- Closing fees pay for three essential charges: out-of-pocket costs, prepaid items and points.
- Out-of-pocket expenses cover third-party services like appraisals and credit reports
- You can lower your monthly mortgage by paying points upfront.
They’re called “closing” costs because you encounter them when you’re nearly finished with the process of buying your house—so give yourself a pat on the back for a job well done! And, if you’re a first-time home owner, some of these fees may appear unfamiliar to you.
While they vary from lender to lender, they generally account for 2-5% of the purchase price and cover three basic expenses: out-of-pocket charges, prepaid items/escrow and mortgage points. This Closing Costs Calculator can give you a general idea of what to expect.
Here’s more on what you need to know about these three charges:
Out-of-pocket expenses. Paid by the borrower for services typically performed by a third party, out-of-pocket expenses include fees for appraisals, attorneys, credit reports, deed recordings, tax services and other miscellaneous expenses. Most of these fees are required, and they can vary from state to state. Home buyers need to carefully review their Loan Estimate (LE) to fully understand the fees. If something on your LE appears overly costly, you can ask your lender if a second quote is available.
Prepaid items via escrow. To make budgeting for property taxes and insurance premiums more manageable, the lender will establish an escrow account at the time you close.
You’ll have to deposit an amount for both those items to initially fund the escrow account at closing. That amount—plus what’s collected each month for escrow as part of your monthly payment—will contribute to future expenses of your insurance premium and/or property taxes. This way, you make good on these expenses “a little bit at a time” throughout the year, rather than get hit with a couple of big bills at once.
Mortgage points. Mortgage points reduce the overall cost of borrowing for your home over time. If you spend $4,000 upfront to get 2 points on a $200,000 loan at 4% interest, for example, you’ll end up with monthly payments of just under $955, according to Bankrate.com. Without points, you’ll pay about $993 a month. Obviously, this can amount to a great deal of savings over the life of a 30-year loan. How many points you “buy,” however, depends upon your individual situation. If you plan on staying in your home for a long time, paying points upfront could save you a bundle. But if you think you’ll only stay for a few years, you may not benefit from the savings. This Mortgage Points Calculator can help you run the numbers.