What are mortgage loan closing costs, and why do I pay them?

Home buyers, especially first time home buyers, commonly fail to understand all the costs involved in buying a home.  Everyone understands down payment, so no issues there. But mortgage loan closing costs are a whole different story.

I often hear potential home buyer comment that they thought they had saved enough for a down payment, only to be blind sided with mortgage loan closing costs.

WHAT ARE MORTGAGE CLOSING COSTS?

All mortgage loans have closing costs. They include appraisal, credit report, state taxes, title company fees, loan origination fees, state deed taxes, and more.  You also have what is known as pre-paid items, which include pro-rated property taxes on the house you are buying, and paying for the first years home owners insurance up-front.

Actual closing costs and pre-paid items can easily range from about 2% to 8% of the sale price of a home, depending on where you live, and the purchase price of the home.

Your Loan Officer will provide you with a detailed estimate of these closing costs based on the actual home once you pick it out, and can give you a good ballpark number during your initial loan review.

TIP: Anyone telling you closing costs are always a certain percentage is flat out simply wrong.

HOW TO PAY CLOSING COSTS

Yes, closing costs can really add up.  If you were planning on a 10% down payment, this means you really need 12% to 18% of the purchase price of the home.  Yikes.

The good news is, the mortgage industry understands this, and allows you to pay closing costs multiple ways.

Option 1) Pay cash out of pocket. Always the best move, but incredibly burdensome for most home buyer.

Option 2) Seller paid closing costs. You simply ask the seller to pay your closing costs for you when making your offer. Depending on the loan program you are using, the seller can pay between 2% and 6% of the purchase price in closing costs on your behalf. While this sounds free, because the ‘seller’ is paying them for you, the reality is the seller isn’t paying anything. Rather, this is a method of you rolling the closing costs into the loan itself.

For example, the seller is asking $200,000 for the home.  You offer $200,000 – but also ask the seller to pay $6,000 of your closing costs. If the seller agrees, many people think they just got free money.  The reality is the seller has accepted $194,000 in their pocket. So you could have bought the house for $194,000, and paid your own closing costs.  Instead you are buying the house for $200,000, and paying closing costs over time, versus out-of-pocket today.

It is a little more obvious to buyers that they are paying over time, when the same seller who wanted $200,000 refuses to budge, but you need closing costs rolled in to lessen your out-of-pocket burden. In this case, you’d restructure your offer to $206,000, and have the seller pay the $6,000 of closing costs.  The seller gets what they wanted, and you rolled closing costs into the loan, again paying over time instead of out-of-pocket today.

Option 3) Lender Paid Closing Costs (also known as Lender Credits). Under this option, the lender will reduce your actual real closing costs by increasing your interest rate. You can choose to increase your interest rate a tiny amount, for a tiny reduction in closing costs, all the way to completely eliminating all of your closing costs with a much higher interest rate.

This isn’t a good or bad option, rather it is a depends option. How much reduction do you need? Do you have all the closing costs money today? How much higher will the payment be?  How long will you live in the home?

TIP: ALL LENDERS HAVE ESSENTIALLY THE SAME TRUE CLOSING COSTS. When shopping lenders, many people will receive a closing cost quote lower than someone else, giving the illusion of a better deal. Many banks and lenders claims things like they give free appraisals, or never charge loan origination fees. No closing cost loans were all the rage a few years ago.

Little do many people realize that all these lenders are doing is increasing your loans interest rate to cover these items, but not telling you they are doing it. They don’t work for free, and someone has to pay the appraiser.  This lower closing cost ploy makes unsuspecting home buyers potentially pick a lender based on a perceived better deal, when in fact, it isn’t. You pay, you always pay. How do you choose to pay? Lower rate = higher costs.  Higher costs = lower rates.

Option 4) Any Combination. This is actually the most common way people pay closing costs. Many ask the seller to pay some, maybe increase the rate 1/8 or 1/4% to pay some, and maybe a little bit out-of-pocket to pay the rest.

CLOSING COSTS – THE BOTTOM LINE

It is very common for many home buyers through these options, to completely eliminate closing costs as an out-of-pocket expense, leaving them with just needing their down payment to buy the house.

So don’t ever let the fear of closing costs keep you from buying your dream home.

 


NO Closing Costs Loans COST Money

I constantly receive requests for a No Cost loan. Sadly there is no such thing.

All loans have closing costs associated with putting the loan together.

Just like you, participants in the mortgage loan process don’t work for free. The Appraiser, Title Officer, Title Insurance, County Recording Fees, Minnesota Mortgage Registration Tax, as well as your lender all need to get paid as part of the process.

Each of these parties charge fees for their service in processing and funding your loan. The Lender’s responsibility is to explain to you what the services and costs are, and to give you an estimate of the total costs when you apply for a loan. This estimate comes in the form of a document titled Good Faith Estimate of Closing Costs. It is only an estimate, but it should be very close to your actual costs. Lenders are not allowed to pad, or add onto the costs charged by these other parties, but rather simply pass on what they charge. The vast majority of closing costs go to third parties, not your actual lender.

The real question is: How do I get a loan so I don’t have to pay for these required services? The simple answer is you can’t. What you can do is determine how they get paid.

Purchasing or refinancing, it basically works the same way. All of the costs associated with transaction are paid in one of four ways: By you in cash, by the Seller (in a purchase), by rolling it into the new loan amount (refinance), by the Lender, or a combination thereof.  The most common way in a refinance is by rolling the closing costs into the new loan amount.

