BY ANNA & MICHELLE
There are fees and expenses associated with mortgages that must be paid by the closing date for closing costs, and pre-paid items, in addition to the down payment. These amounts can vary according to the type of loan, mortgage company, customary practices of the area, and the terms of the contact.
According to Freddie Mac, the amounts could vary between 2%–5%, which is considerable. Most buyers want a more specific number and that can depend on the conditions mentioned previously.
For buyers, the largest amounts are loan origination fees, which is usually 1% of the amount borrowed; points paid by buyer, which are 1% or more of the mortgage amount; owner’s title policy if paid by the buyer; and the pre-paid items mentioned above.
Certain types of mortgages allow the seller to pay specific closing costs for the buyer with full disclosure in the sales contract. For example, all the buyers’ closing costs can be paid by the seller for VA mortgages up to 4% of the sales price. FHA and USDA allow sellers to pay up to 6% of the sales price to be used for closing costs and pre-paid items.
For conventional loans, underwritten by Fannie Mae or Freddie Mac, sellers can contribute up to 3% if the down payment is less than 10% and up to 6% if the down payment is 10%–25%.
Asking a seller to pay a buyer’s closing costs is tantamount to lowering the price of the home. In a highly competitive market, the seller may be less willing to pay a buyer’s closing cost than in a soft market.
Settlement dates affect the amount of pre-paid interest. Mortgage interest is paid in arrears, after the money has been used. The principal and interest portion of the payment is allocated to pay for the interest on the principal balance for the previous month and the remainder is applied to reduce the principal of the loan. Each succeeding payment has less going to interest and more going to principal until the loan is fully retired.
When a buyer closes on the sale of a home, the first payment will not be due until the first of the month following the next full month after closing. The buyer is also responsible for interest from the funding date, usually at closing. This amount is usually reflected on the buyer’s closing statement, as interest to the end of the month. It pre-pays the interest from closing until the next first of the month.
If the buyer closed on the second of the month, the pre-paid interest would be far greater than if the buyer had closed on the last day of the month. To minimize this out-of-pocket expense, many times closings will be scheduled toward the end of the month.
Another large buyer’s closing cost is property insurance. The lender will require that the home be insured for at least the amount of the mortgage being borrowed. Insurance must be paid for in advance, usually at closing. In addition to the annual premium, the lender may require an escrow account be established to collect 1/12 of the annual property taxes and property insurance to be paid with the payment so there is enough money in the account to pay them when they are due.
When setting up the account, the lender may require an additional two months of reserves for the insurance to be renewed in advance of the policy expiring.
The amount of reserves for the taxes depends on when the taxes must be paid. At closing, the seller will credit the buyer with the amount of taxes from January 1 to the closing date since taxes are also paid in arrears. The lender will probably have the buyer pay two to three months’ taxes additionally at closing so the tax bill can also be paid before it is due. Some states give the taxpayer a discount for paying them in advance.
Your real estate agent will be able to give you an estimate of closing costs that should prepare you to purchase a home. The lender is required by law to supply you with a Loan Estimate within three days of receiving your loan application.
A Closing Disclosure will provide the final details of the mortgage loan you have selected. It includes loan terms, estimated monthly payment, and the fees and other costs incurred with the mortgage. You must receive it three business days before you close on the mortgage loan so that you can compare it with the Loan Estimate.
