How to Reduce Closing Costs
The ability to purchase a house for many people comes down to whether or not they can afford to pay closing costs. This is unfortunate considering that the average homebuyer pays only about $3,700— which is a lot of money, but isn’t when you consider the grand scheme of things.
Believe it or not, there are a few ways around paying the full cost of closing costs.
Option 1: Ask the seller to pay for closing costs.
A lot of first time home buyers don’t even think about doing this. You have to have played the game for a bit to realize it’s an option (or, at the very least, have an older, wizened mentor help navigate you through the purchase process). Asking for closing cost assistance is a good strategy if you’re low on cash, and works far more often than you would think.
To do it right, make sure that you ask the seller to cover closing costs during the initial negotiation phase. If you don’t, it’s likely too late. A typical amount that most purchaser’s ask for is $5,000. If you want to sweeten the deal, ask for a little less.
It’s key that you do it from the very onset. Don’t wait until after the home inspections to negotiate closing costs. Needed structural repairs are a completely different matter and should be dealt with on their own. Plus, when you put in an offer, you and your realtor will have already put in an amount that the seller, if he or she agrees, will agree to pay if the house needs work. The usual amount is $1,000, but if the seller is confident in his house, he may agree to more.
Don’t be afraid to ask for both closing cost assistance and repairs.
Needed repairs and closing cost assistance are two completely different things. It’s all business, and the seller can always say no to both; however, if you don’t ask, you definitely won’t get it.
Tip to the wise:
Don’t expect to get the seller to drop the purchase price by twenty grand and pay for closing costs. Many people have gotten both, but many sellers have simply walked away from negotiations altogether. Read the market, see how long the house has sat, and use your best judgement.
Use the sales history to determine a bidding strategy.
Unfortunately, you can’t ask your realtor to tell you how much foot traffic and interest the house has gotten. Realtors are commission based, and will likely try to steer you away from driving a hard bargain. For these things, Realtor and Zillow are your friend.
Don’t look at how long the house has been listed on the site because people list and remove houses all the time. A 20 day listing may actually have been on the market for months on end. What you need to look at is the price history. If you see multiple listings over the course of a year or two, you may see that the seller has been having trouble selling and that a hard bargain might be accepted.
But… if you go super low, be prepared to lose it. Every house bid is a balance between how much you want it and how much of a deal you want.
*** If you’re buying a foreclosure, banks never pay for closing cost assistance. If this is the boat you’re in, keep reading. ***
Option 2: Roll closing costs into the loan.
Yes, you can do this. If you don’t have the money, it might be an option.
But is it recommended? It depends on your situation.
Say you get a standard FHA insured loan at 4% to purchase a $200,000 house. Closing costs on a $200,000 house would be somewhere in the neighborhood of $6,000. If you were to roll it in, you would be paying 4% interest on that additional $6,000 for the life of the loan--meaning that, in the end, you’ll end up paying more money for the same product.
You’ll also pay a slightly higher interest, too. How much will depend on the lender, which means it’s something to talk about with your loan officer after you’ve been approved.
How much will the interest likely go up?
It will vary, but it will likely be 0.1% and some change (meaning 0.12% or higher).
Tacking on a few extra thousand dollars onto your loan and taking a 0.1% increase in your interest is barely going to change your monthly mortgage payments. $10 to $30 tops (if buying a $200K-$300K house). So don’t sweat it if you have to do this.
No matter the interest change, it will still be cheaper than renting:
Buying is always less expensive than renting. Always. Even if you account for real estate tax; even if you account for yearly maintenance; even if you account for insurance; even if you account for interest increase because of rolled closing costs; buying is always cheaper than renting.
When you rent, you never get your money back. When you buy, you save money every month, you build equity, and, if you sell, you get back what you put into it (minus interest and insurance), plus whatever amount it appreciates.
Rentals take your money and never give any of it back. They’re financial black holes.
Why you may not be able to roll your closing costs into your loan:
Reasons you might not be able to roll your closing costs into the loan include your home’s LTV (loan to value) ratio and your DTI (debt to income) ratio. The LTV ratio will be too high if it is appraised for an amount that is too close to the purchase amount. Since banks are the true owners of a house at the beginning, they like to get a good deal, which is why they’ll be less inclined to roll closing costs into a loan.
Increasing the amount you pay each month on your mortgage will increase your monthly debt obligations. A higher mortgage means a higher DTI. If your DTI gets too high, many lenders won’t loan to you. So while you may be fine to purchase a house in the beginning, rolling your closing costs into the loan may push you past the lender’s DTI limit. Many borrowers are close to their DTI limit and don’t know it.
