Credit Report Fee – The lender may order additional items from the same credit reporting company, such as verification of employment/deposit and tax transcripts. Again, everything associated are true costs, and your lender cannot legally mark anything up here.
Title Company – Most of the remaining costs will be associated with the title company. While the buyer always has the right to choose the title company, in Texas deals, 99.9% of the time, it is negotiated that the seller pay for the owner’s title insurance policy. Due to this, in practice, it is normally the seller that chooses the title company. The good news is, in Texas, it’s a very competitive business. So the individual fees charged by title companies vary very little. It’s uncommon to find variances of much more than $300 between companies. The sample worksheet pictured above, includes a cost break-down from a local title company, here in Plano, TX – Superior Abstract & Title
Additionally, the title insurance policies themselves, are regulated by the state, and cost exactly the same, regardless of which company issues them. The premium is primarily based on the policy amount.
Settlement/Closing/Escrow Fee – This is what the title company charges for physically sitting down at the closing table, and closing the loan, in addition to the miscellaneous tasks they help everyone with to get to that point. This generally ranges from $300 – $500.
Title Insurance – Title insurance protects buyers and their lender from “imperfect title.” I.E., it protects the parties in the event that after the purchase is complete, someone claims they’re due an ownership interest in the property based on an incorrect title transfer in the past.
There are generally two title policies issued. There’s an owner’s policy, that protects only the owner. Secondly, there is a lender’s policy, that protects only the lender. As mentioned above, the seller, normally pays for the owner’s policy. In Texas, if an owner’s policy and lender’s policy are purchased at the same place, at the same time, the lender’s policy is normally $100 (plus applicable endoresements). Due to disclosure regulations, this will appear differently on your mortgage closing cost worksheet, loan estimate, and closing disclosure. However, this is what is hapenning in the background.
Per Diem Interest – The final, “normal” closing cost, is actually another lender cost. It is technically a closing cost, but in reality, it’s more of a prepaid. Conventional mortgage loans are paid in “arrears.” This means that a mortgage payment made on Feb. 1, is actually paying for January 1st – 30th. Due to this, at closing, some of the interest has to be paid in advance. This isn’t extra interest, it simply accounts for the period between the day you close, and your first closing date. It will consist of 1 – 30 days of interest, simply depending on what day of the month you close.
For example, generally speaking, if you close on June 15th, your first payment won’t be due until August. However, the August payment is for July. So the per diem interest paid at closing, covers the interest from June 15th – June 30th.
Prepaids often account for a substantial portion of total cash-to-close, and generally consist of prepaid homeowner’s insurance, and property taxes.
Home Owner’s Insurance – Homeowner’s insurance, not to be confused with mortgage insurance, is the basic insurance that protects a homeowner in the case of fire, etc. Homeowner’s insurance is paid in advance. So if a buyer is establishing an escrow account, they’ll purchase a 12 month policy, and place 2-3 months of payments in reserve.
Property Taxes – For Texas deals, this will appear as a large line-item, but is normally offset by a credit. This is because the seller will normally be paying for the taxes covering their time in the property. For example, if a buyer is purchasing a home in June, the lender will want to collect 8-9 months of tax payments for the escrow account. This is what will normally show on a closing cost worksheet and loan estimate. However, it is the seller’s responsibility to cover the 5-6 months of taxes associated for the time they’ve owned the property. So the buyer would be issued a credit for 5 months, plus however many days in June the seller owned the property.
Can I Roll Mortgage Closing Costs into the Loan?
This is a very common question, and generally the answer is “no.” There’s only two basic caveats to this.
First, FHA loans have a fee called the “Up Front Mortgage Insurance Premium.” VA loans have something similiar, called the “VA Funding Fee.” These are generally the only mortgage closing costs that can be “rolled in.”
Secondly, in certain scenarios, lenders can help with closing costs through what’s called “premium pricing.” This means a borrower will opt for a slightly higher interest rate, and in return, the lender will be able to provide a credit (based on a percentage of the loan amount). Premium pricing is the opposite of purchasing discount points. These credits can be used towards some, or all of the closing costs. They cannot be applied towards down payment, and cannot result in cash back at closing.
Understanding the Break Down
As you can see, a lot goes into breaking down what all makes up closing costs. That’s why so often, the subject is breezed over, and buyers are forced to rely on very vague answers. I break every transaction down, with every buyer because I know I wouldn’t be happy with a vague understanding of where, and how, I’m spending so much money!