5 Tips to Reduce Closing Costs
What’s the best way to reduce the closing costs on your next home purchase or refinance transaction? Here are five tips on how to lower the bottom line and keep the cash in your pocket.
Get the seller to pay the buyer closing costs
On most purchase transactions the seller can pay some of the buyer’s closing costs. This payment by the seller of all or portion of the buyer’s closing costs and prepaids is referred to as a “seller concession”:
There are some limits on seller concessions.
On conventional loans conforming to Fannie Mae or Freddie Mac guidelines, financing the purchase of an owner-occupied property, the seller concession is limited to:
• 3% of the purchase price on purchases with a down payment of less than 10%
• 6% of the purchase price on purchases with a down payment of 10% or more but less than 25%
• 9% of the purchase price on purchases with a down payment of at least 25%
• 2% of the purchase price on investment property purchases
On purchase transactions utilizing an FHA mortgage loan, the seller concession is limited to 6% of the sales price or the appraised value, whichever is less.
On purchase transactions utilizing a VA mortgage loan, the seller concession is limited to 4% of the loan amount. Note that the concession is based on the loan amount, not the purchase price, for the VA seller concession limit.
On non-conforming conventional loans the limits on seller concessions are set by those programs’ specific underwriting guidelines but will usually fall between the 3% and the 9% limits, depending on the transaction LOAN-TO-VALUE (LTV) ratio.
A seller concession is such an important strategy that we explain the use of this strategy in greater detail in our article on Seller Concessions and Seller Paid Closing Costs.
Shop for third party service providers
Although the mortgage lender will typically require use of their approved appraisers and other service providers that they choose, other types of service providers, most notably the title company and title insurance company, can be chosen by the borrower. Although the cost of title insurance policies and endorsements in Texas are set by state law, the fees charged for other services provided by the escrow agent or title company may vary significantly from one company to the next.
Although most service providers competitively price their services, in some transactions, the charge for these services among providers can vary significantly. This is especially true if the contract between the seller and the buyer allow the seller to choose the settlement provider. A prudent buyer will determine prior to signing a contract whether the costs of the settlement providers being chosen by the seller provide products or services at a competitive price. If not, the terms of the contract should be changed to grant the buyer the right to choose that settlement provider.
Put less money down
Although the down payment is not technically a closing cost, it is part of the total amount the buyer will be required to pay at closing in the transaction. Accordingly, the amount of cash required at closing can be reduced by reducing the amount of the down payment.
Bear in mind that reducing the down payment can increase the loan points and other closing costs that are depending on the loan amount or the loan-to-value (LTV) ratio. So consult with your real estate agent and your mortgage loan originator to determine whether a reduction in the amount of the down payment would be beneficial.
Accept a higher interest rate to reduce costs
Two of the most substantial elements of the costs paid in a mortgage loan transaction are the origination fee and discount points paid to the mortgage lender or mortgage loan originator.
The amount of these fees and points are related to the interest rate on your mortgage. By accepting a higher interest rate you can reduce the amount of these charges you pay at closing.
But you must weigh the benefits of reducing these lender fees against the higher monthly payment that results from the higher interest rate.
On a fixed-rate mortgage you can typically reduce costs by an amount of between 0.5% and 1% of the loan amount for every 0.25 point percentage reduction in interest rate. This amount can vary significantly at each chosen rate so obtain a specific cost quote showing the principal and interest payment at a variety of interest rates so that you can compare how much the cost savings up front for each interest rate option will cost you over time in the form of a higher monthly payments.
For example, on a $300,000 loan amount, by increasing the interest rate from 6% to 6.125% you might be able to reduce the costs paid at closing by $1,500. In this example, this would increase the monthly principal and interest payment from $1,798.65 on the 6% mortgage to $1,822.83 on the 6.125% mortgage. You would pay $24.18 more each month because of the higher rate. That’s $290.16 per year. After 62 payments (a bit more than 5 years) you would have offset your initial savings of $1,500 by the extra amount you paid each month as a result of the higher interest rate.
Under this scenario, if you’re only going to be in the mortgage for five years or less, then it obviously makes sense to pay less up front since it will take five years to offset those savings with the higher mortgage payments during those five years. But the longer you stay in the mortgage after that five year period, you’ll be paying a bit more every month.
Bear in mind that in our example it still might make sense to reduce the costs with a higher interest rate even if you plan to live in the property for much longer than the 5-year cost recovery period. That’s because during that 5-year period, if you anticipate keeping the property for several more years, you will likely benefit from refinancing to a lower interest rate, paying off the existing mortgage prior to having paid a sufficient number of payments at the higher interest rate to compensate for the savings you experienced with the lower closing costs on that existing mortgage.
For this reason, a borrower will typically benefit by reducing upfront costs at the expense of a higher rate of interest and the corresponding higher monthly payment.
Shop for a loan with lower costs
The amount of costs you pay at any particular interest rate varies significantly between banks, lenders, and mortgage loan originators.
For example, on a 30-year fixed rate mortgage with a $275,000 loan amount, Quicken Loans was recently quoting 7.25% (APR of 7.577%) with 2 points ($5,500) and other lender fees of $1,095. On the same day, Retiro Financial was offering the same rate with an APR of 7.076% with zero origination fee and discount points, $1,095 in other lender fees, and a lender credit paid to the borrower to be used against other closing costs of $2,442. So with identical interest rate and payment a borrower could reduce their closing costs by $7,942 on that mortgage merely by using Retiro Financial instead of Quicken Loans obtaining the same interest rate and identical payment.
On the same day, Bank of America was quoting 6.875% (APR of 6.701%) with 0.671 points. On the same loan program with the same interest rate and payment, a loan from Retiro Financial would produce an APR of only 6.882%, with zero origination fee and zero discount points and providing a lender credit of $854 applied toward other closing costs. On that transaction using Retiro Financial in lieu of Bank of America, the borrower would reduce their closing costs by $3,202.50.
Call Retiro Financial today and one of our loan consultants will provide detailed quotes in writing within minutes on a variety of rate options.
We can also provide tips on how to further reduce costs utilizing one or more of the strategies we’ve outlined above.
Questions? Give us a ring!
(Click a number to dial on your device)