If only buying or selling a piece of property was as simple as signing a contract and transferring the funds over from buyer to seller at the agreed upon purchase price. Unfortunately, when completing a real estate transaction, there are closing costs involved. For anyone who has never closed escrow before, this kind of thing can be intimidating because there are so many items to account for.
Naturally, you might be wondering what all of these items are, and worried about overpaying.
Closing costs will always vary from lender to lender (and from property location to location), but I will provide a real example to give readers an idea of what to expect. I will use Rental Property #3 as an example, which closed in July 2013.
When first engaging with a lender, they will typically provide you a good faith estimate (GFE) document that estimates all the closing costs involved in the transaction. In general, the GFE is conservative and will tend to overestimate the closing costs that you will actually need to bring to the table.
Good Faith Estimate (GFE): Chicago
GFE for Rental Property #3:
Here’s a breakdown of each item:
Origination Fee: This activation fee is an expense the buyer pays the lender for setting up an account for the processing of your loan.
Rental Property #3: Origination Charge: $990
Origination fees typically varies from about 0.5% to 2.0% of the purchase price.
Points: Depending on the lender, it may be possible for the buyer to secure a lower interest rate by paying an upfront charge to purchase points. Also, during the loan process, at some point, the lender will ask you about locking in your interest rate. A rate-lock protects the buyer from rising interest rates. Typical rate-locks expire somewhere around 15-60 days. From my own experience, most lenders will lock the rate for around 45 days or so.
For Rental Property #3, the rate-lock was set for 49 days. Should the rate-lock expire, the buyer would need to buy points to extend the rate-lock, or accept the current market rate. If you are attempting to close escrow at a time when interest rates are rising, it makes sense to do so before the rate-lock expires. With Rental Property #3, I wasn’t able to close on time and needed to pay extra to preserve my 30 year fixed, 4.5% interest rate. At the time of expiration, my lender was quoting me around 4.7% or so. So, I should have done a better job of closing on time (although not always within the control of the buyer since there are many other parties involved with closing).
Rental Property #3: Points Charge: $378
Appraisal Fee: An appraisal is typically ordered by the lender 1-2 weeks after the loan origination. With residential real estate, appraisals are set using the “Sales Comparison Approach”, which is one of three valuation methods (Cost Approach and Income Approach being the others). The value of your property will be assessed based off of what nearby comps have been selling for recently. The appraiser will do their best to handpick a few “like” properties, similar in makeup/characteristics.
Rental Property #3: Appraisal Charge: $350
In my own experience, I’ve seen appraisals priced anywhere between $350 to $500.
Lender’s Title Insurance: The Lender’s Title Insurance, or Loan Policy, protects the lender in case there are issues with the title of the property you are purchasing. This charge is typically paid for by the buyer. A Lender’s Title Insurance is required for a lender will issue out a loan for you. It protects the lender ONLY, not the buyer.
Rental Property #3: Lender’s Title Insurance Charge: $2,600
In my own experience, the buyer has ALWAYS been responsible for paying for the Lender’s Title Insurance. Also, I’ve seen this charge vary A LOT! I’ve been quoted as little as $595 to $2,600.
Owner’s Title Insurance: The Owner’s Title Insurance is needed to protect the buyer in case there are issues with the title. This can be due to liens, legal judgement, or unpaid taxes. Although purchasing an Owner’s Title Insurance may be optional in some cases, it is always better to be safe than sorry.
Rental Property #3: Owner’s Title Insurance: $2,000
In my own experience, the seller has ALWAYS paid for my Owner’s Title Insurance. This will vary from state-to-state, but so far, I have never paid for my own policy in: Bay Area, Chicago, and Indianapolis.
Government Recording Charges and Transfer Taxes: These are fees assessed by the state and local agencies for recording your deed and documents, and entering them into official record. Transfer taxes will vary from location to location.
