What happens at closing?
The property is officially transferred from the seller to you at "Closing" or "Funding."
At closing, the ownership of the property is officially transferred from the seller to you. This may involve you, the seller, real estate agents, your attorney, the lender’s attorney, title or escrow firm representatives, clerks, secretaries, and other staff. You can have an attorney represent you if you can't attend the closing meeting, i.e., if you’re out-of-state. Closing can take anywhere from one-hour to several depending on contingency clauses in the purchase offer, or any escrow accounts needing to be set up.
Most paperwork in closing or settlement is done by attorneys and real estate professionals. You may or may not be involved in some of the closing activities; it depends on whom you are working with.
Prior to closing you should have a final inspection, or "walk-through" to insure requested repairs were performed, and items agreed to remain with the house are there such as drapes, lighting fixtures, etc.
In most states the settlement is completed by a title or escrow firm in which you forward all materials and information plus the appropriate cashier's checks, so the firm can make the necessary disbursement. Your representative will deliver the check to the seller then give the keys to you.
What are statutory costs?
These are expenses you have to pay to state and local agencies, even if you paid cash for the house and didn't need a mortgage:
- Transfer Taxes – Required by some localities to transfer the title and deed from the seller to the buyer.
- Deed Recording Fees – To pay for the County Clerk to record the deed and mortgage, and to change the property tax billing.
- Pro-Rated Taxes – Such as school taxes and municipal taxes may need to be split between the buyer and the seller since they are due at different times of the year. For example, if taxes are due in October and you close in August, you would owe taxes for two months, and the seller would owe for the other 10 months. Pro-rated taxes are usually paid based on the number of days, not months of ownership. Some lenders may require you to set up an escrow account to cover these bills. If not, you may want to set one up yourself to insure the funds are set aside for these important expenses.
- State & Local Fees – Other state and local mortgage taxes and fees may apply.
What are third-party costs?
There may be expenses paid to others like inspectors or insurance firms, even if you paid cash for the property:
- Attorney Fees – You may want to hire an attorney when purchasing a home. They usually charge a percentage of the selling price up to 1%, or some work on an hourly basis or for a flat fee.
- Title Search Costs – Usually your attorney will perform or will arrange for the title search to ensure there are no obstacles such as liens or lawsuits regarding the property. Or you may work with a title company to verify a clear property title.
- Homeowner's Insurance – Most lenders require you prepay the first year's premium for homeowners insurance, sometimes called hazard insurance, and must show proof of payment at the closing. This insures that the investment will be secured even if the property is destroyed.
- Real Estate Agent's Sales Commission – The seller pays the real estate agent's commission, and if one agent lists the property and another sells it, the commission is usually split. The commission is negotiable between the seller and the agent.
What are finance and lender charges?
Most people associate closing costs with finance charges levied by mortgage lenders. The charges you pay will vary among lenders, so it’s good to shop around for the best combination of mortgage terms and closing, or settlement costs:
- Origination Fee – For processing the mortgage application there may be a flat fee, or a percentage of the mortgage loan.
- Credit Report – Most lenders require a credit report on you and your spouse, or an equity partner. This fee is often a part of the origination fee.
- Points – One point is equal to 1% of the amount borrowed and can be payable when the loan is approved either before or at closing. Points can be shared with the seller which is negotiable in the purchase offer. Some lenders will let you finance points which will add to the mortgage cost. If you pay the points up front they are tax deductible in the year they are paid. Different deductibility rules apply to second home loans.
- Lender's Attorney's Fees – For your attorney to draw-up documents and to ensure that the title is clear, and for representation at the closing.
- Document Preparation Fees – There are several documents and papers prepared during the home-buying process ranging from the application to the closing. Lenders may charge for this, or the fees may be included in the application and/or attorney’s fees.
- Preparation of Amortization Schedule – Some lenders will prepare a detailed amortization for the full term of your mortgage. This is usually done for fixed mortgages or adjustable mortgages.
- Land Survey – Lenders may require that the property be surveyed to ensure it has not been encroached and to verify the buildings and improvements to the property.
- Appraisals – Professional Appraisers can do a comparison of the value of the property to that of other recently sold neighborhood properties. Lenders want to be sure the property is worth the value of the mortgage loan.
- Lender's Mortgage Insurance – If your down payment is 20% or less, many lenders require that you purchase Private Mortgage Insurance (PMI) for the loan amount. If you should default on your loan, the lender will recover their money. These insurance premiums will continue until your principal payments, plus the down payment equal 20% of the selling price and may continue for the life of the loan. The premiums are usually added to any amount you must escrow for taxes and homeowner's insurance.
