Of all the steps in buying
a home or refinancing a loan, the mortgage closing or
settlement probably causes more confusion and
uncertainty for the borrower than any other.
A settlement may involve several people, and a variety of
documents and fees. Once you understand what is involved, you may
find the entire closing process far simpler than you might have
imagined. While this brochure focuses on settlements in home
purchases, much of the information also will be useful
if you are refinancing a mortgage.
Let's start with two
important facts.
Fact Number 1: Many buyers may think of settlement
as the last step to becoming the legal owners of their new home. But
it's a process that begins weeks or even months before, and follows
an outline set largely by a buyer's original offer to the seller of
the house. That offer becomes the sales contract, once it's
signed by the seller, and it covers many of the key
elements of the settlement or closing.
Fact Number 2: Practices differ from one locality
to another regarding who pays what closing costs. Across the
country, however, buyers and sellers are free to negotiate certain
fees. In some cases, certain costs can be shifted, it may affect the
sale price of the property. In most states, costs can also be cut by
shopping around among providers of the settlement services.
The point is this: The more you know about the
process, the better your chances are for saving money at
settlement time.
Types of Closing Costs
There are three basic categories of charges and fees in
settlement or closing transactions:
- Charges for establishing and transferring
ownership.
These include title search, title insurance,
related legal fees, and fees for conducting the
settlement.
- Amounts paid to state and local governments.
These include city, county and state transfer taxes,
recordation fees, and prepaid property taxes.
- Costs of getting a mortgage.
These include survey, appraisals, credit checks,
loan documentation fees, notary charges, loan
origination, commitment and processing fees, hazard
insurance, interest pre-payments, and lender's
inspection fees.
Let's examine them one by one.
Title Search: Who Owns What?
When someone buys or sells a car, proving ownership is
relatively easy. The owner has a certificate of title issued by the
state in which the car is registered. When it comes to houses,
providing clear title is not so simple. Moreover, your lending
institution will not give you a mortgage loan on a house unless you
can prove that the seller owns it. The proof comes in the
title search.
How the title search is carried out depends upon where the
property is located. In many parts of the country, public records
affecting real estate title are spread among several local
government offices, including recorders of deeds, county courts, tax
assessors, and surveyors. Records of deaths, divorces, court
judgments, liens, and contests over wills (all of which
can affect ownership rights) also must be examined.
In a few localities, property records are fully
computerized and the job can be completed fairly quickly. In the
majority of localities, however, title search must be performed to
establish the seller's clear title. This means examining
public records, in courthouses and elsewhere, to assure
both you and your lender that there are no claims
against the property that you are buying.
The title search may be carried out by an escrow or title
company, a lawyer, or other specialist.
Title Insurance
In addition to a formal title search, your lender is
likely to require a title insurance policy. The policy guards the
lender against an error by whomever searched the title. (In some
cases, the title insurer might arrange for or conduct the title
search.) Let's say, for example, that a long-lost relative of the
seller turns up with indisputable evidence that the relative - and
not the seller - holds legal title to the property. Though it should
have been found in the public records, the relative's claim was
missed somehow. Errors are rare, but they do occur.
When this happens, the lending institution finds that it
has loaned the home buyer thousands of dollars to buy a house from
someone who did not own it. To avoid such problems, the lender will
insist on title insurance prior to settlement. The cost of the
policy ( a one-time premium ) is usually based on the loan amount,
and is often paid by the purchaser. There's nothing, however,
to keep you from asking the seller, during your
negotiations, to pay part or all of the premium.
The title insurance required by the lender protects only
the lender. To protect yourself against unforeseen title problems,
you may also want to take out an owner's title insurance policy.
Normally the additional premium cost is only a fraction
of the lender's policy, but this can vary from area to
area.
Some final advice on keeping title insurance costs low: if
the house you are buying was owned by the seller for only a few
years, check with a title company. If you can obtain a re- issue
rate, the premium is likely to be significantly lower than the
regular charge for a new policy. If no claims have been made
against the title since the previous title search was
done, the seller's insurer may consider the property to
be a lower insurance risk.
Finally, shop around. Not just for the premium (which can
vary depending on how much competition there is in a market area),
but for coverage as well . Generally, you should look for a policy
with as few exclusions from coverage as possible. The exclusions are
listed in each policy. Some policies have so many exclusions - that
is, situations under which the insurer will not pay for your title
problems - that you end up with little coverage for your premium
dollar.
Government Imposed Costs
In some parts of the
country, the transfer, recordation, and property taxes
collected by local and state governments may be among
the heftiest charges paid at settlement.
While there is no way to avoid paying these taxes, you may
be able to lessen your share of the bill. Try shifting some or all
of the cost to the house. But remember, you must do this when you
make your offer to purchase the property.
