25 Steps to a Penny Pinching Closing
Marc Eisenson is the author of The Banker's Secret, the book which tells you everything you ever wanted to know about prepaying your mortgage. The following article is reprinted with permission from his quarterly newsletter.
So you want to buy a house, that great American Dream thing. Brace yourself. It's going to cost a lot more than you thought, thanks in large part to closing costs -- that laundry list of miscellaneous fees that could immediately add up to 7% to your home's purchase price.
While fees vary widely, these are representative:
A Closing Cost Sampler
Based on a $100,000 loan (purchase price $125,000, 20% down)
Application fee: 0 to 125
Appraisal fee: 225 to 275
Credit check fee: 45 to 60
Lender's attorney fee: 375 to 275
Title insurance: 600 to 700
Survey: 500 to 600
Homeowner's insurance: 300 to 400
Recording fee: 60 to 75
Tax service fee: 65 to 75
State transfer tax: 0 to 725
Points (0% to 2.5%): 0 to 2,500
Homeowner's attorney: 500 to 1,250
Total cost: 2,670 to 7,360
What's worse, this $2,670 to $7,360 won't buy a nickel's worth of anything you'll ever get to enjoy. Ouch!
There'll be other home buying costs as well: Termite, health, water, radon, and/or engineering inspections, for example, plus various other fees and taxes, courtesy of one government agency or another. Your lender will probably insist on at least a few months of escrow payments up front, to cover property tax and homeowner insurance payments.
Oh, lest I forget, if your down payment is less than 20%, you'll have to carry private mortgage insurance (PMI) -- for your lender's benefit. PMI could set you back another $3,000 or more! (For more on this rarely discussed, but extremely costly aspect of homeownership, see #'s 18 and 19 below.)
How to Save Money at the Closing -- and Beyond
1. Learn the tricky language of the real estate industry. For example, a "binder" is often downplayed by brokers as nothing more than a formality. However, when both the seller and potential buyer sign it, and money changes hands -- say a check for 1% of the offer -- many jurisdictions will enforce that binder as a legal (and binding) contract. If it's not carefully worded, a change of mind could cost you your deposit, or more. So ...
2. Learn your rights. Two of the best resources are FREE. Get "A Consumer's Guide to Mortgage Settlement Costs" from the Federal Reserve Board, Publications Services, 20th & C Streets, NW, Washington, DC 20551.
Lenders must give you a good faith estimate of the closing costs, plus a copy of "Settlement Costs -- A HUD Guide," within 3 days of your loan application. Why wait? Get this helpful booklet from a lender before you apply.
3. A little knowledge can be profitable. The more you know about real estate practices, the more you can save. For example, by visiting whoever keeps the records in your area (it's the county clerk in these here parts), you can do your own preliminary title search -- and maybe find out what the seller paid (a handy figure to have at the ready when you negotiate the purchase price). Just be careful.
4. Too little knowledge can be dangerous. While you can do your own legal work, or house inspection, for example, a mistake could cost you a fortune. So get educated, and do everything you can to cut costs. But temper frugality with wisdom. Use experts, unless you're certain that you can do the job right.
5. First the horse, then the cart. Most buyers do all the hard negotiating of price and terms, sign a binder, hand over a check -- then hire a real estate lawyer. That's nuts!
It shouldn't cost you any more, and it may save you quite a bit of money ... as well as anxiety ... if you select your counselor before you find your dream house.
6. Seek and ye shall find. Ask local people whose judgment you respect, preferably not the seller, real estate broker, or lender, to recommend a few good lawyers. (Trust me. Some exist.) Call to ask how much they'd charge.
Legal fees vary widely, and can be surprisingly flexible. Some lawyers will quote a standard percentage fee (of anywhere from 1/2% to 3% of the purchase price), but just a bit of a suggestion that times are tough may get you a discount. Others will offer a flat package price, or an hourly rate, either of which could save you quite a bit.
You may also be able to save by doing some of the legwork yourself ... or by making sure a lower paid, junior member of the firm or a paralegal will be doing the routine chores ... and that you'll be billed accordingly.
7. Get pre-qualified. Before you even begin your property search, you can find out how much you'll be able to borrow. It'll save you the stress of a last minute rush for financing, teach you a lot about the whole house buying process, and it may put you in a stronger negotiating position -- especially if it makes clear to sellers that you can afford to pay what you're offering, but no more.
It'd be nice to pre-qualify with the lender you'll end up using, but that's not necessary.
8. Get a free copy of your credit report from TRW, before you walk into your first bank lobby (800-392-1122). If there are errors, act quickly. It can take 30 days or longer for a credit bureau to investigate and fix a mistake. (We've put the Do-It-Yourself Credit Repair Guide on sale, to help you straighten things out. See page #6.)
