Now that you have found your ideal property and negotiated a purchase price, you will need to consider the closing costs that come with your mortgage loan. While mortgage closing costs can vary depending on your property’s location, the Federal Reserve Board estimates that closing costs are usually between 3% and 7% of the total purchase price of the property.
In a depressed housing market, buyers may be able to have the seller assume some of the mortgage closing costs, as an incentive to expedite the sale of the property. This can also be advantageous to the seller ― the longer their property remains on the market, the longer they will incur mortgage payments, real estate taxes, and other expenses to maintain the property. Therefore, it is wise for buyers to negotiate the home’s purchase price as well as certain mortgage closing costs.
Below are the most common closing costs that are incurred with mortgage loans.
Loan Application Fee
The amount charged by the lending institution to process your mortgage application and perform a credit check. The fee should not be more than a few hundred dollars. Some lenders may waive this fee to obtain your business.
Loan Origination Fee
A fee charged by the lending institution for evaluating and preparing your mortgage loan. This fee typically covers the lender’s attorney fees, document preparation costs, notary fees, and other administrative expenses. The loan origination fee is usually a percentage of the loan amount, often expressed as “points.”
Mortgage Points
A one-time charge by the lending institution based on the total loan amount. One mortgage point is equivalent to 1% of the loan amount. For example, 1 point on a $200,000 loan would equal $2,000. On government-backed mortgages (e.g., VA and FHA loans), points are often broken down into 2 categories: a loan origination fee (which is usually 1 point) and discount points (which are also a percentage of the loan balance). Generally, if you pay the points at mortgage closing, they are deductible on your income tax return (in the year they are paid). Note that different tax deduction rules apply when you refinance a loan or purchase a second home. Buyers may try to negotiate to have the seller pay all (or a portion of) the points in order to help reduce the buyer’s mortgage closing costs.
Prepaid Interest
The amount of interest that will accrue on the loan from the time you close until the first payment is due. Your first regular mortgage payment is usually due about 6 to 8 weeks after closing day. (For example, if you settle in June, your first regular payment will probably be due on August 1; the August payment covers the cost of borrowing the money for the month of July.) The mortgage closing costs will include the amount of interest you owe for the part of the month in which you settle. (For example, if you settle on June 15, you would owe interest for 16 days ― June 15 through 30.)
Private Mortgage Insurance (PMI)
Extra insurance that lending institutions require from most homebuyers who obtain loans that are more than 80% of the home’s purchase price. Typically, buyers who make less than a 20% down payment are required to pay for mortgage insurance. Under the Homeowner’s Protection Act (HPA), buyers may request cancellation of PMI when the mortgage is paid down to the point that it equals 80% of the original purchase price, or 80% of the appraised value of the home at the time the loan was made ― whichever is less. To decide whether the PMI can be terminated, the lending institution may consider the buyer’s payment history and request proof that the property has not declined in value.
Property Appraisal Fee
A fee charged by a qualified real estate appraiser, hired by the lending institution, to estimate the property’s fair market value. Mortgage lenders require a real estate appraisal to determine how much they are willing to lend on the property that the borrower wants to purchase.
An appraisal report typically includes the following:
- The appraiser’s method for determining the value of the property
- The property’s size and condition, and a description of any improvements that have been made
- Information about structural problems (such as wet basements, cracked foundations, or pest damage)
- Details about the community or surrounding area (such as new construction, established developments, and rural acreage)
- Recent market trends of the area that may affect the property’s value
- An analysis of comparable properties in the area
- Photographs of the interior and exterior of the property, as well as sketches and maps
Home Inspection Fee
Fees charged by the lending institution to cover the cost of a professional home inspection. This is charged in addition to any fees assumed by the buyer for separate, precautionary inspections. A proper home inspection will determine if the property has been exposed to termite damage, or chemical or environmental pollutants. An engineer (or other expert) will examine the structural condition of the property to certify that it’s sound. In rural areas, the lender or buyer may request a septic system test, a water test (to make sure the well and water system will provide an adequate supply of water), and a water quality test. These inspection fees, required by lenders, are included in the loan settlement costs ― however, the buyer will need to consider the overall inspection fees when calculating mortgage closing costs.
Homeowners Insurance Policy
The cost to obtain insurance coverage to replace the home, should it be damaged or destroyed by natural disaster. The insurance company will consider the age and size of your home, the materials used to build it, where it is located, and its distance from a fire station in determining the cost of your coverage. You might need additional coverage for earthquakes, wildfires, flooding, or windstorms, depending on where you live. You may also want to obtain insurance coverage for the contents of your home, including furnishings and other personal valuables.
Funds for an Escrow Account
A reserve account, typically set up at mortgage closing time. Escrow accounts are required by many lending institutions to pay for property taxes and homeowner’s insurance. By having the borrower deposit money into an escrow account, the lender can be assured these expenses are paid on time. Note that not all lenders will require an escrow account, depending on the candidate.
Other Closing Costs
Other mortgage loan closing costs may include the following:
- Property survey fees
- FHA, VA, or RHS fees (for government-backed loans)
- Flood or wind insurance premiums (or other supplemental property insurance beyond what the lending institution requires)
- Third-party mortgage broker fees (if you choose to use a broker to help you find optimum mortgage terms/rates)
- Mortgage assumption fees (if you assume the seller’s current mortgage)
- HOA fees (if you purchase a condo or other community unit)
- The costs to repair or replace certain items (such as appliances, flooring, or heating/cooling units)