What’s the deal with closing costs?

By Jonathan Washburn, The Solido Group · NMLS #1645952

Closing costs bucket #1: prepaid items

What are prepaid items? Property taxes and homeowner’s insurance.

You’ll usually see prepaid interest in this bucket too. That’s the interest that builds up on your loan between your closing date and the end of that month.

You always have to have homeowner’s insurance. Your lender will require it, and for good reason. A lender would never want a borrower to close on a house and then cancel their homeowner’s insurance a few days later. That’s why almost all lenders require you to pay for a full year of homeowner’s insurance up front at closing.

Suppose your homeowner’s insurance costs $1,500 for the year. You’ll actually bring that entire $1,500 to closing. Then, each month, as you make your mortgage payment, part of that payment goes into your escrow account. By the end of that first year, you’ll have enough money set aside in escrow to pay for your second year of homeowner’s insurance.

Now you might wonder, “Jonathan, does that mean I’m always kind of paying ahead on my homeowner’s insurance?” Yes, it does. But don’t worry. If you sell your house or refinance, you’ll generally get a refund for the unused portion of your premium.

How property taxes affect your closing costs

Now, property taxes often work the exact opposite way. In many states, local governments collect property taxes in arrears. So after you buy a house, you may have to pay a tax bill that covers months when somebody else still owned it. In other words, you’re paying a tax bill that partly belongs to the previous owner.

So, at closing, you’ll often receive what’s called a tax proration. That’s a credit from the seller. It reimburses you for the part of the upcoming tax bill that belongs to them. For instance, say you move in during January and a tax bill comes due in February. Part of that bill may cover a period when you didn’t even own the house. So the seller may give you a nice, healthy tax proration at closing to help offset that cost.

Either way, the lender, the Realtor, and the title company don’t control how much your property taxes are. So prepaid items—property taxes and homeowner’s insurance—are generally going to cost the same regardless of which lender you choose.

Closing costs bucket #2: title fees

Title fees: the title company you use sets these. Now, title insurance is really important. But what else does the title company do? They research the property for outstanding tax liens, ownership issues, or other title problems. You’d definitely want to know about those before buying the house. Essentially, the title company helps protect you and your ownership rights throughout the purchase process.

Every title company has its own set of fees, and those fees can vary from one company to another. So definitely look around and find a company you’re comfortable with. Talk to your Realtor—they work with title companies all the time. They can tell you which ones they’ve had good experiences with and which ones they haven’t. Talk to your lender, too. They probably work with title companies regularly and may have some they prefer or recommend. But ultimately, the title company sets those title fees. Again, the lender, the Realtor, and the seller don’t control how much the title company charges.

Closing costs bucket #3: lender fees

These are the only purchase fees that change from lender to lender. There are several different types of fees you might see here. You might have an origination fee, which is basically the lender’s cost for doing the loan. There may also be a processing fee and an underwriting fee. On certain down payment assistance programs, an administration fee can show up too.

Discount points vs. lender credits

One other thing you might have is discount points. Planning to stay in the house a long time? Then it can make sense to pay a little extra up front to buy your interest rate down. For instance, say an extra $1,000 at closing would lower your rate and save you $40 a month. Well, it wouldn’t take very long to make that $1,000 back. After that, the monthly savings are going directly into your pocket. In those situations, discount points can save you quite a bit of money over time.

Other times, it might make sense to do the exact opposite. I worked with a buddy of mine in Indiana a few years ago. He and his wife knew they’d stay five years at the absolute most before eventually moving. So for him, it actually made sense to take a slightly higher interest rate and a slightly higher monthly payment. In return, we gave him a nice lender credit. It covered some of his title fees and prepaid items and reduced the cash he needed for closing costs.

So definitely talk to your lender. Ask them which route makes the most sense for your situation: Should I pay a little more up front to buy my interest rate down? Or should I consider taking a higher rate in exchange for a lender credit and lower my upfront costs? Those are two very different strategies, and they can have a significant impact on how much you pay in closing costs.

Ready to buy?

Your Loan Estimate breaks down all three buckets of closing costs, so it is the best place to compare offers. Before closing, check your Closing Disclosure against it. Reach out to somebody at the Solido Group today!

This article is for general educational purposes only. It is not an offer or solicitation, a commitment to lend, a rate quote, or financial, legal, or tax advice. Loan program guidelines, rates, and requirements change and vary by borrower, lender, and state; confirm current details with a licensed loan officer. All loans are subject to credit approval. The Solido Group is a branch of Barrett Financial Group, L.L.C., NMLS #181106. Not all products are available in all states; see our licensing page. Equal Housing Opportunity.