Mortgage
settlement--sometimes called mortgage closing--can be confusing. A
settlement may involve several people and many documents and fees. This
information will help you understand all that is involved. Although the
focus of this guide is on settlements for home purchases, much of it
will also be useful if you are refinancing a mortgage.
Settlement costs can be
high, so it pays to shop around and negotiate with the seller, your
lender, and your attorney or settlement agent. The less you have to pay
in settlement costs, the more funds you will have for other things.
Different regions have
different customs and practices regarding who pays for what at
settlement. Buyers and sellers are free to negotiate certain fees. In
slow-moving real estate markets, the seller may agree to pay points or
fees for the buyer. In fast-moving markets, the buyer may have to agree
to pay more costs to close the deal. Whatever you negotiate will become
the sales contract. However, be careful; if some buyer’s costs are
shifted to the seller, it may increase the price you pay for the
property.
You can reduce some
settlement costs by shopping around for the services. The point is
this: the more you know about the process, the better your chances are
for saving money at settlement time.
Because practices vary
significantly from area to area, it is difficult to provide estimates
for settlement costs that fit everywhere. However, one rule of thumb
for buyers is to figure that settlement costs will be about 3% of the
price of your home. In some relatively high-tax areas of the country,
5% to 6% is more common.
Some settlement costs, such
as homeowner’s insurance, private mortgage insurance, or points can be
more expensive if your credit rating is low. Knowing your credit score
can help you understand how lenders will evaluate your applications.
Beginning December 2004 your lender is required to give you a copy of
your credit score.
Mortgage- and Lender-Related Settlement Costs
Most people associate
settlement costs with mortgage loan charges. These fees and charges
vary, so it pays to shop around for the best combination of mortgage
terms and settlement costs. Mortgage-related costs that may apply to
your loan include the following items.
Application fee
Imposed by your lender or
broker, this charge covers the initial costs of processing your loan
request and checking your credit report.
Estimated cost: $75 to $300, including the cost of the credit report for each applicant
Loan origination fee
The origination fee (also
called underwriting fee, administrative fee, or processing fee) is
charged for the lender’s work in evaluating and preparing your mortgage
loan. This fee can cover the lender’s attorney’s fees, document
preparation costs, notary fees, and so forth.
Estimated cost: 1% to 1.5% of the loan amount
Points
Points are a one-time
charge imposed by the lender, usually to reduce the interest rate of
your loan. One point equals 1% of the loan amount. For example, 1 point
on a $100,000 loan would be $1,000. In some cases--especially in
refinancing--the points can be financed by adding them to the amount
that you borrow. However, if you pay the points at settlement, they are
deductible on your income taxes in the year they are paid (different
deduction rules apply when you refinance or purchase a second home). In
your purchase offer, you may want to negotiate with the seller to have
the seller pay your points.
Estimated cost: 0% to 3% of the loan amount
Appraisal fee
Lenders want to be sure
that the property is worth at least as much as the loan amount. This
fee pays for an appraisal of the home you want to purchase or
refinance. Some lenders and brokers include the appraisal fee as part
of the application fee; you can ask the lender for a copy of your
appraisal. If you are refinancing and you have had a recent appraisal,
some lenders may waive the requirement for a new appraisal.
Estimated cost: $300 to $700
Lender-required home inspection fees
The lender may require a
termite inspection and an analysis of the structural condition of the
property by an engineer or consultant. In rural areas, lenders may
require a septic system test and a water test to make sure the well and
water system will maintain an adequate supply of water for the house
(this is usually a test for quantity, not for water quality; your
county health department may require a water quality test as well, but
this test may be paid for outside of the settlement). Keep in mind that
this inspection is for the benefit of the lender; you may want to
request your own inspection to make sure the property is in good
condition.
Estimated costs: $175 to $350
Prepaid interest
Your first regular mortgage
payment is usually due about 6 to 8 weeks after you settle (for
example, if you settle in August, your first regular payment will be
due on October 1; the October payment covers the cost of borrowing the
money for the month of September). Interest costs, however, start as
soon as you settle. The lender will calculate how much interest you owe
for the part of the month in which you settle (for example, if you
settle on August 16, you would owe interest for 15 days--August 16
through 31).
