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Lesson 6.2

Closing Costs

 
Samantha Reeves | Real Estate Expert

Mortgage Costs & Fees

Every mortgage comes with closing costs and related expenses. For many homebuyers, closing costs are one of the most confusing parts of this entire journey.

In fact, “closing costs” is really a catchall term. There are all different kinds of costs and fees that can be part of finalizing this process. In the mortgage world, you’ll also hear these referred to as “settlement charges.”

Some of these costs represent the actual costs of doing a loan. Others involve expenses like homeowners insurance and property taxes. Some need to be paid before you get to the closing table, while others can wait until that happy day arrives.

Your closing costs will vary depending on a host of factors, from your lender and loan type to the location and more. With VA loans, this program actually limits what buyers can pay in closing costs. In fact, there are certain costs and fees that VA buyers aren’t allowed to pay.

Who pays what in closing costs and concessions is always up for negotiation. It’s important to understand that sellers aren’t obliged to pay any costs on your behalf. But you can always request that the sellers pay a portion or all of the closing costs when you’re making a formal offer on a home.

Let’s first take a look at the different kinds of loan-related costs you’re likely to encounter.

Non-Loan Closing Costs

Now, here’s a look at some of the common closing costs not directly related to obtaining a home loan:

  • Prepayment of your property taxes and homeowners insurance. You might hear these referred to in the context of an “escrow account.” Your local municipality will levy property taxes on an annual basis. You’ll also be responsible for paying for homeowners insurance. At least a portion of these annual bills will be due at closing.
  • Daily interest charges: Your mortgage is paid in arrears, meaning your monthly payment actually covers the previous month you lived in the home. So if you close in mid-September, your first mortgage payment wouldn’t typically be due until November 1. But lenders will collect prepaid interest on the loan between your closing date and the end of the month you close. Lenders calculate it as a per-day rate (yearly interest cost/365 days per year = one day of interest payment). That prepayment is due at the closing table.
  • Recording fees: State and local governments charge a fee to record your deed and mortgage-related documents. Some of the details of your real estate transaction will become public records, accessible to anyone in your community and beyond.
  • Homeowners Association (HOA) fees: There may be costs and fees associated with closing a loan on a property in a homeowners association. It's common for homeowners associations to charge annual dues, which may need to be factored into your closing cost picture.
  • Home Warranty fees: There may be a fee involved with obtaining a home warranty on a property. These policies will often cover the cost of certain repairs during the first year you own the home.
  • Real estate commissions: The listing agent and the buyer’s agent will often split a predetermined commission that reflects a percentage of the home’s sale price. This typically comes out of the seller's sale proceeds.

Closing Costs v. Concessions

One of the big benefits of VA loans is that sellers can pay all of your loan-related closing costs. Again, they’re not required to pay any of them, so this will always be a product of negotiation between buyer and seller.

In addition, you can ask the seller to pay up to 4 percent of the purchase price in “concessions,” which can cover those non-loan-related costs and more. VA broadly defines seller concessions as “anything of value added to the transaction by the builder or seller for which the buyer pays nothing additional and which the seller is not customarily expected or required to pay or provide.”

Some of the most common seller concessions include:

  • Having a seller cover your prepaid taxes and insurance costs
  • Having a seller provide credits for items left behind in the home, like a pool table or a riding lawn mower
  • Having a seller pay off your collections, judgments or lease termination fees at closing

In some respects, as long as you stick to that 4 percent cap, the sky’s the limit when it comes to asking for concessions.

VA buyers are also subject to the VA Funding Fee, a mandatory charge that goes straight to the VA to help keep this loan program running. For most first-time VA buyers, this fee is 2.15 percent of the loan amount, provided you’re not making a down payment. Buyers who receive VA disability compensation are exempt from paying this fee.

The funding fee is the only closing cost VA buyers can roll into their loan balance, and that’s how most borrowers approach this fee. You could ask the seller to pay it, but doing so would count against the 4 percent concessions cap. The other potential approach would be to ask the seller to lower the purchase price by whatever the fee totals.

