In 2010, we decided we will be buying a home in a couple of years. As a first time home buyer, all I knew was there would be a mortgage and a down payment.  We started with figuring out how much house we can afford and set up a goal to save at least 20% for the down payment. So far, so good. Now, we want this year to be the year we actually pull the plug on buying a home. So I have been attending some real estate seminars and reading more about the buying process.

I started hearing the phrase “closing cost” thrown around a lot. When I asked the folks teaching the seminar what exactly it was, all I got was “Oh it is a bunch of one-time costs you pay when you close the house, sometimes you pay the entire thing, sometimes if the seller is motivated they will pick up the costs”. Books and online articles were a little more helpful in refining the closing costs, but even then I couldn’t get an estimate on how much more these costs will be? How much should I save over than the down payment? Some sites said $1000 whereas some quoted 3-5%. That is quite a big range! I don’t want to get close to finding the house we like only to realize we don’t have enough money to close. So I decided to get as specific and possible.

(Update: We got pre-approved for a loan. During the pre-approval process we were asked to show proof that we can pay the 20%+Closing cost on our own to get the conventional loan. Good thing I had taken the time to figure out a ball park and save it along with the down payment. Otherwise it would have really complicated the process. So if you are planning to buy a home but are not planning to bundle the closing costs in the mortgage, know what the ballpark closing costs are.)

Here is a laundry list of costs that are all bundled together as simply “closing costs”.

Image source: Brianac37

Conventional loans closing costs explained

Part 1: Costs associated with the loan

• Origination fee: Fee charged by the bank to give you this loan. This fee covers charges like lender’s attorney fee, notary fees and document preparation fees.
• Processing fee/underwriting fee: Usually if they charge the origination fee, the processing fee and the underwriting fee is included in that. Otherwise, the processing fee is charged by the bank to process all your information for this loan. Underwriting fee is again, charged by the bank for researching whether they should approve this loan for you. Sometimes origination fee, processing fee, administrative fee and underwriting fee are used interchangeably.
• Discount points: To reduce the interest rate of your loan, some loans come with discount points. These are essentially prepaid interest. For example, if you pay 1% of your loan now, they will reduce the mortgage interest rate by 0.5%. This might be worth it if you are going to keep the house for the entire length of the loan.
• Loan application fee: Again, another fee to process your application. If you are paying an origination fee, negotiate this one away.
• Appraisal fee: The property you are buying has to be appraised to make sure the lender is not lending you more than the property’s worth.
• Document preparation fee: Another processing fee, to prepare the documents related to the mortgage. If you are paying an origination fee, this is probably included in that fee.
• Credit report fee: To get your credit report. Sometimes this fee is included as part of the application fee, some lenders charge this even before you apply for a loan.
• Flood certification fee: Fee charged by the lender to hire a third party to check if your property is in a flood zone. If the property is in a flood zone, along with the hazard insurance (the general home owner’s insurance), you will also have to purchase flood insurance before closing. This flood insurance cost is additional.
• Survey fee: This fee is charged to survey the property lines, shared fences, etc.
• Broker fee: If you are using a mortgage broker to shop for rates, the broker will probably add a fee for his service.

Part 2: Prepaid charges

• Daily interest charges: Partial monthly interest rate for the month you close. For example, if you close on May 15. You will have to pay prorated interest for the 16 days left in May. Your first payment will be in July.
• Private mortgage insurance: If you put less than 20% down, the lender will require you to get private mortgage insurance (PMI). The PMI protects the lender in case you default on your loan.
• Home owner’s insurance: To cover any damage to your home.

Part 3: Escrow/Reserves

If you put less than 20-25% (some lenders will waive the escrow at 20%, some will want the escrow until you have 25% equity) lenders will want to establish an escrow account. This escrow account will hold your property taxes, PMI and home owner’s insurance payments. The monthly payments are bundled together with your mortgage payment. But to start the account, they will want some buffer amount, which is usually 6 months worth of payments.

• X months (usually 6) worth of property taxes
• X months (usually 6) worth of mortgage insurance
• X months (usually 6) worth of home owners insurance
• Settlement/closing fees: Fees paid to the settlement or escrow agent to establish your account.

Part 4: Title charges

• Title services and lender’s title insurance: The lender wants to make sure they are the first lien holders in the property. So they will do a title check to make sure it is clear. They will also get the insurance, which you will have to pay for.
• Owner’s title insurance: Similar to the lender’s title insurance, this is for your own title protection.

Part 5: Recording and transfer charges

• Government recording charges: Fee charged by the local Government to record the sale of the property and the loan details.
• Transfer taxes: Taxes charged by the state and local Government on mortgage and sales. They can also be called real estate conveyance taxes, real estate excise taxes, mortgage transfer taxes, documentary stamp taxes and property transfer taxes. To find out how much tax you have to pay on the sales, check this list of transfer taxes by state.

