March 20th, 2014 2:40 PM by Richard T. Cirelli
Closing Costs, Prepaids & No Surprises. What to Expect When You Close Your Loan
Nobody wants to be surprised by the cost to close their mortgage loan. The Government-designed one-size-fits-all Good Faith Estimate and Truth-In-Lending statements add to the confusion despite the Government’s attempt to protect the borrower. Many homebuyers and refinance borrowers end up paying more than expected when they close their loans. If their mortgage professional doesn’t take the time to fully explain the various costs to close, unhappy borrowers is the result.
The cost to close can be lumped into four categories. They are not all “Closing Costs”. It is helpful to have an understanding of the difference between closing costs, pre-paid items, property taxes and insurance and how they all impact the cost to close a transaction.
1. Closing Costs:
Closing Costs are actual non-recurring or one-time costs associated with closing a transaction. Most of the costs are third-party costs for necessary services such as Escrow, Title Insurance, Appraisals, Flood Certifications and Lender Underwriting or Document Preparation fees, etc. These are charges to a borrower no matter which mortgage company they choose to work with.
2. Prepaid Items:
Pre-paid items are not technically closing costs. They are recurring or pro-rated items that would be payable by any borrower but required to be paid at the time of closing. They may include the following:
· Proration of Interest: Interest on the new loan will be collected from the day of closing until the end of the month in which the loan is funded. It can range from one-day to 30-days of interest. Since interest on mortgages is always paid in arrears, this cost to close is offset by the fact that the borrower has no payment to make in the first full month after the closing of the new loan. For example, when a loan closes on the 15th of May, the borrower pays interest for 16 days through the end of May at the time of closing. But, the first payment on the new loan is not due until July (not June).
· Property Taxes: A borrower will always have to pay property taxes. On a purchase transaction, they are prorated between buyer and seller. The amount depends on whether or not the seller has already paid them and the date through which they were last paid. If taxes are due within 60 to 90 days of closing, the lender will require that they be paid at the time of closing.
· Homeowners Insurance: Insurance companies require payment in advance for the year. Therefore, at closing, the borrower will pay the first year homeowners insurance premium. On a refinance transaction, the lender will require payment if the next premium due date is within 90 days of the loan closing.
· Impounds/Escrows: With most types of loans, the borrower has the option of paying the cost of property taxes and insurance with their monthly payments. Again, depending on when the taxes and insurance are next due, the lender will need to collect some money from the borrower at the time of closing so there will be enough funds to make the payment when they come due again next year. In California we call this collection of tax and insurance costs “impounds”. In most of the country it is called “escrow”.
3. Interest Rate, Discount Points & Rebates:
Lenders offer multiple interest rate/point options for each loan program. The rate/points change daily depending on the performance of the financial markets. Additionally, there are adjustments for most buyers depending on their down payment or equity, credit scores, occupancy and other factors. In most cases, the borrower has the option of taking an interest rate that is below-market or above-market. The borrower has the option of paying a point or some fraction of a point in return for a lower interest rate. The borrower also has the option of taking an above-market rate in return for the lender paying a credit or rebate to the borrower that can be applied toward their cost to close. For example, if the “market-rate” is 4.5%, the lender may offer rates between 4% and 5% in 1/8% increments. Each option has a cost or rebate associated with it.
4. Down Payment:
The Down Payment is simply the difference between the Purchase Price and the Loan Amount.
No Surprises:
On purchase and refinance transactions, all money flows through the escrow company. It is the escrow company’s responsibility to verify all of the costs, prepaid items, taxes, insurance, impound/escrow amounts and down payment amounts from all of the service providers. An Estimated Closing Statement, also called a HUD-1, should be given to the borrower in advance of closing so they have time to review it, ask questions, etc.
It should be the duty of the Loan Officer or Mortgage Broker to explain the costs and the process to the borrower in the beginning, during the process and prior to the closing. When dealing with a mortgage professional that does their job properly, there should be no surprises at the closing.