Option 3: Closing Cost Assistance Programs
Yes, such programs exist (there are also down payment assistance programs, too). Are they competitive? The grant programs are, but there are also loan based ones, and these are not that hard to get. Just compare rates and loan terms to see if it’s better to get a closing cost loan through another lender rather than stick with your original home loan with a higher interest (often only 0.1%). Look at the total cost, and what the added monthly expense would be. Shorter loan terms mean higher monthly payments but more money saved overall.
This will likely only be a better option for you if adding closing costs on top of your loan would cause your home’s LTV ratio or your DTI ratio to go too high (meaning you wouldn’t be able to roll closing costs into your loan). Again, because the loan amount is so small (compared to that of your first mortgage), you’ll likely have both a higher monthly payment and a higher interest.
Shop around for the grants before you settle.
If you need closing cost assistance you’ll likely meet the requirements to qualify for a lot of programs. Do some digging.
First start searching within your county; if that doesn’t yield results, next go to your state; and if that doesn’t yield any results, go to the national level.
Example:
Chesterfield County, VA, Closing Cost Assistance
Virginia Closing Cost Assistance
Closing Cost Assistance, US
If you’re a US Veteran, teacher, cop, firefighter, try putting those into the search. Across the country there are a lot of programs tailored specifically to people who have undergone or who are currently engaged in public service.
One last note: Many down payment assistance programs can also be used for closing costs. Many of these programs come in the form of forgivable loans, which means as long as you live in your purchased home for a set period of time (usually five to ten years) you don’t have to pay anything back.
Option 4: No Closing Costs Mortgage
You may be wondering why this isn’t option 1. This is mainly because it’s the same as rolling your closing costs into your mortgage, which means you’ll pay a higher monthly mortgage because of a higher loan amount and interest rate.
However, if you’ve done the math and know that your potential home is likely going to sell for the same amount as it’s appraised (discussed in option 2), then this type of mortgage may be for you.
Option 5: Close at the end of the month.
If you close at the beginning of the month, you won’t have to make a mortgage payment for that month, but you will pay a per diem fee in your closing costs.
Say you close on the fifteenth of the month, and there are fifteen days left. To calculate how much you’ll pay for the per diem interest fee:
Multiply your loan amount by your interest rate
Divide that number by 365
Multiply that number by the remaining days of the month
Example:
$200,000 X .04 (4%)= $8,000
$8,000/ 365= $21.92
$21.92 X 15= $328.80
It won’t save you thousands of dollars, but a few hundred is nothing to ignore if you can manage it. If you can, close at the end of the month to save a few bucks.
Option 6: Don’t accept all lender fees.
Some lenders will charge for unnecessary things— such as a $90 fee for delivering an envelope. It may not happen, but many borrowers have stated that their simply bringing them up caused the lender to drop the mentioned fees.
So read through all of the fees. If they sound vague or very similar to another fee, ask why you’re being charged for it.
Option 7: Shop around for ‘Services You Can Shop For”
When you choose a lender, there are certain services that you can choose on your own. Of course your realtor and lender will both have guys who are ‘fast and trustworthy,’ but these are likely just companies they have an undisclosed partnership with. Services you can (and should) shop for include:
Lender’s title policy
Pest Inspection
Settlement agent
Survey
Title insurance binder
Title search
Title insurance and settlement services are where you’ll save yourself the most money if you shop around. If you haven’t put an offer on a house yet, start now because these can take time.
You may not have that many options where you live, or you may be overwhelmed by the amount. The sooner you know and dig, the easier and cheaper your closing costs may be.
Option 8: Shop around for the best lender
People tend to feel special whenever a lender agrees to work with them. Most borrowers feel self conscious about their credit scores and get a jolt of relieved delight whenever a lender says they’ve been ‘approved.’ It shouldn’t be this way. Lenders are the ones who should feel elated when borrowers choose them.
Don’t be afraid to shop around; and don’t be afraid to walk away from a lender who has ‘approved’ you.
When you apply, the lender must give you a ‘loan estimate’ form within 3 days of applying. This form will give you the total cost of taking out the loan with them. It won’t go into super detail, but at the very least will let you know how much you’ll spend to work with them. Make sure you shop around with banks at the same time as one another so you don’t hurt your credit score too much (FICO takes into account rate shopping, and won’t ding you if you apply with lenders within a short period of time of one another).
Compare the total costs between each company. If the rate is basically the same, and the loan amount is the same, you’ll know the jump likely comes from closing fees. Obviously you’ll want to choose the one that is the most affordable.
Make yourself informed.
The key to saving money lies in doing groundwork and reading everything. Read, ask questions, and shop around and you will save yourself money.