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How To Avoid Closing Cost Sticker Shock

Picture of lady looking at computer and is shocked at her closing costs.

Confused By Closing Costs?

Closing costs are one of those things that some people may not understand and many people are unaware of until they receive the sticker shock upon seeing the amount of money they need to bring to the table due to closing costs. Depending on the type of loan, the amount of the loan, or the terms of the home purchase closing costs can greatly vary. With the way the home loan process works often times closing costs are not known until close to the actual closing date. With this article I will explain some of the terminology associated with closing cost line item charges and present some ideas on how to minimize your out of pocket expenses when it comes to closing costs.  By being familiar with closing cost terminology and possible ways to reduce those costs perhaps you can learn how to avoid closing cost sticker shock.

Terminology

Any discussion about closing costs should begin with defining certain terminology. Not every term in here will be seen in every closing. Depending on the type of loan and other facts some of the terms may not apply to your individual scenario.  With any fee being charged by the lender you should ask what those fees are and are they necessary. Some fees can be negotiated away or you may be able to find other lenders who do not charge those same fees.

Appraisal Fees: Appraisal Fees are fees charged by the lender to hire an Appraiser to give a value estimate of the home you wish to purchase. Lenders generally want to lend money where the amount being borrowed is less than the value of the home and land that is being purchased. Where the amount of the mortgage loan is less than the appraised value there is less risk of loss to the lender in the event the mortgage is not paid back since the lender could theoretically sell the home and recover their losses from the sale.

Credit Report Fee: The credit report fee is a fee that is charged by the lender to run your credit report and check your credit score as part of the loan application process.

Daily Interest: Daily Interest is the amount of interest owed on the mortgage loan starting from the date you close on the loan to the first day of the period your first loan payment is due.

Discount Points: Discount points are a fee charged by lenders to reduce the interest rate you are paying on the mortgage. It is basically a fee you pay upfront in order to get a lower interest rate over the life of the loan. This is an optional fee that you do not need to pay if you don’t want the interest rate deduction or if the fee does not fit within your current budget. Money paid for discounts points may be tax deductible in the year you paid for the points. Consult with a tax practitioner to see if you can deduct any amounts for discounts points prior to paying for the points.

Document Preparation Fee: A Document Preparation Fee or Doc. Prep. Fee is a fee charged by lenders to prepare the mortgage loan documents.

Endorsement Fee: An Endorsement is an addition or limitation of coverage to a Title Insurance policy. You should obtain an explanation for this fee if you see it on your closing statement.

Escrow Holdback: Escrow Holdback is an amount of money held in an escrow holding account (usually held in the title company’s escrow bank account) for purposes of paying for something after closing. The reasons for Escrow Holdback include repairs that have not yet been made, work yet to be done on a new construction home, further title work, lien discharges and more.

Flood Certification Fee: A fee charged to determine if the home you are wanting to purchase is in a flood zone. If the home is in a flood zone, flood insurance will be required.

Government Recording Fees/Property Transfer Taxes: Government Recording Fees are fees charged to register the new deed in the buyer’s name.   State and local governments may also charge a Property Transfer Tax that can be based on the value of the home being sold or some other formula and is collect at the time of closing.

Homeowners Insurance: Homeowners Insurance is the premium paid to an insurance company to insure the home from loss or damage. Homeowners Insurance is generally required by the lender when borrowing to purchase a home. Homeowners Insurance can also be collected and be paid out of escrow similar to Property Tax as noted above.

Loan Application Fee: A fee charged to the borrower as part of the application process for a mortgage loan. This fee may not be present if an Origination Fee is charged. It may be possible to request this fee be waived if there is an origination fee or some sort of other lender charged application fee.

Origination Fee/Processing Fees/Underwriting Fees: These fees are charged by a lender for giving you a mortgage loan. These fees may not be mandatory fees as they can vary based on lender requirements and may not be charged by every lender, so it pays to shop around.

Private Mortgage Insurance: Private Mortgage Insurance (also known as PMI) is a monthly payment added to your mortgage payment and paid to the lender to guarantee the lender from losses should the borrower be unable to pay off the loan. PMI is usually only paid when the borrower does not have at least 20% down payment to put towards the house they wish to buy. Once you get to 20% equity in your home based on paying off your mortgage balance over time you can request the lender stop collecting PMI payments.

Property Tax: Property Taxes are what you pay to the City, County and State for services provided to your property. Services such as police and fire protection, sewage, water, utilities and more are examples of services that may be provided in the area the real estate is located. If you are using the escrow service of your lender, then the lender will collect property taxes and hold them in a separate escrow account to be paid when the taxes are due. Usually the total Property Tax amount is divided by 12 and then each month 1/12th of the total property tax due is collected along with your mortgage payment. Depending on the type of loan you are using and the amount you are putting towards down payment the escrow may or may not be mandatory.

Title Examination Fees: Title Fees are fees charged by the title company to process the deed transfer from the seller to the buyer. It includes amounts to pay for the title company attorney to review the deed and prepare a new deed with the buyer’s information.

Title Insurance:  When borrowing money to buy real estate, the lender will require Title Insurance which protects them in case the deed from the seller is bad and they did not truly own the real estate purchased by the buyer. Title Insurance is usually a one-time fee paid at the time of closing and generally only covers the lender. For home owner Title Insurance there is usually an optional separate fee. If you don’t purchase Title Insurance for yourself then only the lender is protected in the event the seller did not really own or have the right to sell the real estate you purchased. For more information on whether or not buying Title Insurance is worth it to you check out my podcast entitled What Does A Title Company Do.

