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Closing Costs: Calculations & Practice

Instructor: Racquel Fulton
There is an old wise saying: 'There are two sides to every story'. In real estate, the transaction is the story; one side belongs to the buyer, the other side to the seller. In this lesson, you will learn how both sides complete the story of a transaction.

Disclosing the Closing

When there is a sale of real estate both the buyer and the seller have to pay expenses. These expenses are called closing costs. Closing costs are fees for services and products needed to help finalize the sale. The cost of each expense is itemized on the closing disclosure form.

The closing disclosure form was created by the Consumer Financial Protection Bureau (CFPB). Home buyers and sellers are able to see a detailed view of the entire cost of a transaction. Join us as we review closing costs with a buyer and seller.

A View of the Transaction

Jordan is at a closing to complete the purchase of his first home. The closing is the last stage of the home buying process. He is presented with the first page of the closing disclosure form, which provides a summary of the entire transaction.

Sale Price: $125,000

The sales price is the price that a buyer has agreed to pay the seller for the property.

Loan Amount: $112,500

Mortgage lenders are now referred to as 'creditors' under the federal TILA-RESPA disclosure rule. The creditor provides the buyer with a loan that will be applied toward the property's purchase price.

Interest Rate: 4.25 %

The creditor is charging 4.25% interest every year on the loan amount of $125,000.

Loan Term: 30 years

The loan term is the length of the loan in years.


Top Half of Closing Disclosure Form


The Buyer's Side

Jordan proceeds to the second page to see an itemization of every expense he has to pay to complete the sale. The page has two large columns. He will focus on expenses under the 'Borrower-Paid' column.

Points: $1,125

A point, also referred to as an origination fee, is paid by the buyer to reduce the interest rate of the loan. One point represents one percent of the loan amount.

As an example:

Loan Amount x 1 Point = Origination Fee
$112,500 * 1% = $1,125

By paying one point, Jordan has reduced his interest rate from 5.25% to 4.25%.

Appraisal: $250

An appraisal is an evaluation of the present value of real estate.

Jordan's appraisal fee is listed in a special column titled 'Before Closing'. Items paid before the closing are sometimes shown with the abbreviation P.O.C, meaning 'paid outside of closing'. Jordan paid the appraiser directly. The item is listed with the closing costs because it was needed to complete the purchase of the property. However, 'Before Closing' items are NOT calculated into the total costs that the buyer needs to pay at closing.

Title Insurance: $1,025

Title insurance ensures that the buyer and creditor rights are protected against liability that may have been caused by previous owners. The creditor requires that the buyer purchase a loan policy on their behalf. Buyers commonly purchase an owner's policy, although they are not required to do so.


Loan Costs - Closing Disclosure Form


Transfer Tax: $625

Transfer taxes, also referred to as stamps, are established by local governments. These taxes must be paid when real estate is exchanged. In most states, there are no laws requiring who has to pay the taxes. Local closing customs determine if the taxes are paid by the buyer or the seller, or split equally.

Prepaid Interest

Jordan's closing is in the month of February; therefore he will not have to make his first mortgage payment until April. The payment will include principal and interest. Principal is the portion that will be applied to the loan balance. Interest is how the creditor makes a profit for providing the loan.

Although the payment is not due until April it will cover the month of March. Mortgage payments are based on a system of arrears, which means to pay for something after the time period. This is similar to how an employee receives a paycheck two weeks after performing work.

Each mortgage payment covers the previous month. From the day the loan is issued, interest begins to accrue. Interest from the date the loan is issued until the first day of the next month is called prepaid interest. That is because it is paid in advance.

Prepaid interest is calculated as follows:

Loan Amount x Interest Rate = Annual Interest Amount

$112,500 x 4.25% = $ 4,781.25

Annual Interest Amount / Number of Days in a Year = Daily Interest Amount

$ 4781.25 / 365 = $13.10

Number of Days From Closing Date to First Month x Daily Interest Amount = Prepaid Interest

2/26 to 3/1 @ $13.10 = $ 52.40

Escrows

Unpaid taxes and physical damage to a property may affect the creditor's and buyer's rights. Homeowners insurance provides compensation if a loss occurs. Creditors establish escrow accounts to hold payments for insurance premiums and property taxes.

Not all loans require borrowers to pay taxes and insurance, but Jordan's loan does. His escrows are based on the following calculation:

Yearly Homeowners Premium: $ 750

Divided by 12 months: 750 / 12 = $ 62.50

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