Nobody wants to pay closing costs. They are the transaction costs of buying real estate that we all would rather do without. Nevertheless, closing costs do exist, and sometimes they are abused. It’s important to understand that closing costs are not completely regulated. Lenders can sometimes charge what they want, leading to so-called “garbage fees” or unnecessary charges that only benefit the lender. (What are garbage fees is open to interpretation I give you my take on it throughout this article.) On the other hand, there are rules that lenders need to live by. Under RESPA(Real Estate Settlement Procedures Act), a lender must give you a good-faith estimate of what your costs for the loan, and in effect the transaction, will be within three days of your making a formal application. Giving you notice, however, does not necessarily mean reducing those costs or even being totally accurate. In addition HUD (Department of Housing and Urban Development) requires that a HUD-1 statement of your closing expenses be given to you, but not until within one day of closing. By then, of course, it’s usually too late to do anything about the costs.

New Changes to Closing Procedures Because current closing procedures have produced so many problems and complaints, HUD has indicated it may adopt a two-tiered

system (not yet in effect as of this writing). Under this plan there would be two kinds of closing costs:  GFE Good Faith Estimate. This is pretty much the old system where the lender can give you an estimate that may or may not prove to be accurate.  GMPA Guaranteed Mortgage Package Agreement. Here the lender guarantees that the closing costs will be no more than a set amount. However, that amount could be higher than the estimate given under the other plan. In addition, there is some thought being given to identifying the various lender fees (which compose most of the closing costs for the buyer) and codifying these. Nevertheless, it behooves every buyer to examine what the closing costs might be to see where they can be reduced. Here’s a list of typical closing costs when purchasing a home. (Note: You probably won’t have all of these; you may have most of them.)

Typical Closing Costs

Checklist  Hazard insurance policy (fire insurance)  Homeowner’s insurance home warranty package  Tax prorations  Tax service contract  Mortgage fees  Attorney fee  Escrow fee  Title insurance fee  A variety of other fees may also be imposed Most buyers are confused by these fees, so let’s go over some of the more common ones.

The attorneys who work in real estate usually have set fees for standard transactions. These fees are normally between $500 and $1500, depending on the size and complexity of the deal. Be sure you discuss the fees before hiring an attorney. Remember, the attorney fees, like everything else, are negotiable.

Why Do I Have to Pay for Hazard Insurance? As the buyer of a home (new or resale) you will want to carry fire insurance. This insures you, and the lender, that in the event of a catastrophe, the home can be rebuilt. Don’t think you can save money by just taking a chance and not insuring the property. The lender will demand that you carry minimum fire insurance as a condition of the financing. If you don’t, the lender will put its own, usually more expensive policy on the property and bill you for it. If you refuse to pay, you could be placed in default and the lender could foreclose. While you are required to pay for fire and basic hazard insurance, you are not usually required to carry a “homeowner’s policy” (although some lenders do now require it). The homeowner’s policy runs almost twice as much as the basic fire/hazard policy, but it’s a good investment. It protects you against a variety of losses, including liability if someone gets hurt on your property.

In some areas of the country, insurers have recently been refusing to issue new policies because of losses. Be sure to check to see that you can actually get insurance, or else you might not be able to conclude the purchase of your home!

What’s a Home Warranty

Package? A home warranty package is optional. It typically costs from $250 upward annually, depending on the quality of coverage. The plan covers problems with many of your home’s systems, such as electrical and plumbing. Most sellers will pay for the first year, to keep you from calling to complain about something such as a leaking water heater. You can usually continue the plan in subsequently years by paying the premium yourself.

Why Do I Have to Pay Taxes

on My Purchase? It’s the only thing that’s certain, besides death! You do not have to pay sales tax (at least not yet!) in any area of the country that I know of, although some states do charge a usually nominal “transfer tax.” But you do have to pay property taxes. The escrow company prorates your share of the year’s taxes. Proration simply means that if the sellers have already paid taxes in advance, you pay them back for that portion of time that you own the property. If you are getting a new loan that has a tax impound account, the lender may also require that you pay one or two month’s worth of taxes up front to get the account started. (This account pays your taxes for you each year.)

