Closing Costs are the fees associated with the purchase of real property. Closing costs may include fees charged by your lender, such as originating or processing fees, expenses associated with inspecting the property or any other cost incurred in the process e.g.: survey expense, attorneys fees and government recording fees are also examples of closing costs.
In addition to paying for services employed during the purchase process, closing costs can also include money that is set aside to pay for future expenses; these are known as prepaid items. As a home owner, you are expected to maintain a hazard insurance policy and pay property taxes for your home every year. To facilitate this, and avoid having a large bill due all at once, your lender may collect 1/12th of these charges each month along with your mortgage payment. Then when these items come due, your lender pays the bill from this escrow account so you won’t have to! Escrow accounts are simply accounts held by your lender for your benefit.
For example, if your annual hazard insurance premium is $500, your lender may collect 1/12th or $41.67 every month with your mortgage payment and credit your escrow account. As mentioned earlier, the escrow (also known as a trust account) holds money on your behalf until the payment due date. When the bill is due and payable, the $500 is withdrawn and the invoice is paid for you.
Your lender will typically require a minimum of three months worth of reserve for the escrow account. This money is collected on the day of Closing and is identified as prepaid items. These monies are referred to as prepaid items because they are collected in advance.
Planning for Closing Costs
A good rule of thumb for closing costs is is to plan for 2-3% of the purchase price. Therefore, a purchase of a $200,000 home would likely incur $4,000 – $6,000 in total closing costs; remember, this amount does not include any down payment. Depending on your credit, the timing of your purchase and the amount spent on inspections, these costs could be higher or lower.
How to Reduce Your Closing Costs
NOTE: Some closing costs will occur in nearly every transaction, regardless of financing or property type, while others depend on the services enlisted in evaluating the property. You, as the Buyer, ultimately have some control over the total amount.
You should never reduce closing costs by eliminating recommended inspections. Closing costs can be reduced in several ways. The easiest method is to carefully choose the day of your Closing.
How the Closing Day Selection Affects Closing Costs
Timing your Closing to occur near the end of the month can greatly reduce your closing expense. The reason is that by doing so you reduce the number of days for which prepaid interest is collected for the month of Closing.
Mortgage interest is collected in arrears, or after it occurs. On the day of closing you technically don’t owe any interest because it doesn’t start accruing until the day of closing. However, the lender realizes that they may be unable to complete processing your loan, issue a mortgage payment coupon and collect the interest they are owed before the end of the month, so they instead collect that interest upfront on the day of Closing. This allows the lender is to collect the interest that would have otherwise been paid on the 1st of the month, following the closing, and the buyer is able to avoid paying the first mortgage payment until the second full month.
For example, if you close and become the owner on January 15th, the lender will give instructions to your closing attorney to collect per-diem interest from the day of Closing through the end of the month (January 31st). This represents the interest that would have been collected if a mortgage payment was made on February 1st. However, since the the lender requires time to set up your loan and issue you your first mortgage statement, this first payment is moved to the second full month following Closing; in this example, March 1st. In order to collect the interest that would have been collected on February 1st, the borrower (buyer) pays this interest on the day of Closing, essentially skipping the initial principal payment.
Not All Closing Costs are the Same
In a typical purchase, the majority of closing costs are lender fees. This is where Coastal Credit Union can help you the most. Just as Daymark Realty does not charge unnecessary ‘transaction fees’, Coastal does not charge ‘junk’ fees, or fees that are not required to originate a loan. Coastal also offers a reduced origination fee which can save you hundreds, if not thousands, of dollars.
Other Ways to Reduce Closing Costs
There are several ways that you can reduce your exposure to closing costs. Here are a few:
Make a Larger Down Payment
By making a larger down payment, the loan amount is reduced and this will reduce your loan origination charge. Since the loan origination charge is normally a percentage of your total loan value, this can have a nominal effect on your closing costs. If the origination charge is 1%, then increasing your down payment by $100 will reduce your origination charge by $1.
Ask the Seller for Help
As part of the purchase negotiation, you have the opportunity to request that the Seller pay a portion of your closing costs. This can be part of the terms of your offer. Keep in mind that the more you request, the less attractive your offer may become. Your Daymark agent will help you make the right decision.
Get a Conventional Loan
Financing your purchase with a Conventional loan from Coastal can help reduce closing costs by eliminating upfront loan guarantee fees associated with Unconventional (government guaranteed) financing. Unconventional loans are more accessible to borrowers with lower credit scores but they bring much higher fees as a consequence. Some unconventional loan types can nearly double the amount of your closing costs.
Offset Fees with a Higher Rate
In some cases, it is possible to negotiate a higher rate with the lender to offset some closing costs. This is a riskier approach since the higher rate will increase your monthly mortgage payment and may reduce the total amount that you can borrow. Remember, the amount you can borrow is based on a percentage of your income and your recurring debts. By choosing a slightly higher rate, you are essentially financing your closing costs with a loan that has tax deductible interest (not bad!).