Mortgage Closing Costs

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A mortgage escrow account is an integral part of the financial picture for many homeowners. These accounts are typically used in two ways: to hold an earnest money deposit a buyer puts on a home after signing a contract with the seller (it’s released at the closing), and to pay a homeowner’s property taxes, mortgage insurance and homeowners insurance premiums.

When it comes to the latter, some homebuyers are required by their mortgage lender to have an escrow account; others may opt into one through their mortgage servicer. Here’s how mortgage escrow accounts work, and if you do have a choice, the pros and cons to consider.

How do mortgage escrow accounts work?

Once you become a homeowner, a mortgage escrow account is an account used to hold and ensure that some of the major, ongoing expenses associated with your home are paid on time. Typically these expenses include:

  • Mortgage insurance payments
  • Homeowners insurance premiums
  • Property taxes

Instead of paying insurance and taxes separately, from a personal account, the money to cover these bills — plus a little extra, known as a “cushion” — is included in your total monthly mortgage payment. The mortgage lender or servicer holds these funds in an escrow account and makes the payments on the homeowner’s behalf as they are due. Payments might be made monthly, quarterly or bi-annually.

The key difference between an escrow account and any other financial account you might have: You don’t manage an escrow account yourself. Escrow is facilitated by a third party — in this case, your lender or servicer.

Should you use an escrow account?

Depending on the type of loan and its specifics, you might not have the option to forgo an escrow account. If you’re obtaining a conventional mortgage — that is, one from a private bank or lender — an escrow account is often required with a down payment of less than the standard 20 percent, as is mortgage insurance. You often don’t have a choice if you’re getting a federally backed loan, either. FHA loans and USDA loans require escrow accounts, though VA loans do not.

Let’s assume you do have a choice. There are viable reasons to have an escrow account: It can be an easy, hassle-free way to make payments for your mortgage, homeowners and mortgage insurance and property taxes, and the cushion can help cover potential shortfalls. You don’t need to be diligent about setting aside the funds, including extra for any unforeseen increases in premiums or taxes, and then making sure you meet the due dates for payments. Of course, there are negatives as well — it increases your monthly mortgage payment, and you might prefer to handle your own finances yourself, without a third party involved.

Pros of a mortgage escrow account

It’s automatic

Having your mortgage lender or servicer hold your property tax and homeowners insurance payments in escrow ensures that those bills are paid on time, automatically. You don’t have to keep track of it, or even think about it, and you avoid penalties such as late fees or potential liens against your home.

You’re covered when there are shortfalls

Homeowners insurance premiums and property tax assessments can fluctuate over time. For example, if your escrow account happens to be short due to your property tax bill increasing, your servicer will typically cover the difference temporarily. To make up for it, they’ll eventually increase your monthly mortgage payment.

No surprises

The exact amount needed for escrow is added to your monthly mortgage payment for you, so you’ll know what to expect the majority of the time. If the escrow component of your monthly mortgage payment needs to increase, you’ll get a notice from your lender or servicer in writing. Plus, your lender or servicer is required to send you an annual escrow statement that shows the amounts you’ve paid (and the drawdowns) along with any overages or shortages.

“Escrow accounts make life a lot easier for the majority of homeowners that want to add predictability to their monthly expenses, rather than getting whacked twice a year with big insurance and property tax bills,” says Greg McBride, CFA, Bankrate’s chief financial analyst.

Potentially lower mortgage costs

Depending on your mortgage lender, you may be able to get a discount on your interest rate or closing costs just by having an escrow account.

Cons of a mortgage escrow account

It’s automatic

While it’s convenient to not have to think about making various payments on time, this pro can actually be a con for organized homeowners who prefer to have full control over their payments. Many mortgage lenders allow homeowners to make property tax payments directly to the county assessor and homeowners insurance payments to their insurer.

