Many homebuyers want the most favorable home loan terms they can get—the lowest interest rate and fewest points without the need for private mortgage insurance. One way to do this is to save your pennies until you can come up with a down payment that’s 20 percent of the sale price. On a $400,000 home, 20 percent down would be $80,000. That’s a lot of dough.
Now, imagine going into escrow on your dream home, only to have the lender tell you they actually need $85,000 in cash—you’re $5,000 short. What?!
If you’re working with a good Realtor, you shouldn’t get this nasty surprise. But in case no one has mentioned it to you, the difference between your down payment and the actual cash you need to complete the transaction is in the closing costs.
Closing costs pay for all sorts of necessary components in a real estate transaction.
Loan Fee
First is the loan fee. Mortgage brokers review your financial profile and compare it against a variety of loan options from various lenders so they can find the best mortgage rate, tailored specifically for you. The loan fee runs 1 to 1.5 percent.
Loan Origination Fees
Next, there are loan origination fees that include funding, warehousing, and underwriting. These fees are often built into the loan via the interest rate. If the interest rate on a loan goes up an eighth of a percent, the loan is more valuable. Either the lender gets the higher rate of return or, because of the increased value, the original lender can sell the loan for a higher price, making up the cost of originating the loan.
Administrative Fees
In addition to loan fees, there are several administrative fees: title and escrow fees, tax fees and recording fees. Title insurance protects both the buyer and lender from unknown liens or flaws in the title. Escrow fees pay for an escrow officer to process the transaction, including drafting escrow instructions, ordering demands and handling the money. There’s also a fee paid to a third-party tax service to verify property taxes are calculated and paid annually. Finally, recording fees are paid to the county; this pays for cost of documenting and maintaining searchable records of the transaction. This last service allows anyone to look up who owns what property and to ascertain whether there are liens on that property, thereby streamlining the real estate sales process and helping protect people against fraud. Imagine having to sift through a 200-year-old stack of documents to confirm a clean title. No thanks.
Service & Miscellaneous Fees
Before an escrow can close, additional service fees may include appraisals, credit reports, flood and hazard insurance, pest and fungus inspections, homeowners’ association fees, and anything else outlined in the purchase agreement. As you can see, closing costs can add up quickly.
Working It Out
If the buyer cannot raise enough cash, there are still ways for buyers and sellers to work together to make the transaction work. It’s common for a buyer with limited cash to negotiate a price higher than the list price, and then ask the seller to pick up some or all of the closing costs. Keep in mind, the property must appraise for the higher negotiated price or the lender won’t go for it.
Ideally, the buyer has enough cash to pay for all the necessary expenses associated with closing the deal, but if not, it’s in everyone’s best interest to be creative so both the buyer and seller get what they want—the buyer gets their dream home and the seller gets the cash for the down payment on their new dream home.
If you have questions about property management or real estate, please contact me at rselzer@selzerrealty.com or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery.
Dick Selzer is a real estate broker who has been in the business for more than 40 years.