It's common knowledge that when you buy a home you'll need to produce a down payment. However, fewer people know about closing costs.
When you start your rent to own journey, they're an important factor for you to plan for so that you can afford to purchase a home at the end of your lease.
What Are Closing Costs?
Closing costs are a broad term that encompasses all of the fees that anyone pays at closing for a home.
The seller pays some of these fees, like real estate agent commission. The commission comes out of the purchase price of the home. Typically, the buyer's agent gets 3 percent and the seller's agent gets 3 percent of the home's cost. The seller also needs to pay homeowners association transfer fees, which pays for the HOA to produce documents that prove the seller is up to date on monthly HOA payments.
Other's will fall into the buyer's lap. These include fees from the lender, the title agency, inspections, taxes and insurance.
Application Fee or Underwriting Fee
Some lenders will charge you to process your application. This is the kind of fee you should try to negotiate your way out of. Not all lenders will charge them. You should avoid lenders that do unless this lender is giving you a better rate that outweighs the money you're putting in for this fee.
Appraisal Fees
It's not likely you will find a way around this fee. Lenders require appraisals to ensure that the property is worth what they're helping you pay for. That way, if you ever foreclose on the home, they'll have a way to recoup what they put into it.
Attorney's Fees
Some states require you to have an attorney review the contract on your behalf before you close. This is helpful to you because they will make sure that the deal is fair, but it can be pricey. Regardless, of whether it's required, having an attorney review your contract will cost you.
Closing or Escrow Fee
Independent companies and attorneys charge these fees for overseeing the closing of the deal.
Property Tax and Mortgage Insurance
Your lender may ask you to put down the next two months worth of property taxes and mortgage insurance at closing. Namely, because they want to make sure they have the funds to cover all necessary payments between the date of closing and your first mortgage payment. Taxes are typically bundled in with your mortgage payment and the bank takes responsibility for handling them.
When writing your purchase contract, you WANT the seller to prorate taxes (i.e. pay for the time they were in ownership of the property). Otherwise, you may get stuck with paying for the entire year's taxes come April.
Note: If you give a down payment of 20 percent or more, you're no longer responsible for paying mortgage insurance (PMI).
FHA Up Front Mortgage Insurance Premium
If you chose an FHA loan, you will need to pay for an up-front mortgage insurance premium. This is 1.75 percent of the base loan amount.
You can either pay this amount up front or roll it up into your monthly payments, which allows you to pay the money over the next 30 years instead of coming up with it all along with your down payment.
Flood Determination or Life of Loan Coverage
This fee is to determine whether your property is in a flood zone. If they determine that your property is within a flood zone, you'll need to pay an additional amount of insurance each month.
Homeowner's Insurance
Homeowner's insurance covers damages incurred to your property. You typically pay the first year's insurance at closing.
Some lenders require you to pay insurance as part of your mortgage. The insurance protects their investment. They want you to have the money to keep your property in pristine condition so that it doesn't lose its value in case of foreclosure.
If you live in an apartment building, HOAs typically have insurance to cover everything in the building outside of the individual units. Find out if you truly need to have homeowners insurance before purchasing it. Often times homeowners insurance isn't worth it in apartments because the minimal damages that can occur within them will not meet the deductibles set by the insurance company.
Lender's Policy Title Insurance
This insurance ensures that the bank's claim to your property in the case that you don't pay your mortgage is valid and of greater importance than any other claims or liens that may be made against your property.
Lead-Based Paint Inspection Fee
You need to pay every inspector that comes through the property. This inspector evaluates what risk (if any) lead-based paint in a unit poses to those who live there.
Loan Discount Points
You earn loan discount points when you prepay your interest in favor of having a lower monthly payment for the entirety of the mortgage. For every loan discount point you earn, you've paid 1 percent of the mortgage.
Owner's Policy Title Insurance
This is an optional type of insurance that protects you in case someone challenges your title to the property.
Origination Fees
Origination fees cover the lender's cost in processing your mortgage. Not all lenders charge origination fees.
Note: This fee is different from an origination fee because, when a lender charges an application fee, you pay whether you're approved for the mortgage or not. The origination fee comes into play when you've been approved for a mortgage and the lender actually goes through with lending you the money.
Pest Inspection Fee
Government loans and private lenders, in some states, require you to have your unit inspected for termites and dry rot. This fee pays for the inspector to check the property.
Lenders that require it do so because damages from termites and dry rot can be expensive. Paying for these types of repairs can cause the buyer financial strain that could make it difficult to pay the mortgage.
You may want to get one of these inspections done even if your lender does not require it. Taking care of dry rot and termites could be more expensive than this particular property is actually worth to you.
Lenders ask for these inspections because if termites or dry rot is found, they may not approve the loan.
Prepaid Interest
Some lenders will ask that you pay at closing for the interest that will build up between the day that you close and the day of your first mortgage payment.
Recording Fees or Transfer Taxes
Your city or county recording office charges recording fees/transfer taxes to pay for the cost of modifying public land records.
Survey Fee
This fee covers payment to a surveying company that comes to verify your properties lines. You shouldn't have to pay this fee when you're purchasing an apartment because where your property ends is pretty self-explanatory.
For homes, surveyors can clarify whether the fence bordering you and your neighbor's property belongs to you or to them. Not all states require this type of inspection, but it is an option for anyone looking to have complete information about their land.
Title Company Title Search or Exam Fee
You pay this fee to the title company to ensure that once you purchase the property, you will actually have a claim to it. They are making sure that the seller of the property actually has the right to sell it to you.
It makes sense to pay the title company to do a search of the properties records so that you don't end up with someone else claiming ownership.
VA Funding Fee
If you're getting a loan backed by the Department of Veterans Affairs they may ask you to pay a fee at closing that helps the VA to fund the program. Some people choose to incorporate this fee throughout the length of the mortgage instead.
Depending on the extent of your service and the size of your down payment, the VA will assign the percentage of your loan that you will need to pay. Some may be exempt from this fee altogether.