Estimated cost: Depends on
loan amount, interest rate, and the number of days that must be paid
for (a $120,000 loan at 6% for 15 days, about $300; a $142,500 loan at
6% for 15 days, about $356).
Private mortgage insurance (Private MI)
If your down payment is
less than 20% of the value of the house, the lender will usually
require mortgage insurance. The insurance policy covers the lender’s
risk in the event that you do not make the loan payments. Typically,
you will pay a monthly premium along with each month’s mortgage
payment. Your private MI can be canceled at your request, in writing,
when your reach 20% equity in your home, based on your original
purchase price, if your mortgage payments are current and you have a
good payment history. By federal law your private MI payments will
automatically stop when you acquire 22% equity in your home, based on
the original appraised value of the house, as long as your mortgage
payments are current.
Estimated cost: 0.5% to 1.5% of the loan amount to pre-pay for the first year
Some lenders will pay for
private MI--called lender’s private mortgage insurance (LPMI)--and in
turn will charge a higher interest rate. Unlike private MI that you
pay, there is no automatic cancellation once you acquire 22% equity. To
eliminate the LPMI, you must refinance the loan, which in turn means
carefully considering market interest rates and settlement costs at the
time to see if refinancing would be an advantage, rather than keeping
your current mortgage.
FHA, VA, or RHS fees
The Federal Housing
Administration (FHA) offers insured mortgages and the Veterans
Administration (VA) and the Rural Housing Service (RHS) offer mortgage
guarantees. If you are getting a mortgage insured by the FHA or
guaranteed by the VA or the RHS, you will have to pay FHA mortgage
insurance premiums or VA or RHS guarantee fees. As with Private MI,
insurance premium payments will stop when you acquire 22% equity in
your home. FHA fees are about 1.5% of the loan amount. VA guarantee
fees range from 1.25% to 2% of the loan amount, depending on the size
of your down payment (the higher your down payment, the lower the fee
percentage). RHS fees are 1.75% of the loan amount.
Homeowner’s insurance
Your lender will require that you have a homeowner’s insurance policy
(sometimes called hazard insurance) in effect at settlement. The policy
protects against physical damage to the house by fire, wind, vandalism,
and other causes. This insures that the lender’s investment will be
secured even if the house is destroyed. If you are buying a
condominium, the hazard insurance may be part of your monthly
condominium fee; you may still want homeowner’s insurance for your
furnishings and valuables.
Estimated cost: $300 to
$1,000 (depending on the value of the home and the amount of coverage;
you can estimate the cost to be about $3.50 per $1,000 of the purchase
price of the home).
Flood determination fee
If your home is in a flood
hazard area where federally subsidized flood insurance is available,
lenders cannot make a mortgage loan for your home unless you buy flood
insurance. Your lender may charge a fee to find out whether the home is
in a flood hazard area.
Estimated cost: $15 to $50
(this is not the cost for the flood insurance; flood insurance, if
required, would be in addition to your homeowners insurance and may
cost from $350 to $2,800 depending on location and property value)
Escrow (or reserve) funds
Some lenders require that
you set aside money in an escrow (reserve) account to pay for property
taxes, homeowner’s insurance, and flood insurance (if you need it).
Lenders use escrow funds to ensure that these items are paid on time to
protect their interest in your home. With an escrow account, money is
held by the lender or the lender’s agent, who then pays the taxes and
insurance bills when they are due. At settlement, you may need to
provide some payment into this account, depending on when payments will
be due. For example, if you are buying your home in August and property
taxes are due the following January, you will need to deposit funds
into your escrow account at settlement so that you have enough to pay
the taxes when they become due in January.
Survey costs: Lenders
require a survey to confirm the location of buildings and improvements
on the land. Some lenders require a complete (and more costly) survey
to ensure that the house and other structures are legally where you and
the seller say they are. Estimated cost: $150 to $400
Other miscellaneous settlement costs:
Depending upon the location and type of property, and the extra
services you or your lender request, you may also have to pay some of
the following fees at settlement:
Assumption fee: If
you are assuming (or taking over) an existing mortgage, the lender may
charge a fee. Estimated cost: Depends on the lender, but will range
from several hundred dollars to 1% of the amount of the loan you are
assuming Expenses prorated between the seller and the buyer. In your
purchase contract, you may agree to split some costs with the seller.
