Given most real estate buyers need a mortgage to purchase, it is even more relevant to go through all the closing costs when debt is involved.
Let’s go through an example and highlight each closing cost as well as the main difference in closing costs between a cash purchase and a purchase with a mortgage.
Closing Costs When Using A Mortgage
Below is an example of a $1.7 million mortgage preapproval amount. The target purchase price is $2.8 million. Therefore, the borrower is putting down $1.1 million, or 40%.
The closing fees paid by the borrower are under the Borrower column. The Lender column could be the fee it pays or a credit to the borrower. We’ll discuss the ambiguity below.
Closing Fees Analysis
Total Origination Charges ($679.57): An origination fee is an upfront fee charged by a lender for processing a new loan application. It’s compensation for putting the loan in place. An origination fee is often quoted as a percentage of the total loan.
Notice how the Lender has an origination charge of $1,548.43. The Lender origination charge could really be $1,548.43 or it could be a made-up number it highlights to make it seem like the Lender is subsidizing the majority of the total origination charge. As a borrower, you don’t really know for sure.
A savvy Lender will position the entire Lender column as a credit to the borrower to entice the borrower to do business with them. In other words, the Lender can tell the borrower that it is covering $1,548.43 of the $2,228 origination fee ($1,548.43 Lender fee + $679.57 Borrower fee). Or, a Lender can say if the borrower takes out a mortgage with them, the Lender will pay a total of $2,125 in buyer closing costs.
The reality is, a bank can charge whatever origination fee it wants. The higher the subjective origination fee it charges, the higher the credit they can give to the borrower to make it seem like the borrower is getting a great deal. The origination fee is something you should be able to negotiate with your lender.
Credit Report: $15.43. A good lender will usually credit you this cost upon closing. However, the credit report fee exists because the spreadsheet is only an estimate provided during a preapproval process.
Title – Closing Escrow Fee: $3,723.43. An escrow fee, or closing fee, is paid to the title company, escrow company, or attorney for conducting the closing of a real estate transaction. Typically, the title or escrow company oversees the closing as an independent party.
The seller usually picks the title company because the seller initially pays a fee to analyze the title of the property before selling. For the buyer to insist on another title company would be a waste of money since analyzing the initial title costs ~$500, and the title was already analyzed.
The closing escrow fee is something that can be negotiated with the seller. You can ask the seller to pay part of this fee or all of it.
Title – Lender’s Policy: $3,657. This fee is the main difference between paying all cash and buying a home with a mortgage. If you have no lender, then a lender has no lien on your property. The lender wants to protect its investment in you.
A Lender’s Policy, or Loan Policy, only protects the lender’s interests in the property should a problem with the title arise. It does not protect the buyer. Therefore, you may be able to negotiate down the Lender’s Policy cost with the lender.
Recording Fees: $127. This is an unavoidable expense charged by your city to record the new homeowner. The fee varies city by city.
Title – Owner Policy (optional): $4,571.50. Although owner’s title insurance is optional, it is highly recommended all buyers get owner’s title insurance to protect their purchase from any title defects, such as liens on the property or wrong names. The older the property, the more potential defects to the title.
In this example, if you are going to buy a $2.8 million dollar property, you better get an Owner Policy. The Title Owner Policy lasts for the life of ownership.
Title Notary: $50. This fee is not included in the spreadsheet, but it is a common fee a buyer has to pay when signing official closing documents. If you want the notary to come to your house, then the fee will likely go up.
No Inspection Fee: Some of you may be wondering where the inspection fee is. The inspection fee is optional and not a fee that is normally associated with a lender. Perhaps a lender might require a borrower to perform a inspection and put in an inspection contingency to be approved, but I haven’t heard of such a situation.
No Real Estate Attorney Fee: In California, a real estate attorney is not necessary. However, a real estate attorney is necessary in many states. The cost usually ranges from $150 – $350/hour. However, a real estate attorney fee has nothing to do with the cost owned to the seller, lender, and escrow company.
