Some banks and mortgage companies like to advertise that their loans have low or no closing costs and will disguise how the borrower will pay for the costs that a new loan requires. The fact of the matter is that it costs money to originate a loan and that cost must ultimately be borne by the borrower. Originating a loan involves dozens of professional and clerical workers spending countless hours, having an untold number of conversations, creating and checking hundreds of typed pages of instructions and documents.
It is the borrower who must ultimately pay the costs of these services. When it comes to paying the closing costs, the borrower has choices. Put simply, it is pay now or pay more later. How long the loan will stay in place will dictate the best method for paying the closing costs. When purchasing a home, the fees can be paid all or in part by the seller or entirely by the borrower from savings or they may be paid in part by the lender in exchange for a higher interest rate which will result in higher payments for the life of the loan. In the case of a refinance and in some purchase transactions, the homeowner may choose to increase his loan amount rather than withdraw money from savings for those fees.
The one-time fees associated with obtaining a mortgage are called non-recurring closing costs. The typical title, escrow and lender fees on a purchase loan of $400,000 are on the order of $3,000 – $4,500 plus the loan origination fee, or points, if any. One point is 1% of the loan amount. The more a borrower is willing to pay in the loan origination points, the lower the interest rate. Conversely, if a borrower accepts a high enough rate, the lender will give a credit back to the borrower that can be used to pay all or some of the closing costs.
The borrower also has recurring closing costs to pay at the close of escrow. Prepaid interest, 12 months of homeowner’s insurance, property taxes plus additional costs to cover an impound account are called recurring closing costs and can be as much or more than the non-recurring closing costs.
For example, a lender might make an offer to pay all of the borrower’s nonrecurring closing costs but offer a rate of, say, 3.00%, which would result in a mortgage payment of $1,686. However, if the borrower is willing to pay the closing costs, his/her rate could drop to, say, 2.75%, which would result in a mortgage payment of $1,633 for a savings of $53 per month. The increase in payments (if the loan is kept for 30 years) would be over $19,000. Compare that to the $4,500 that could have been paid at the time the loan was originated.
If the borrower is only going to keep the loan for a short period, he or she may be better off to accept the slightly higher rate and pay little or no closing costs at the close of escrow. Some lenders have been known to state that their loans have no loan origination fees but then charge the borrower points which is contradictory. These are just some of the reasons a borrower should carefully review the lender’s estimate of their closing costs and be sure they understand the charges. It is best to not rely on advertising but to work with reputable lenders who have been referred to you by someone you trust.
Peter Boutell has been writing this column in the Sentinel since 1995. You may reach him at Peter@SantaCruzHomeFinance.com.