Other fees paid during closing but not generally included as part of closing costs

• Buyer’s attorney fee: Not everyone will hire a real estate attorney. Some people want to make sure they are not missing anything in the hundreds (or even thousands) of pages of legalese, so they will hire a RE attorney.
• Home owner’s association transfer fee: To get into the new HOA, you will have to pay a transfer fee and all the back fees (if the seller has not kept his dues up to date).
• Home inspection fee: Home inspection is an absolute essential step in buying a home unless you are a licensed contractor and have the knowledge to inspect the home yourself.
• Pest inspection fee: It can be part of the home inspection, if not, the lender can require you get a pest inspection done.

Closing costs for FHA loans

The closing costs for FHA loans are similar to conventional loans. The only difference I could find was, there are a couple of extra closing costs (for >15 year loan term) –

• Upfront mortgage insurance premium (UFMIP): There are two parts to the FHA mortgage insurance, the first part is the upfront mortgage insurance premium. This one you pay when you close. The UFMIP is currently 1.75% of the loan value.
• Monthly mortgage insurance: This is similar to the PMI in a conventional loan, except, in case of an FHA loan, you pay this mortgage insurance for 5 years regardless of how much money you put for down payment or how much the property value changes AND the loan value should be less than 78% of the property. (If you are getting an FHA loan on/after June 3, 2013, the FHA monthly mortgage insurance will NOT cancel for loans starting with loan to value exceeding 90%. Translation: If you put less than 10% down, you pay this for ever. Even if you do put more than 10% down, you still have to pay the mortgage insurance for at least 11 years).

Closing costs for VA loans

Again, the basic closing costs are similar to the FHA/conventional loans. The additional fee that is unique for the VA loans is

• VA funding fee: This fee is established to offset the cost of the VA loan guarantee program. This fee can be paid at closing or included in the loan.

More information on VA loan closing costs.

Closing costs for USDA loans

The closing costs and fees for USDA loans are customary for the similar mortgage transactions (VA, FHA). The two additional fees that is unique to USDA loans are-

• Upfront guarantee fee: This guarantee fee is similar to the PMI, but paid up front. This can be paid by the borrower at closing or included in the loan. The current upfront guarantee fee is 2% of the loan value.
• Annual fee: This annual fee is applicable for the life of the loan. It is calculated based on the unpaid average balance and added to the monthly mortgage payment. The current rate for the annual fee is 0.4% of the unpaid balance.

More information on USDA loans.

Now that I know what these costs are, it is time to figure out how much each of these will cost me (buyer). Are any of these costs negotiable? Or can be passed off to the seller?

Estimate of closing costs + who pays and gets the money (buyer, seller, broker or lender)

The buyer pays all the closing costs. But depending on the loan, the seller is allowed to pay up to 3-6% of the closing costs. Some loans also allow the closing costs to be included in the loan (again, depending on the type of the loan and loan amount). The estimates are from my research. Make sure to get the Good Faith Estimate and the HUD-1 form from your lender for the exact cost you will be paying.

Also most closing costs are negotiable esp. if you shop around for a good mortgage deal.

It is best to shop around for a mortgage. Get at least 3 preapprovals and compare the rate & closing costs side by side. This is the closing cost worksheet we are using.

You can download the PDF of the worksheet here.

Do you know that one of the reasons you are losing money could be your friends? No, you might not literally be spending money on your friends but they are the reason you buy what you buy and do what you do. Surprised?  It is called Social Proof. Let me show you how.

What is social proof? And why should I even bother reading about it?

Because it could save you a lot of money, prevent you from losing money in investing and even get you better jobs. Now do I have your attention?

March 13, 1964

A young New York City woman was brutally murdered in the borough of Queens, NY. Her murder became one of the most widely covered topics in the newspapers within 2 weeks of the tragedy. Why? Because 38 people witnessed the crime, but no one took any action nor did anyone call the police. The murder case triggered a number of psychological studies to study why none of the neighbors did anything to help the victim.

May 17, 2012

I was restless. Was I making a mistake? This IPO was one of the most anticipated offers in years. Almost everyone in my circle of friends were either buying or seriously considering buying. I kept asking myself – what are they seeing that I am not? I am not an excellent investor, so may be I am missing something. I set up a stop order and cancelled it, three times. I almost bought the sensational IPO – Facebook.

September 21, 2012

The Best Buy near my house looked like a circus that day. I have seen such long lines only for two things – Black Friday and an iPhone release. The long queue outside the Apple store stretched and wrapped around the entire building. Apparently people even paid someone else to wait in line for them. I don’t have an iPhone, so I checked with one of the people waiting in line to see why the line was so long. Could the fear be that the iPhones would sell out on the first day and then there would be months of waiting? Not according to the person I spoke to. She simply wanted to be the first person among her friends to get it. I left feeling fascinated. Hours of waiting in line for what? When they can’t even tell an iPhone 4s and an iPhone 5 apart?

http://www.youtube.com/watch?v=rdIWKytq_q4&feature=player_embedded

All seemingly unrelated events right? No. There is one thread that is connecting all the above events – Social proof, also known as following the herd.