You might miss out on investment opportunities

In particular, the money that might end up as an overage in an escrow account could be used for short-term investments. Earning interest on such investments may make more financial sense for you, instead of allowing a bank or lender to reap the gains.

Digital tools and attractive CD rates can help you invest your money outside of escrow and earn a better return for the long term, notes Henry Yoshida, founder and CEO of Rocket Dollar, a platform based in Austin, Texas, that enables users to invest funds from tax-advantaged retirement accounts.

“With interest rates where they are, there is limited opportunity cost from forgoing interest earnings on money that is instead being escrowed by the loan servicer throughout the year,” McBride says.

A large upfront deposit

Often, setting up an escrow account requires a homebuyer to deposit an amount equal to two to three months’ worth of property taxes and insurance premiums. These are sometimes called “prepaids,” and they can significantly add to your mortgage closing costs.

Because you’ll be paying for insurance and taxes with your regular mortgage payment, you’ll have a higher payment each month. Of course, you have to pay for insurance and taxes anyway, so they aren’t an additional cost. But having them in your monthly payment could leave less room in your budget month-to-month, and prepaids can exacerbate that.

Can be a target for scammers

Large sums parked in an escrow account make it an attractive target for fraudsters. Common mortgage escrow fraud schemes include cyber-thieves setting up fake websites that look similar to the servicer you’re working with, or spoof email addresses to try to get your personal information. Some sophisticated scammers even set up fake phone lines in an attempt to build trust. Under these false pretenses, fraudsters might try to persuade you to wire them money.

Possibility of incorrect estimates

The amount that needs to be tucked away in your escrow account hinges on your insurance premiums and property taxes, which can vary year-to-year. Generally, the previous year’s bills are used to figure out how much you’ll need, but incorrect estimates can happen if, for example, the assessed value of your home has increased — or you appeal and get a reduction in your property taxes.

FAQs

  • No. Mortgage escrow accounts are typically only required with certain types of loans — if you’re not financing your home purchase with a mortgage loan, it’s not a requirement. You can pay your insurance and property taxes on your own if you choose, as you would any other types of bills, or you can set up an escrow account at your bank if you’d like the convenience of them doing it for you.

  • An escrow account for a home purchase is managed by a third party, such as a mortgage servicing company, escrow agent or escrow company. Its purpose is to pay for taxes and insurance — the funds are included in your total monthly mortgage payment, and the servicer or agent makes the payments automatically on your behalf. Many people find this convenient, but some would rather manage their finances themselves.

  • No, you cannot take money out of your escrow account. The money held in a mortgage escrow account is held by the lender or loan servicing company on your behalf, to serve a specific purpose, and it is not typically accessible to the homeowner.

Bottom line

With a mortgage escrow account, your mortgage lender or servicer is allowed to collect the amount of your homeowners insurance, mortgage insurance and property tax payments, sometimes plus a cushion, month in and month out. It’s a very common financial tool and helps to ensure your obligations as a homeowner are met without much effort on your part (aside from making your mortgage payment). However, if escrow isn’t required, you might want to explore alternative uses for those funds.

Source: thesimpledollar.com

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When you take out a mortgage, whether it’s for a purchase or a refinance, you must pay “closing costs,” which can vary considerably from transaction to transaction.

There are fees that must be paid to the bank/lender, along with optional ones, such as mortgage discount points, and fees that must be paid to third parties, such as title/escrow and insurance.

Whether you pay these fees out-of-pocket is another question, but either way there will be a cost, and you must pay it in one way or another.

How Much Are Closing Costs on a Mortgage?

  • There is no set amount that everyone pays in mortgage closing costs
  • It can vary substantially based on the loan amount and loan type
  • Along with the lender you choose to work with
  • And the time of the month you close your home loan

It depends on your loan amount, the way you structure your loan, which lender you use, and when you close during a given month.

For example, if the lender you work with charges a flat 1% loan origination fee, that’ll cost $10,000 on a $1 million purchase and $5,000 on a $500,000 purchase.

