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What Are Closing Costs on a Mortgage and How Do They Work?

What are closing costs on a mortgage?

What Are Closing Costs?

When you purchase a home there are fees associated with the transaction that are referred to as closing costs. There are different types of closing costs including fees paid to the mortgage lender, charges paid to the title and escrow companies, and prepaid items such as property taxes, homeowner’s insurance, and mortgage interest. These costs will be collected at closing in addition to your down payment.

Your lender will provide an estimate of these fees upfront. During the escrow process, the fees will be confirmed and at the close of the transaction, you will receive a final settlement statement outlining the costs incurred during the transaction.

How Do Closing Costs Work?

As you learn about the home buying process, you may hear from other parties that you should have enough saved for closing costs. Without any starting knowledge of what closing costs are, you might initially think it sounds like a few hundred dollars, right?

Unfortunately, that’s not the case. When processing the purchase of a home, closing costs are charged to the buyer and seller to compensate all parties and services involved. Simply put, they are a compilation of various fees associated with your loan. Closing costs will vary from mortgage to mortgage, but to give you a rough estimate, an $800k purchase price will involve closing costs of about $13,000 – $14,000. Closing costs can fluctuate depending on certain aspects such as the purchase price, location of the property, loan amount, and whether you decide to impound your taxes and insurance.

We won’t sugarcoat it and tell you closing costs are a breeze to go through because they’re not! It is best to plan for these expenses, especially if you’re already in a tight budget situation. Each cost is associated with an important part of the transaction, so it is important to review these estimated fees upfront with your Loan Officer to best prepare yourself once you are in escrow.

What’s Included in Closing Costs?

How do closing costs work?

Appraisal Fee

When you buy a home, you will most often be required to get an appraisal to determine the home’s market value. If you do not pay for it at the time of service, it will be included in your mortgage fees. The size of the property, location, and the type of property are a few of the many things that can affect how much your appraisal fee will cost.

Closing Fee or Escrow Fee

Your closing fee is paid to whichever independent third party is handling the closing. This will either be an escrow or title company. You can think of this party as the accountants in the transaction.

Credit Report

To decide your loan qualification and rate, your lender will pull a tri-merge credit report (a credit report that pulls information from the three major credit repositories: Equifax, Trans Union, and Experian). Be cautious of your credit raising any red flags and be prepared with ways to repair it. The credit report fee will be included with your total loan closing costs.

Escrow Deposit

Your lender may have you make a deposit towards an impound account, which will be used for paying property taxes and homeowner’s insurance. Take a look at our post on impound accounts to learn more.

FHA/HUD Up-Front Mortgage Insurance Premium (UPIMP)

Loans under the FHA program require the borrower to pay an up-front mortgage insurance premium. At the time of this post, the rate is 1.75 percent of the base loan amount. This premium is typically financed into the loan.

Home inspection part of closing costs

Home Inspection

You can choose to order a home inspection to understand the current condition of the home. The inspector will evaluate the roof, electrical system, plumbing, fireplaces, and other factors that can affect the safety of the home. This fee is typically paid directly to the inspector outside of escrow.

Lender’s Policy Title Insurance

This is included in the title company’s fees and is an insurance policy for the lender. This policy ensures that the lender has priority to be paid first over any other claims that others may have in your property.

Loan Discount/Origination Points

Loan discount points are fees charged to achieve a certain interest rate and are a percentage of your loan amount. For example, a lender may charge 1 point for a lower rate. This would cost 1% of your loan amount and is charged on top of the traditional loan closing costs.

Origination Fee

Your lender may charge an origination fee for processing your loan. Origination fees can include processing, underwriting, and funding fees.

Prepaid Interest

When you make your mortgage payment, you are paying interest from the previous month so when you close your loan, you will pay interest starting on the day your loan closes through the end of the month. Your first mortgage payment will not start until the following month. For example, if you close your loan on August 15th, you will pay interest at closing until August 31st and your first mortgage payment will be October 1st.

