Buying a house is a big undertaking with a lot of legal paperwork filled with fine print. It can be overwhelming to understand exactly what you are signing and what you are actually paying for. One big piece of buying a home is paying the closing costs. But what exactly are closing costs? What is included in them?
What are Closing Costs? Closing costs are items that must be paid in order to formally close your mortgage loan proceedings.
Photo by Thirteen of Clubs via Flickr
Items Included in the Closing Costs
There are a lot of items included in your closing costs. You need to be aware of what you are being charged as it is easy to sneak in higher fees that generate more profit for the lender without the borrower noticing. Some of these fees are non-negotiable, while others you can have reduced or wiped out completely.
These are non-tax deductible charges paid to the lender to pay for the evaluation of your credit and situation to see if they want to lend you money. One point represents 1% of your loan; a $200,000 mortgage paying one origination point would have $2,000 added to the closing costs. This is different from discount points.
These are similar to origination points in that one point is equal to 1% of your loan. However, you pay these points to receive a lower interest rate on your loan. The amount of a discount you can earn from paying points (or partial points) can vary. Borrowers must calculate whether paying 1% in extra costs will be worth it to get a lower interest rate. You must live in the house a certain number of years for the difference in the monthly payment to make it worthwhile to pay discount points.
Administrative and Processing Fees
These fees are paid to the lender to compensate them for processing your loan. In my experience, these are completely negotiable and represent a profit center for the bank. My last loan had $500 of these fees in total, and we were able to get them waived without question.
Similar to administrative and processing, this is to pay the lender for preparing your documents. You should tell your loan officer that is a cost of doing business, and if they want your business they will reduce or waive the fee.
This seems like another profit center for the bank, but it is a legitimate fee. The bank works with a tax servicing company to make sure first that your property has no tax liens on it, and second to make sure you pay your taxes on time. They monitor your taxes to make sure nothing goes delinquent, and if it does the bank will pay your taxes to make sure when they foreclose that they own the property instead of the state you owe taxes to.
A professional appraisal must be done in order for the lender to know they aren’t lending more money than the home is worth. The lender cannot control who the appraisal is done by, and neither can the borrower. This is a legitimate fee that must be paid for your mortgage and home purchase to move forward. If the appraisal comes back as less than what you agreed to buy the house at, the seller must decide between selling at the lower price or not selling at all. Here are some thoughts on what to do if your appraisal comes in lower than the contracted price.
This fee is to pay for the attorneys involved in closing your loan contract.
When you go through the pre-approval process with a mortgage lender, they check your credit score and reports to gauge how much of a credit risk you are. You may be able to get this fee waived if you have outstanding credit (and know it), but the lender will still incur the cost. Even if you end up paying it, I wouldn’t want to pay more than $20 because the lender is going to get a good deal with a company that pulls the scores. Paying higher than that doesn’t make sense.
The bank needs to know if the home you are purchasing lies in a flood plain. If it is, they will not lend to you without flood insurance since your normal homeowners insurance does not flood. This is an inexpensive fee that must be paid.
Similar to flood certification, the lender needs to know if the home is seriously damaged by pests like termites. If so, they may not want to lend you the money or get you to repair (or have the seller repair) the damage.
A survey of the property provides a legal document of the boundaries of the property. Having a survey done may not be a requirement in your area. If it isn’t you don’t pay the fee, but you might consider having it done regardless so you know the legal boundaries of what is yours and what is your neighbors.
Title Search and Insurance
The lender hires a firm to look for liens of any kind against the property. Any liens in place will have first claim to the property before the bank, and they will not risk lending you the money for the home until the liens are resolved.
These are legitimate fees paid to record the transaction in your municipality’s legal records.
Escrows for Prepaid Items
Your prepaid items are technically a separate line item from closing costs, but are still paid at the time of closing. Your bank will require an escrow account that holds several months worth of homeowners insurance premiums and property taxes. You will pay into the escrow account every month with your mortgage payment, so the amount you pay at closing provides a buffer should you start paying your mortgage late.
Kevin Mulligan is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. He’s building a personal finance freelance writing career and has written for RothIRA.com, Discover Bank, and many others.