First Time Home Buyers Guide to Closing Costs

You have your downpayment. Great. You are ready to close the deal on your loan and start making bids on houses! Soon you get your closing statement and there are extra charges you might not be expecting. Wait — is someone trying to pull a fast one and pad their profits? Well no. The mortgage lending industry is set up to block anything like that. Fortunately, there are whole books of legislation that protect the borrower from such tricks and scams. But what are closing costs?

If you’re a first time home buyer, it pays to learn about the loan closing process so you’re prepared for closing expenses. Here are some questions that might occur to you with simple answers.

What are closing costs?

Closing costs are fees paid at the close of a real estate transaction, at the point when the title to the property is conveyed to the buyer. They can be paid by either the buyer or the seller.

There are two different categories of closing costs. Recurring closing costs, also called prepaid items, and nonrecurring closing costs (NRCCs). We’ll describe more below.

Recurring Closing Costs or Prepaid Items

What are prepaid items?

These are costs that are associated with the maintenance of the borrower’s loan and normal property maintenance that are regular recurring costs that are paid monthly or annually. These costs include normal interest due on the loan, property taxes that are paid twice a year or monthly, and insurance.

What kind of insurance is in prepaid items?

Insurance includes home owner’s insurance/fire insurance/hazard insurance — three terms for the same exact thing — and in some cases, private mortgage insurance (PMI). PMI is required when the loan amount is greater than 80% of the purchase price/value of the property.

What is private mortgage insurance (PMI)?

When the loan amount is greater than 80% of the property price/value (greater than 90% in California), the lender requires you to have insurance on the loan. PMI allows for collection of the property taxes and homeowner’s insurance in advance to protect the lender in case something happens and the mortgage goes unpaid. The lender will then be able to recoup their losses.

When do I pay the PMI bill?

PMI is collected monthly as part of the total mortgage payment. The loan servicer will make the biannual property tax and annual home owner’s insurance payments on the borrower’s behalf when due.

How does PMI get paid?

In order to start this process, you will have to set up an escrow/impound account (both terms for the same exact thing in California) with the new lender/servicer. You can then pay monthly property taxes and homeowner’s insurance as part of the total monthly mortgage payments.

What is an escrow/impound account?

An escrow/impound account is simply a bank account that your loan servicer has access to. You put your money into the account and the loan servicer is able to send it out to the various recipients as needed. This is the service that a loan servicer provides.

How much money should I put into the escrow/impound account at closing?

You can estimate between 4 and 10 months of property taxes and 2-3 months of fire insurance impounded (collected) at closing to set up the escrow/impound account. That is your money that sits in the escrow account accruing a negligible amount of interes