Closing Costs Explained
While there is no doubt that buying a home is commonplace, it's also a complex financial transaction. As we explain some of the most common closing costs, it should be clear why it's an expensive process too.
HUD Settlement Statement at Closing
The good news is all of the costs are summarized in one place, and the form is standardized. The HUD Settlement Statement is the form used to outline all the costs both the buyer and seller are expected to pay at the closing. Homebuyers will be familiar with this form, and are likely to have encountered it at least twice before the closing date: once during a meeting with the mortgage lender, as well as during one of the pre-close meetings with an attorney.
In this article, we're going to run through an explanation of the higher cost items appearing on this form. Individuals that are interested in finding out how much they might spend will want to look at our article: Closing on a Home.
Closing Cost Breakdown
The settlement form is broken down into two categories: The Buyer's Transactions and the Seller's Transactions. Money and property is being exchanged between these two parties, so it only makes sense the closing cost documentation reflects that relationship.
The bottom line number is the cash paid to or from the borrower OR the cash paid to or from the seller. Over the remainder of this article, we're going to explain what goes into those calculations; later on, we'll provide an example that summarizes this information.
Total Settlement Charges
In order to figure out how much money is transferred from the borrower (the buyer) to the seller at closing, there is another worksheet that acts as backup to the closing cost breakdown, and it's called the Total Settlement Charges. This form is composed of approximately 50 or 60 line items, most of which are rarely used. The commonly used line items are explained below.
Items Paid in Connection with the Loan
This can include lock-in fees, credit report charges, application and commitment fees paid by the borrower to their mortgage company or lender. Before the date of the close, borrowers would have paid most of these fees as part of the process of obtaining a loan. So while it's good to understand exactly what was spent acquiring a loan, these are really prepaid items.If the mortgage requires points to be paid, this is where the charge for the prepayment of mortgage points would appear. This is usually one of the more expensive line items on this form.
Items Required by Lender to be Paid In Advance
Typically, the lender will require mortgage insurance, or PMI, if the borrower doesn't meet their down payment requirements; usually 10 to 20% of the home's value. Borrowers will be asked to pay interest expense from the day of the close until the day the first mortgage payment is due.
One of the ways to minimize closing costs is to schedule the date towards the end of the month. Some people believe this is the best day to close on a home. By doing so, it's possible to reduce the interest charges. On the other hand, closing at the end of the month means the first mortgage payment is due sooner.
Reserves Deposited with Lender
The biggest reserve line item with a lender is the city / county property taxes. Most lenders like to have at least three months of property taxes held in an escrow account. Depending on when these taxes are due, buyers can expect to place anywhere from three to five months of property taxes into this escrow account.
The two most common charges associated with the legal transfer of a home are attorney fees and Title insurance. The legal fees negotiated with the attorney should appear in this section, as will the cost of the Title insurance.
Government Recording and Transfer Charges
Most counties charge nominal fees to record changes to a deed or mortgage. It's likely the attorney paid these fees on the buyer's behalf when filing these legal documents. This money needs to be returned to the attorney.
Additional Settlement Charges
This is a catch-all category of expenses that includes survey fees and courier charges (FedEx, UPS, and USPS). Once again, the attorney is likely the party to have paid for these services as part of filing the legal paperwork and exchanging information with a variety of parties. This expense is repayment of money owed to the attorney for providing this service.
Finally, the sum of all the above will be equal to the Total Settlement Charges. When most people talk about closing costs, they are usually referring to this bottom line number.
Cash at Settlement
Earlier we mentioned the concept of cash at settlement. This is where the sales price of the home, deposits held by attorneys, mortgage, down payments and closing costs all come together, and the attorneys figure out who has to pay what amount.
Home buyers will pay the cash at settlement from the borrower. This is roughly equal to the down payment plus the total settlement charges, minus any deposit money previously provided to the attorney.
Example Summary Closing Statement
Illustrated below is an example of the major components of the borrower's section. In this example, Bill is buying a home for $300,000 and he's decided that he needs a mortgage for $200,000.
In the above example, the settlement charges were $5,000 and Bill has already given his attorney a deposit of $15,000 on the home. Effectively, $5,000 of the deposit is applied to his settlement costs. In this example, Bill would need to present a cashier's check for $90,000 at the time of closing to match the cash from borrower value.
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