What Are Closing Costs?

You've found your dream home, the seller has accepted your offer, your loan has been approved and you're eager to move into your new home. But before you get the key, there's one more step--the closing.

Also called the settlement, the closing is the process of passing ownership of property from seller to buyer. And it can be bewildering. As a buyer, you will sign what seems like endless piles of documents and will have to present a sizeable check for the down payment and various closing costs. It's the fees associated with the closing that many times remains a mystery to many buyers who may simply hand over thousands of dollars without really knowing what they are paying for.

As a responsible buyer, you should be familiar with these costs that are both mortgage-related and government imposed. Here are some common fees:

Appraisal Fee: This fee pays for the appraisal of the property. You may already have paid this fee at the beginning of your loan application process.  If you are taking a loan, the lender will require you to pay for an appraisal so they know the home is WORTH what you are paying.  Usually, you have will to pay for the appraisal at the time it is done -- $350-$400.

Credit Report Fee: This fee covers the cost of the credit report requested by the lender. This too may already have been paid when you applied for your loan.

Loan Origination Fee: This fee covers the lender's loan-processing costs. Under current law, any Origination Fee must be disclosed to you by the lender before you agree to a loan, on an Estimated Costs worksheet.

Loan Discount Points: Since interest rates have been low for many years, very few borrowers have been paying "points" to reduce their interest rates. One "point" is one percent of the loan amount, which can add up quickly.  Usually, it's not financially sound to "buy down" your mortgage rate if you will be in your home for less than about seven years.  You may wish to talk with your lender about this, and whether it would make sense in your situation.

Title Insurance Fees: These fees generally include costs for the title search, title examination, title insurance, document preparation and other miscellaneous title fees.  You will be offered the chance to buy "owners' title insurance", which you should always do.  This insurance policy protects you against any "claim" that anyone may have against your property -- from an un-recorded lien to unrecorded sale of part of the land that you think you are buying.  For instance, what if the previous owner never paid the contractor for that new roof? A title search will find this if the roofer's lien has already been "recorded", but not if it hasn't!  The lender will force you to buy and pay for insurance to protect them, but the same protection for you is optional.

PMI (Private Mortgage Insurance) Premium: If you buy a home with a low down payment, a lender usually requires that you pay a fee for "mortgage insurance". This fee protects the lender against loss due to foreclosure. Once a new owner has 20 percent equity in their home, however, he or she can normally apply to eliminate this insurance.  Basically, if you had borrowed 95% of the value of your home, your lender might lose money on the sale if you defaulted on your loan (In other words, the lender would have to file a foreclosure lawsuit, take the home, prepare it for sale and pay costs of sale for less than 5% of the home's value -- very unlikely).  This mandatory insurance policy protects the lender against that loss.

Prepaid Interest Fee: This fee covers the interest payment from the date you purchases the home to the date of your first mortgage payment. Generally, if you buy a home early in the month, the prepaid interest fee will be substantially higher than if you buy it towards the end of the month.

Escrow Accounts: In locations where escrow accounts are common, a mortgage lender will usually start an account that holds funds for future annual property taxes and home insurance. At least one year advance plus two or more months worth of homeowner's insurance premium will be collected. In addition, taxes equal approximately to two months in excess of the number of months that have elapsed in the year are paid at closing. (If six months have passed, eight months of taxes will be collected.)  Note that money held in escrow is still YOUR MONEY, and will be used by the lender to pay your homeowners insurance and property taxes.

Recording Fees and transfer taxes: This expense is charged by most states for recording the purchase documents and transferring ownership of the property.

Make sure you consult a real estate professional in your area to find out which fees--and how much--you will be expected to pay during the closing of you prospective home. Keep in mind that you can negotiate these costs with the seller during the offering stage. In some instances, the seller might even agree to pay all of the settlement costs.

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