As a soon to be homeowner, you’re doing your research on what fess expect for the home loan. You know about closing costs but there’s a separate but related cost that many first time home buyers are completely unaware of. Being unprepared for these other costs is upsetting, to say the least. At worst, it can ruin your ability to secure the mortgage, but we’re not going to let that happen to you.
In this video, I break down the other costs related to your home loan so you can be fully prepared for what’s in store.
TRANSCRIPT:
How much are closing costs on a home loan? Most of us have heard that closing costs are between 1 and 3% of the purchase price, so that’s what new home buyers expect. But then they get into escrow, see the Loan Estimate and lose their minds because the costs exceed 3% of the purchase price.
This video will attempt to preempt your Loan Estimate shock and help you avoid disappointment. Let me backup for just a second so I can explain what a Loan Estimate is. It’s the standard document, used by all lenders, that breaks down all the costs you’ll be expected to cover in order to secure your home loan. It lists the Closing Costs, which are lender fees, the cost of your appraisal, and all the title and escrow fees.
These usually add up to that range of 1-3% that people are expecting. But then on the right side of the Loan Estimate is a column called Other Costs, which are very confusing. So then when people look at the bottom right corner where it says Cash to Close, which is the amount of money that you have to bring to close the loan, people are shocked to see an amount much higher than 3% of the purchase price.
Other Costs are confusing because they’re not closing costs but they are listed on the Loan Estimate since they are associated with the close of your loan. I realize that sounds super confusing so please let me explain. These costs are associated with the close of your loan because they occur at the same time but they are not costs of getting the loan. Often these costs are things you’d be paying even if you didn’t have a loan.
For instance, you’re going to pre-pay the first year of your homeowner’s insurance to get a home loan. But most people would have a homeowner’s insurance policy even if they didn’t have a loan and they purchased their home in cash, so it’s not really a cost of getting a loan, for most homeowners it’s the cost of homeownership.
Same goes for property taxes, you’d have to pay those if you didn’t have a home loan but they’re listed in Other Costs because you need to pay some money up front to begin the escrow account that the lender uses to pay the taxes when they’re due. The lender will also pay for the homeowner’s policy out of this fund when the renewal is due.
On the Loan Estimate, these are called prepaids, interest, and escrow. Let me further break these down. When you buy a home with a mortgage, you will be required to have homeowner’s insurance and you’ll have to pre-pay that for the year by the time the loan closes. You’ll also have to pre-pay some interest, which covers the day you close the loan to the first day of the next month. Those days or weeks of interest will need to be paid at the close of your loan. You will also have to put some money in an escrow account for your property taxes and homeowner’s insurance.
It’s an escrow account that the lender uses to pay your property taxes and homeowner’s insurance, on time, so that there are no late fees or periods without coverage. How much money you’ll need to put in the fund depends on the month that you close your loan in. If your loan closes shortly before property taxes are due, you’re going to have to put more in than if they’re not due for another six months.
This is actually something to look out for when you are shopping for lenders. This section of the Loan Estimate is a place that some brokers and loan officers use to try and appear more competitive ie. less expensive than others. They will enter a 1 for 1 month of pre-paids, even though you will need to put in more than 1 month. But by putting in just one month, it makes the total closing costs appear lower than they really are. Tricky tricky, but now you know the truth about pre-paids and initial escrow deposits.
Lots of people ask if you have to put money into an escrow account for property taxes and homeowner’s insurance or if you can pay the taxes and insurance yourself directly. The answer is it depends. Some loan programs do require that you impound taxes and insurance and sometimes lenders give you a slightly better interest rate to incentivize you to include taxes and insurance in your monthly payment. Sometimes it’s totally up to you but if you’re a first time home buyer, it’s usually recommended to have this escrow account so go ahead and plan to save up just a little more to cover these “other costs”.
If you’re shopping for a loan officer who’ll be honest with you about closing costs, other costs and all the costs, please reach out to see if I can help. I’ll catch you soon.
