Closing Costs and ESCROW

You found a REALTOR®. Your lender helped you get pre-approved. You know what you can afford. You found a home. You make an offer.

Now you hear about things like earnest money, closing costs, escrow, and title insurance and you’re not quite sure what they all mean.

When you get close to sealing the deal there are some things you need to be aware of. Here is some help…

Making an Offer

You make an offer by signing a contract; make sure your offer is contingent on appraisal and financing.

You’ll also pay a deposit called earnest money, to show that you are intent or “earnest” in purchasing the home. The earnest money is applied towards the purchase price if the transaction is finalized. If it doesn’t go through then you can generally get your earnest money back, though this depends entirely on how the contract is worded.

The earnest money is held in escrow by independent third party, usually the title company, which is the business that will handle the paperwork for the sale.

If the seller accepts your offer they’ll sign the contract, and then you can proceed with having the house inspected and appraised. If they don’t agree then they’ll likely make a counter-offer, by preparing a new contract with different terms that they ask you to sign. The process repeats until you either have a contract signed by both parties, or the deal falls through because the two parties couldn’t agree.

The Appraisal

Lenders require an appraisal to determine the value of the property before they can finance your loan. Usually a bank or mortgage broker will handle this for you, but you will still foot the bill unless it’s built into your closing costs.

Appraisals typically cost anywhere from $250 to $500. The cost will vary based on property type, location, and square footage.

The value of the property is really the most important factor when it comes to securing financing. That’s why it’s always important to use a qualified appraiser who assigns a realistic value to your home so there aren’t any surprises. It’s better to know the true value of your home upfront before you sign any contingencies or purchase contracts.

It is wise to get an inspection. An inspection is not required but it is a good idea.

You may want to include an inspection clause in the offer when negotiating for a home. An inspection clause gives you an “out” on buying the house if serious problems are found, or gives you the ability to renegotiate the purchase price if repairs are needed. An inspection clause can also specify that the seller must fix the problem(s) before you purchase the house. Talk to a REALTOR® to determine a reasonable length of time to do the inspection and include it in the offer.
Home Inspection Cross Section
An inspector checks the safety of your potential new home. Home Inspectors focus especially on the structure, construction, and mechanical systems of the house and will make you aware of only repairs that are needed.

The Inspector does not evaluate whether or not you’re getting good value for your money. Generally, an inspector checks (and gives prices for repairs on): the electrical system, plumbing and waste disposal, the water heater, insulation and ventilation, the HVAC system, water source and quality, the potential presence of pests, the foundation, doors, windows, ceilings, walls, floors, and roof. Be sure to hire a home inspector that is qualified and experienced.

Title Insurance

Before you close, a title search will be conducted on the home through available records related to the property to make sure that the seller is the legal owner and that there are no outstanding claims against the property.

Purchasing title insurance, a one time fee at closing, prior to acquiring a property is not legally required. However, any lender will require you to obtain, at a minimum, a Lender’s policy of title insurance for an amount equal to the loan. This protects the lender’s investment in the event of a third-party claim. The insurance remains effective until the loan is repaid.

Homebuyers will also want to obtain their own protection of the equity in the property since a Lender’s only policy extends solely to the loan amount. This requires an Owner’s title policy for the full value of the home. Typically, the additional cost to add Owner’s coverage to the cost of the Lenders policy is small; all the more reason for any homebuyer to get the necessary coverage.

Here is an example: If the sale price of a home is $200,000 and the homebuyer is borrowing $180,000 the title insurance policy would include Lender’s coverage in the amount of $180,000 and Owner’s coverage in the amount of $200,000.

Homeowners Insurance

A paid homeowners insurance policy (or a paid receipt for one) is required at closing, so arrangements will have to be made prior to that day. Plus, involving the insurance agent early in the home buying process can save you money. Insurance agents are a great resource for information on home safety and they can give tips on how to keep insurance premiums low.

Be sure to shop around among several insurance companies. Also, consider the cost of insurance when you look at homes.

Closing

The point in time at which the contract is actually executed and the title to the property is conveyed to the buyer is known as the “closing”. This is where you need to read the document you are signing and ask questions if you don’t understand something. There are no dumb questions when it comes to a purchase of this size.

It is common for a variety of costs associated with the transaction (above and beyond the price of the property itself) to be incurred by either the buyer or the seller. These costs are typically paid at the closing, and are known as closing costs.

How much will closing cost you? Typical closing costs run from 3 to 5 percent of your loan amount. In all likelihood, you have already paid some of these fees to pull credit reports, apply for the loan or, as earnest money, a prepaid portion of your down payment. All other unpaid fees and deposits come due at closing.

Escrow

What is an escrow account?

An escrow account is used to collect and hold funds to pay your property taxes, home owners insurance premiums or other charges when they become due. Most mortgage companies require an escrow account for mortgages with less than a 20 percent down payment.

A mortgage escrow service is much like a savings account. Money is paid directly to the escrow service where it is held until payments are due.

For example, when you pay your mortgage bill, several hundred dollars per month are added to your payment. That money doesn’t go toward your interest payments or principle. This money is set aside in your escrow account and used to pay your annual or biannual property taxes, insurance, and other bills.

The account is often established for you by your mortgage company when you take out your mortgage.

What are the benefits of an escrow account?

An escrow account helps you:

  • Manage your budget—You do not have to make lump sum payments when your taxes and insurance are due. You have made monthly payments throughout the year to cover those obligations.
  • Gain peace of mind—You don’t need to keep track of when your tax and insurance bills are due. The payments will be made, on time, on your behalf.
  • Ensure that your home is protected—With paid-up insurance coverage and taxes, you protect your investment in your home and meet your lender’s requirements.

How does an escrow account work?

Your monthly mortgage payment includes an amount for property taxes and insurance in addition to the amount you owe for principal and interest. The amount of your monthly mortgage payment that is for taxes and insurance is placed by your mortgage company into an escrow account. The funds can be used only to pay taxes and insurance on your behalf.

Here is a simplified example* of how escrow payments are calculated:
Annual real estate taxes: $1,800 ÷ 12 months = $150 per month
Annual property insurance: $720 ÷ 12 months = $60 per month
Total monthly taxes and insurance: $210
So in this example, $210 would be added to your total monthly mortgage payment and applied to your escrow account.

You might hear your total monthly mortgage payment referred to as your “PITI” — for Principal, Interest, Taxes and Insurance.

*The amounts you owe for real estate taxes and insurance will vary — this is a simplified example, and your mortgage company will likely use a more detailed calculation method that considers various factors. Ask your lender for a full explanation and an estimate of the escrow payment on your mortgage.

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