In addition to prorated property taxes, some of these expenses may
involve large amounts. For example, annual condominium fees,
homeowners’ association fees, water bills, and other lump-sum service
charges may be split between you and the seller to cover your
respective periods of ownership for the calendar year or tax period.
Inspections: As
a buyer, if you make your purchase offer contingent on the results of a
home inspection--such as testing for structural damage, water quality,
and radon gas emissions--you will have to pay for these inspections.
Escrow Account Fees:
In the purchase contract, you can request that the seller set up an
escrow account to cover any costs for repairs, radon mitigation, house
painting, or other items. For example, if you have not had a chance to
test all the appliances (for instance, if you buy in the summer, you
may not test the furnace), you may request an escrow account to cover
repairs if they are needed in the future. The seller may agree to split
the costs with you, in which case you would need these funds at
settlement.
Fees paid to find a lender: As
a buyer, you may work with a mortgage broker or other third party to
find a mortgage loan. For example, you may want to work with a broker
to find a loan with nonstandard terms or conditions. Brokers arrange
transactions rather than lending money directly; in other words, they
find a lender for you. Brokers will generally contact several lenders
regarding your application, but they are not obligated to find the best
deal for you unless they have contracted with you to act as your agent.
Estimated cost: Depends on agreement with the broker; can range from no
fee to a percentage of the loan amount
Charges for Establishing and Transferring Ownership
Title search
The goal of a title search
is to assure you and your lender that the seller is the legal owner of
the property and that there are no outstanding claims or liens against
the property that you are buying. The title search may be performed by
a lawyer, an escrow or Title Company, or other specialist.
Public real estate records
can be spread among several local government offices, including
surveyors, county courts, tax assessors, and recorders of deeds. Liens,
records of deaths, divorces, court judgments, and contests over
wills--all of which can affect ownership rights--must also be examined.
If real estate records are
computerized, the title search can be completed fairly quickly. In some
cases, however, the title search may involve visiting courthouses and
examining other public records and files, which is more time-consuming.
Title insurance
Most lenders require a
title insurance policy. This policy insures the lender against an error
in the results of the title search. If a problem arises, the insurance
covers the lender’s investment in your mortgage.
The cost of the policy (a
one-time premium) is usually based on the loan amount and is often paid
by the buyer. However, you may negotiate with the seller to pay all or
part of the premium.
The title insurance
required by the lender protects only the lender. To protect yourself
against title problems, you may want to buy an “owner’s” title
insurance policy. Normally the additional premium cost is based on the
cost of the lender’s policy, but this premium can vary from area to
area.
Some 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 the seller’s title company. You
may be able to get a “re-issue rate,” because the time between title
searches was short. As well, if you are refinancing, you may be able to
get a “re-issue rate” on your title insurance. The premium is likely to
be lower than the regular rate for a new policy. If no claims have been
made against the title since the previous title search was done, the
insurer may consider the property to be a lower insurance risk.
Usually you will have to
buy title insurance from a company acceptable to your lender. However,
you can still shop around for the best premium rates (which can vary
depending on how much competition there is in a market area). If you
decide to buy an “owner’s title policy,” look for one with as few
exclusions from coverage as possible. Exclusions are listed in each
policy, and if a policy has many exclusions--that is, situations under
which the insurer will not pay for your title problems--you may end up
with little coverage. The estimated cost of title services and title
insurance varies by state. For example, a lender’s policy on a $100,000
loan can range from $175 in one state to $900 in another. In some
states, the price can even vary by county.
Settlement companies and others conducting the settlement
Settlements are conducted
by title insurance companies, real estate brokers, lending
institutions, escrow companies, or attorneys. In most cases, the
settlement agent is providing a service to the lender, and you may be
required to pay for these services. You can also hire your own attorney
to represent you at all stages of the transaction, including
settlement.
