Posted On: January 21st, 2020 5:54PM
The Mystery of the Closing Costs…..
So you are looking for a home and after touring what feels like every home on the market, you have finally found the perfect home. TIME TO MAKE AN OFFER! NOW WHAT?
There is a good chance that you have found yourself watching one of the many real estate themed reality shows that saturate cable these days, and most of them are pretty entertaining. You can learn a bit about the home buying process, but the serious details don’t really make for good TV, so, although they give you the headlines, they tend to skip the story. One big story is the infamous closing costs. What are they? Who pays them? Am I getting a better deal when the seller pays the closing costs? You’ve no doubt made a lot of purchases in your life, and they have all probably gone pretty much the same way. Someone identifies what they want for an item or a service, you agree to that amount or maybe negotiate for a better price, you pay them, you get the item or the service and everyone goes home happy. Seems like buying a home should be about the same thing, right?
The home is going to cost you more than the negotiated price. For example, if you buy a home for $100,000.00, the amount you pay out of pocket might actually be $103,000.00 or more!
WAIT! WHAT?! HOW IS THAT POSSIBLE?
The simple answer is that there are costs associated with the home buying process. Someone has to research the title for you to make sure that you will own that home and that there are no hidden liens or other issues that might transfer to you upon purchase. There’s title insurance, deed preparation, and the fee to record your new deed. There are costs associated with the loan. Some of them are the fees you pay for the opportunity to get a loan like the application fee. Others are items that help the lender qualify your property for the loan like the appraisal and survey fees. Still others are costs that the lender collects from you on your behalf like the property insurance. Then there are charges that are used to fund the escrow account so that when the time comes, there is enough money to cover things like next property tax bill and the following year’s homeowner’s insurance policy cost. These are your property taxes and your homeowner’s policy, but the bank makes these payments for you using money that they
collect from you each month as part of your payment. They are also part of your closing costs! All of these things and a few more make up the basket that we collectively call Closing Costs. So, even though you have been working hard to save your down payment, you still need some way to pay for the costs that are associated with getting your loan, etc. Most Buyers have no idea that they will need even more money, and have no way to raise the money to cover these costs.
GUESS WE CAN’T BUY A HOME AFTER ALL, RIGHT? WRONG AGAIN!
Although you can’t casually add the cost of, say, a new car, to your home loan, the lender will allow you to borrow enough to pay the Seller for the home and cover your closing costs! The good news is that you can buy that home now. The bad news is that you have just financed your closing costs over 30 years. Of course since interest rates are really low, it beats the heck out of using a credit card at 22%!
HOW DO WE GO ABOUT THIS?
In order to get your closing costs rolled into the loan, we essentially raise the purchase price by whatever amount we need (up to a maximum of 6%), and then we write into the purchase agreement that the Seller will give us this money back to cover our costs. We say that the Seller is “paying” our closing costs, but really the seller is using our money to do it. By the way, it is really important to understand that when the Seller looks at your offer, he is going to do the math and figure out exactly what he gets after giving you some of the money back. His decision to accept your offer is going to be based on this net number – not the offer amount. For example, let’s say a Seller needs to net $100,000.00 to pay off his home, and let’s also say you have offered him $100,000.00 with 3% back to cover your closing costs. There is a good chance he will reject your offer because he will only net $97,000.00 ($100,000.00 less 3% back to you). He may counter you at $103,000.00 with a flat $3000.00 back for Closing Costs so he still gets his $100,000.00 number, and you get your closing costs covered. There is some risk with artificially raising the purchase price. The home must now appraise for this higher number which may not happen, and the deal will collapse. You would be surprised at how often a home will appraise for just under the offer amount rendering the deal dead in the water. It is also important to estimate the closing costs as accurately as possible. If you are getting an FHA loan, and most of you are, you are not permitted to leave the table with any money. If it turns out that you have asked for more than the total of your closing costs, the extra money goes back in the pocket of the Seller and you are out of luck!