Home insurance part of closing costs

Property Taxes Currently Due

If your first property tax payment is due within the same month as your first mortgage payment, your lender will require you to make the payment at closing. The seller may share in this expense depending on your closing date.

Recording Fees

Fee charged by the county/city for registering (or recording) the home purchase/sale as a matter of public record.

Sales/Broker Commission

This fee is paid to real estate agents at file disbursement and is typically charged to the seller.

Survey Fees

Depending on which state you live in, you may be required to have a property survey performed to verify the property lines and fences.

Title Company Title Search/Service/Exam Fee

Paid to the title company, this fee covers the cost of the title’s search of your property records and deed to ensure there are no other claims on the house.

Transfer (Excise) Taxes

This tax is for when the title of the home transfers from the seller to the buyer and is determined by the City and County. Transfer taxes also vary state-by-state.

Underwriting Fee

Paid to the lender, this covers the cost of determining whether or not your loan will be approved. Not all lenders charge this fee.

VA Funding Fee

Most VA loans involve a VA funding fee that goes directly to the Department of Veterans Affairs to keep the VA program running. This fee is a percentage of your loan amount and will vary depending on the type of transaction, down payment, and whether you have used the VA program before. The fee is financed into your loan amount. The fee is also determined by the borrower’s branch of service. Learn more about these rates here. Some veterans are eligible to have their funding fee waived including those that have a service-connected disability.

Can I Lower My Closing Costs?

Can I lower my closing costs?

There are a few scenarios where your closing costs can be reduced, although not all scenarios can be guaranteed. You can consult with your loan originator on each scenario before proceeding.

Compare Initial Quotes: If you are receiving multiple quotes from lenders, review the lender’s charges. Keep in mind, the title and escrow fees will be estimated upfront as the seller will decide which title and escrow companies will be used in the transaction. All the fees will be consistent once you are in escrow except for what the lender charges. You can compare these costs amongst different lenders, but also consider which lender will put you in the best position to make sure your offer is accepted and ensure that you can close on time.

Get help from the seller: Although this can be difficult in a competitive market, it is not uncommon for the seller to offer the buyer credit towards their closing costs. If the seller is motivated to sell their home quickly, this may be an option to attract buyers or help a potential buyer who is short on closing funds. The purchase price of the home may be increased to offset the credit given to the buyer. It is good to discuss this option with your agent as they will be negotiating items like this on your behalf when your offer is submitted.

Rate options: Make sure to review your quote from the lender to see if they are charging any discount points. Discount points are typically charged to achieve a lower rate. Ask about your options with increasing the rate to reduce the discount points. There is also the opportunity with a higher rate to receive a lender credit that will go towards reducing your overall fees. There may not be a large payment difference with taking the higher rate so it may be better depending on your financial situation to go with the higher rate if that means coming in with less cash at closing.

Review Your Disclosure Thoroughly

What's included in closing costs?

Lenders are required to provide you with TILA-RESPA Integrated Disclosures, which come in the form of a loan estimate when you begin the transaction, and a closing disclosure which is sent prior to closing. The Loan Estimate will be updated throughout the loan process and you will receive the closing disclosure prior to signing the final loan documents. You will have many opportunities to review your loan closing costs throughout the process. Your Loan Officer should review these disclosures with you so that at the time of closing you are confident in what will be expected.

In the meantime, check out our move-in checklist to ensure you’re prepared for your big day! Remove the hassle and stress of moving with a few tips and tricks on how to get started and what to keep in mind. As you close in on the final steps of your mortgage, this simple walkthrough will make the moving process a breeze!

Financing details are for educational purposes only. Rates, program terms, fees, and conditions referenced are subject to change without notice. Not all products are available in all states for all amounts. All mortgage applications are subject to underwriting guidelines and approval. This is not an offer of credit or a commitment to lend. Residential Wholesale Mortgage, Inc. dba RWM Home Loans is an equal housing lender licensed by the CA Department of Real Estate #01174642 and CA Department of Financial Protection and Innovation under the California Residential Mortgage Lending Act. NMLS# 79445

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