What's up with those closing costs?
Important notice to readers: This post has been filed under “Boring Stuff About Contracts,” and I wasn’t kidding. Agents armed with feed readers might do well to move along.
Ah, closing costs. They are an expensive annoyance, and they tend to confuse at best. Mostly, they serve as a cold shower dose of home buying or selling reality.
Caveat emptor: I work in Southern California. What is typical in Southern California may not be the norm in other areas. Like Northern California. Or the Ozarks. Consult your local expert before making my remarks the cornerstone of your retirement planning. Fees cited are estimates only. Your mileage may vary.
The 1% Rule
We, the people of the Agent genus, like to say that whether buying or selling, closing costs will ring up at about one percent of the sale price, and here we are excluding the real estate agent’s fee. This is mostly true for sellers, but in our new lending world, this is not necessarily true for the buyer.
In Southern California, there is a traditional laundry list of buyer and seller closing costs. The agent’s fee ordinarily rears its ugly head on the seller’s side of the balance sheet. With this exception, both parties are created sort of equal.
Whether buying or selling, you will undoubtedly see a bunch of little charges that collectively start to equal a big, three-digit number. These include fees associated with recording and notarizing documents, courier charges, and title “binder” fees to name a few. The big boys for both sides are the title and escrow fees. In our market, escrow fees are traditionally split down the middle, with each paying his own (the exception being in VA loan situations where the lender requires the seller to shoulder the entire escrow fee burden).
Sellers usually pay for the Wood Destroying Pest and Organisms inspection (more affectionately referred to as the Termite Report) and any work required to remediate active infestation, although this is technically a negotiable item. Sellers also pay for the Natural Hazard Disclosure Report (which will tell you if, among other things, the home is located in a protected habitat for the spotted toad, and I am not kidding), for City and County transfer fees (“tax stamps,” currently carrying a price tag of $1.10 per $1,000 dollars of value in San Diego County), for Homeowners Association Transfer Fees (yes, they will charge between $250 and $400 to produce the HOA documents for the buyer’s review and to transfer the billing), and for a buyer Home Warranty policy. Think of the latter as catastrophic illness coverage. If your dishwasher makes funny noises the day after closing, they will give you headphones and charge you the minimum $45 service call, your deductible; if, on the other hand, the dishwasher decides to channel Old Faithful one week after possession, they might replace it (but not your wood floors). In any event, it beats a poke in the eye.
Don’t forget the lender fees
Buyers beware. If you are getting a loan versus paying cash (which means you), there will be loan tie-in fees (to compensate escrow or title for dealing with the lender), sub-escrow fees (to compensate title for dealing with an outside escrow), a tax service fee (beats me, but it is purportedly related to the lender servicing your loan), and other fun charges. There are two categories of closing costs which tend to whop the buyer upside their unassuming head: Loan origination fees and prepayments.
Loan origination fees are lender-dependent. It can be a small fixed fee or it can range from 0.5% to 2% of the loan amount. Agents in our area typical assume a default 1% loan origination fee in their buyer closing cost estimates.
Prepayments can add up
Prepayments will vary based on the flavor of the loan and the time of month and year you close. These days, the rule of thumb is that with less than 20% down, the lender will require that taxes and insurance be “impounded,” meaning that you pay these items with your mortgage payment in installments, rather than when they are due, and the lender makes the payment for you. With impound accounts, a lender may require four to six month’s worth of “reserves” to be paid up front. This insures them against a late pay or default situation. So goes the homeowner’s insurance. Almost always, it is required that a one-year policy be bound at closing (in our market, $1200 to $1400 is a good rule of thumb for a single-family detached home). With an impound account, the lender may require an additional reserve on this as well.
Even if you are bringing buckets of money into the transaction, you can expect some property tax prepayment depending on the time of year you close. Our San Diego property taxes cover a July 1st to June 31st tax year. The first “bill” is delinquent on December 10th and the second on April 10th, but each covers a period forward and in arrears. So, say you close escrow on October 1st. The seller has presumably not yet made their first installment payment, so they will be charged in escrow for property taxes for the period between July 1st and September 30th. The buyer will be charged in escrow for the period from October 1st and December 31st. It is not a cost of the transaction; it is a cost of homeownership. But, if it cash needed to close, and you should be aware. There will be a test later.
For lower down-payment buyers, there might be a Private Mortgage Insurance (PMI) required by the lender. PMI will vary, but it can add a hundred dollars or two hundred dollars or more to your monthly payment, and the lender may require reserves for this as well. The “piggy-back loans” of yesterday avoided this, but these are effectively obsolete (for now), so buyers with less skin in the game are back to having to insure that they will perform.
Finally, there is the mortgage prepayment. As a buyer, assume that you will be paying your first month’s mortgage payment at closing. It could be a little more or a little less depending on the lender and the closing date. Again, this is a cost of homeownership, not of the transaction, but cash out is cash out, and you need to plan for it. Mortgage interest is paid in arrears. When my bill is due on the 1st of the month, I am paying for the preceding month of enjoyment. So, when I close escrow on the last day of the month and prepay my first month’s interest through escrow, I will not owe a payment again for 60 days. Get it? I didn’t think so.
There is more, of course. I didn’t even broach the subject of inspections and appraisals. But, the moral to the story is that, whether buying or selling, there are costs involved beyond the agent fees which you should be aware of and prepared for. Your agent and lender can break it down for you and your particular situation, but sooner is always better. Don’t let yourself be blindsided.
You can wake up now. I’m done. You’re welcome.