The second question most people ask when they’re considering a first mortgage is “What are the closing costs?” (The first question is always “What’s the interest rate?”)
The closing cost question is not as Easy to answer as it sounds. While a good rule of thumb is that closing costs on a purchase will be about 5% of the purchase price, and closing costs on a refinance will be 2.5% - 3% of the loan amount, closing costs will vary depending on the type of mortgage transaction, the type of property, the area you live in, and other factors. And not all lenders will answer your question the same way. Some will only tell you about lender fees. Some will tell you lender fees and title company fees. Some will include property taxes and insurance, and some will not. So it’s important to know what to ask so that you can make a valid comparison. (Once you actually apply for a mortgage, you’ll get a Good Faith Estimate, which is a document that formally lists your anticipated closing costs. Those costs can vary only by certain limited percentages as required by law when you reach the settlement table.)
First of all, you should know that your “closing costs” are not the same as “the money you need to bring to settlement.”
If you’re refinancing and the value of your home is high enough, you can choose to include all of your closing costs in your new loan amount and bring no money to settlement. If you’re purchasing, the cash you need to bring to settlement will include not only closing costs, but your required down payment. The good news for purchasers is that often you can negotiate for sellers to pay a portion of your closing costs to reduce the cash you need to bring to the settlement table.
Secondly, you should understand that some of your closing costs will vary depending on where you get your mortgage and what title company conducts your settlement, and other closing costs will be the same wherever you go.
Closing costs that will remain the same regardless of where you get your mortgage or conduct your settlement are the fees that are paid to the state and county where the property is located. These fees are called transfer taxes, recordation taxes, and document stamps. They are based on the purchase price of the property and the amount of your mortgage. Calculating these can be somewhat complex since the calculation changes if the property is a principal residence as opposed to a second home or rental property, if the property is a one-unit home versus a multi-unit home, if an existing mortgage is being paid off and closed, and if the purchaser is a first-time home buyer, for example.
You’ll want to find out what these are for your own loan transaction, but don’t waste time trying to compare these from one lender to another. Likewise, funds that must be brought to closing to pay property taxes and insurance and to fund an escrow account to provide for next year’s payment of these items will not vary by lender—your property taxes are your property taxes no matter where you get your financing!
So find out how much this will be, but don’t bother trying to “shop” this category, referred to as “pre-paids and escrows.” Lender points and fees are a closing cost category that will change from lender to lender. Points, origination fees, broker fees, tax service fees, underwriting fees, documentation preparation fees, and similar items can seem bewildering and hard to compare, particularly since a loan with a low rate may have higher lender fees than a loan with a higher rate, and it can be hard to tell which is better for you.
These lender fees must be considered in the “Annual Percentage Rate” or “APR” for the loan. The APR is a calculation that takes into account not only the interest rate, but also certain fees payable in connection with the loan. If you’re trying to compare two loan offers with different interest rates and lender fees, ask about the APR on each. The lower the APR, the better the deal, as a general rule. Do keep in mind that to calculate the APR, the lender will need to ask you some questions specific to your transaction, so expect to spend some time on the phone!
The last broad category of closing costs is title costs.
Again, these can vary depending on the title company or attorney who closes your loan, so you may want to shop around. Keep in mind, though, that you do get what you pay for. If a title company’s fees are far below market, this may indicate that they cut costs by not doing as thorough a job, and this could mean problems for you later when you try to sell or refinance and don’t have clear title because work was not done properly the first time.
The bottom line?
Closing costs are an important consideration when you’re shopping for a mortgage, and you should definitely consider the lender and title company fee categories when you’re making your choice—but don’t forget about interest rate, service reputation, stability of the financial institution and ease of doing business there. Make sure you choose your mortgage lender for ALL of the right reasons!