Friday, August 26, 2011

How Do You Estimate Closing Costs?

How much are closing costs?  1%, 2%, 3%, 4%?  Today's winning question by Cary Sanger of Your Castle Real Estate addresses that subject. Cary receives a $25 Starbucks card and gets his contact information sent to the 6,600 people on our contact list. We also list his contact info on our blog (10,199 visits for the first 6 months of 2011) and on our blog at Active Rain, a real estate blog with more than 210,000 members.

Cary's contact info follows:

Cary Sanger
Managing Broker
Your Castle Real Estate Inc.
Phone: 720-560-0111
Free Metro Denver Home Search at:
www.DenversBestHomeSearch.com

Cary's question is: Do you have a rule of thumb for closing costs based on a percentage of the purchase price if people want a general idea of what they will need in addition to their down payment?

Here's the answer: It is extremely difficult to estimate a percentage for closing costs without knowing all about the borrower and the property. Here's why.

Many of the closing costs are fixed costs, meaning they are the same regardless of how big the loan is. Some examples of fixed closing costs are:
  • Appraisal fee
  • Credit report
  • Underwriting fee
  • Tax certificate
  • Loan closing fee
  • Real estate closing fee
  • Title insurance fees
  • Recording fees
Other closing costs change depending on the size of the loan or the purchase price. Here are some examples of closing costs that change:
  • Origination fee (usually 1% of the loan amount)
  • State tax stamps
Still other closing costs depend on the individual property, the interest rate, the borrower's credit, or the closing date. Here are some examples:
  • Property taxes: depends on the property and the date of closing
  • Homeowner's insurance: depends on the property and the borrower's credit score
  • Pre-paid interest: depends on the borrower's credit score (which determines the interest rate), the loan amount, and the date of closing
Now let's see how these different fees determine the closing cost percentage. Let's assume a property sells for $100,000 and the fixed costs are $2,000. The variable costs (the costs that are different in every situation) will probably be low because the taxes and insurance will be low. Let's assume the variable costs total $2,500. Total closing costs would be $4,500, which is 4.5% of the purchase price.

Now let's assume we have a property selling for $500,000. The fixed costs would be the same - $2,000. The variable costs would be higher because the loan amount, the taxes, and the insurance would be higher. They might be $8,000. The total closing costs would be $10,000, which is 2.0% of the purchase price.

Even though the closing costs are $5,500 less for the cheaper house, the percentage is much higher than it is for the expensive house - 4.5% versus 2.0%.

It's always a good idea to have your lender (preferably us) tell you how much the closing costs are. Guessing based on a "rule of thumb" will give you an incorrect number most of the time.

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