Now you may be saying “Wooh-Hooh, let the lender pay”, but you need to know how the lender can do this, and why it may not always be such a smart move.

To have the lender pay your closing costs, you agree to accept an interest rate that is higher than what is considered a “Market Rate.” In doing this, the lender receives more cash than just the face amount of the mortgage loan when they sell it to an investor on the secondary market. This excess cash is what the lender uses to pay some or all of your closing costs. This means that over the life of the loan, you will be paying more interest to the lender than you otherwise could have.

Does this strategy make sense for you? Maybe. It depends on several factors. How much higher is the mortgage rate and what is the monthly cost to you in increased payment? How big or small is the loan? How long do you plan to stay in this loan? Do I have the cash to pay the costs out of pocket?

This is where it becomes important to work with a Licensed Mortgage Originator and not a bank employee. As I have said many times, A Mortgage Banker / Broker is required to be Trained, Tested and Licensed in all aspects of Mortgage Origination. A bank employee is usually just registered, not tested, not licensed, and not required to be educated, tested, or licensed.

A NO COST loan is not automatically good or bad.

A local licensed Loan Officer will do the math with you, and take the time to show you the pros and cons of each method of paying closing costs so you can choose the best option in your particular situation.


No Closing Cost Mortgage Refinance? Good or Bad?

No Closing Cost Mortgage Refinance? BUYER BEWARE?
Good or Bad Idea? YOU DECIDE after reading thisJoe Metzler, MMS - (651) 552-3681

St Paul, MN: Mortgage interest rates are currently at historic lows. Your mailbox and the airwaves have become full with mortgage companies competing for your business. Many of these advertisements are for “No Cost” or “No Lender Fee” loans.

Are No Cost Loans a Deal? For most people, usually not.

One of the most confusing areas for consumers in a mortgage loan transaction are closing costs. Here I’ll explain the advantages and disadvantages of the highly advertised “no closing cost” or “low cost “loans.

First and foremost, there is no such thing as a NO Closing Cost Loan! Everyone knows there are costs associated with getting a mortgage loan; appraisal, credit reports, state taxes, county recording fees, title companies fees, lender fees, escrows, and more. Someone has to pay these fees, and it is always YOU. How you pay them is what this article tries to explain.

Homeowners in Minneapolis, St Paul, Madison, Milwaukee, and throughout all of Minnesota and Wisconsin need to understand that in a no lender fee or no closing cost mortgage loan, the lender simply uses “negative” points to offset your costs. In the example below, by having the 5.00% rate (versus the 4.5% rate), you can reduce (or offset through interest rate) $5,000 of closing costs. By choosing this option, it appear as if you saved thousands in closing costs. GREAT! But while lower costs always sounds good, you now have a significantly higher interest rate! OK, now what?

No matter what anyone says, a zero cost, or no lender fee loan is NOT automatically a great deal. Although it may sound so much better than adding thousands in closing fees to your principal balance, you have to analyze each individual loan and client situation to determine the benefits. Many lenders speak highly of the “thousands of dollars” you save in fees. They never discuss the fact that you may spend significantly more in interest over the full life of the loan than you ever saved in up-front closing costs! In the example below, you can pay $12,578 MORE for your no cost loan!

FACT: In a refinance loan, the vast majority of people roll the closing costs into the new loan.

View the following chart, then call us. We’ll run your personal numbers. Then you can decide if a no closing cost home loan is right or wrong for you.

Deal or No Deal? Most Common /
NORMAL
OK short-term
BAD long-term
Most CommonLow Cost Option
OK short-term
Very BAD long-term
Loan Amount $205,000 $203,000 $200,000
Interest Rate 4.50% 4.75% 5.00%
Principal & Interest Payment $1,038 (+$20) $1,058 (+ $45) $1,073 (+$60)
Closing Costs On Estimate $5,000 $3,000 $0
Out of Pocket Closing Cost Paid $0 – all rolled in loan $0. $2k in rate, $3k in loan $0. $5k in rate
Interest Paid over 5 years $48,192 $50,271 $52,054
Interest Paid over 15 years $121,743 $127,744 $133,002
Interest Paid over 30 years $172,932 ($373,935) $182,215 $190,491 ($386,513)

OK, so you are looking at the math, and maybe say “this isn’t so bad”, especially if you are in the home under 5-years.

But wait, here is a giant “Gotcha”

ANY LENDER who sells the no cost mortgage simultaneously sells a client into becoming a “serial refinancer,” which is not looking out for the client. They are “churning” the client and raking in fees year after year by fooling you into refinancing constantly at “no cost”, but always moving you BACKWARDS into a new 30-year loan. How many times have YOU gone backwards?

Factor in the monthly payments on all those additional “backward years” on all those “no cost” refinances, and that “biggest no brainer in history” no closing cost loan has actually cost you dearly.

Churning of home owner mortgages is illegal in most states

I hope this article has helped you to understand the varied measures used to determine the advantages and disadvantages of zero cost loans. Each borrower is different, and the evaluations must be made on a case-by-case basis. As you can see, there are many factors to consider when looking at the available options. With us as your personal Mortgage Consultants, we will be able to answer all of your questions, outline the costs and benefits, and even give you a few new ones to consider!

While everyone’s individual financial situation varies, let us show you the math so you make the correct choice. Of course, if a zero cost loan makes sense for your case, we will be happy to do one for you.