Buying housing represents the largest outlay of funds over most people’s lifetime. Some of these costs occur up-front. The largest of these is usually the down payment. Others, such as the mortgage payment, occur monthly. A few items, such as real estate property taxes, require both an initial outlay and recurring monthly payments. Table 9.1 illustrates these outlays for the purchase of a $185,000 home with $25,000 down financed by a 30-year mortgage at 6.5 percent interest.
Most Up-Front Costs Are Due at the Closing
First-time home buyers are often surprised by the high initial costs of buying a home. These costs include the down payment and closing costs. Closing costs include fees and charges other than the down payment and may vary from 2 to 10 percent of the mortgage loan amount. The down payment and closing costs must be paid at a meeting called the closing at which ownership of the property is transferred. All the parties to the purchase, sale, and the mortgage loan are represented at the closing. Up-front costs are indicated in green in Table 9.1.
The Down Payment
Most Up-Front Costs Are Due at the Closing
First-time home buyers are often surprised by the high initial costs of buying a home. These costs include the down payment and closing costs. Closing costs include fees and charges other than the down payment and may vary from 2 to 10 percent of the mortgage loan amount. The down payment and closing costs must be paid at a meeting called the closing at which ownership of the property is transferred. All the parties to the purchase, sale, and the mortgage loan are represented at the closing. Up-front costs are indicated in green in Table 9.1.
The Down Payment
The down payment on a home is simply the portion of the purchase price that is not borrowed. The buyer actually writes a check to the seller for that amount. In this example, we assume that the prospective homeowner has $25,000 to use as a down payment on a $185,000 home and will, thus, need to borrow $160,000.
Points A point (or interest point) is a fee equal to 1 percent of the total loan amount. Any charges for points must be paid in full when the home is bought, although sometimes they can be added to the amount borrowed. Lenders use points to increase their returns on loans. For example, a lender might advertise a loan as having an interest rate 0.25 percentage point below prevailing rates but then charge 1 point. Any points are, in effect, prepaid interest and compensate the lender for having a low interest rate. In our example, the lender charged 2 points on the $160,000 loan, resulting in a charge of $3200. By law, interest points must be included when calculating the APR for the loan. Interest points are deductible on federal income tax returns.
Points A point (or interest point) is a fee equal to 1 percent of the total loan amount. Any charges for points must be paid in full when the home is bought, although sometimes they can be added to the amount borrowed. Lenders use points to increase their returns on loans. For example, a lender might advertise a loan as having an interest rate 0.25 percentage point below prevailing rates but then charge 1 point. Any points are, in effect, prepaid interest and compensate the lender for having a low interest rate. In our example, the lender charged 2 points on the $160,000 loan, resulting in a charge of $3200. By law, interest points must be included when calculating the APR for the loan. Interest points are deductible on federal income tax returns.
Attorney Fees
Home buyers should hire an attorney to review documents and advise and represent them prior to and during closing. Attorney fees commonly amount to 0.5 percent of the purchase price of the home, although some attorneys do this work for a flat fee ($500 in our example).
Title Search and Insurance
The title to real property is the legal right of ownership interest. In real estate transactions, the title is transferred to a new owner through a deed, which is a written document used to convey real estate ownership. Four types of deeds are used:
Title Search and Insurance
The title to real property is the legal right of ownership interest. In real estate transactions, the title is transferred to a new owner through a deed, which is a written document used to convey real estate ownership. Four types of deeds are used:
- A warranty deed is the safest, as it guarantees that the title is free of any previous mortgages.
- A special warranty deed guarantees only that the current owner has not placed any mortgage encumbrances on the title.
- A quitclaim deed transfers whatever title the current owner had in the property with no guarantee.
- A deed of bargain and sale conveys title with or without a guarantee that the seller had an ownership interest.
A title search and the purchase of title insurance protect the buyer’s title to the property. Your attorney or title company will conduct a title search by inspecting court records and prepare a detailed written history of property ownership called an abstract. The seller normally pays the fees for this process ($200 in our example). Lenders often require buyers to purchase title insurance because it protects the lender’s interest if the title is later found faulty. Premiums for title policies vary among title companies. The one-time charge at closing may amount to 0.20 percent of the amount of the loan for each policy [$320 ($160,000 0.002) in our example]. Homeowners who wish to insure their own interest must purchase a separate title insurance policy(another $320 in our example).
Miscellaneous Fees
When a prospective mortgage borrower applies for a loan, the lender may charge a loan origination fee at the closing to process the loan ($800 or half of a point in our example). In addition, credit reports ($75 in our example) are needed before a home buyer can obtain a loan and the borrower pays the fee for this report as well. Another important up-front cost is the home inspection ($400 in our example) conducted to ensure that the home is physically sound and that all operating systems are in proper order. Title and deed recording fees ($250 in our example) are charged to transfer ownership documents in the county courthouse. An appraisal fee ($250 in our example) may be required to obtain a professionally prepared estimate of the fair market value of the property by an objective party. If you are charged an appraisal fee, you have the right to receive a copy of the appraisal. Occasionally, termite and radon inspections ($130 in our example) are required by local laws but are a good idea even when not required. A survey ($100 in our example) is sometimes required to certify the specific boundaries of the lot. Finally, separate notary fees ($150 in our example) may be charged for the services of those legally qualified to certify (or notarize) signatures.
Miscellaneous Fees
When a prospective mortgage borrower applies for a loan, the lender may charge a loan origination fee at the closing to process the loan ($800 or half of a point in our example). In addition, credit reports ($75 in our example) are needed before a home buyer can obtain a loan and the borrower pays the fee for this report as well. Another important up-front cost is the home inspection ($400 in our example) conducted to ensure that the home is physically sound and that all operating systems are in proper order. Title and deed recording fees ($250 in our example) are charged to transfer ownership documents in the county courthouse. An appraisal fee ($250 in our example) may be required to obtain a professionally prepared estimate of the fair market value of the property by an objective party. If you are charged an appraisal fee, you have the right to receive a copy of the appraisal. Occasionally, termite and radon inspections ($130 in our example) are required by local laws but are a good idea even when not required. A survey ($100 in our example) is sometimes required to certify the specific boundaries of the lot. Finally, separate notary fees ($150 in our example) may be charged for the services of those legally qualified to certify (or notarize) signatures.
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