by Michael Licamele
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If you are planning to buy a home this year, you are probably focusing on saving for a down payment. You can purchase a $200,000 home with as little as $10,000, which is only a 5% down payment. So why did your attorney and mortgage representative just tell you that you would need $9,000 in addition to your $10,000 down payment?
Closing costs are one of the least understood aspects of the home buying process. Most home buyers have a vague notion when they buy a home that there will be additional costs besides the down payment, but nearly every buyer is shocked when they see the first estimate of the total cash they will need at their closing. Fortunately, the estimate you get at time of application can easily be reduced by thousands of dollars by carefully planning your purchase transaction with a mortgage professional.
A major goal of the home buying process should be to minimize closing costs. The best way to accomplish this goal is to first understand exactly what closing costs are and then take actions that will reduce costs.
Closing costs include all items that must be paid on the closing day when you take possession of your new home. You should also include any fees that any service provider charges you prior to closing as well. These charges include actual out-of-pocket costs, pre-paid items and mortgage points.
Out-of-pocket costs are the hardest costs to reduce but the easiest to understand. These charges include fees for appraisals, credit reports, attorneys, couriers, title insurance, title searches, underwriting, deed recording and tax services among others. There is usually very little variation in these charges among mortgage companies and lenders because these costs reflect actual costs that are incurred. For example, each town charges a fee for every page that is recorded on the land records, so the pages required for your deed and mortgage note could cost up to $65 or $70.
When reviewing out-of-pocket costs with your mortgage representative, watch out for "junk fees," or additional charges. While nearly every mortgage program includes some charge of this type, this is the one fee that should be negotiable between you and your mortgage representative.
Another major hard cost that you can eliminate is the need for two attorneys. Attorneys are needed in a real estate transaction to represent you with the seller and to properly close your mortgage
loan. If you select an attorney who is not approved by your lender, you may need to use another attorney selected by the lender to close your mortgage loan. By choosing a lender that can perform both functions, you can save up to $500.
It is important not to be fooled by mortgage lenders who offer reduced out-of-pocket costs but just increase your interest rate. While this may be a good solution if you need to finance your closing costs, you will pay substantially higher interest charges.
The second major part of closing costs includes pre-paid items. These are the most confusing costs because they vary based on the type of property and the time of month and time of year that you close. At your closing, you must bring a homeowner's insurance policy that is paid for one year. This is one pre-paid item. You must also set up an escrow account with the lender for your property taxes, homeowner's insurance and mortgage insurance if needed. These are not additional out-of-pocket, but are needed so that when your next payments are due on these items, the lender will have enough in your escrow account to pay for them with your money.
Another part of pre-paid items that can be reduced to zero is pre-paid interest. Because all mortgage loans are due on the first of the month, you will have to pay interest from the day you close until the end of the month. By closing on the last day of the month, you will have no pre-paid interest due and can save hundreds of dollars.
The last part of closing costs and definitely the most expensive is mortgage points. A point is equal to one percent of the mortgage loan amount and is actually pre-paid interest that helps reduce your interest rate. A 30 year fixed rate program today, for example, can be obtained at 7.75% with 2 points or 8.25% with no points. On a $100,000 mortgage, the lower rate will cost about $35 less per month, but you will have to pay $2,000 at closing in points. The best option depends on your individual needs, but if you need to cut closing costs dramatically, simply choose the zero point option on your loan program and save thousands immediately.
In addition to these strategies, there are numerous other actions that you can take to reduce your closing costs. Monthly mortgage insurance and seller-paid closing are just two examples. The key for all home buyers is to plan your transaction carefully with a mortgage professional before you purchase, because if you wait until the day of the closing it will be too late!
Michael Licamele is the Editor of MortgageAlmanac.com.