Cost Of Prepaid Interest And Reserves/Escrow
All the expenses in this section are non-negotiable since they are expenses a buyer would have to pay sooner or later. These costs are the costs of owning a property with a mortgage.
Interest: $98.87. This is mortgage interest that accrues between the time of closing and when you pay the first mortgage. In this example, interest accrues at $98.97 a day for 10 days.
Notice how the interest rate is only 2.125% for a 7/1 ARM. That’s the lowest I’ve ever seen for an amortizing super jumbo loan. With a 2.125% mortgage rate, the monthly principal & interest payment on a $1.7 million loan is only $6,390.33.
The rate is lower than normal due to relationship pricing, where the borrower has a better relationship due to having a certain amount of assets with the lender already.
Either way, everyone should be taking advantage of record-low rates. Record-low interest rates is one of the main reasons why housing will likely hold up during a recession.
Real Estate Tax Escrow: Some cities and title companies will make you pay your real estate taxes upfront. In this case, the amount is $0.
Insurance Escrow: Some cities and title companies will make you pay part of your homeowners insurance during the transaction. In this case, the amount is $0.
1st Year Insurance Premium: $2,649.60. Some cities and title companies will make you pay for an entire year’s worth of homeowners insurance. Your lender will force you to get homeowners insurance to protect their investment in you. In this example, the homeowners insurance premium looks to be about $1,200 too high.
Real Estate Taxes Due At Closing: Some cities and states will make you pay for a pro-rated amount of real estate taxes at closing. In this case, the amount is $0. In this example, the lender estimates a monthly real estate tax bill of $2,916.67, or $35,000 a year. This comes out to 1.25% of the $2.8 million purchase price of a home.
Total “Cost” To The Buyer
When buying property, it’s always good to have a cash buffer after making a down payment and paying all the closing fees. My general rule of thumb is to put down at least 20% to avoid paying private mortgage insurance (PMI) and have a 10% cash buffer remaining.
Therefore, in this example, the buyer should have about $280,000 in cash or highly liquid securities remaining after purchase. The last thing you want to feel after buying a property with leverage is to feel stressed out. If you lose your job or your investments start declining in value after purchase, having a nice cash stash will help hold you over until a recovery.
The buyer in this example would be mistaken if he thought he only needed a $1.1 million downpayment to buy a $2.8 million home with a $1.7 million mortgage. He needs to come up with $1,115,522.50 due to $12,773.93 in actual closing fees and $2,748.57 in prepaid interest and reserves.
In general, the lender will tend to have conservative closing fee estimates so that a buyer ends up getting a refund after closing. This way, the lender insures that it makes 100% of its money instead of having to chase a buyer down.
Always Calculate Your Closing Costs Before Buying
Before you make an offer to buy a property, always bake in your estimated closing costs. This way, you will properly calculate the true purchase price so you can plan your funds and your offer strategy accordingly.
As a homeowner, one of your main goals is to find a way to minimize fees, minimize ongoing maintenance costs, lower your mortgage rate, and reduce your property taxes. The more you can lower your costs, the higher your cash flow.
It is sometimes a good idea to aggressively negotiate with a seller on closing costs. However, too much negotiation on the nitty-gritty might turn a seller off. Instead, it’s better to just negotiate hard on the final price.
All the closing costs to buy a property are a good reminder to try and keep your property for as long as possible. When it comes time to sell a property, the fees are even higher due to the 4-5% selling commission and transfer taxes! A savvy buyer will also know the approximate selling fees as well in order to make a more informed offer.
Real Estate Suggestions
To take advantage of record-low interest rates, check out Credible, one of the leading mortgage lending marketplaces where qualified lenders compete for your business. It’s free and takes less than three minutes to get real quotes.
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Readers, have you ever successfully negotiated your closing fees when buying a property? Which closing fees were easier to negotiate than others?