Closing Costs in Your Purchase Offer

One of the early questions many borrowers have is: What are my closing costs? It’s an important question for a lot of reasons. Many VA buyers want or need the seller to pay at least some of these costs, if not all of them. And that means asking for a specific percentage or dollar amount in your purchase offer.

Where things can get confusing is that lenders can only give you a rough estimate until you’ve zeroed in on a property. That’s in part because they’ll need the property address in order to estimate things like homeowners insurance, property taxes and more. Some lenders will provide a “fees worksheet” or some other document to help give you a broad idea of closing costs. Other times, a loan officer might provide a rough estimate based on other recent purchases in that community.

But you won’t get an official estimate of your closing costs until a lender has a full application that includes information on your income, your credit and a specific property address. Once a lender has that application in hand, they’re legally required to send you some key documents and disclosures within three business days. One of the most important is the Loan Estimate.

The Loan Estimate

This is a relatively new document that came out of the banking and mortgage industry reforms following the housing crisis. The new Loan Estimate replaced two longtime federal forms, the Good Faith Estimate and the initial Truth-in-Lending statement.

The Loan Estimate offers a detailed picture of the loan’s estimated costs and fees along with some of its key features.

The Loan Estimate will include:

  • A closer look at the loan amount, the interest rate and the monthly principal and interest payments of the loan
  • Your projected monthly payments over the life of the loan
  • A detailed breakdown of your estimated loan-related closing costs, such as origination charges, appraisal fees, title insurance and more
  • A detailed breakdown of other estimated costs to close, such as prepaid taxes, homeowners insurance and interest charges
  • A total estimate for how much cash you’ll need to close, including the down payment amount
  • Information about your borrowing costs, annual percentage rate (APR) and total interest percentage (TIP) that you can use to compare with other loan offers
  • Information about appraisals, assumptions, late fees, loan servicing and more

Along with your Loan Estimate, the lender will identify what closing-related services you can shop for and include a list of companies you might consider. Some of these services can include things like title work, closing agents and homeowners insurance. Regarding the services for which you can shop, you’re not required to use any of the companies identified by the lender.

The Loan Estimate is ultimately an estimate, and that means some of the projected costs can change. But there are limits on what charges can and cannot increase and by how much.

With the Loan Estimate, you’ll have a good look at the estimated costs needed to get into your new home. That’s critical information when you’re making an offer and asking a seller to cover some or all of your closing costs. You need to know what to ask them for, right?

This is why it’s so important for VA buyers to get preapproved and to talk with their lender before making an offer on a home. The sooner you and your real estate agent communicate with your lender about a specific property, the faster they can prepare a Loan Estimate. And that helps ensure you ask for the right amount of closing costs and concessions in your offer.

To be sure, every purchase situation is different. If you’re in a hot real estate market or there are multiple offers on a property, you may not have time to wait for a Loan Estimate to be issued. Talk with your real estate agent and your lender about how best to proceed.

What if the Seller Balks?

Sellers often realize they need to engage in some give-and-take in order to sell their property. But not all markets are competitive, and not all sellers are motivated.

Sellers aren’t required to pay any of your closing costs. Even if the VA doesn’t allow a buyer to pay for something, that doesn’t automatically mean it’s up to the seller. So what happens if the seller refuses to cover some or any of your closing costs?

Talk with your real estate agent and your lender about your options. You may be able to increase your purchase offer by the amount of your closing costs. For example, let’s say you’re buying at $150,000 and your closing costs are $5,000. You may be able to increase your offer to $155,000 and have the seller use those proceeds to cover your closing costs. They still net the same $150,000 in this example.

One of the challenges with this approach is making sure the home appraises for the higher amount. Lenders will lend whichever is less between the purchase price and the property’s appraised value. The other challenge is making sure you can afford the higher amount. You should also understand that this scenario means you’re effectively paying these closing costs with interest over the life of the loan, because you’re borrowing more money.

You may also be able to have the lender cover these costs. To do so, you’ll usually have to take a higher interest rate. You may also be able to use gift funds from a family member or close relation.