Your Closing Costs
Most people focus on the current mortgage interest rates when shopping for a home loan. Interest rates are certainly important, but they do not represent the only significant expense associated with financing a home. When you are making plans to purchase a new home, it is important to consider the big picture of all the fees associated with getting a mortgage, rather than focusing solely on interest rates.
Before you can decide just how much house you can afford to purchase, you need to look at an overall summary of mortgage fees so that you will have a clear understanding of all the expenses involved. Many factors can impact the total amount of money you need to borrow, as well as the final out-of-pocket requirement for your monthly payment.
When you apply for a mortgage, the lender is required to disclose the Loan Estimate, which is a multi-page document that outlines the estimated fees for your loan. Note the name of this disclosure, the Loan ESTIMATE. It’s nearly impossible at this point to know exactly how much money you will need to close, however, the Loan Estimate provided will help you understand the approximate total. (For details on how to read your Loan Estimate, please visit the Consumer Financial Protection Bureau’s Loan Estimate Explainer.)
Most home buyers will be required to make a down payment to be considered for mortgage loan approval. The down payment is not a transaction cost. Rather, it’s the portion of the sales price that the buyer pays in cash.
The amount of money an individual is required to contribute as the down payment may vary significantly based on a variety of factors, including the cost of the home, the applicant's credit history, the borrower's qualification for down payment assistance programs, and many other variables.
Down payment requirements can range from 0% to 45%, depending on the loan program. For example, VA and USDA loans can be eligible for 0% down payment. Conventional loan programs can start at 3% down payment for First Time Home Buyers, or 5% for repeat buyers. FHA loans start at 3.5% down payment. Many jumbo loan programs require 20% down payment, but there are specialized jumbo loans that can accept as little as 5% down.
A common mistake that many renters make is assuming they can't qualify for a mortgage because they don't have enough saved for a down payment, or because they are waiting to save for at least 20% cash for a down payment.
Discount points, typically referred to as just "points," are a charge by the lender paid by the borrower. 1 point = 1% of the LOAN amount (not the sales price.) So for a $500,000 loan, 1 point is $5,000. Points are paid by the borrower in exchange for a lower interest rate. The lower the interest rate, the higher the number of points the borrower must pay. The higher the interest rate, the fewer points paid by the borrower. The interest rate charging the lowest amount of points is considered the "par rate" or "market rate."
Alternatively, the borrower can select an interest rate that is higher than the current market rate and receive a credit from the lender to help pay for some or most of the costs associated with purchasing a home. The higher the interest rate, the greater the credit provided by the lender, and the lower the overall costs are to purchase or refinance a home.
It's important to note that the discount points vary from lender to lender, and they change daily until the loan is locked for a specific time period, usually 30-60 days, to close out the loan. Although there are other fees to consider, the discount points are the biggest factor when gauging a lender's "pricing" for a given loan scenario. At C2 Hawaii, we are able to compare your loan amongst our network of lenders to ensure we are only working with lenders offering the most competitive pricing.
The discount points mentioned in the previous section are considered Origination Fees or Lender Fees, since these are fees charged by the lender for originating the loan. Unlike the discount points, which are a percentage of the loan amount, the other origination fees discussed here are a fixed amount or a flat fee. These origination fees include, but are not limited to:
Underwriting or Administration Fee
Document Prep Fee
Condo Review Fee (if the property is a condominium)
Trust Review Fee (if ownership is vested in a trust)
The type of fee and the amounts charged vary from lender to lender. It's important to look at the overall picture of the total lender fees charged to you, rather than focusing on a specific origination fee.
Title and Escrow Fees
Title and Escrow are two different services that are involved in purchasing a home. In many areas of the country, a separate title company and escrow company are involved. However, in Hawaii, it’s very common that the same company handles both the title and escrow services in the same transaction.
The escrow company acts as a neutral third party to the buyer and seller, to ensure all requirements of the purchase contract are met prior to transferring title from the seller to the buyer. An Escrow Fee, sometimes referred to as a “Settlement Fee” or “Closing Fee” is charged to both the buyer and the seller for these services, and the amount charged depends on the sales price of the home.
One of the most important components of a home loan transaction is the process of verifying that the seller has the legal right to transfer title of the home to the buyer. In addition to verifying that the title of the home is clear prior to closing, it is advisable to protect the home from future title problems tied the actions of past owners with a title insurance policy.
Sellers are typically responsible for paying for title research since this work is required to verify that they do in fact own the property and have a legal right to transfer it to the buyer. Home buyers, however, usually pay for the accompanying owner's title insurance policies, which protect them against potential prior claims to the home's title that might surface once the transaction has been completed. Mortgage lenders typically require title insurance policies as a condition of closing.
Mortgage interest is always paid in arrears. When you take out a new mortgage, your first payment date does not start until at least a full month after the funding date. For example, if your new loan funds in April, you won’t make your first payment until June 1st. The interest you pay on June 1st as part of your regular monthly payment is for the interest accrued in May. So, what happens for those days in April after the loan funded? The interest due for those days is collected at closing as prepaid interest.
The day you close on your home loan, you will be required to pay the interest that will accrue on the loan between the day the loan is funded through the end of that month. For example, take a look at the calendar above. If your loan funded on April 10th, then 21 days of prepaid interest is collected at closing (April 10th through April 30th). If instead, the loan closes on April 25th, then 6 days of prepaid interest is due at closing (April 25th through April 30th), as illustrated below.
When you finance a home, the premium for your first year of Homeowner's insurance coverage is due at the closing table. No mortgage company will allow a sales transaction to take place without being certain that all required insurance coverage is in effect the day the loan is funded.
All properties in Hawaii require Hurricane (aka Windstorm) insurance coverage in addition to Homeowner's insurance. This too must be paid in full for the first year at closing. Some insurance agencies will write one policy that is a combined Homeowner's and Hurricane Insurance policy, while other carriers may write two separate policies from different insurance carriers.
If your property is in a flood zone, then you will be required to purchase Flood insurance as well.
(*Note, "escrow" in this section is not to be confused with the Escrow Company discussed in the previous section)
If you have a mortgage on your home, naturally you will be making mortgage payments. In addition to your regular mortgage payments, your lender is likely to require you to make EXTRA monthly payments toward your property taxes and homeowners insurance premiums. This money goes into an escrow account, and the money is kept there until your Property Tax and Property Insurance bills are due. Not all mortgage programs require an escrow account, but more often than not, this will apply to you.
To ensure sufficient funds in this escrow account throughout the year, the lender will require that this account is funded at closing. Several months of Homeowner’s Insurance premiums and Real Property Tax will be collected at closing to fund the escrow account. The exact amount depends on which month closing takes place, as well as when the Homeowner’s Insurance and Real Property Tax bills are due. Typically, 2 to 3 months worth of Insurance premiums and anywhere from 2-8 months of Real Property Tax payments are collected at closing.
Lenders require escrow accounts because they have a vested interest in making sure the property is sufficiently insured and remains free of tax liens. Since these payments are property-related expenses, it would be incorrect to consider them a “cost” or “fee” for your mortgage, however, it does affect the total amount of funds needed to close the loan, and is lumped together as part of your closing costs.
Other Closing Costs
A number of additional expenses must be considered in any comprehensive summary of mortgage fees. For example, when title to a property is transferred, a warranty deed must be created, and the changes to the title of the property must be recorded. Some loan programs require property appraisals, surveys, and termite inspections prior to approving a loan. The fees associated with these legal and real estate services are part of the closing costs for a home loan. They can be paid for by the buyer or seller, based on the terms agreed upon in the purchase agreement.