9. Remember, lenders want your money as badly as you want theirs. Competition is stiff, and even without up-front fees, a $100,000 mortgage at 8% for 30 years can net your lender more than $164,000 in interest.
Mortgage shop with both bankers and mortgage brokers. Be prepared for a dizzying array of options. For example, we were offered 8% with 2.5 points, 8.125% with 2 points, 8.5% with 0 points, or 9% with 0 points and reduced closing costs -- just at one savings bank!
Brokers generally offered us the best deals, and were better informed and more attentive than bankers. (Brokers only make money if they strike a deal for you, while bankers get paid whether you close, or not.)
Get a detailed, written list of every fee you'd have to pay for each loan. Be warned, your best bet may not be intuitively obvious. For an easy way to compare loans, see "12 Simple Things You Can Do to Save on Your Next Mortgage," in Bulletin #4. It could save you thousands.
10. Phone your watch dog. If your best deal is through a broker you don't know, call your state banking department. Ask if the broker is registered or licensed. Some departments can tell you how long a lender's been in business, how many loans it's arranged in the last year or two, and whether there are any consumer complaints on file. Check references with a few homeowners, too.
11. Watch out. Applications are costly. Patently unjust though it may be, most lenders charge potential customers for the privilege of being evaluated as borrowers. If there's a non-refundable application fee, make certain that your financial situation is well within the lender's limits for approval. For help honestly enhancing your statement, I recommend The Bank Book (see page #6).
12. There's more than one way to skin a fee. Ask if each closing cost can be waived, reduced, or handled differently. And be sure to find out if you're eligible for any special discounts. Don't be afraid to push it a bit.
One of our readers got a lawyer to give him a discount as a first time home buyer. Actually, he came out even further ahead, because his money saving closing motivated us to write this article, which also netted him a free subscription to our Bulletin.
Unless a fee is required by law, there's a chance that a hungry lender will become creative. So, for example, ask lenders to accept an updated version of the previous property survey. You could save 50% or more, compared to the cost of a brand new one.
13. Who's insuring what? The title insurance policy you'll be required to buy protects the lender in the extraordinarily unlikely event that the seller wasn't the only, or the "real" owner. See if you can get a discounted "reissue rate" from the seller's insurer. If the seller has owned the house for only a few years, your chances are good.
To insure yourself against the same surprise losses, find out what the additional charge would be for an "owner's policy." On our $100,000 hypothetical mortgage, it'd cost about $350 more than one written just to protect the lender.
14. Make the most of a seller who's hot to trot. Ask the anxious owner to pick up (or at least split) some closing costs, like title insurance and points. As I often say, not asking is an automatic "No!" And now, under the latest IRS rulings, even if the seller pays the points on your home loan, you may be able to deduct them.
15. Skip mortgage life insurance if you have a choice. There are lots of cheaper term (and decreasing term) policies that will pay the same, or more -- and won't require you to list the bank as your beneficiary. Let your heirs decide when to pay off the mortgage.
16. Question escrow. While standard bank policy, you don't have to acquiesce without a murmur. However, once stuck, you'll be paid a piddling interest rate. So try to negotiate, before closing, for a clear contractual out that will eventually let you take over the escrow payments.
Meanwhile, periodically ask for an escrow analysis. If there's more than a small excess (for contingencies like tax increases), ask the lender for an explanation.
17. Be in really good hands. The last thing you want is for your house to burn down, leaving your family out in the cold. Lenders, however, are much more concerned about their collateral, which you'll be obliged to insure. The right policy -- and insurer -- can save you money now, and grief later, should a disaster strike. See "Home Insurance Can Cost Less," on page #4.
18. Don't reach beyond your means. Without a 20% down payment, you'll have to carry private mortgage insurance (PMI), which is very expensive. Say you want to buy a $125,000 house, but can only put down $12,500, instead of $25,000. Your PMI premiums could easily reach 26% of the up-front cash you don't have ... $3,000 or more. (For more on how costly PMI can be, see "Nightmare on Elm Street," in Bulletin #10.)
19. Strong ARM your way out of PMI. Looking to avoid PMI? Speak to those who love you, have deep pockets, and realize they can't take it with them. By helping you buy your dream house, they'll get "nachus" -- a Yiddish word that evokes the pride and joy we take in the achievements of our children, grandchildren, nieces, and nephews.
Just a word of caution. Lenders don't like surprises. If a big chunk of money suddenly appears in your bank account, be prepared to produce a gift letter from your benefactor, along with a copy of the cancelled check.
