Ever wonder what closing costs are? To buyers, they often seem like a black hole. It is an important item to budget for when buying a home. The quick answer is to budget 3% of the purchase price. Read on for more detail.
Closing costs are the fees you pay in addition to your down payment. These fees are paid when your escrow closes and are paid out of the escrow account. So what makes up closing costs? They are the costs associated with escrow and title, financing, government mandated taxes and recording fees. I’ll explain each of these areas. For the purpose of this discussion, we’ll use a purchase price of $500,000 and a 20% down payment, which is $100,000.
ESCROW & TITLE
Escrow and title are two different functions that are performed by the same entity here in Northern California. The escrow company is a neutral third party that holds all the money for the transaction and only distributes the money when they receive the same instructions from all parties involved. It is your protection that the seller won’t take your money and run. Escrow is opened by your real estate agent and closes when all money deposited in the escrow account has been paid out. Escrow fees are based on the purchase price. For this example I’ll use $800. There are also smaller fees for notary, courier, endorsements, etc. which for our example I’ll use $125.
Title is a general term used to describe two important functions, a title search and title insurance. A title search of the property assures that the owner really owns the property and can legally transfer title to you. Title insurance is an insurance policy you purchase for yourself and your lender to protect you from any possible claims related to who owns the property. This can include items like contractor liens, property boundary lines, easements and unrecorded deeds. The cost for the buyer’s policy is based upon the purchase price of the home and varies depending on the coverage you choose. The cost of the lender’s policy is based upon the loan amount. The buyer pays for both policies. I’ll use $1700 for this example. In total Title and Escrow fees for this example are $2625.
FINANCING FEES
Financing fees include the lender fee, appraisal, discount points, flood check fee, tax service fee, impound account deposits, insurance, interest, etc. The lender fee is the money you pay the loan officer for helping you get the loan. Generally these fees run $800 – $1000. I’ll use $800 for this example.
The appraisal is an independent assessment of the home’s value, so the lender can be sure they are not loaning more than the home is worth. Figure $400 for the appraisal. Discount points are optional and buyers often choose to pay them to reduce the interest rate on their loan and subsequently their monthly payments. 1 point is 1% of the loan amount. Let’s assume the buyer of this home is paying 1 point, so that will be a $4000 charge. Flood check fees and tax service fees are small. I’ll use $100 for both.
Impound accounts are like savings accounts that the lender keeps for some buyers. The lender charges you more than your loan payment each month and puts this money into the impound account. This is used to pay your homeowners insurance and property taxes. It works out nicely for new homeowners, because you don’t have a large payment to make few times a year and you often get a reduced interest rate on your loan when you agree to have an impound account.
Generally the lender wants 3 months of homeowners insurance payments paid into the impound account at close of escrow, say $150. The amount of property taxes you must pay into the impound account varies depending upon the time of the year you purchase. For the purpose of this discussion, let’s say the buyer must pay 3 months of taxes or $1500.
Be aware, the money you pay into your impound account for homeowners insurance will be used to pay your second year of homeowner’s insurance. You still have to pay for the first year’s premium. This is paid in advance out of escrow. I’ll add $600 for this example.
The last most common financing associated fee is interest. You need to pay interest on the money from the time it is deposited in escrow by your lender until the time your first loan payment begins paying the interest. This amount will vary depending upon the time of the month that escrow closes. Let’s assume this buyer must pay 15 days of interest and has a 6% interest rate. That would be about $985. That brings our grand total for loan associated fees to $8,535.
TRANSFER TAXES AND RECORDING FEES
Lastly, there are government mandated taxes and recording fees. In Alameda, both the city and the county charge transfer taxes at the time of sale. Think of it like sales tax. The county charges $1.10 for every $1000 of purchase price. The city charges $12 per $1000. These amounts are customarily split 50/50 with the seller. So for this purchase the buyer will pay $3,275. Recording fees vary. I’ll use $100 for this example. This brings our grand total for government taxes and fees to $3375.
IN SUMMARY
$3,025 Title & Escrow associated fees
$8,535 Financing associated fees
$3,375 Government associated fees
$14,535 Total Closing Costs (3% of $500,000 is $1,500, so this is a good rule of thumb)
Remember this money for closing costs is paid in addition to the down payment, which in this example is $100K. So the total amount of cash this buyer would need to purchase a $500,000 home is $114,935.
Many factors can affect closing costs. Sometimes buyers negotiate with sellers to pay some or all of these costs. Your real estate agent can help you sort through all these costs and help you negotiate the best possible solution for your unique situation.
Look for my blog article entitled “Who Pays For What“ for the various costs in different cities.
