When a homebuyer, or homeowner looking to refinance, obtains a mortgage, there are always associated costs. Even in the so-called “no cost” loan structures, trust me, you’re paying something. When a consumer does the research on what it will cost to get a loan, there are a few ways to categorize and better understand what’s being charged. Specific numbers will vary wildly depending on the nature of the transaction, the amount and where the settlement takes place. A key takeaway of this article will be to differentiate between a “cost” and a “settlement charge.” They are not the same, and how they interact plays a large part in the total amount of cash a borrower ends up bringing to the closing table. I have found that by using three broad categories, we can get a better sense of how things will play out, and as a result, feel less of a sense of shock about the total amount of any settlement. Let’s look at these “buckets” now:
Lender Costs and Fees
Most lenders will charge an “origination fee,” and that cost is usually intended to cover their overhead. What I see across the industry is that this fee will typically range from $500 to $1500, though it may be called something other than origination. Lenders might also charge separate fees for credit reports, appraisals, flood certs and tax service, for example. If you are paying any discount points to lower your rate, they will be listed in this section as well.
Title/Escrow/Closing Agent Fees
Two things you’ll likely need in your transaction will be a closing agent (this can be an escrow company, attorney or other, depending on the real estate practices in your area) and some form of title insurance. While your fees for the settlement services themselves and the title insurance policy(s) will be the largest costs in this category, you’ll also see smaller amounts such as document preparation, notary, recording and other costs associated with title and escrow.
If there’s a place where things get tricky and where a settlement can “blow up,” this is it. “Prepaids” are amounts of mortgage interest, property taxes, insurance (both homeowner’s and flood, if required) and other components of the total monthly housing payment that are collected in advance and that contribute to your settlement. Without going into the complex calculations, know that when you have an impound or escrow account and you close a purchase or refinance transaction, your lender will collect those amounts in multiples of months. If the timing of your close predicates that you must reserves six months of property taxes and your property taxes are $6000 per year ($500 per month) then at close the lender will collect $3000 in tax impound reserves. It should be noted that this is not a “cost” of getting the loan. Your property taxes are due once you are an owner, but how you pay them drives this calculation and adds to your settlement.
While in this category, let’s do a little refresher on how mortgage payments are made. You pay mortgage interest ‘in arrears,’ which means that you live in the house for one month and then you pay your mortgage payment on the first date of the next month. If you close a home transaction on July 15, for example, your first payment on your mortgage will be due on September 1, not August 1. But why? Because mortgage interest is paid in arrears. At this closing, you would pay prepaid interest from July 15 through the end of July. You would have no August 1 regular payment (sometimes called “skipping a payment”). Then, because you’d live in the home all of August, you would get a ‘regular’ mortgage statement on September 1 for that time. It is by this logic that we discourage our clients from financing the prepaid interest, which can amount to several thousand dollars. If your settlement statement shows this amount of closing costs, it may be financially wise to bite the bullet and pay it, as you will not have your regular mortgage payment coming right on the heels of the closing.
Understanding how closing costs work goes a long way to understanding the actual amount you’ll see on your settlement statement. In any transaction there will be a total settlement amount, of which only a part will be actual costs to get the loan. Still, there is always a bottom line and understanding that at the start can help avoid confusion and unwanted surprises with cash to close. If you have questions or need my help, get in touch any time.
Coffee is for closers,
Robert J. Spinosa
Vice President of Mortgage Lending
Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709
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