One of the most mysterious parts of the home buying and refinancing process are mortgage closing costs. Most consumers interested in applying for mortgage financing are aware they exist, but most are unfamiliar with how much they are, and where they come from.
In this guide, we’re going to answer the question, what are mortgage closing costs? But we’re going to go beyond closing costs themselves, and also include mortgage escrows. Those are allowances for taxes and insurance that must be paid at closing. For that reason, they can seem indistinguishable from closing costs – in no small part because they’ll have much the same effect on the transaction.
What are Mortgage Closing Costs?
Mortgage closing costs are any costs incurred in connection with obtaining a mortgage. The lender provides the loan, but since mortgages are ultimately a type of investment security that will be sold to third parties, there are numerous transaction fees involved in the process.
In addition, a mortgage is also a legal transaction that requires the filing of documents with the appropriate state, county, and local authorities. That process adds an additional layer of fees.
Typical closing costs you can expect to incur are listed below. However, this list is not comprehensive. There may be certain closing costs unique to individual states or markets that are not included on this list. As well, some of the costs listed below may not be charged in your local area.
Mortgage points are a percentage of the loan amount paid upfront. There are three types of mortgage points. Each point is equal to 1% of the loan amount. They come in two flavors: origination fees and discount points.
Origination fees are the lender’s compensation for arranging the mortgage. The fee is typically 1%, but it can be eliminated by accepting a slightly higher interest rate. For example, by agreeing to a rate increase of 1/8% (0.125), the lender may waive the origination fee.
Discount points are what you will pay if you want to lower the interest rate on your mortgage. For example, if you want to lower your interest rate from 3% to 2.75%, the lender might charge 1.5% in discount points to make that happen.
This type of strategy is only recommended if you plan on being in the home for many years and will have a chance to recover the cost of the discount points through the lower rate and monthly payment.
A similar fee is what’s known as a rate lock fee. Many lenders will allow you to lock your loan rate at application free of charge if the lock term is no more than 30 days. But if you want a longer lock, like 45 days or longer, they may charge you a rate lock fee, which is also expressed as points.
For example, the lender may charge you 0.50% of the loan amount to lock your rate for 60 or 90 days. But generally speaking, that fee will be applied to the origination fee, rather than being an additional closing cost.
However, if you fail to close on the loan you may forfeit the rate lock fee. This is because the lender will have incurred a fee to reserve that rate for the time specified.
Upfront Mortgage Insurance Premiums
Both FHA and VA loans charge an upfront mortgage insurance premium (FHA loans also have a monthly premium). Conventional and jumbo mortgages have only monthly mortgage insurance premiums, that only apply if your down payment or the equity in your home is less than 20%.
On FHA loans, the upfront mortgage insurance premium is typically 1.75% of the loan amount. On a $200,000 mortgage, this will be the equivalent of $3,500.
The upfront mortgage insurance premium on VA loans is known as the VA funding fee. It is currently set at 2.3% of the loan amount for most borrowers, which means you’ll pay $4,600 on a $200,000 loan.
In the case of either an FHA or VA loan, the upfront mortgage insurance premium is not generally paid out-of-pocket by the borrower. More commonly, it’s added to the loan amount and financed over the life of the loan. But in some cases, the property seller may pay the upfront mortgage insurance premium as an inducement for the borrower to purchase his or her property.
Most mortgage lenders will charge an application fee due at the time of application, not closing. However, in most cases, the application fee covers the appraisal and credit report fees. You can generally expect this to be in the range of $300 – $500.
When a mortgage lender originates a loan, they must use the services of an independent, third-party appraiser to determine an objective value of the subject property. The lender will collect the fee for this service, but it will be paid to the appraiser, and not retained by the lender.
An appraisal fee will typically run between $300 and $500, though it can be more in some markets and for specialized properties.
Credit Report Fee
To process your application, the mortgage lender will need to run a credit report. Since the reports are provided by an outside source, the lender will incur a fee for the service. That will generally be between $15 and $30. It will either be included in your application fee or paid at the closing.
