Closing Costs and Lender Credits

There is a simple way to calculate closing costs without learning to interpret a loan estimate. If you remember that closing costs, aside from what is in section A of the LE’s page two, will be similar from lender to lender, then your only task if figuring out lenders fees. Although lenders can estimate higher or lower third-party fees than another, those fees are not lender fees and are not something you can negotiate with a lender. There are four categories you can account for when you are trying to estimate closing costs and how much cash you need for closing. This breakdown can be used for home purchase loans, refinances and cash-out home equity loans. The four categories are down payment, lender fees, third-party fees, and escrow deposit. Calculating the cash needed for closing can help you budget for your home purchase or help you get an understanding of how much you will need if you are requesting down payment assistance. 

The amount of down payment needed is usually where homebuyers start the homebuying process. However, this will cover how to calculate the cash needed for closing, and a simple way to compare mortgage lenders. To calculate down payment, multiply the purchase price you are requesting by the percentage of down payment you plan on leaving on the home loan. If you plan on buying a $500,000 home on a conventional loan with a 3% down payment, then this is the calculation you would use - $500,000 x 0.03 = $15,000. This is the amount you will bring to closing and the amount of home equity you should have on the first day you own your home – assuming you paid market value for the home. Talk to your loan officer if you plan on requesting down payment assistance. You can skip this step if you are shopping for a refinance loan or cash-out home equity loan. 

This is the amount that you should be using to compare lenders when you are shopping for the best mortgage lender. Don’t forget, you still need to compare APR and APY. You can always check current market rates without impacting your credit. Section A of the loan estimate is where you will find lender fees. These fees are specific from lender to lender and can vary by thousands of dollars. The fees you might see are origination fee, underwriting fee, processing fee, administration fee, etc. If you understand each fee, then you are better equipped to negotiate the lowest cost home loan.

Origination Fee

Most lenders do not charge an origination fee. It is common to see an origination fee if you are working with a commission loan officer. In this case, the origination fee is the fee you are paying to the loan officer for assisting you with the loan. Since the loan officer spent the time and effort originating the loan for the lender, the origination fee is their compensation. It is likely you can negotiate a lower origination fee or no origination fee if you see this in section A of the LE. This is important because 1% origination fee can cost you thousands of dollars, and the origination fee does not help you get a lower rate like discount points do.

Discount Points

Discount points are different than an origination fee. Also known as a rate buydown, buydown, or points, discount points are meant to reduce your interest rate. Important: retail lenders use discount points to offer rates that compete with wholesale mortgage brokers. Wholesale mortgage brokers can offer lower rates without discount points. In general, each discount point could reduce your rate by .25%. This is not an exact formula. Talk to a licensed mortgage loan officer to get exact information about how much a discount point will reduce your rate. One discount point is equal to 1% of your loan amount. Paying a discount point to reduce your rate is an effective way to save money over the life of your loan. Again, talk to your state licensed loan officer about the benefits of discount points based on your specific goals, and about the breakeven timeframe to ensure you will see the overall savings. 

Miscellaneous Fees

Other fees that can be found in section A are miscellaneous fees such as processing fee, administrative fee, underwriting fee, etc. Regardless of the fee’s name, it is normal to see these types of fees in section A. However, the sum of these fees, on average, is approximately $995. Most lenders have an underwriting fee. An underwriting fee can be waived. Though the underwriting fee waiver is usually a trade-off for a slightly higher rate. Processing fees are usually added on to your closing costs if your mortgage lender does not have an in-house processor. 

Third-party fees account for all services necessary to underwrite your mortgage loan. Examples are an appraisal, a tax certificate, title search, title insurance, title endorsements, credit reports, government recording of deed and mortgage, and survey. It may seem like a lot, but some of these fees might be paid by other parties involved in your home loan through closing cost credits. Although some of these fees are from services you can shop for, most of these fees on the loan estimate will not vary much from lender to lender. And they are likely to fall within the cumulative tolerance category. This means they could be slightly overestimated to avoid cost-to-cure fees. 

This is a very important part of calculating closing cost for two reasons. First, although they are categorized as a closing cost, escrow fees are items you would pay for whether or not you financed your home or paid in cash. Second, adding escrow to your monthly payment can be optional. Therefore, waiving escrow would eliminate this cost. Furthermore, if you paid the loan off at any point, your escrow account balance would be refunded to you directly. This is a common occurrence with refinance mortgages. 

There are three parts to escrow fees. The first is your homeowner insurance binder. Your processor might refer to it as your HOI binder. This is the proof that you will have adequate homeowner’s insurance on the day you sign for your loan. Your insurance agent will usually request that you pay the entire year’s premium up-front in order to start the policy. You can pay it when you get the quote, but most homebuyers pay it at closing, therefore it adds to the amount of cash needed for closing. Talk to your insurance company about policy payment options. 

Second, although you pay an entire year to start your HOI policy, you will be required to deposit approximately two more months’ worth of HOI premium to start your escrow account because you will not have a mortgage payment for at least 30-days after you close. Therefore, you will need to have enough funds in your escrow account next year to cover an entire 12 months of HOI. If you did not leave a two-month deposit, then you will likely be short two months when your HOI renews the following year due to the delay in the first mortgage payment due date. 

The third part of your escrow fees is the property tax deposit. Although you are only responsible for the portion of property tax from the day you close on the home to the end of the year, there will be a gap between your closing date and your first mortgage payment. Therefore, you will likely need about three months’ worth of property taxes deposited into your escrow account to ensure your tax bill is not short. If you purchase towards the end of the year you might see a huge tax deposit into escrow. Do not panic, you will see a seller credit to cover the portion of taxes owed prior to your closing date.