Its a scenario I've seen countless times now... A young couple walk into a home, maybe its an open house or maybe they've gone out of their way to contact an agent to take them through several homes they've fallen in love with online. Their eyes get big, they look at each other and smile. They know they've found their future home and they are as happy as when they first met each other.
This scene plays in their head...
... and then, in steps the evil villain, the Dream Squasher, generally played by the part of the mortgage/bank rep or the Realtor.
"I'm so happy you love this home! Its great isn't it!?", the Dream Squasher starts, "Have you had a chance to be pre-approved yet?"
The couple frown a bit, look down and shake their heads silently.
"No problem!", the Dream Squasher says, giving them a bit of hope before delivering the final blow. "How about we just look at some estimated costs."
The Dream Squasher then pulls out a few cost scenarios. The totals, at the bottom of the page, even at the cheapest scenario, something called an FHA loan, are TWICE the amount the couple had thought.
"I don't understand!", complains the potential homebuyer." We had calculated 5% down and that was well within our budget! Where is this number coming from?!"
"Closing costs", retorts the Dream Squasher.
I hate playing the Dream Squasher. It gets real old, real fast. I like people feeling like Joseph Gordon Levitt feeling like Han Solo - thats what I want for people. I don't like seeing the sad head shake.
And for something that has been around since financing has been around, you would think the average person would have heard about CLOSING COSTS. But few have. And if they have, they assume its some set of fees that probably total to an extra $1500 or something.
Somehow we become adults figuring out how to balance a check book (which you don't need to know how to do anymore, high school guidance counselor), set up Comcast on your apartment and even figure out how much to budget for groceries and rent in your monthly income but out of all of the simple economical lessons we get to be average adults, you would think they would give you a heads up on what it takes to buy a home.
So here's my intro session to THE ACTUAL cost of buying a home: Closing Costs 101!
Taxes make up the bulk of your closing costs. Some sites don't include this under the term "closing costs" but, again, for the sake of simplicity, I am.
The first tax you probably didn't think of is a transfer tax. In every municipality, there is a tax on transferring property from one person to another. Unless you are buying from a bank (in a short sale, perhaps, or a bank-owned property), you are probably splitting the full transfer tax with the seller. As a general rule of thumb, transfer taxes are about 2% of the sales price. So you, as the buyer, have to pay 1% of the sales price in transfer taxes. In Philadelphia, that shoots up to 2%!
You also have to pay some tax reimbursements to the seller. Taxes to the state, city and school district are generally paid annually. The seller has already paid for taxes for the year you are buying. If you buy any day of the year other than at midnight on Dec 31st (good luck getting that closing on the schedule), you are going to owe the seller some money for those days you are living in the house and he or she isn't. They aren't going to pay your taxes for you. So if you move in July 1st, you owe the seller for July 1-Dec 31st.
(*side note: if you are buying a condo in an HOA, you will likely be reimbursing the seller for some condo fees too)
While I still have some bit of your attention and brain power, lets go over the most confusing bit - your escrow account. I won't go into detail here, thats for a more detailed post, but essentially, if you are getting a mortgage, the bank/lender is a 3rd party in this deal - an investor in your home and your transaction. As such, they have a stake in your home. They want to make sure their investment isn't going to go under. So they don't trust you to make your tax and homeowner payments all by yourself (I mean, be honest, thats probably a good point...). So they set up an escrow account for you to pay into monthly. Then all of those monthly payments make one big annual payment that the bank/lender dishes out to pay your taxes and annual home owners insurance bill.
If you left the settlement table with no money in that escrow account, then when your first, next tax bill came due, the bank would likely not have enough money in that escrow account to fully pay that bill. So they are going to automatically request you put some money in that account as a cushion on the day of settlement BEFORE you start paying your monthly payments into it. As a rule of thumb, the bank/lender can ask for a 2 month cushion, so expect to be paying at least 2 months up front in taxes and insurance in your escrow account.
SO, annoying as it is, you are going to have to pay back taxes to the seller, pay into an escrow account as a cushion AND start making monthly payments. It seems overkill but that's so that escrow account never goes dry!
Ok, now for an easier equation. You need title insurance. Even if you are paying cash on a home, don't be so cheap to skip this. Then you'll be "that guy who lost his house and he didn't even have title insurance!" Unlike every other insurance on the planet, this is a one-time fee. AND, its regulated by the government, so they can't overcharge you for it! You can easily calculate how much your title insurance will be by putting your purchase price in a title insurance calculator. But there are also some other fees, such as a notary, incoming wire fees (because your title company will play ringleader for all the money coming in and out of this transaction on all sides), title searches (to make sure all is copacetic on who owns the home), recording fees (so you don't have to walk your deed ad mortgage into the township office and record it!), and any other relevant fees, such as surveys. A title company can give you a break down of potential fees before you start doing business with them. But a title calculator can give you a good idea of what it might be.
A little less straight forward than title fees, mortgage fees depend on who you are using and what loan package you get. For instance, if you are a vet, some of the closing costs are limited by the VA. If you put down 20% or more on a loan, you aren't going to see mortgage insurance. If you don't, you may see this as an up-front payment and/or a monthly fee. Etc, etc, etc.
However, its good to assume the fees to get you your mortgage (doc prep, credit reports, appraisals) are going to cost at least $900+. Again, ask your agent and/or mortgage lender for a breakdown on mortgage fees.
Depending on where you are buying and how, you are likely going to see a few other miscellaneous fees as part of your total cost. Some of these are paid upfront, as in before you settle on the home, and some are paid the day of settlement. The two most obvious of these fees are your home inspection costs and your real estate agent/lawyer fees. In states that require/suggest using a lawyer, you are going to have to pay for their services. And while most buyer agents are paid by the seller (more on how that works in another post), most buyers are asked to pay a small fee for all the paperwork and transaction processing done by the agent's office - generally about $300-400.
Sure, you don't have to get an inspection, but if you don't, you are an idiot and asking for the roof to collapse in on you. This is the biggest purchase of your life, likely, so don't skimp on the few hundred dollars to get an inspection. If you are buying a 3 bed home on the East coast, this is probably going to cost you $500-600 before adding on extras, such as radon testing, termite inspections or additional contractor inspections/quotes, such as electricians or plumbers. However, I generally say estimating $600 for a visually-average home is a good rule of thumb.
Finally, if you are buying a condo or home in a homeowners association (HOA), you probably have a move-in fee, or capitalization fee, that might run $500-1,000.
Adding it all up
So you can see that all of these fees are going to add up quickly, and to something far over the $1500 mark. If you are paying cash for your home, you have the option to pass on some of these fees, but for most transactions, these closing costs apply.
A for instance...
For a home that costs $300,000 and has taxes of $3500...
If a couple decides to put down 10%, they probably came in thinking they had to pay a bit over $30,000.
But what they are really paying is..
$30,000 down payment
+ $6,000 in transfer tax (2% in Philadelphia)
+ $1,300 in tax reimbursements to the seller
+ $2,000 in title insurance
+ $3,700 in escrows
+ $4,600 in mortgage and title fees, realtor fees, home inspections, etc.
$47,600 total to purchase this house!
For most people, that additional $17,600 isn't just lying around and just made that $300,000 out of their reach or comfort zone, potentially.
So PLEASE, PLEASE, don't make me be the Dream Squasher any more. Please get acquainted with estimated closing costs BEFORE you start looking at a certain price range of home.
Ask your mortgage rep or real estate agent (or me!!) for estimated costs of a home you are looking at before you start getting that Joseph Gordon Levitt-Han Solo feeling.