What exactly are closing costs?

In fact, part of the reason lenders aren’t supposed to advertise “100% financing” is because some borrowers take that to mean there will be no costs associated with the loan.

I’ve heard that phrase a lot. What many people don’t know is that your down-payment has very little to do with closing costs.

They are what you might call “mutually exclusive”.

Putting money down means you have skin in the game. It’s an investment in the transaction. Closing costs are simply the cost of doing business.

So what are the closing costs?

Closing costs are broken down for you on your Good Faith Estimate. They are the fees paid to all of the vendors involved in bringing your transaction to a successful close.

Who am I paying?

I remember the days of the big banks trying to compete with the smaller shops by saying things like “no closing costs” or “we’ll pay the closing costs for you“.

Anytime a prospective client indicated they were pitched like this from a competitor, I would ask them the following question:

I asked it that way because some people may not know just how many hands are in the proverbial cookie jar when it comes to their transaction. Let’s talk about some of those hands.

Title company: They provide a Title insurance policy. This protects you and the bank against any encumbrances against the title to the property in the future. A worthwhile expense.

Escrow company: The escrow company is a neutral third party that handles the fiduciary aspects of the transaction. Earnest money, setting up your taxes and insurance account, and wiring and distribution of the funds from the loan. Again, a worthwhile expense.

Appraisal: This one is actually paid up front many times, but it is part of the cost of doing business. This assures you that the house is worth at least what you are paying for it. It also assures the lender that they don’t start out in the red.

Recording: This is the cost of legally recording the transaction. This makes the transaction public record. It is generally charged by the county the transaction takes place in.

Prepaid Items

When people say “closing costs”, they frequently lump the prepaid items in with that. Though these technically aren’t closing costs, I have yet to see a home loan close without these items being paid for. For that reason, I will choose to lump them in with closing costs as well.

Prepaid items are the interest, insurance, and taxes. See, when you buy a house from someone else, there’s all kinds of things that need to be accounted for.

Prepaid insurance: When you own a home, you pay for the time you have lived in the house (as opposed to rent, where you pay for the time you are going to live there). This means you don’t make a payment until the 1st day of the 2nd month following the purchase. In other words, if you close your purchase on November 15th, then your first mortgage payment isn’t due until January 1st. Pretty cool right? Well, the bank doesn’t just give you that for free. Thus, there is a charge for prepaid interest to cover the time between when you take possession and the next month.

Property Taxes: The government is kind of like the bank. They want to get their money too. So, when you buy a house, one of the prepaid items covers the property taxes from the time you become the home’s owner to the next time the taxes come due. Think of it this way: if you buy the house halfway through the year, the seller is responsible for the taxes for the half of the year they lived there, and you owe for the other half.

Hazard Insurance: Oddly enough, the insurance company won’t insure the home unless you have paid for an insurance policy. Thus, the bank requires you pay for the policy when the loan closes to protect the asset that secures your debt to them. That carries you through to the next time the insurance becomes due.

Sounds expensive!

Anyone who says that buying a home is a cheap affair is either nutty or lying. There are a lot of costs associated with buying a home.

However, that doesn’t really address the question of who is actually paying for them (hint: you can ask the seller to chip in). We’ll cover that in another post.

There may be other closing costs involved with your loan. These are just the “boilerplate” ones for home loans in the Pacific Northwest, where I live and work.

If you have any questions about closing costs, or other home loan questions in Oregon and Washington, hit me up. You can call 503.799.4112, email jason@mypmb.us, or fill out the following spam-free contact form. I am here to inform, not sell :-)