Rental Property #3: Government Recording Charges: $400
Rental Property #3: Transfer Taxes Charges: $1,182
Initial Deposit to Escrow: This is the initial payment you make into your escrow account to get it funded. It may, or may not be different from your monthly payments moving forward, depending on what your lender requires. The money in this account is used to pay for property taxes, insurance, and flood insurance (if required). I do not have an escrow account setup for any of my Bay Area properties (Rental Property #1 and #2). Escrow accounts are convenient, and I plan on using them for all purchases moving forward.
Rental Property #3: Initial Deposit to Escrow: $2,799.30
Daily Interest Charges: Daily interest charges are for any daily interest that will accrue on your loan from the period of settlement until the first day of the period covered by your first scheduled mortgage payment.
Rental Property #3: Daily Interest Charges: $218.45
Credit Report: Credit report is obtained through a credit reporting agency. Your lender will run your credit at the beginning of the loan application process to qualify you and determine what interest rate you are entitled to. The three major credit bureaus are: Equifax, Experian and TransUnion. You will receive a credit score from each of the three bureaus, and the middle score will be the one your lender uses.
Rental Property #3: Credit Report: $5
Credit report fees typically range from $5 to $15.
Flood Certification: Flood Certification is needed to verify that the property is not located in a flood zone.
Rental Property #3: Flood Certification Charge: $5
Flood Certification fees typically range from $5 to 20.
Total GFE Breakdown: The GFE estimated that the total settlement charges that I would be responsible for to close escrow was $10,927.75. This is the additional funds needed on top of the downpayment for the actual property itself (typically 20% to 30% for a residential investor property).
Final HUD: Chicago
As mentioned above, the GFE is conservative, and tends to overestimate the amount you will need to bring to the closing table. This isn’t necessarily a bad thing, and it helps insure that the buyer has sufficient funds available to close escrow. When in doubt, aim to have at least the amount estimated in the GFE on the day of closing.
Here’s the breakdown of the Final HUD for Rental Property #3:
Origination Fee (GFE): $990
Origination Fee (Final HUD): $990
Points (GFE): $378
Points (Final HUD): $378
Appraisal Fee (GFE): $350
Appraisal Fee (Final HUD): $400
Lender’s Title Insurance (GFE): $2,600
Lender’s Title Insurance (Final HUD): $1,935
Owner’s Title Insurance (GFE): $2,000
Owner’s Title Insurance (Final HUD): $0 ($1270 paid for by seller)
Government Recording Charges (GFE): $400
Government Recording Charges (Final HUD): $146
Transfer Taxes (GFE): $1,182
Transfer Taxes (Final HUD): $1,181.25
Initial Deposit to Escrow (GFE): $2,799.30
Initial Deposit to Escrow (Final HUD): $606.46 (3 months insurance; 2 months property taxes)
Daily Interest Charge (GFE): $218.45
Daily Interest Charge (Final HUD): $131.07
Credit Report (GFE): $5
Credit Report (Final HUD): $5
Flood Certification (GFE): $5
Flood Certification (Final HUD): $5
Total Closing Costs (GFE): $10,927.75
Total Closing Costs (Final HUD): $5,777.78
The above example shows that for a GFE of $10,927.75, the actual costs came out to be $5,777.78 for a 2-flat purchase in Chicago. For one, the GFE budgeted $2,000 for an Owner’s Title Insurance, which is customarily paid for by the seller (in Chicago). Also, other items such as: Lender’s Title Insurance, Government Recording Charges, Initial Deposit to Escrow, and Daily Interest Charge were overestimated. Of course, your mileage will vary, depending on both the location of the property, and lender you decide to use.
One thing to keep in mind is this — Closing costs are not fixed, and like most things in real estate, are negotiable. It doesn’t hurt to shop around, getting quotes from various lenders. Also, when negotiating with a seller, don’t be shy about bringing up the subject of closing costs. If negotiations reach a standstill, concessions made towards closing costs can help bridge any gaps in the deal. Always work with the other party (both seller and lender) and see what they can concede to you; this can help you save hundreds, if not thousands of dollars in closing costs.