What the !%@#$ are closing costs?

Confused stick figure and humorous breakdown of closing costs

It's only scary because it's vague.

Closing costs. The term can strike terror into the hearts of most first time buyers. Leave it to the real estate industry to come up with a special snowflake term for something the rest of the world understands as "sales tax." Admittedly there's more components involved than your standard skimmed bit off the top taken by the government every time you make a purchase. (Unless you live in New Hampshire, Delaware, Montana, Oregon or Alaska.) Legally we can't call it "sales tax." But for homeowners who are already making a big plunge here, it's probably easier to think of closing costs in the same manner as sales tax and plan accordingly.

In Chicago these days, provided you're taking out a loan of less than $417,000, for closing costs you'll want to plan on needing about 3-4% of purchase price, in addition to your down payment and your loan, in order to buy a piece of property. If your lender chooses, they may require you to pay "points" to decrease your mortgage interest rate - in this case, add one percentage point for each "point." Some lenders will charge less, some more, but on the average it will be between 3-4%. If you have reasonable credit and it looks like your lender is charging more than 4% on the good faith estimate, go find a new lender!

Despite the government requirement of reasonably accurate Good Faith Estimates from lenders, the actual cost to close will not be revealed to you until the day before you actually close, on a form called the HUD-1. Therefore, for the majority of the purchase process you will need to be carrying that number in your head.  Don't forget about it and add the amount to your down payment. Don't leave it tied up in non-liquid accounts until the last minute, either. Bits of it will be dribbling out from the day you get a signed contract to the day you receive the keys.

Who gets a cut?

If you're buying property in Chicago, here's the big list of who gets a cut of your "closing costs":

  • Appraiser
  • Attorney
  • Cook County and Chicago, in the form of...
    • Property Tax Escrow
    • Recording Fee
    • Transfer Tax
  • Escrow Company
  • Homeowner's Insurance Company
  • Inspectors
  • Lender, in the form of...
    • Commitment Fees
    • Courier Fees
    • Credit Report Fees
    • Flood Certification
    • Loan Origination Fees
    • Processing Fees
    • Prorated mortgage interest
    • Tax Service Fee
  • Title Company, in the form of...
    • Document Prep fees
    • Title Endorsements
    • Title Insurance

Notice that there's a couple of things missing there, namely the real estate agents (we're paid by the seller), the moving company and the utility companies. Don't forget that you actually have to move at some point, too!

Getting around closing costs

As soon as I've explained all of the above to first-time buyers, the immediate follow up question is usually "I heard I can ask for the seller to pay my closing costs. Is this true?"

Basic answer is, yes, you can ask. However, there are certain restrictions. Most lenders will not permit the seller to pay more than 3% of the total purchase price towards the buyer's closing costs. The amount needs to be clearly delineated on the sales contract and the buyer must obtain written permission from their lender to do it. Additionally, the seller has to be in a position where they're not already bringing money to the table or short selling.  Finally, the buyer needs to bear in mind that the seller is already footing the bill for closing costs of their own, which can nick anywhere from 9-15% off their sale price depending on the situation. A seller may not want to give up an additional 2% on top of everything else. Needless to say, asking the seller to pay closing costs in a multiple bid situation is not advisable. It doesn't make it look like you're playing it cool. It makes it looks like you're short on cash.

Once we've covered that topic, the buyer will then ask, "I've also heard that I can roll closing costs into my loan amount. Is this true?"

Again, the basic answer is yes, you can try. However, in order to do so you must be very clear with your lender from day one that you're planning on doing so, and make sure you indicate it not only verbally but in writing.

Like it or not, real estate is a pay to play situation. As much as the get-rich-quick books will tell you that you can go in with 0% down and no closing costs, you need to understand that in doing so you are not really buying property - you are signing an 10-year long lease with a landlord who happens to be a bank, and increasing your interest payment proportionately. Sure, you'll get ownership of the property, with all of the rights that go with it. However, it will take you at least a decade in a steadily appreciating real estate environment to build up the equity that you'd have started with if you'd put 20% down and paid the closing costs out of pocket. Also, if you're one of the sensible people who has chosen to buy a home because it's cheaper than renting right now, remember that those rent vs buy indexes are calculated for the 20% down crew.

We agents are supposed to pressure you to buy now while interest rates and prices are at their lowest in decades. To my mind, though, it wouldn't be proper client service for any agent to force a buyer into a home purchase before they're ready. The market, as it comes back, will come back at a measured pace. We will not see astronomical increases like we did in 2004-07 until long after you've had time to save up to cover a decent down payment and closing costs, provided you start now, set your mind to it and make an effort. We'll be here when you're ready to buy well.

Stick figure artist unknown. Found on DoughRoller.net.