Financing

Closing Costs

The fees associated with buying or selling a home are called closing costs. Certain fees are automatically assigned to either the buyer or the seller. Others are either negotiable or follow local rules and customs.

Buyer Closing Costs
When a buyer applies for a loan, lenders are required to provide them a good-faith estimate of their closing costs. The fees vary according to several factors, including the type of loan and terms of the purchase agreement. Also some of these costs, especially those associated with the loan application, are paid in advance. Typical buyer closing costs include:

  • Appraisal
  • Documentation stamps
  • Down payment
  • Hazard insurance
  • Inspection
  • Loan fees (points, application fee, credit report)
  • Mortgage insurance (not always required)
  • Prepaid interest
  • Title insurance

Seller Closing Costs
If the seller has not paid off the outstanding loan on the property, the most important closing cost will be to satisfy this loan. Before closing, the settlement company will contact the seller’s lender to confirm the amount needed to pay off the balance. Along with any other fees, the original loan will be paid for before the seller receives any proceeds from the sale. Other seller closing costs can include:

  • Broker commission
  • Documentary Stamps on Deed
  • Property taxes (prorated)
  • Title insurance
  • Transfer taxes

Negotiating Closing Costs
In addition to the sales price, buyers and sellers may include closing costs in the negotiation. This includes both large and small fees. For example, a buyer may want to save on up-front costs and agrees to pay the seller’s full asking price. In return, the seller would pay some or all allowable closing costs.

Prorations
At closing, certain costs are often prorated (or distributed) between buyer and seller. The most common proration is for property taxes. This is because property taxes are typically paid at the end of the year for which they were assessed. So if a house is sold on June 30th, the seller will have lived in the house for half the year. But the tax bill is not due until the following year. To make the situation equitable, the taxes are prorated. So in this example, the seller will credit the buyer for half the taxes at closing.

How Much Can I Afford

Knowing how much you can afford is one of the most important aspects of home buying. Your budget will affect many things such as the neighborhoods, house size, and the type of financing you choose. Remember that in addition to your income, lenders will review other factors to determine the amount of the loan. You may find some financing options that can increase your purchasing power.

Prequalification vs. Preapproval
A key way to establish a budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval, as it is an estimate of what you can afford. However preapproval is a more formal process where a lender reviews your finances and agrees in advance to loan you a specific amount.

Factors Important To Lenders
Below are the key criteria used to determine how much money you can borrow:

Gross monthly income
Credit history
Outstanding debts
Savings, i.e., amount of money available for down payment and closing costs
Type of mortgage (30-year, ARM, FHA, etc.)
Current interest rates

Two Important Ratios
Lenders also use your financial information to figure out two, very important ratios: They are:

Debt-to-Income Ratio: Most lenders use this rule of thumb. The amount of debt you pay each month (car payment, student loan, credit card, etc.) should not be more than 36% of your gross monthly income. FHA loans are somewhat more lenient.

Housing Expense Ratio: It’s more difficult to obtain a loan if the mortgage payment would be more than 28-33% of your gross monthly income.

Down Payments Matter
If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20% down payment may be qualified using the 33% housing expense ratio. However, someone with a 5% down payment is more apt to be held to the stricter 28% ratio.

Ways To Improve Purchasing Power

Gifts
If you have limited savings, many lenders will allow you to use gift funds for the down payment and closing costs. However they will require a “gift letter” stating the gift will not have to be repaid. They will also require you to contribute part of the down payment with your own money.

Negotiating Closing Costs
By negotiating, the seller may be willing to pay some or all of the closing costs, such as if you meet the full asking price. If you do this, make sure to get guidance from your real estate agent. However in today’s very competitive market, few Sellers are offering to pay closing costs for the Buyer.

Loan Programs
Many local governments have special loan programs designed to help first-time homebuyers. Loans may be available at a reduced interest rate or with little or no down payment. See your local housing authority for more information.

Loan Types
Some homebuyers choose an adjustable rate mortgage (ARMs) because of the low initial interest rate. Others opt for a 30-year loan as it will have lower monthly payments vs. a 15-year loan. But there are significant differences between these loans so make sure you consider all issues before making a decision.

Mortgage Calculator

For an easy-to-use Mortgage calculator, go here: mortgagecalculator.net

Mortgage Rate Table

To view a table of mortgage rates, click here.

Mortgages

Principle and Interest
Excluding property taxes and insurance, a fixed-rate mortgage payment has two parts, principle and interest. The amount paid towards principle and interest (P&I) varies dramatically over time. This is because the initial loan payments are primarily to cover interest with the later payments going mainly towards the principle.

To calculate monthly payments based on different interest rates, lenders use “amortization tables.” These tables allow you to see how much money of each payment goes for interest and how much for principle. Take a look at the P&I for the first monthly payment on a 30-year/$100,000 loan at 7.5% interest. Based on the amortization tables, the fixed monthly payment is $699.21. To get this you:

Multiply $100,000 x .7.5 % (interest rate) = $7,500; divide $7500 by 12 (months in a year) = $625 (monthly interest payment)

Subtract $625 from $699.21; this shows $625 is interest and $74.21 is principle

If we subtract $74.21 (first principle payment) from the $100,000 loan, you get a new unpaid balance of $99,925.79. To get the next month’s P&I payment, just repeat the above steps:

Multiply $99,925.79 (new balance) x 7.5% = $7,494.43 (new annual interest payment)

Divide this by 12 to get $624.54 (2nd month’Â’s interest)

So in the second month, $624.54 is for interest and $74.67 goes to principle.

Equity As seen in the above example, even though you pay a lot of interest early on, you’re also paying down (albeit slowly) the overall balance. This is known as building equity. If you sell a property before the loan is fully paid, you only have to pay the unpaid principle on the loan. The difference between the sales price (after sellerÂ’’s closing costs) and the unpaid principle is the equity. In order to build equity faster (and save money on interest), some homeowners take out loans with faster repayment schedules–such as a 15-year loan–or make extra payments that are applied directly to principle.

Time versus Savings To show how this works, consider the previous example of a $100,000 loan at 7.5% interest. The monthly payment is around $700, which over 30 years adds up to $252,000. Over the life of the loan, the total interest paid would be $152,000. With the aggressive payment schedule of a 15-year loan, the monthly payment goes to $927–a total of $166,860 over the life of the loan. While the monthly payments are more than a 30-year mortgage, you would save more than $85,000 in interest. Of course shorter term loans are not right for everyone so make sure to choose the best loan for your individual situation.

Sample Settlement Sheet

For a example settlement sheet, go here.