How much are the closing costs going to be?

by Barry L. Thompson, Esq.

The very first question almost always asked of us when speaking to a real estate client, even if the actual closing is several weeks away, is "How much are the closing costs going to be?" This seemingly simple question is far more complex in the real estate closing situation than the generic question that we all often ask, "How much does it cost?" The reason for the difficulty is the confusion over what exactly is included in the term "closing costs." It appears to mean different things to different people, that is, does it include every expense required to be paid by the purchaser in order for them to leave the transaction clutching a set of house keys, or is it only those items which are truly "costs?"

Some items commonly referred to as "adjustments" change depending upon the day the closing actually occurs, making it impossible to predict their amounts unless the closing date has been set. This method of reconciling the expenses between the parties has evolved to insure that each party only pays the expenses of ownership for those days that they each actually own the property. Items such as real estate taxes, water and sewer bills, condominium common charges, and rental payments fall into this category. The buyer and the seller are responsible for these "adjustments," as opposed to requesting a final bill from the municipality. Municipal governments do not wish to be involved in the mundane and time-consuming practice of generating individual partial bills each time a piece of property changes hands. The municipalities require that the owner, whoever it may be, pay the real estate taxes every January and July, and of course just to keep things interesting some towns in Connecticut require real estate taxes to be paid in total every July. Some towns will give a final bill for water and some will not. Some towns even have more than one separate taxing district!

These "adjustments" are not real costs, but rather they are advance payments of a portion of the future expense of owning a home but they do count when adding up the amount of money the purchaser needs to bring to the closing. Similarly, lenders often require that some of these future expenses be placed in "escrow accounts" (not "escarole accounts") to insure that those funds are available for immediate payment when they become due. Typical items placed in escrow accounts are future real estate taxes and homeowner’s insurance premiums. These amounts are often based on the number of months between the date of the closing and when the payment is due in the future. For that reason the amount put in escrow for real estate taxes may be the equivalent of anywhere from one to seven months of the real estate taxes. In fact, the month in which the closing occurs may cause a swing of hundreds, if not thousands of dollars. Of course all of these distinctions between advance payments of future expenses versus real costs are not often understood by the buyer who is told the day before the closing to bring two thousand dollars more than he originally anticipated.

Another block of real estate closing expenses come from the lender’s side of the ledger, including prepaid interest, inspection fees, application fees, title insurance, flood certification fees, points, appraisal fees, credit report fees, and mortgage insurance, to name a few. Prepaid interest is often the culprit when a buyer is surprised by the amount of money he is required to bring to the closing. This amount can swing dramatically if the closing occurs even one day later than originally anticipated. Here is what happens:

If a closing occurs on September 30, the buyer will only be required to pay one day’s worth of prepaid interest - roughly 1/30th of his principal and interest payment. His first mortgage payment will be due November 1, only about four weeks away. However, if the closing occurs on October 1, the buyer will be required to pay thirty days of prepaid interest at the closing, which is just about equivalent to an entire month’s principal and interest payment. His first mortgage payment will not be due until December 1, some eight weeks away. Lenders are due interest for every day you borrow their money so there really is not any increased cost to closing at the beginning of the month. The only difference is WHEN you need to come up with the money, but that can be an important difference.

It is extremely difficult to accurately estimate all of the "closing costs" at an early stage of the closing process because of the many variables associated with a real estate closing, but a buyer should be able to get a good handle on the largest of the closing costs early in the process by calculating mortgage expenses and points, title insurance, and legal fees. Points vary from lender to lender and from mortgage to mortgage. Generally the greater the number of points paid, the lower the annual interest rate on the mortgage loan. The borrower can determine the points payable during the mortgage application process - one point is equal to one percent of the mortgage amount, thus one point on a $140,000.00 mortgage equals $1,400.00. Occasionally fees are charged to guarantee interest rates for a fixed length of time. This is called a "rate lock." Title insurance is based on a fixed rate per thousand on title insurance coverage and all title insurance companies in Connecticut charge the same premiums.

Finally, as to legal fees, once you have explained the details of the transaction (when, where, new construction versus existing home, lender or personal representation or both) to your attorney, he or she should be able to provide you with a firm legal fee estimate. The vast majority of closings are routine, smooth, and pleasant happenings. If you ask questions, prepare, and do the math in advance your closing should not contain any large unpleasant financial surprises.

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