If you don’t have an impound account, the lender will undoubtedly want you to pay for a service that will report any time you fail to pay your taxes. This is so the lender can then step in, pay them, and then foreclose on you! The fee is usually around $25 to $50. And there’s no getting out of it!

Why Do I Have to Pay Mortgage Fees? If you get a new mortgage, you’re going to have to pay closing fees on it. These usually compose the largest part of the closing costs. Often the costs of closing the mortgage can come to as much as 4 or 5 percent or more of the total purchase price. Here are some of the fees and what they represent:

Mortgage Closing Costs Fees

Checklist  Assumption Fee If you’re assuming an existing mortgage, you will undoubtedly have to pay a fee. It’s typically in the $100 or less range. However, most loans today are not assumable.  Document Preparation Fee Agarbage fee paid to the lender for preparing the loan documents. Since the lender is making the loan and since it takes only a few taps on a computer keyboard to spit out the documents, in this author’s opinion it’s absurd to charge a high fee for it.  Points A point is equal to 1 percent of the mortgage. If the mortgage is for $100,000, 2 points is equal to $2000. Lenders charge points for a variety of reasons, usually to offset a lower-than-market interest rate that you may be getting. The amount of points you pay varies according to the market. I’ve seen points as high as 10 and as low as zero. Be sure you shop around before you secure financing from the lender offering the lowest points. (See Article 5.) The points you pay to get a home loan may be considered interest and may be deductible from your annual income tax. The rule for this, however, seems to change frequently, so check with your tax accountant to see how much, if any, may be deductible.  Loan Fee The loan fee is an up-front charge in addition to points. Many lenders, for example, will charge “2 points plus $600.” The $600 is the loan fee and usually goes to cover such work as preparing documents and funding the money. Of course, it’s preposterous to pay points as well as a loan fee and a document preparation fee. A good lender will not charge these, or will charge only a minimal loan fee. All the costs should be up front, where you can clearly see them.  Account Setup Fee Some lenders may charge you to set up the payback account, the little payment article or monthly invoices you’ll get when you pay. This is another garbage fee.

Impound Account and Setup/Service Fee Some loans require you to pay one-twelfth of your taxes and insurance each month. “Impound” simply means the holding of tax and insurance money for you (and then paying it out appropriately). Recent legislation has required lenders to be more scrupulous as to how they handle impound accounts and to demand only a minimum amount of money, usually no more than a month or two, for the account. Some lenders, however, will charge you for setting up this account. Again, to my way of thinking, this is a ridiculous charge.  Attorney Fee If it’s your attorney, then of course you will need to pay the fee. On the other hand, if it’s the lender’s attorney for checking over the mortgage documents and the transaction, it’s probably another garbage fee. Unless the deal is unusual in some way, the lender should have attorneys on staff virtually all do who automatically check documents and deals. It should be part of the lending service, not a separate charge.  Collection Setup Fee A collection setup fee is usually charged if part of the property is a rental and rents need to be collected and paid directly to the lender, or if your payment is going to be paid directly out of your paycheck or checking account to the lender. This fee is atypical and shouldn’t appear unless the lender discusses special circumstances with you in advance.  Recording Fees The escrow company charges fees for recording documents. They are usually under $25 apiece. It’s a garbage fee if the lender wants to charge you a second time for the same fee.  Lender’s Escrow The lender may insist on a separate escrow for the mortgage. If so, this is the fee. Ask in advance and go with a different lender if it is exorbitant.  Lender’s Title Insurance The lender may require a more comprehensive policy of title insurance called an ALTA. If so, this is the charge.  Additional charges that lenders throw in. They can be very creative.

There are lots of title insurance companies. Sometimes the agent will prefer a specific company. That may be because the title company is giving them perks or because the real estate agency owns the title company. (Perks might be something as innocuous as free stationery.) The relationship between the title company and the agent should be disclosed to you and you should be given the option of going elsewhere. Since for practical purposes one title company is usually as good as another, it really shouldn’t matter to you except in the case of fees. If one title company is cheaper than another, I would insist on the cheaper company. You must do this at the time escrow is opened.