Attorney or Title Agent Fee
Closings generally take place in the office of either an attorney or a title agent. This is due to the requirement for preparing and filing legal documents connected with the loan.
In some states, closings routinely take place in the office of a title agent. In others, it’s handled in an attorney’s office.
Generally speaking, title agents charge lower fees for closings. They may charge between $200 and $500, while attorneys may charge between $500 and $1,000.
In order for a new mortgage to have a clear title, a search must be performed to determine if there are any outstanding liens against the property. These can be liens filed against the property owner (and the property) by contractors who performed services on the home but were not paid.
Sometimes the liens are so old they are forgotten by the current property owner. Title searches are used to uncover these liens, and to make sure they’re paid before you close on the loan. The fee for this service will generally run between $200 and $400.
No matter how thorough a title search is, it’s always possible one or more liens could go undiscovered. To protect against the possibility, mortgage lenders require having a title insurance policy in place with each loan. The purpose of a policy is to protect the property against unexpected liability from undetected liens.
This policy costs several hundred dollars, which is based on the loan amount and the state where the property is located. The lender is named as the beneficiary in the policy. It’s designed to protect the lender’s first lien position on the home.
Since the lender will be concerned with protecting the structural integrity of the property – which is their collateral – they’ll require a pest inspection to be performed by a certified expert. The cost can range between $50 and $100 but may be more in some locations.
Similar to a pest inspection, the mortgage lender will want to know if the property is in an area designated as a federally recognized flood zone. If it is, the borrower will be required to obtain flood insurance. The cost of the certification is generally in the $20 and $30 range.
A home inspection can be performed at the option of the buyer. It is not generally a lender requirement, unless the appraiser identifies issues with the home that necessitate a closer inspection.
But even if the lender doesn’t require it, it’s in the buyer’s best interest to obtain one. Any major repairs that are not discovered before the closing will need to be made by the buyer. The home inspection offers buyers an opportunity to have those repairs completed by the seller before closing.
The cost of a home inspection can range between $200 and $500, depending on the property.
This fee will only be required by the lender if exact property lines are either unknown or in dispute. It may also be required if there are any encroachments, like the physical structure from a neighbor’s property extending into the subject property. Depending on the size of the property, a survey can cost anywhere from $300 to $1,000 or more.
Real estate tax search
This is similar to a title search, except it’s specifically used to determine hidden tax liens. If there are any, they can be paid by the seller prior to closing. The cost of the service is between $50 and $100.
Some states, counties, and municipalities impose transfer taxes on both real estate and mortgages. They’ll establish a tax rate based on the loan amount or the property value.
For example, if the mortgage tax is $.25 per $1,000 of value, and the loan is $400,000, the tax will be $100.
If the real estate transfer tax is $.50 per thousand dollars of value, and the sale price is $500,000, the transfer tax will be $2,500.
In many markets, the mortgage tax will be paid by the buyer, while real estate transfer tax will be paid by the property seller.
In addition to the primary fees listed above, there are minor fees that are incurred during the mortgage process.
An example is recording fees. These are the fees that must be paid to the local municipality or county for legally recording the property deed and mortgage. Expect to pay between $50 and $100.
Courier fees are another example. If the attorney or title company needs to have packages courier to and from third parties, those fees will generally be paid by the borrower at closing.
What is an Escrow Account?
There are other costs associated with a mortgage that will be paid by the borrower, but aren’t considered closing costs. Those are the costs required to establish an escrow account for the loan.
An escrow account encompasses what is often referred to in the mortgage industry as prepaid expenses. They’re expenses related primarily to monthly payments for interest, property taxes and insurance. Some of these expenses must be paid in advance, while others require holding a certain amount in escrow in preparation for future payments.
The main examples of escrows are the following:
Mortgage interest is collected in arrears. That means you’ll pay last month’s interest with this month’s payment.
