The Home Buyer's Korner

Information presented should be used for educational purposes only.

September 1st, 2015

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The Home Buyer’s Korner

Real Estate G+

Mortgage Lender

General Contractor G+

Understanding Closing Costs

581275_1332444561700_bWith mortgage interest rates at near or record lows, many lenders are advertising their Annual Percentage Rates or APR under 4 percent, but what many home buyers aren’t familiar with is, with these low APR’s closing costs have often increased. Recently, analysis has shown that currently closing costs have increased about six percent in the past year. Much of this has come from additional cost lenders have incurred due to regulatory changes and passing the cost to home buyers.

In this post, we’ll discuss ways to ensure you not only get a good rate, but also how to compare closing costs to determine which lender is giving you the best deal.

All mortgage loans require closing costs. You’ll either pay for them in cash, finance or have a third party cover them. Third parties normally include either the seller or the lender. If the seller pays them, it’s pretty straight forward. At closing, your title agent will collect the appropriate fees from the seller and disburse them accordingly. If your lender pays the closing costs it’s done by charging you a higher than normal interest rate, consequently the lender will get what’s called premium pricing for the higher rate from the loan servicing mortgage lender and use some or all of these fees to cover your closing costs. Mortgages, where the costs are paid by the lender in full are known as “zero closing costs mortgage loans” and they can be to your advantage, depending on how long to plan to own your home.

Mortgage rates for a zero closing costs mortgage loan typically are priced at about one-eighth to one-quarter percentage higher than a mortgage for which the home buyer would pay their own closing costs. If you have sufficient funds to pay your closing costs in cash and want to see which option best fits your needs, ask for a good faith estimate for a borrower paid and a zero closing costs mortgage loan.

Next have your lender provide you with an amortization schedule for both. Within your amortization schedules you’ll see the payment difference and you’ll be able to see if it’s to your advantage to pay the closing costs up-front or pay a little more each month and keep your money in reserve for as a rainy day fund.

With rates this low you probably won’t be refinancing anytime soon and if you intend to live in the home for years to come, paying the fees up front probably is a good idea. However, if this is a starter home and you might sale in the not too distant future, you may want to pay a little higher monthly payment and keep your cash in reserves.

Only you know your short term and long term intentions. Knowing this, you’ll want to take your amortization schedule and locate both payments and deduct the lower from the higher payment. This is the difference you pay between the two. Then multiply that figure to get it as close to the upfront closing costs your lender provided you. From here you’ll know how long it would take to break even and hopefully you’ll have a good idea how long or short a timeframe you plan to live in the home to determine which option might be best for you.

Closing costs are broken down into two categories – mortgage lender closing costs, which are fees the lender charges to offer you a loan like; discount points, origination fees, underwriting fees, processing fees, lender doc prep fees or broker fees. Title insurance, appraisal fees, credit report fees, tax service fees, escrow fees and any fees not directly paid to the lender for your loan are third party fees and shouldn’t be included in your analysis.

Lenders often give their fees unique names, which can make it difficult to compare specific loan costs between banks. This is why it’s better to compare TOTAL lender costs rather than any one specific line-item.

Now that we’ve explained closing costs, let’s take steps to make sure you don’t pay more closing costs than you need.

The first rule is not to pay more discount point, then you should. Discount points are one-time, up-front fee paid at closing, which lowers the mortgage rates. They’re paid as a percentage of your loan size and one discount point carries a cost equal to one percent of your loan size. A $300,000 loan with one discount point would require $3,000 in cost.

We recommend you begin your mortgage rate comparison by visiting Freddie Mac’s Mortgage Interest Rate Comparison website to see what the average rate home buyers pay weekly. Rates here aren’t to be construed as an absolute, as each home buyer has a different variable. For example, a home buyer with a 740 FICO and 20 percent down payment will pay a lower rate than a home buyer with a 620 FICO score and paying only 3.5 percent as a down payment. It’s all about risk, but you’ll see what the average interest rate is and it’s updated each week on Thursday at 10 a.m. The only best way to see what rate you’ll be offered is to shop around and compare. Based on your unique circumstance and a little rate shopping, you’ll get a good idea of what rate you can expect.

For home buyers who plan to keep their mortgage, at least seven years or more would probably benefit paying discount points, but the best way to know this yet again, another amortization schedule. This time, you want one that provides you with a zero discount point rate and one or more with discount points charged. What you will be looking for here is again the monthly payment for each rate and discount points, then depending on how long you plan on keeping your mortgage is the variable to determine and if paying points or not is best for you.

One last topic to cover about discount points is they are tax deductible. If you choose to pay discount points make sure you include them as a deduction along with any interest you pay for the year you close on your new home.

Another way to reduce your closing costs is to lock your mortgage rate for the appropriate time frame. Rate locks are typically available in 15, 30, 45 and 60-day increments, with the shortest lock period normally having the best rate and/or discount points. Be careful to choose a rate lock that’s at least as long as your estimated closing date, if not just a little longer. It makes no sense to get a 15-day lock if you don’t plan to close for 35 days. Conversely, don’t let you lock expire. You can do this by making sure you get your loan conditions to your lender immediately, so they can get your mortgage application to underwriting as soon as possible.

If you put things off. You could go past your lock date and might have to pay an extension fee or be forced to get a new lock at that day’s pricing, which could be higher than when you made the application. Keep your closing costs low by selecting a realistic and appropriate rate lock for your loan.

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