- Lender's Title Insurance – Even with a title search for any property obstacles, liens or lawsuits, many lenders require insurance to protect their mortgage investment. This is a one-time insurance premium usually paid at closing, and is for the lender only, not the homebuyer.
- Release Fees – If the seller has worked with a contractor who put a lien on the house and is expecting payment from the proceeds of the house sale, there may be fees to release the lien. The seller usually pays these fees which could be negotiated in the purchase offer.
- Inspections Required by Lenders – The lender may require a Termite Inspection if you apply for an FHA or a VA mortgage loan. In many rural areas a water test may be required to ensure the well and water system will maintain an adequate water supply to the house; for quantity not quality. Depending on the sales contract and property type, additional inspections may be required.
- Prepaid Interest – The first regular mortgage payment is usually due from six to eight weeks from closings; however, interest costs begin at closing time. The lender will calculate the interest owed for that period of time, and that fraction of interest is sometimes due at closing.
- Escrow Account – Lenders often require that you set-up an Escrow Account that you will make monthly payments to for taxes, homeowner's insurance and, sometimes, PMI (Private Mortgage Insurance). The amount placed in this account at closing depends on when property taxes are due and the timing of the settlement transaction. The lender can give you a cost approximation during the application process of your mortgage loan.
Are there any other up-front expenses?
The major portion of other up-front expenses is the deposit or binder you make at the time of the purchase offer, the remaining cash down payment you make at closing, or can include:
- Inspections – Home inspections are highly encouraged. Lenders may require inspections, and you can make your purchase offer contingent based on satisfactory completion of some other inspections such as structural, water quality tests, septic, termite, roof and radon tests. You and the seller can negotiate these inspection fees.
- Owner's Title Insurance – You may want to purchase title insurance in case of unforeseen problems so you're not left owing a mortgage on property you no longer own. A thorough title search ensures a clear title.
- Appraisal Fees – You may want to hire an Appraiser either before you sign a purchase offer, or after reviewing the lender's appraisal report.
- Moving Expenses – If you are changing jobs, your new employer may pay for your relocation, otherwise you must figure in the moving costs such as truck rentals, professional movers, cash for utility deposits like telephone, cable, electricity, etc.
- Escrow Account Funds – In the purchase offer, you can request that the seller set up an Escrow Account to defray any costs for major cleanup, radon mitigation procedures, house painting, appliance repairs, etc. Depending on the purchase offer contract and contingency clauses, you may discover that you have expenses upon moving in.
Example: Your purchase offer contract has a clause making the purchase contingent on a satisfactory structural inspection, and it’s determined that the house needs a new roof. You can negotiate to have the seller arrange for the work to be done but, this will delay the closing date. Or you and the seller may split the cost using estimates from a contractor of your choice, and each of you will put funds into an Escrow Account.
- Time Investment – One often overlooks major up-front costs in buying a home. The time and expenses invested in house-hunting, which can take up to four months, plus the time spent searching for the best mortgage for you, the right real estate agent, an attorney, and other related things that take up your valuable time.
What is RESPA?
The Real Estate Settlement Procedures Act (RESPA) contains information regarding the settlement, or closing costs, you are likely to face. Within three days from the time of your mortgage application, your lender is required to provide you a "Loan Estimate" (LE) based on their understanding of your purchase contract. This estimate will indicate how much cash you will need at closing to cover prorated taxes, first month's interest, and other settlement costs.
Within the loan estimate, lenders will provide you with information on your loan’s annual percentage rate, finance charges, the amount financed, and the total payments required.
The LE will also contain information on security interest, late fees, prepayment provisions, and whether or not the mortgage is assumable. If you have an adjustable rate loan, the statement may outline the limits on the adjustments, annual and lifetime caps, and give an example of what your next year’s payment may be, depending on interest rates.
For adjustable rate loans, the total payments figure is estimated as a worst-case scenario. The figure reflects the payments you would make if your loan adjusted upward to the maximum rate allowed by annual and lifetime caps, and then stayed at that rate for the loan duration.
RESPA requires lenders to give you an information booklet about settlement costs, written by the U.S. Department of Housing & Urban Development which address how to negotiate a sales contract, ways to work with professionals like attorneys, real estate agents, lenders, etc, and your given rights as a home buyer. It gives an example of the Uniform Settlement Statement used at your closing. You are entitled to see a copy of the statement one business day prior to closing indicating your final costs.