If you're going to have to carry PMI, consider an ARM with a low "introductory" interest rate. Pre-pay with the additional amount that a higher fixed rate mortgage would have required. You'll have 20% equity in no time, but:
20. Be ever vigilant -- because of the SIC risk (Sudden Interest Climb) ARMs present. Be prepared to switch to a fixed rate loan if rates go ballistic.
When you're mortgage shopping, consider "convertible" loans, which give you the opportunity to bail out of an ARM when the interest rate gets too high. The new rate won't be as low as the fixed rate you could get now, but you'd be protected from yet higher interest.
21. Banks don't own all the money. Avoid taking out a brand new mortgage, and you're bound to save.
* If possible, consider assuming the current mortgage -- even if the rate is slightly higher. Chances are, closing costs will be lower than with a new mortgage. However, to make sure that it's the best deal for you, read the fine print, and crunch the numbers. (Most conventional mortgages aren't assumable, but FHA and VA loans are.)
* See if the sellers will finance all, or part of the sale. If they don't need the cash in one lump sum, your mortgage may be a great investment for them.
* Ask cash rich friends or relatives for a loan. Pay a higher rate than they'd earn at the bank, and it'll still cost less than the bank would charge you.
Although lending to loved ones can be risky business, some of the best investments Nancy and I have made were mortgages and loans to relatives and close friends. (Sorry, we're not taking applications now.)
* Find a local investor who lends mortgage money. Real estate brokers, lawyers, and accountants should be able to offer some good leads.
22. Talk with your tax preparer before you set a date for the closing. It might save you money. For example, while you can fully deduct the points on your primary residence's first mortgage in the year you take out the loan, a poorly timed closing could wipe out this benefit.
Say you close on December 31, with no deductions other than the points, plus a bit of interest and real estate taxes. They might be swallowed by your standard deduction ($6,350 in 1994 for married couples filing jointly).
23. Not all deductions were created equally. Points paid on a refinance or a mortgage on a second home, generally must be amortized over the loan's life. Say you were to pay $3,000 in points on a 15 year refi. You'd be able to deduct a maximum of only $200 a year ($3,000 divided by 15).
24. Get a last minute check-up. As close to the closing as possible, arrange to inspect the house one last time. If there's a problem -- be it a broken window, frozen pipes, or a missing dining room fixture -- get reimbursed by the seller at the closing.
25. After the closing: The best way to cut the cost of homeownership is by pre-paying your mortgage. Just $25 a month, 83 cents a day, will save over $23,000 in interest on a $100,000 loan at 8% for 30 years.
The whole pre-payment story is in my book, The Banker's Secret, where I answer questions like, should you let someone "convert" your loan to a bi-weekly. My answer: "NO!" Don't believe anybody who makes pre-paying sound tricky or expensive.
There's no "right" amount to pre-pay, no contracts to sign, and there's nothing complicated about it. Just send in a bit more than your required payment, whenever you can.
A mere $16.23, which would round our sample loan's required payment up from $733.77 to $750 a month, would save you over $16,000.
Not bad for 54 cents a day, huh?
The Banker's Secret is a best-selling handbook which shows exactly how to save thousands, by using your "pocket change" to pay off your debts. It shows you how to double check the bank's numbers, and answers all your pre-payment questions. For example: Will I lose my tax deductions? What about pre-payment penalties? Should I have my loan converted to a bi-weekly? (No!) Also includes 160 exclusive money saving tables that show you how much money you'll save on your loans. Ask for it at your favorite bookstore: Villard Books, ISBN 0-394-58604-2. Or order it online at the Good Advice Press site!
The Pocket Change Investor, begun in 1990, is quarterly newsletter published by Marc Eisenson and Nancy Castleman. Each issue focuses on something that costs you and your family a lot of money. Let this team of consumer advocates show you how easy it is to profit from your debts, how to finance your child's education, when to rent ... or buy, and how to teach your youngsters to manage their money.
Learn painless ways to save on taxes, credit cards, closing costs, cars, insurance, appliances, utilites, vacations, trips to the supermarket, and the myriad of other expenses that regularly confront us all. It's worth far more than the $12.95 annual subscription rate. (Don't tell them, or they may raise the price!)
To subscribe to The Pocket Change Investor ($12.95 for 1 year, $19.95 for 2) or to get a copy of The Banker's Secret book ($17.95, includes s/h), call 800-255-0899 or fax 914-758-1475 with credit card info. You can send a check for the newsletter and/or book to: Good Advice Press, Box 78, Elizaville, NY 12523. Or order it online at the Good Advice Press site!