Usually the party (buyer or seller) who pays for the escrow and title insurance is determined by custom in the particular area. Sometimes it is customary to split these costs with the seller. Other times, either the seller or the buyer pays all of them. You will be pressured to follow custom for your area. You don’t have to, however. Remember, virtually everything is negotiable in real estate. As part of the escrow charges there may also be other prorations of interest, taxes, rents, and insurance. Just be sure that you’re paying only your fair share. Check with your agent, attorney, or accountant if you’re not sure. Items typically are prorated at the close of escrow. However, if you are not getting possession of the property until a later date, then it’s unfair for you to have to pay interest, insurance, and taxes until that date. If you’re taking possession later than the close of escrow, be sure that prorations are made as of that later date.

How Do I Avoid Garbage Fees? There are two ways, both of which have already been suggested. First, know what the costs and fees should be. If you can’t recognize a garbage fee, how can you challenge it? Second, demand that all garbage fees be eliminated or at the least reduced. However, you must do this at the opening of escrow. If you wait until the deal is ready to close to try to make changes, you could endanger your loan, which could mean no deal and a very angry seller. If the lender won’t dismiss garbage charges when you bring them up at the time of applying for a loan, get a different lender. There are no shortages of lenders in the country.

Remember, everything in real estate is negotiable! That includes closing costs. To have the seller pay yours, make it a contingency of the purchase. If the seller doesn’t pay, you don’t buy. The trick, of course, is getting the seller to go along. In a strong market, sellers will simply show your agent (who’s presenting the deal) to the door. They won’t consider it. In a weak market, however, where the sellers have been trying unsuccessfully to get out of their house for six months, it may work. The key is to find a seller who’s highly motivated to sell. If you’re the only buyer to come by in a long while, you may get them to pay your closing costs. Other considerations are when you’re giving that seller a better price than he or she anticipated, or better terms. In a trade-off, the seller might consider paying your closing costs.

Remember, the closing costs are cash. However, sometimes they can be financed. You offer the seller a good price (assuming the property appraises out) and get a big

loan, sometimes for the full value of the home (see Article 4). In return, the seller pays your cash closing costs. Of course, some buyers who are very tough negotiators argue for it all good price, good terms, and seller pays closing costs! As I said, in a bad market where houses just aren’t selling, sometimes desperate sellers will agree.

Finally, it may be possible to wrap the closing costs into the mortgage. Many lenders these days offer “no cost” mortgages. You could opt for one. A“no cost” mortgage is a misnomer. There are costs. It’s just that they are hidden. For example, I recently obtained such a mortgage. At closing, the lender paid all of my NRCC (nonrecurring closing costs), which included title, escrow, and lender’s fees. (It did not, of course, pay my recurring costs such as prorations and hazard insurance.) In exchange for doing this, the lender increased the interest rate, by 3/8 of a percent. I had a choice. I could pay the closing costs in cash. Or I could pay a slightly higher interest rate (and slightly higher monthly payment) and have no NRCC. Other lenders will roll the closing costs into the mortgage. In other words, they will give you the same interest rate, but you’ll end up owing more. The closing costs will be added to the mortgage. Either way, it’s an effective method of reducing the amount of cash you have to come up with at closing. Just remember that the downside is either a higher interest rate or a bigger loan, both of which usually translate into slightly higher monthly payments. Closing costs are the bane of real estate transactions. To avoid a bad surprise late in the deal, be sure to get good estimates of what they are. For more information on closing costs and “garbage fees” check into, The Homebuyer’s Closing Checklist, McGraw-Hill, 2003.

A recent buzzword in real estate is “flipping.” It essentially means selling a property as soon as you buy it. In some cases, even before you buy it! I’m sure that if you’ve heard the term, you’ve wondered if you, too, could do this. The answer is, yes, you can. But, and it’s a BIG BUT, you have to find a property that will work as a “flipper.” What works as a flipper? Simple any property that you can buy below market value. If you can find a property that’s selling for less than it’s worth (hopefully far less), you may be able to quickly flip it resell it to someone else. And pocket the difference, usually in cash. Thus you would have a choice buy it and move in yourself. Or do a rapid resale.

Don’t think that because of the all the hype surrounding the big tax exclusion on homes, you won’t have taxes on a flip. You almost certainly will. Remember, you must have lived in the home as your personal residence two out five years to get the up to $250,000 per person exclusion. You probably won’t even get a capital gains tax rate because you won’t have owned the property for at least a year. Check with your accountant.