The term sounds simple: “Closing Costs.” Unfortunately, this simplicity can lull unprepared Buyers into faulty financial assumptions. Some of our clients are confused by the costs and fees associated with closing, so we decided to create a brief explanation and hopefully clarify what a Buyer should expect to pay at a real estate purchase closing.
The Most Common Types of Closing Costs:
- Lender’s Fees: This term can describe costs associated with origination, underwriting and processing, along with third party appraisals, credit reports, tax monitoring services and flood zone determinations. These are the costs of due diligence performed by the lender.
- Recording Charges: The transfer of real property will invariably involve recording documents with the county registry of deeds and/or Land Court Department. Common recorded documents include deeds, mortgages, assignments, and municipal lien certificates—just to name a few. More complex transactions can result in significant recording charges.
- Title Insurance: This type of insurance protects an insured against financial loss due to title challenges. This insurance is obtained by paying a one-time premium at closing. The coverage continues for as long as the policy holder or her heirs have an interest in title to the property. All Buyers who finance their purchase must purchase a “lender’s policy” on behalf of the mortgage lender to protect the lender’s interest and are highly encouraged to purchase their own policy.
- Attorney’s Fees: As the term suggests, this is the fee charged by the attorney assigned by the lender to conduct the real estate closing and protect the interest of the lender.
The Most Common Source of Other Costs that can Significantly Increase the Amount Due from the Borrower at Closing (Settlement Charges):
Most of our clients can handle the basic arithmetic to determine the balance of their down payment due at closing (Purchase price minus Loan amount minus Earnest Money Deposit) and all of the lenders we work with can effectively quote the “closings costs.” What about the other charges that can’t easily be pinned down?
Prepaid Items: These fees are collected at closing for costs that are not yet due. Common prepaid items include: prepaid interest, mortgage insurance, real estate taxes, hazard insurance (most of us call this homeowner’s insurance), flood insurance and association fees, if applicable.
This list of items may prompt a Buyer to ask two questions:
- What is prepaid interest? Some borrowers are surprised to learn that mortgage interest is paid in arrears. Unlike rent which is paid in advance, mortgage payments are paid after the fact. For example, a mortgage payment due on June 1st is actually paying for interest that accrued in May. Most closings will not occur on the first of the month. Therefore, in order to have the remaining payments due on the first, borrowers must pay the amount of interest accrued for the remainder of the month that the closing occurs. The Borrower’s first payment will then be due a month later. Depending on the principal amount of the loan, the interest rate, and the closing date—prepaid interest can represent a significant upfront cost.
- What are “escrows” and what should I expect to pay in advance? Most borrowers are required to authorize the lender to “escrow” hazard insurance and/or real estate taxes. Escrow (to read other common escrow arrangements in the context of real estate, click this link: The Closing). If these charges are “escrowed,” the lender will establish what is essentially a bank account. The lender will collect, in addition to principal and interest payments, a level monthly amount sufficient to pay property taxes (quarterly) and insurance (yearly) as they come due. Along with purchasing a one year premium of hazard insurance, borrowers are required to fund the escrow account with enough money to ensure timely payment of these items–usually with a two month cushion to account for changes in the tax rate and insurance premium.
One last cost that some Buyers may not anticipate: utilities. Some utilities must be paid by the Buyer at the time of closing. For example, a Buyer will purchase unused oil in the home’s oil tank from the Seller at closing. Unless the Purchase and Sale Agreement (click this link to read about the Five Top Provisions to Understand While Reading a Purchase and Sale Agreement) specifically states heating oil will be sold with the house at no additional cost, the Buyer will have to purchase the remaining oil from the Seller at closing. Depending on the size of the tank, this can be a significant expense. Other utilities may also require an adjustment from the Buyer to Seller . A good example of this type of utility would be trash removal. The Seller may have already paid the quarter’s trash removal bill so there will be an adjustment from the Buyer to the Seller for the Buyer’s use during the remainder of the quarter.
Can someone please pay these for me?
Yes and no. Closing cost credits can be a helpful tool for Buyers because it helps reduce the amount that the Buyer must bring to closing. The term simply means that at closing the Seller will use part of her proceeds from the sale to provide the Buyer with a credit against closing costs. Since the Seller is returning money paid by the Buyer which the Buyer received from the lender, the Buyer is still paying (financing) the closing costs. Most lenders will allow this practice. A Buyer represented by an experience Real Estate Attorney will be certain to define “closing costs” in the Purchase and Sale Agreement to cover closing costs, points, escrows and other prepaid items. Otherwise, a seller could plausibly argue that the credit is limited to the costs defined as “closing costs” above. Be certain to discuss closing cost credits with your lender before making it part of your agreement.
Stiles Law, with offices located in Boston and Marshfield, Massachusetts, is a firm concentrating in real estate conveyancing and mortgage lending services, representing buyers, sellers, borrowers, banks, mortgage companies, investors, builders and developers in all of their real estate and mortgage transactions.
Copyright © 2014 Stiles Law, All rights reserved. Stiles Law is a Massachusetts licensed law firm and all content is based on Massachusetts law. The information presented above is meant to be used for general informational purposes and it should not be construed as legal advice or legal opinion on any specific facts.