Many buyers are confused when it comes to closing costs, pre-paids, and cash to close. What’s the difference between these three terms? In buyers’ defense, real estate is confusing, even to the experts. Thus, any first time buyer would be confused when it comes to the overwhelming terms there are to learn and understand. Read on to find out the differences between the three terms, and why they apply to you while you are searching for your new home!
Closing Costs are fees paid to the many people who work on your loan in all its varied aspects, from your processor and underwriter, to third parties such as the person who completes your home’s appraisal. Closing costs are typically paid by the buyer. Oftentimes, however, costs are divided between the buyer, seller, and at times even the lender in the form of a lender credit. Your realtor can help you if you wish to negotiate closing costs when making an offer or counteroffer to the seller. Be sure to turn specifically to a loan officer if you are confused about what is involved in obtaining a lender credit that goes towards closing costs.
As the term suggests, you are paying in advance for something. At some point in your life, you’ve probably been asked to pay in advance for a service. For example, most cable providers require payment in advance for the next month of usage. Your car insurance premiums are paid in advance. If you need an attorney, you may be asked to pay a retainer for their services. Basically…you prepaid for something you were going to be using later.
Prepaids are not a fee, as such, but are costs associated with your home that need to be paid in advance when getting a loan. These include property taxes, homeowner’s insurance, and mortgage interest that will accrue between the closing date and month-end. Property taxes and homeowner’s insurance are collected to put into your escrow account so that you have enough reserves to pay these bills then they are due.
Whereas rent is usually paid a month in advance, your monthly mortgage payment is paid differently. Say your loan closes on September 15th, your first mortgage payment will be due on June 1st. This may seem as if October is a free or skipped payment but, sadly, it is not. That’s because the November payment will pay the interest for May, and the amount due for the period between September 15th and 31st will already have been paid by you, the borrower, at closing.
Mortgage interest, real estate taxes, homeowner’s insurance, hazard insurance, private mortgage insurance, and any special assessments (usually related to real estate taxes) are the most common items you’ll see listed as prepaids. In order to create an escrow account, your lender needs money to place in the account.
At closing, you’ll be asked to pay a portion of your taxes and insurance, including private mortgage insurance if applicable, as prepaids for this purpose. Depending on when you close, you may not have a payment due for another 30-45 days which would delay your lender being able to fully set up your account in their system. Including a portion of these items in your closing allows them to have your account ready for future deposits and disbursements before your first payment is made.
Cash to Close
Cash to close is, basically, a combination of any closing costs covered by the buyer; all applicable pre-paid monies; and your down payment amount, minus your earnest money deposit. Cash to close is paid by wire fund or a cashier’s check made out to the escrow company. You will be informed of the exact amount needed prior to signing your final loan papers at the escrow office.
Obtaining a mortgage loan incurs a list of expenses that must be paid at closing. Expenses associated with a new mortgage include an application fee, a loan origination fee and loan discount points. Other costs include title insurance and appraisal and inspection fees. Certain lending sources have their own fees or upfront insurance costs. The government sponsored mortgage programs from the FHA, VA and Rural Housing Service have fees or insurance premium that could be included in the cash required at closing.
Your initial loan disclosures include a good faith estimate that details the closing costs on your loan. These are estimates. Before closing, your mortgage’s settlement statement will enumerate the final costs on your loan. Call the lender the day before closing to get the exact amount of the cash to close, so a check can be drawn for the correct amount.