Closing costs are a mystery to many home buyers, who understandably might not know how much they’ll pay, why they’ll pay that amount and what it’s really for when they buy a home.
A 2015 survey by ClosingCorp, a real estate closing data company, found that more than one-third of people who planned to buy a home were either not very or not at all aware of closing costs.
This lack of knowledge was even greater among Millennials, approximately two-thirds of whom didn’t know about closing costs.
Examples of closing costs include mortgage origination fees, owner’s and lender’s title insurance, escrow or settlement fees, transfer taxes and government recording fees. Altogether, closing costs can add up to thousands of dollars for the buyer and seller.
One more thing buyers should know about closing costs is that many builders offer thousands of dollars in incentives to buyers who get their loan through the builder’s preferred lender.
Those incentives mean “it actually may be less expensive to buy a new home than a resale,” says Ron Sozio, builder client relationship manager at Wells Fargo in Somerville, N.J.
Builder incentives of 2 percent to 3 percent are common, says Joanne Stucky, a Realtor at Realty Executives in Las Vegas.
Buyers should ask, “Two to three percent of what?” because some builders offer 2 percent to 3 percent of the home’s base price, others offer 2 percent to 3 percent of the total sale price and still others offer only 2 percent to 3 percent of the buyer’s loan amount.
The difference can be significant, especially if the buyer’s down payment is a big one as a percentage of the sale price.
Could 2 percent of the sale price be more than 3 percent of the loan amount? Yes, Stucky says, it could.
One thing buyers should know about closing costs is that many builders offer thousands of dollars in incentives to buyers who get their loan through the builder’s preferred lender.Buyers might wonder whether they can get the incentive without getting a loan through the builder’s preferred lender. The answer is no — or at least very unlikely.
It’s not always clear whether the builder’s package is a better deal than a loan from another lender without the incentive. That means buyers must shop around and compare lenders’ offers.
“Buyers can seek a comparative bid and make the call whether the incentive is worthy of that loan or whether they should go with an outside lender,” Stucky says. “The interest rate is for 30 years and the difference (of a lower rate) versus the incentive can be quite substantial.”
In a booklet about settlement costs, the Consumer Financial Protection Bureau, a federal agency, advises homebuyers to “shop and compare interest rates and other settlement charges before entering a contractual agreement to use (a builder’s) affiliated companies.”
Applying for multiple mortgages might seem like a hassle, but buyers often must at least meet with the builder’s lender regardless of whether they choose that lender to get their loan.
“Builders won’t allow them to go to contract unless they have been preapproved or prequalified with the builder’s preferred lender, even if they have their own loan approval,” Stucky says.
The preference for an affiliated lender means the builder can make more money from the sale and keep a eye on the loan process, says Tara Moore, a Realtor at RE/MAX Select in Winter Garden, Fla.
That watchfulness isn’t necessarily a negative for the buyer. “It does make things pretty seamless when you’re using the builder’s preferred lender,” Moore adds.
Buyers who shop around can use other lenders’ quotes to negotiate with the builder’s preferred lender. A preferred lender might not match another lender’s rate, but instead narrow the gap, offering a slightly lower rate once a competitive offer is presented, Moore says.
What’s more, many lenders who aren’t affiliated with a builder also offer closing cost credits for resale or new construction to sweeten a loan offer, says Ken Pozek, a Realtor at Keller Williams Realty in Northville, Mich.
“If it’s the right loan amount and there’s enough (profit) in it for the lender, they might eat your closing costs just to get your business,” Pozek says.
By the way, builders can’t require that a buyer get financing from a preferred lender. Buyers can always choose a lender they prefer; even it’s not the builder’s choice.
Buyers should also consider who pays which closing costs because some builders require buyers to pay costs that customarily would be paid by the seller. That cost-shifting reduces the benefit of the builder’s closing cost credit.
“Part of the incentive is going to cover costs that are quote-unquote traditionally seller costs,” says Moore. “They are giving the buyer above and beyond what the charges are, but it’s not a dollar-for-dollar credit.”
Shifted costs such as title insurance and transfer taxes can amount to thousands of dollars, depending on the sale price of the home, local tax rates and other factors.
The bottom line is that buyers aren’t just shopping for a home; they’re also shopping for a mortgage, whether it’s from a builder’s affiliated lender or someone else.
“You need to be thinking that through,” Moore says. “Don’t just go with the first quote you receive.”
For an estimate of the closing costs in your state, check out Bankrate.com’s 2016 report.