You may be involved in some
of the closing activities and not in others, depending on local
practices and on the professionals with whom you are working. In some
regions, all the people involved in the sale--the buyer; the seller;
the lender; the real estate agents; attorneys for the buyer, seller,
and lender; and representatives from the title firm--may meet to sign
forms and transfer funds. In other regions, settlement is handled by a
title or escrow firm that collects all the funding, paperwork, and
signatures and makes the necessary disbursements. The firm delivers the
check to the seller and the house keys to you.
Costs for settlement
services vary widely, depending on the professional services involved.
Regardless of the way settlement is handled in your region, shop around
and ask for information on all services provided and all fees charged.
Amounts Paid to State and Local Governments
In some parts of the
country transfer and recording fees are low. In other parts of the
country costs of transfer fees, recording fees, and property taxes
collected by local and state governments may be as much as 1.25% of the
loan amount. Some of these fees, such as the recording fee and transfer
fee, are one-time fees. Although there is no way to avoid paying these
fees and taxes, you may be able to negotiate with the seller to pay
some of these costs. But remember, you must include these terms as part
of the purchase offer for the property.
Amounts for property taxes
may go into an escrow account. The amount you will need depends on when
property taxes are due and the timing of the settlement. The lender
should be able to give you an approximation of these costs at the time
you apply for the mortgage.
“All-in-One” Pricing of Settlement Costs
Some lenders have bundled most of their settlement costs into a single price.
Generally, they combine the following fees:
application
lender’s attorney
flood certification
title search and title insurance
recording and fees for other tax services
origination
underwriting and processing
points
pest inspection
appraisal
This all-in-one price, however, does not include all of the fees needed at settlement.
You will also need funds for the following:
Prepaid interest (based on the day of the month you settle)
Mortgage and transfer taxes (determined by your state or local taxing agency)
Private mortgage insurance (if needed)
Homeowners (hazard) insurance
Flood insurance (if needed)
Reserve (or escrow) funds for property taxes and homeowners insurance.
Estimates of Settlement Costs
At various points in your
loan application process, you are entitled to get estimates of the
costs and fees associated with getting a mortgage and going through
settlement.
The “good faith estimate”
With such a long list of
potential charges at settlement, it is important to know what to
expect. The Real Estate Settlement Procedures Act (RESPA) requires your
mortgage lender to give you a “good faith estimate” of all your closing
costs within 3 business days of submitting your application for a loan,
whether you are purchasing or refinancing the home. This is a good
faith estimate, but the actual expenses at closing may be somewhat
different. If you are purchasing the home, you will also get an
information booklet, Buying Your Home: Settlement Costs and Helpful
Information.
Truth in lending information
For home purchases, the
lender is required, under the Truth in Lending Act, to provide a
statement containing “good faith estimates” of the costs of the loan
within 3 business days of submitting your application. This estimate
will include your total finance charge and the annual percentage rate
(APR). The APR expresses the cost of your loan as an annual rate. This
rate is likely to be higher than the stated contract 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.
When refinancing your mortgage, you will receive the truth in lending
disclosures before you settle.
The “HUD-1” statement
When you purchase a home or
refinance your mortgage, the Real Estate Settlement Procedures Act also
requires the lender to give you a copy of the HUD-1 or HUD-1A
Settlement Statement 1 day before you go to settlement, if you request
it. This final statement of settlement costs will show all the fees and
charges you will be expected to pay at settlement.
Fees paid outside of settlement
Some fees may be listed on
the HUD-1 and marked as “Paid Outside of Closing” (or “POC”). You will
pay some of these fees, such as for credit reports and appraisals,
before settlement. Other fees, such as those to a mortgage broker, you
will pay at settlement.
Sample Settlement Costs
Because costs may vary from
one area to another and from one lender to another, the following
example is an estimate only. This example is based on a $150,000 home
with a 5% or a 20% down payment. Excluding reserves for property taxes
and down payment, settlement costs for the 5% down payment loan vary
between $4,690 and $13,940; settlement costs for the 20% down payment
loan vary between $4,285 and $12,060. Your costs may be higher or lower
than the examples below.
