Buying a new home is not an everyday event; it's one of those financial milestones that many of us look forward too. Unfortunately, we're not prepared for all of the jargon we encounter when closing on a home; and we usually only get one bit of insight from friends and relatives: closings are expensive.
What to Expect at Closing
We're going to try and separate fact from fiction, and hope to provide some insights as to exactly what to expect when closing on a home. We'll also explain what needs to be paid for during a closing, so it's clear why people think they're costly.
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An attorney will take care of most of the details, but chances are buyers will only meet with them for the first time at the closing itself. We're hoping to make that meeting a bit more comfortable for everyone involved in the process.
Mortgage Documents at Closing
Perhaps the single most important thing that is going to happen during a closing is the exchange of money that takes place. The financing company, or lender, and the attorney will have already exchanged information. All the paperwork will be ready to sign at the closing.
Buyers will be handed a large stack of papers, and their attorney will suggest (halfheartedly) they read every page. A record of the mortgage will be filed with the county clerk, so it's necessary to sign about four copies (one for the attorney, one for the buyer, one for the seller, and one for the county) of each document.
First Payment Letters
Buyers may be asked to sign a first payment letter. This letter spells out how much they'll be paying to their mortgage company, where to send the payment, and the date payment is due each month.
Mortgage Agreement with Lender
In addition to the mortgage papers filed with the county, an agreement needs to be signed with the lender. That agreement will spell out, in detail, the buyer's obligation to pay back the money they borrowed on time. That paperwork will include the total mortgage amount, the term of the mortgage, and penalties that apply to late payments.
Affidavit of Title and Title Insurance
Somewhere along the process, whether it's the mortgage company or attorney, someone is going to talk about title insurance. In order for a home to legally pass from one individual to another, the buyer needs to make sure the home is free from liens or encumbrances.
This form is broken down into two sections. The first section contains the amounts due from, and paid by, the borrower (the person buying the home). The second section is those amounts due to, or paid by, the seller of the home.
Buyers will oftentimes see a preliminary copy of this statement before closing on a home. That's because this document is used to calculate the total settlement costs due at the closing. If a buyer has the time to read one document carefully, it should be the HUD Uniform Settlement Statement. All of the fees referred to on this statement should look familiar to the buyer.
Errors and Omissions Agreement
Buyers will also be asked to sign an errors and omissions agreement. That agreement basically states that if the mortgage company happened to make a mistake on any of their documents, they have a right to correct those documents. For example, if the monthly mortgage payment was not calculated correctly, the lender has the right to fix that error later on.
Escrow Disclosure Statement
Escrow is a fancy name for an account that is held by others to pay for a financial obligation that one party has to another party. In this situation, the mortgage company holds several months' worth of property taxes in an escrow account.
When closing on a home, buyers will sign an escrow disclosure statement that affirms they understand this fund exists, and how much of their monthly mortgage payment will go towards this escrow account. This fund usually starts out with three to five months worth of property taxes.
Truth in Lending Disclosure Statement
The truth in lending disclosure statement is but another document that buyers need to sign at the closing, acknowledging they received a copy of this disclosure. The disclosure once again talks about the terms and conditions of the mortgage such as the annual percentage rate or APR, the total financing charges over the course of the loan, and the total amount financed.
We have an entire section dedicated to mortgage calculators that explains how to figure out many of these values.
Servicing Disclosure Statement
Oftentimes buyers find their mortgage through a broker. As such, that mortgage company may decide to immediately transfer the loan to another lender. This is referred to as servicing the loan.
If a lender frequently sells or services mortgages to another company, the buyer will have to sign a disclosure statement that explains this lender may assign, sell or transfer the servicing of the loan to another mortgage company. This really isn't something to worry about because the terms of the mortgage remain the same with the new company.
Tax and Insurance Sheet
The tax and insurance sheet will outline how much property taxes are owed each quarter, the name of the company providing title insurance, and the name of the company providing homeowners insurance.
Signature / Name Affidavit
Up to this point, the buyer has been signing their name on many different kinds of documents. As part of this process, buyers will likely be asked to sign a Signature / Name Affidavit. This document certifies the buyer's legal name and signature is, in fact, what they've been signing throughout this entire process.
Right to Cancel
After a buyer has gone through the process of signing all these documents, they now have the legal right to sign a document that states they wish to cancel the closing. Granted, they may be subject to several steep financial penalties for canceling so late in the process. But even when closing on a home, a buyer still has a right to back out of the deal at the very last minute.
Other Documents Produced at Closing
At the closing, buyers will also receive many of the documents they've signed as part of the financing agreement and other pre-closing work. Examples of these documents include:
Mortgage Lock in Agreements: signed if a buyer decides to lock in their loan at a certain percentage rate.
Property Surveys: from companies that have completed a survey of the property.
Deeds: the official transfer of property documents.
Request for Copies of Tax Forms: lenders may want to obtain proof of household income from the buyer's federal income tax returns.
Occupancy Statement: tells the mortgage company how the buyer intends to use the home (most often by occupying the house)
Estimated Closing Costs
We have a follow-up article to this one, dedicated to closing costs. But as promised at the beginning of this article, we're going to provide some information in terms of the expected range of these costs:
Interest Expense ($200 - $1,000): owed on the money borrowed until the first mortgage payment is due. This fee depends on interest rates, the amount of money borrowed, and the day of the closing. Closing late in the month reduces this fee, but the first mortgage payment will be due sooner.
Homeowners Insurance ($500 - $1,200): before anyone is going to lend money, they usually demand that their property be insured.
Escrow Account / Property Taxes ($1,000 - $3,000): a lender will usually require three or four months of property taxes held in an escrow account.
Title Insurance ($400 - $1,000): money paid to make sure the home is owned free and clear of encumbrances.
Recording Fees ($100 - $300): standard fees charged by the county to record the mortgage.
Attorney Fees ($300 - $1,000): money paid to the attorney for all their work.
Postage / Copies ($40 - $100): fees for sending packages back and forth between the buyer, the attorney, and lender.
Mortgage Points ($0 - $3,000): one point is equal to 1.0% of the total mortgage amount.
In this example, it's easy to see the closing cost can run anywhere from $2,500 to $9,000. However, three of the most expensive items are prepaid costs a buyer would naturally incur as a homeowner: insurance, points (prepayment of interest), and property taxes.
In fact, the escrow money is really an asset owned by the buyer. When they eventually pay off the mortgage, a large share of that money is returned to the buyer. So all-in-all, a closing is not as expensive as it might seem, because the majority of the money is used to prepay several future expenses.
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