Survey Fee: The Survey Fee is the charge for a Surveyor to come out and identify the property boundary lines. If the property boundary lines do not match up with what is recorded on the deed then the mortgage loan could be denied.

Ways To Reduce Closing Costs

There are a number of ways a buyer can reduce their closing costs in order to have to come up with less money out of pocket at closing. Certain government sponsored loans like FHA and VA loans limit the amount of closing costs that can be charged on the loan. You can also apply for a no closing cost loan that may be offered by lenders in your area. Another option is to ask the seller to contribute towards paying the closing costs as part of your offer.

Picture of soldier salutingVA Loans

VA loans or loans guaranteed by the Veterans Administration are mortgage loans only available to U.S. military service members who are on active duty, are veterans, and available to the service members spouses in certain cases. (See http://www.benefits.va.gov/homeloans/purchaseco_eligibility.asp for eligibility requirements). The loans are provided by private lenders with the guarantee of the Veterans Administration so as a result they are easier to obtain for service members.

Under the VA Loans some costs such as termite/pest inspection fees, lender attorney fees, lender document fees, notary fees and more are not allowed to be paid by the buyer. Those fees are either not included as part of the closing costs or in the case of a termite/inspection fee where a third party contractor does the work, the seller will need to pay that fee. With a VA Loan the buyer can request the seller to pay closing costs as part of the offer.  For more information on the limits of closing costs and VA loans check out this article from Veterans United entitled "Pulling Back the Curtain on VA Home Loan Closing Costs".

FHA Loans

One advantage of an FHA loan is that a seller can contribute up to 6% of the sales price of the home towards closing costs when the buyer is putting a down payment of 10% or less. With a conventional mortgage the seller contribution is limited to 3% when the down payment from the buyer is 10% or less of the home sales price (if your down payment is 10-25% then the seller can contribute up to 6% just like with the FHA). The FHA loan credit requirements are not as strict as that of the conventional loan which makes this a much better option for many buyers who are unable to bring more than 10% down towards down payment on the home and are looking for the seller to help pay a larger portion of the closing costs.

Seller Contribution Towards Closing Costs

Requesting seller contributions toward closing costs is probably the best option with minimal downside to a buyer for getting help with payment of closing costs. As part of the offer to purchase a home have your real estate agent request seller contribution for part or all of closing costs in the offer. Depending on the type of loan, the amount of closing costs, and the offering price by asking the seller to pay a large amount of closing costs your offer could be considered a low ball offer by the seller and outright rejected.  Work with your agent to determine a reasonable offer price that takes into consideration your request for closing cost contribution by the seller. Consider writing in your offer a reasonable upper limit on the closing costs so the seller does not feel they may be on the hook for an high unknown amount and therefore shying away from accepting.

Whether your offer with closing costs gets accepted depends on the type of housing market that you are currently in. If sales and offers are slow you are more likely to get your offer accepted with seller contribution towards closing costs than in a fast selling market. Discuss the current market situation with your real estate agent and offer accordingly.

Down Payment and Closing Cost Assistance Grants

Another option to get assistance with closing costs and even get money for a down payment, you should look for a Down Payment and Closing Cost Assistance Grant. The availability of these grants vary based on the buyers income levels and location of the home to be purchased. These grants are house on top of money rollmainly intended to help low income buyers buy a home and help revitalize/stabilize neighborhoods affected by foreclosure and loan payment delinquencies. For more information on these grants and whether or not they apply to the home you are interested visit this FreddieMac link. There you will find descriptions of the various types of down payment and closing costs assistance programs that are available.  Ask your real estate agent or local housing authority for help in applying for any local grants available in your area.

Bottom Line

Hopefully in the discussion of the various line items fees and charges you will find on your closing statement you have a better understand of what closing costs consist of. By sitting down and discussing your home and borrowing goals with a few mortgage providers you will be able to get a better idea of what type of loan will work best for you and  also be able to better know what types of fees and costs you will have to pay for that loan.

Additional Resources

How To Reduce Your Closing Costs by Bankrate.com
What is an Escrow Holdback by Bill Gassett
The Different Meanings of Escrow by Teresa Cowart
Just Say No to Mortgage Junk Fees by realtor.com
Seller Paid Closing Cost Maximums – Conventional, FHA, VA, USDA by Tim Lucas

About the author: The above article “How To Avoid Closing Cost Sticker Shock” was provided by Paul Sian. Paul can be reached at paul.sian@herrealtors.com or by phone at 513-560-8002. With over 10+ years experience, if you’re thinking of selling or buying, I would love to share my marketing knowledge and expertise.

I service the following Greater Cincinnati, OH and Northern KY areas: Alexandria, Amberly, Amelia, Anderson Township, Cincinnati, Batavia, Blue Ash, Covington, Edgewood, Florence, Fort Mitchell, Fort Thomas, Hebron, Hyde Park, Indian Hill, Kenwood, Madeira, Mariemont, Milford, Montgomery, Mt. Washington, Newport, Newtown, Norwood, Taylor Mill, Terrace Park, Union Township, and Villa Hills.

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