Prepaid interest is the exception. It represents the interest that is due between the day the loan closes and the end of the month in which the closing takes place. For example, if your loan closes on the 21st of June, the lender will collect interest for the balance of the month or nine days’ worth.
Since it’s an odd amount, rather than a full month’s interest, it will be collected at closing. This is a common reason why mortgage borrowers often want to close on the last business day of the month when prepaid interest will be needed for no more than a day or two.
Real Estate Taxes
Real estate taxes are collected through your monthly payment. However, most counties and municipalities require lenders to pay taxes quarterly or annually.
If taxes are due on a quarterly basis, the lender will collect enough to cover three months, so they’ll be able to make the payment on a timely basis. Unlike mortgage interest, property taxes must be paid in advance. Since a new loan won’t have an accumulated escrow balance to pay the taxes, the lender will collect the required amount at closing.
Exactly how much will be collected will depend on the amount of property taxes, the number of months required with each periodic payment, and the next due date for the tax bill.
Like property taxes, homeowner’s insurance must be paid in advance.
Lenders typically require borrowers to provide a paid-up homeowner’s insurance policy for one year prior to closing. They may also collect one month’s worth of the premium, so they’ll have at least enough to cover the renewal of the policy one year later.
If your homeowner’s insurance premium will be $100 per month, the lender will escrow $1,300. This will be $1,200 for the annual cost of a policy, plus an additional month at $100. However, if you pay the full year on the initial premium directly to the insurance company, the lender will only escrow for one month.
Mortgage Insurance – Monthly Premiums
FHA mortgages and (sometimes) conventional and jumbo loans require monthly premium payments on mortgage insurance. If so, the lender will typically collect two or three months’ premiums in advance to ensure sufficient funds will be available to pay the premium even if you were to miss a monthly house payment.
How Closing Costs Affect the True Cost of Purchasing a Home
The total of closing costs and escrows can represent between 2% and 6% of the new loan amount. On a $400,000 loan, expect to pay between $4,000 and $24,000.
The wide range owes to large differences in property values, as well as geographic location. For example, closing costs and escrows will be much higher on an $800,000 property than they will be on a $300,000 home. As well, closing costs are generally higher in high-cost areas of the country.
Whatever the total closing costs and escrows will be, they can have a material effect on the true cost of purchasing a home.
If the purchase price of the house is $400,000, and closing costs and escrows are $12,000, the total cost of acquiring the home will be $412,000.
Where to Find a Mortgage
Quicken Loans and Rocket Mortgage are two sides to the same organization. Rocket Mortgage is the online interface of Quicken Loans. While Quicken Loans is the largest retail mortgage lender in America, Rocket Mortgage is the better known of the two, if only because it’s so widely advertised. But it’s impossible to discuss one without the other.
As an online mortgage lender, Rocket Mortgage offers speed and simplicity. You can complete the entire application process online – including uploading supporting documents – without leaving your home or office. They offer both pre-approvals and full approvals. FHA and VA loans are provided, in addition to conventional and jumbo mortgages.
Credible is an online lending marketplace, offering loan products from multiple lenders. That includes mortgages, in addition to student loans, personal loans, and credit cards. By completing a single, simple online loan application, you can get loan quotes from several companies.
You can then choose the lender that offers the best rate and terms for your purchase or refinance. It will give you an opportunity to shop between various lenders, without the need for completing multiple applications.
Escrow charges, while frequently confused with closing costs, are an entirely separate category. They represent advanced payments for ongoing expenses of owning the home. These include escrows for property taxes, homeowner's insurance, and mortgage insurance.
The second method is what's known as lender-paid closing costs, which are sometimes referred to as lender credits. To reduce or eliminate closing costs, the lender will cover those costs in exchange for a higher interest rate.
For example, the lender may increase the interest rate from 3% to 3.5% in exchange for covering closing costs and escrows equal to 3% of the loan amount.