When planning to buy a home, most people save for their down payment, but give little or no thought to closing costs. . .
or if a first time homebuyer, may not know what closing costs are.
Closing costs are expenses that must be paid at the closing. . . called the ‘Act of Sale’ here in Louisiana. Since those costs may be as much as, or more than the down payment, it’s important to understand what you are paying for and why. Closing costs include the buyer’s ‘prepaid expenses’, lender fees, and charges paid to the title company.
Among ‘prepaid expenses’ are the first year’s insurance premiums for the home… Homeowners insurance to protect against fire and hurricane losses, and Flood insurance to cover ‘rising water’. . . whether from street water caused by inefficient drainage, or bayous overflowing their banks. Since your responsibility begins at your Act of Sale, the first year’s coverage must be in place and premium fully paid at that time.
Other prepaid expenses will include the cost of a Credit Report and Appraisal (always buyer expenses), and sometimes a Property Survey, Elevation Survey, or Termite Inspection. In some cases, the elevation survey and termite inspection may be put on the seller as a condition of sale.
Unless paying cash, lender fees are a necessary cost of buying a home. There are the Loan Application and Underwriting fees – costs covering the work done by the lender to put your loan package together. And in times of high interest rates, the buyer may choose to pay the lender Discount Points – a percentage amount of the loan itself that is paid to obtain an overall lower interest rate on the loan.
Then there is the matter of Prepaid Interest. This is the actual mortgage interest due and payable from the Act of Sale date to the end of the month. So if you are closing on the 2nd of the month, you’ll need to pay at the closing table mortgage interest through the 30th of the month. . . likewise, if closing on the 30th, only one day’s interest. So you can see why many homebuyers prefer to close near the end on the month rather than earlier in the month.
And let’s not forget the title company. Your title company will perform a Title Search to ensure all liens on the home are cleared. Then Title Insurance is issued to protect both you and your lender in the event there is a claim on title that arises after the Act of Sale. And of course for performing the actual closing for you, there is the Settlement Fee and incidentals such as Courier and Filing Charges to record your sale with the Clerk of Court.
All the above represent direct costs in buying a home. However, as discussed elsewhere on this site, there must also be the establishment of an Escrow Account with your lender. . . three months of prorated insurance premiums and property taxes collected at the Act of Sale. From this point forward, your lender will collect escrow (built into your monthly payment), and take the responsibility of making your insurance and property tax payments as they come due in subsequent years.
Whew!! All this is soooo boring! But it is also so important in understanding why you need much more than just a down payment. And since the costs mentioned above can’t always be known ahead of time, a fairly safe estimate for closing costs is roughly 4%-5% of the cost of the home itself.
If you have concerns over the closing costs, talk to me. In negotiating the terms of your purchase, I may be able to get the seller to pay some of your closing costs for you. Of course, this will often depend on factors such as how much equity the seller has in the property or whether the home you’ve chosen is a foreclosure or short sale. . . all matters best discussed with a specific home in mind.