Closing costs are a necessary evil with loans. Putting a mortgage together takes a great deal of work and requires a large team of people both at the lender's office and at third-party service providers. Closing costs are a reasonable way to compensate them -- but it's also possible to overpay. The best way to protect yourself against that is to shop around before you choose a lender and get estimates of costs.
Lenders typically charge an origination fee that pays them for the cost of making the loan and compensates their salespeople for working with you. Origination fees vary, with a charge of around 1 percent generally being reasonable. If you're paying an origination fee to a broker, look to see if he is also making money by charging you a slightly higher interest rate than he gets from his lender. If so, you may be paying too much.
Sometimes, you can lower your mortgage's interest rate by paying discount points at closing. These are a form of prepaid interest that can save you money over the life of your loan, but can also balloon your closing costs. For instance, if you know that you'll be holding on to your loan until you pay it off, you may choose to pay three points to lower your rate. Those three points will increase your closing costs by 3 percent of the loan value, or $6,000 on a $200,000 loan, for example.
Mortgage Insurance and Guarantee Fees
When you put less than 20 percent down or you choose a government-backed loan, such as a Federal Housing Adminstration mortgage, you may need to pay a guarantee, funding or mortgage insurance fee. The premiums for these programs vary depending on your credit, your loan program, and your down payment. If you don't want to pay them in cash at closing, some of them can also be added to your loan balance.
In addition to these fees, your closing costs can include a broad range of other fees. Some fees -- like underwriting, processing or document fees -- are added profit for your lender. You will probably also be charged for reports that come from third parties, such as credit reports, appraisals, or flood or natural hazard reports. The company that provides escrow and closing services will levy a fee, as will the title insurer. Your local government will charge recording fees and may also charge a mortgage registration tax. You might have to pay for wire transfers, couriers, or overnight delivery services.
If your mortgage includes an escrow account, you may be required to pre-fund it so that it has enough money to cover the expenses that it will pay. Typically, this includes putting some money in for property tax and homeowners insurance payments. Depending on the date that you close your loan, you might also have to prepay some interest so that the loan is current through the end of the month.
Bankrate conducts an annual survey of closing costs. It collects estimates from up to 10 lenders in every state, and calculates what the origination fees are and what the third-party fees will be. Across the United States, the national average for a $200,000 mortgage with 20 percent down and a well qualified buyer was $2,402 in 2013, with states ranging from $2,119 to $2,919. This estimate excludes prepaid items, mortgage insurance, discount points and title insurance.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.