Further complicating this is the fact that not all lenders charge origination fees directly. Additionally, some may charge processing and underwriting fees, while others may not.

Next, you need to determine if you’re paying discount points to obtain a lower mortgage rate, or if you’re simply taking the par rate offered. This can greatly affect total closing costs too.

Then there are third-party fees, such as title/escrow and appraisal fees, which can vary tremendously as well. And in some regions of the country they might be paid by the seller or the buyer, assuming it’s a home purchase.

Additionally, you need to consider prepaid items like property taxes, homeowners insurance, and interest, which could amount to a big sum if there are impounds on your loan and you need to set up an escrow account.

When you close in the month can also have a big impact on closing costs. Those who close late in the month can reduce per diem interest, whereas someone who closes early in the month could pay nearly a month’s worth of interest at loan closing.

Two Types of Closing Costs – Recurring and Non-Recurring

There are two main types of closing costs, including “recurring closing costs” and “non-recurring closing costs.”

Recurring closing costs are those that will be charged more than once, whereas non-recurring closing costs are charged just once.

Some examples of recurring closing costs (paid more than once):

– Homeowner’s insurance
– Mortgage insurance
– Flood insurance
– Property taxes
– Interest
– HOA dues

*Note that not all fees are necessarily applicable depending on the property, location, loan type, etc.

Some examples of non-recurring closing costs (one-time fees):

– Lender fees (underwriting, processing)
– Loan origination fee
– Mortgage discount points
– Credit report fee
– Appraisal fee
– Home inspection fee
– Termite inspection fee
– Building record fees
– Title and escrow fees
– Doc prep fees
– Recording and wire fees
– Notary and messenger fees
– Transfer taxes

As you can see, there are quite a few costs associated with obtaining a mortgage, and not everyone has the cash on hand to pay for all these fees. There are also those who like to hang onto their cash and put it elsewhere.

If you want to reduce your closing costs, there are number of strategies to do so.

Use Seller Contributions to Cover Closing Costs

  • If it’s a home purchase you can ask the seller to chip in money toward the closing costs
  • Either in exchange for a higher purchase price or just via negotiation
  • Or receive a credit as a result of repairs found during the inspection

One of the most common ways to reduce your out-of-pocket closing costs is to get a contribution from the seller (if it’s a purchase transaction).

These so-called “seller contributions” or interested party contributions (IPCs) can be used toward the closing costs mentioned above, but cannot be used for the down payment or reserves, nor can they wind up in the buyer’s pocket.

Note that while seller credit can’t be used for down payment or reserves, it can free up your own cash to use toward down payment and/or reserves that may have otherwise gone toward closing costs.

When negotiating a sales price, the buyer and seller can discuss these contributions, and their presence will likely lead to a higher contract price.

As a result, the buyer still pays the closing costs by accepting a higher loan amount associated with a higher purchase price. However, the costs aren’t paid at settlement, so it’s easier for the buyer short on cash.

It’s also possible to get a seller credit for repairs that come up during the inspection, which is why it’s so important to take the inspection seriously. If you’re buying a home, you may actually conduct 3-5 different inspections for separate items like the pool/spa, roof, termite, chimney, and so on.

This is your chance to get money for the many things that might be wrong with the house. Once you present the seller with a request for repairs, they’ll likely offer a credit that you can use toward closing costs or to lower the purchase price. Or both.

The maximum amount of seller contributions allowed will vary based on the type of loan (conventional vs. FHA), the property type, and the LTV ratio. The lowest amount allowed is 2% of the purchase price, and the highest allowed is 9%.

Get a Lender Credit to Offset Closing Costs

  • In exchange for a higher mortgage rate
  • You can get a credit from the lender to cover closing costs
  • So they won’t need to be paid out-of-pocket
  • But instead via higher monthly mortgage payments

Another way to reduce or eliminate your out-of-pocket closing costs is via a lender credit, which is essentially agreeing to take a higher mortgage rate in exchange for lower settlement costs. This works on both purchases and refinances.