Mortgage-Related Closing Costs
The costs of getting a mortgage may be imposed by your
lender as early as when you apply for your loan. Mortgage-related
closing costs include:
- Application Fee.
Imposed by your lender, this charge covers the
initial costs of processing your loan request and
checking your credit report.
- Appraisal Fee.
This fee pays for an independent appraisal of the home you want
to purchase. The lender requires this opinion or estimate
of the market value of the house for the loan.
- Survey.
At a minimum, the lender will require an independent
verification from a surveying firm that your lot has not been
encroached upon by any structures since the last survey
conducted on the property. Alternatively, the lender may
insist upon a complete (and more costly) survey to
ensure that the house and other structures legally
are where you and the seller say they are.
- Loan Origination Fees and Discount Points.
The origination fee is charged for the lender's work in
evaluating and preparing your mortgage loan. Discount points are
prepaid finance charges imposed by the lender at closing to
increase the yield to the lender beyond the stated interest rate
on the mortgage note. One point equals one percent of the loan
amount. For example, one point on a $75,000 loan would be $750.
In some cases - especially with refinances - the
points can be financed by adding them to the loan
amount.
- Mortgage Insurance.
Buyers who make down payments less than 20 percent (and in some
cases 30 percent) of the value of the house may be required by
lenders, and by law in some states, to take out mortgage
insurance. The policy covers the lender's risk in the event the
buyer fails to make the loan payments. Premiums are typically
paid annually from an escrow or reserve account, or in a lump
sum at closing. A buyer, whose mortgage is insured by FHA
or guaranteed by VA, will have to pay FHA mortgage
insurance premiums or VA guarantee fees.
- Homeowner's & Hazard Insurance.
A form or protection against physical damage to the house by
fire, wind, vandalism, and other causes. Your lender will
expect you to have a policy in effect at closing.
Miscellaneous Closing Costs
Depending upon the location and type of property, and
extra services you or your lender request, you may also have to pay
some of the following at closing:
- An assumption fee is charged when you are taking over
or assuming an existing mortgage on the house. The size of
the fee will depend on the lender, but it may range
from several hundred dollars to 1 percent of the
loan amount.
- Home inspection fees
for an analysis of the structural condition of the
property by an engineer or consultant, and for
termite inspections.
- Adjustments for various types of expenses prorated
between the seller and the purchaser. Some of the adjustments
may involve large amounts. Local property taxes, annual
condominium fees and other lump-sum service charges,
for instance, may be split between you and the
seller to cover your respective periods of ownership
for the calendar year or tax period.
Settlements are conducted by lending institutions, title
insurance companies, escrow companies, real estate brokers, or
attorneys. In most cases, whoever conducts the settlement is
providing a service to the lender. You may be required to pay for
related legal services provided to the lender. You can also retain
you own attorney to represent you at all stages of the transaction
including settlement.
How Can You Anticipate How Much You Will Have To Pay In
Closing Costs?
With such a long list of potential charges at settlement,
it is important to know what to expect. To enable you to do that,
Congress passed the Real Estate Settlement Procedures Act (RESPA). Your mortgage lender is required to supply you with a
Good Faith Estimate of all your closing costs within three
business days of your application for a loan, together with a
special information booklet called Settlement Costs - A HUD
Guide. In addition, a statement of your actual costs should be
given to you at or before settlement. Within the same three days,
the lender is required, under the Truth in Lending Act, to
provide you with a disclosure estimating the costs of the loan you
have applied for, including your total finance charge and the Annual Percentage Rate (APR). The APR expresses the cost of your
loan as a yearly rate. This rate is likely to be higher than the
stated interest rate on your mortgage because it takes into account
discount points, mortgage insurance, and certain other fees that add
to the cost of your loan.
What Charges Are You Likely To Encounter For Different
Services?
Because customs vary significantly from area to area, it
is difficult to provide estimates for closing costs that fit
everywhere. One rule of thumb for buyers is to figure that at least
an additional 3 percent will be added to the price of your home
through settlement expenses. In some relatively high-tax areas
of the country, 5 to 6 percent is more common.
Remember the key rules:
- think about settlement fees before you submit your
sales offer;
- shop around for competitive prices for as many
services as possible; and
- never hesitate to
negotiate.
This page has been prepared to help you make the important
decisions involved in buying and financing your home. Because real
estate settlement practices vary depending in state law and local
custom, the information contained in this brochure should not be
viewed as a replacement for professional advice. Talk with mortgage
lenders, real estate agents, attorneys, and other advisors for
information about lending practices, mortgage instruments, and your
own interests before you commit to a specific loan.
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