Closing Costs

When you take out a mortgage, whether it’s for a purchase or a refinance, you must pay closing costs, which can vary considerably. There are fees that must be paid to the lender, along with optional ones, such as mortgage discount points, and fees that must be paid to third parties, such as title/escrow and insurance. Whether you pay these fees out-of-pocket is another question, but either way, there will be a cost, and you must pay it in one way or another.

Two Types of Closing Costs:

There are two main types of closing costs, including “recurring closing costs” and “non-recurring closing costs.” Recurring closing costs are those that will be charged more than once, whereas Non-recurring costs are charged just once. 

Here are some examples of recurring closing costs (paid more than once):

- Homeowner’s insurance
- Mortgage insurance
- Flood insurance
- Property taxes
- Interest
- HOA dues

*Note that not all fees are necessarily applicable depending on the property, location, loan type, etc.

Here are some examples of non-recurring closing costs (one-time fees):

- Lender fees (underwriting, processing)
- Loan origination fee
- Mortgage discount points
- Credit report fee
- Appraisal fee
- Home inspection fee
- Termite inspection fee
- Building record fees
- Title and escrow fees
- Doc prep fees
- Recording and wire fees
- Notary and messenger fees
- Transfer taxes

As you can see, there are quite a few costs associated with obtaining a mortgage and not everyone has the cash on hand to pay for all these fees. There are also those that like to keep their cash and put it elsewhere. If you want to reduce your closing costs, there are a number of strategies to do so.

                       Use Seller Contributions to Cover Some of the Closing Costs:

One of the most common ways to reduce your out-of-pocket closing costs on a purchase is to get a contribution from the seller. These so-called “seller contributions” can be used toward the closing
costs mentioned above, but cannot be used for the down payment, nor can they wind up in the buyer’s pocket.

When negotiating a sales price, the buyer and seller can discuss contributions, and their presence will likely lead to a higher contract price. As a result, the buyer still pays the closing costs by accepting a higher loan amount associated with a higher purchase price.

However, the costs aren’t paid at settlement, so it’s easier for the buyer short on cash.The maximum amount of seller contributions allowed will vary based on the type of loan (conventional vs. FHA), the property type, and the LTV ratio. The maximum amount allowed on a Conventional loan  is 3% of the purchase price, and 6% for FHA loans.

Get a Lender Credit to Offset Closing Costs:

Another way to reduce or eliminate your out-of-pocket closing costs is via a lender credit, which is essentially agreeing to take a higher mortgage rate in exchange for lower settlement costs. This works on both purchases and refinances.

For example, a lender might tell you that you can secure an interest rate of 4.25% paying $5,000 in closing costs, or give you the option of taking a slightly higher rate, say 4.5%, with a $3,500 credit back to you. If all your costs are paid via a higher rate, it’s a no cost loan, though sometimes this definition only covers lender fees, not third party fees.

Either way, you’ll pay a bit more each month when making your mortgage payment, but you won’t need to come up with all the money for the required closing costs. Again, your out-of-pocket costs are reduced
here, but you pay more throughout the life of the loan via that higher mortgage rate. That’s the trade-off.

                   Negotiate and Shop Your Closing Costs:

It’s also possible to shop around for certain settlement costs, instead of just blindly using the companies your real estate agent recommends. For example, you can comparison shop for title insurance and/or
your homeowner’s insurance and save on costs there. 
The same goes for your home inspection.

If refinancing your mortgage, ask for the “reissue rate” or “substitution rate” when purchasing the lender’s title insurance policy.  There is no reason you should have to pay full price again for a title search when you’ve been the only person living in the property.  This could save you a significant amount of money on closing costs with as much as a phone call to the title company.

Similarly, when looking for a bank to work with, be sure to look closely at the fees they charge. They don’t all charge the same fees or the same amounts, so finding a lender with a low rate and low fees could save you big. Also watch out for unnecessary junk fees, which can really add up. But remember that certain closing costs just aren’t negotiable, like property taxes.

Gift Funds

If you find yourself in a situation where you are needing to get money from your parents or other family members to make a down payment on your new house, you will be required to prove that you did not borrow the money from them with an expectation on their part t it be repaid or with an intention on your part to repay it. 

When you apply for a new FHA mortgage, you should receive as part of your  loan application package a special form called a “gift letter request.” The goal of this letter is to identify the source of the funds and assure the lender that they are in fact a “gift.” 

But, there is a catch. The lender will  require that every dollar used for a down payment be documented back to a specific funding source, and this can be particularly difficult when the money comes from a third party, which is why we have “gift letters”.

Your lender generally will only allow you to use money given to you by a true family member, i.e. your spouse, mother, father, brother, sister, uncle, aunt, grandfather, grandmother, first cousin, etc. In fact, both you and your family will need to prove to your lender that the money was given to you in the form of a gift and verify that the funds are in fact given freely. 
Conventional lenders also accept “gift” funds. However, the admission of these will be considered on a case by case basis.