For example, a lender might tell you that you can secure an mortgage interest rate of 4.25% paying $5,000 in closing costs, or give you the option of taking a slightly higher rate, say 4.5%, with a $3,500 credit back to you.

If all your costs are paid via a higher rate, it’s a no cost loan, though sometimes this definition only covers lender fees, not third party fees.

Either way, you’ll pay a bit more each month when making your mortgage payment, but you won’t need to come up with all the money for the required closing costs.

Again, your out-of-pocket costs are reduced here, but you pay more throughout the life of the loan via that higher mortgage rate. That’s the tradeoff.

Ask for a Credit from Your Real Estate Agent

  • Hello controversy!
  • While it’s frowned upon by some real estate agents
  • It’s perfectly acceptable to ask for a credit from your agent
  • Though they can decline your request

Another way to reduce your closing costs (not just out-of-pocket) is to ask your real estate agent to give you a credit toward closing costs.

If they want your business, or just want the transaction to close, they might be willing to part with some of their commission to help you with closing costs.

For example, if they’re earning 2.5% to close the deal, they might be willing to give you 0.25% of that to help with your closing costs. Sometimes both agents will get together and give a small portion of both commissions to the buyer to get the job done.

And this will actually reduce what you pay, as you won’t take on a higher interest rate or pay for the costs via the loan.

Just be careful when combining credits to ensure they don’t exceed the maximum allowed by the lender. Assuming you find that you’re leaving money on the table, consider using the excess to buy down your mortgage rate or to cover prepaid items like escrows.

Negotiate and Shop Your Closing Costs

  • Like mortgage rates
  • You can negotiate your closing costs
  • Which can vary considerably from lender to lender
  • You may also be able to shop certain third-party costs

It’s also possible to shop around for certain settlement costs, instead of just blindly using the companies your real estate agent recommends.

For example, you can comparison shop for title insurance and/or your homeowner’s insurance and save on costs there. The same goes for your home inspection.

If refinancing your mortgage, ask for the “reissue rate” or “substitution rate” when purchasing the lender’s title insurance policy.

There is no reason you should have to pay full price again for a title search when you’ve been the only person living in the property.  This could save you a significant amount of money on closing costs with as much as a phone call to the title company.

Similarly, when looking for a bank to work with, be sure to look closely at the fees they charge. They don’t all charge the same fees or the same amounts, so finding a lender with a low rate and low fees could save you big.

Also watch out for unnecessary junk fees, which can really add up. But remember that certain closing costs just aren’t negotiable, like property taxes.

What Else Should I Know About Closing Costs?

  • Closing at the end of the month is one way to cut down on closing costs
  • Because you can reduce per diem interest
  • But your first mortgage payment may be due sooner
  • If refinancing you might be able to roll closing costs into loan
  • Also look out for closing cost specials

There are a few other ways to cut down on closing costs. Prepaid interest, which is the per diem interest due between the time you close and your first mortgage payment, can be costly depending on the size of your loan and when you close.

If you close near the end of the month, you can greatly reduce the number of days of per diem interest due at closing. This can significantly reduce your closing costs.

However, the tradeoff is that it’s a very busy time for lenders, and they might not close in time.

For those refinancing, it may also be possible to roll closing costs into the new loan, instead of paying them out-of-pocket.

Again, the implication here is that you’ll be paying interest on those closing costs for as long as you hold your mortgage, as opposed to just paying them at face value upfront.

But it’s worth consideration, especially if you don’t plan to stay in your home, or with the mortgage very long. There’s also a thing called inflation that makes today’s dollars less valuable over time.

Lastly, check out special programs like HomePath and HomeSteps, which offer closing cost assistance if you take part in homeownership education courses. And be sure to look into state programs that offer incentives to first-time home buyers.

Source: thetruthaboutmortgage.com

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