In the Kitty Genovese murder, one of the explanations that emerged out of the extensive studies was  that everyone who was watching looked at everyone else and nobody was doing anything, so everyone decided doing nothing was the right thing to do. Social proof!

Facebook IPO – I was listening to everyone at work talking about the IPO and lost my head. I was scared that I was missing out on something by not trying to get a piece of the Facebook pie. I woke up at 3:00 in the morning on the day of the IPO to cancel my stop order for the fourth and final time. Good thing too, because I checked with my friends and the conversation went like this -

Me : Hey! I decided to cancel my stop order for Facebook. I couldn’t go through with it.

My friend : You are being stupid. It is one of the best opportunities for investing in recent years. Your loss!

Me : Yeah, I might regret it later, but I don’t understand all the bits and pieces of it and I cannot comfortably say that they have a great revenue model.

My friend : Do you know how many people are on Facebook? Everyone is on Facebook.

Me : Yeah. I just didn’t feel comfortable and I am not good at valuing companies.

My friend : Why are you valuing companies? Value what exactly?

Me : Did you read FB’s S-1 registration?

My friend : S what? I bought the shares via Fidelity. They are good.

Me : Yeah. Fidelity is good, I am not talking about that. I was talking about FB. Did you read the prospectus?

My friend : What prospectus?

Me : Ummm [Changes subject]

It turns out no one, not even a single person has actually read the S-1 Registration Statement or the prospectus! They were going by the  hype and I was no different by following them! Social proof!

iPhone release –   How did Apple manage to create such a cult following? Brilliant marketing strategies, using their army of core Apple followers to create social proof. Create an image of “coolness”. Make it appear that being one of the cool kids requires you to have an iProduct. Social proof!

Let’s not forget the market crash of 2008.  All the banks were mimicking each other and so went down together.

How social proof is costing you money?

If you say you are not influenced by your social circle, you are lying to yourself. ALL of us base our decisions on others’ reviews. In this information avalanche world, we save time and our energy by shortlisting our choices based on what our like-minded friends like. It most certainly works, but as companies know us much better than ourselves it costs us a lot of money too.

Social proof in consumerism

Apple product launches are always a fascinating affair. A powerful person from Apple usually starts the launch with an exciting presentation and every Apple fan is glued to the talk. As soon as that is over, all the major sites are abuzz with talk about the launch, video demonstrations, reviews from Apple fans and blogs after blogs writing about how amazing the new iProduct is. At the end of the day, you will want that product too… whatever it is. That ladies and gentlemen is social proof perfected.  Apple will bring in a product that you never even knew you required and within a short time make you feel it is a necessity, not just by you using the product but by the buzz it creates among their target market.

Do you know why Amazon provides you with a list of their “Best sellers” as soon as you go to their website? Because if everyone is reading it, we tend to want to read it as well.

Do you know why QVC has a live count of how many products are sold during any particular infomercial? Because it makes you think “everyone thinks this product is a definite buy. You are stupid if you don’t buy it and you will lose it for ever”.

Companies know exactly how to empty our wallets by making us feel that we belong to the class of people in the ad.

Social proof in investing

For the twenty years ending on December 31, 2010 S&P 500 returned an average 9.14% per year. So an average investor’s return should be around 9.14%, right? Nope. it is 3.27%, a lot less than the S&P 500 performance. Why? Because we listen to others and buy/sell when others are buying/selling. When everyone is selling, the price drops and you will end up selling low. When everyone is buying the price goes up with you buying high.

How to make Social proof work for you?

Social proof is not all bad. We can take this concept and make it work for us instead of against us.

Social proof your way into a better job : Almost every hiring manager now Googles a prospective employee. Get as many testimonials as possible from your previous managers on LinkedIn. If there are two equally qualified candidates – one of them has 5 great testimonials on LinkedIn and the other one has 2 connections with no testimonials, which one do you think the manager will pick? Even though he does not know any of the managers personally, having 5 people vouch for his candidate is a great sign. This can differentiate you from the other candidates.

Social proof your review to get a better raise or a promotion : I started my career as an intern. At the end of my internship I put together a proposal based on the work I did. In that proposal I included not only my work but a separate section on how my work other people’s life better. I got testimonials on how much time my product saved them and how much better their results were by using my product.  I had a job offer from them 2 weeks later.

Know when to use the social proof in investing to make money : Social proof is an excellent tool to have in your arsenal if you are working with private markets. When dealing with public markets, rely on your research and strategic planning, not the grapevine.

Make friends with like minded people to save money : If everyone in your friends circle enjoys a potluck instead of hitting the bar, you will automatically start liking it even if you are not a fan initially. Instead of hanging out with people who borrow their way into an over the top lifestyle, hang out with people who want to be debt free. Soon a debt free lifestyle will look  cool to you too.

Social proof is a powerful, powerful concept. It makes our life simpler by simplifying our everyday decisions – which restaurant to eat (go to Yelp), where to stay on vacation (go to Tripadvisor), what games to play (Zygna on Facebook) or what book to read (Amazon reviews).  Whether we make it work for us or against us depends on how much effort we put on understanding ourselves.