Out of the entire home purchasing process, closing costs are often the least understood pieces. Because of that, we will take the time to address your questions and offer answers.
Although closing costs tend to vary from lender to lender, they are generally considered any costs tied to the purchases of a new home. Today, these costs range from 2 to 7 percent of the home’s purchase price and include three basic categories: prepaid expenses, mortgage points, and out-of-pocket expenses.
The following items are prepaid expenses: homeowner’s insurance, mortgage insurance, and the costs to set up an escrow account. An escrow account is when a lender pays the annual insurance premiums and various taxes on the borrower’s behalf. The amount that goes into this account is based on the first year’s premiums; an additional amount also is included to pay for future premiums. Because they vary based on the type of property and the time of the closing, prepaid expenses are usually difficult to determine.
A mortgage point is equal to 1 percent of the mortgage loan amount and actually helps reduce the loan’s interest rate. For example, depending on prevailing rates, a $100,000 mortgage might be obtained at 7.75 percent with two points, or at 8.25 percent with no points. Obtaining the lower interest rate would cut the mortgage payment by about $35 a month, but would require $2,000 — or two points — up front at closing.
The following items are out-of-pocket expenses: fees for appraisals, attorneys, credit reports, deed recording, tax services, and other miscellaneous expenses. The borrower typically pays the fees for these services, which are usually performed by a third party. The majority of out-of-pocket fees are necessary and legitimate; however, if the borrower encounters a fee that causes confusion, he or she should ask the mortgage professional about it.
Purchasing a home is one of the largest financial investments you can make. It is important that you understand it fully and completely so that you avoid unwelcomed surprises and are confident in every step you take towards your new home.