Breaking It Down: Understanding Your Home Closing Costs

When you’re a first-time homebuyer, the concept of closing costs may be elusive and intimidating. You know they’re coming, but you have no idea what to expect. Luckily, a little knowledge can go a long way.

Closing costs are fees for loan application services and costs associated with your monthly mortgage. They can be divided into four main categories.

1. Lender Fees

Fees charged for the processing of your loan application:

• Underwriting and processing fees
• Government recording fees
• Origination fees – calculated as a percentage of the loan amount, this fee covers lender overhead costs and profit

2. Third-Party Fees

Fees assessed based on the type of loan and type of property you’re purchasing:

• Appraisal fee – cost to assess and confirm the property’s value for the lender
• Owner’s title insurance – protects the owner from financial loss as a result of title defects or any liens discovered after the purchase
• Lender’s title insurance – protects the lender from financial loss as a result of title defects or any liens discovered after the purchase
• Transfer taxes – cost of transferring the title from the seller to the borrower
• Document preparation fee
• FHA UFMIP or VA funding fee flood certification – applicable based on loan type
• Flood certification – applicable if the property is in a government-certified flood zone
• Notary/wire/courier fees – if applicable

3. Prepaid Items

• Interest – interest is prorated based on the date of purchase and the month’s end
• Homeowners insurance – at the closing, you’ll be asked to bring proof that you purchased home insurance

4. Escrow Account Funds

The lender requires a deposit to open an escrow account. The costs listed, plus mortgage and interest, make up your monthly payment.

• Property taxes
• Homeowners insurance
• Mortgage insurance – applicable if you’ve paid less than 20% of the value of the home as a down payment

Adjustment to Your Interest Rate

When working with your lender, they will explain different ways that you can reduce your interest rate:

• Borrower credit – this adjustment would be made to reflect any discount the lender may offer
• Buy down points – also known as “discount points,” these can be used to “buy” a lower interest rate. Each quarter basis point you purchase to lower your overall interest rate equals 1% of your loan amount. Discount points lower the interest rate for the entire term of the loan.

Loan Estimate and Closing Disclosure

Don’t worry, the closing table is not the first time you’ll get to review your closing costs. As the borrower, you’ll receive a preview of the closing costs twice during the loan application process.

The first time, a “Loan Estimate” will be mailed to you within three business days after you’ve applied for the loan. As the title suggests, this is only an estimate.

A second, more thorough and exact document, known as a the “Closing Disclosure,” must be received by you three business days prior to the closing. Both documents are required by law.

We can’t avoid closing costs — they’re a mandatory part of the homebuying process. But understanding what they are and how they work helps you come to the table prepared.