Veterans are sometimes caught off guard when they learn about the closing costs associated with a home purchase. While it is true that VA does not require a down payment, closing costs are still a thing when buying a home no matter what type of loan the buyer is using. In a survey done by ClosingCorp, 17% of buyers were surprised closing costs were required on a purchase and another 35% were surprised at how much the closing costs were for their home purchase. The total costs to purchase a home can be anywhere from 2% to 5% of the purchase price. Being prepared and knowing the numbers is very important for any Veteran looking to purchase a home with a VA loan. There are two main types of closing costs/fees to be aware of. Non-recurring and Recurring closing costs.
Non-Recurring Closing Cost
As the name implies, Non-Recurring Closing Costs include items that only occur during the actual transaction. For example, an appraisal is needed for the purchase, but will not be needed on an ongoing basis unless the borrower is looking to do another transaction or refinance the loan. Non-Recurring Closing costs include fees for the loan, property inspections, title and escrow fees, etc. Below is a list of fees that you may see on a California home purchase.
- Appraisal - VA sets the Fee for an appraisal. In California it can range between $700 and $1,000 depending on the county the property is located. The VA appraisal cost in Orange County and Los Angeles County is $700. The California VA lender will order the appraisal.
- Credit report - the VA lender will pull your credit. The credit report is a "Tri-Merge" report which included the FICO scores from all three bureaus which include Experian, Equifax, and Transunion. The cost of the report and any additional updates to the report and passed on to the buyer. The lender does not make a profit on credit reports (or appraisals). The credit report fees can range from $50 to $100. Some lenders include the cost of the credit report in their Origination Fee.
- Origination Fee - this is charged by the lender. It can range from $500 to 1% of your VA loan amount. The Origination Fee on a VA loan cannot be more than 1% of the loan amount. The Origination Fee covers lender costs to Process, Underwrite, and close the loan. Some lenders automatically charge 1% on all VA loans. For example, CalVet charges 1% on all CalVet loans. It is important to understand the difference between the Origination Fee and Discount Points.
- Discount Points - Discount Points are using the "buy" the interest rate down. Many VA borrowers don't realize it, but VA does not lend and does not have one "rate". Interest rates are formulated based on how Ginnie Mae Mortgage Backed Securities are trading on the secondary market. All lenders are starting from the same point when it comes to pricing a loan so there should be too much of a difference in rates from one lender to the next. But in some situations there is a big difference, so its important to know that just because one lender quotes a certain rate doesn't mean all lenders will quote the exact same rate and fees. When a California VA Loan Officer quotes an interest rate they are looking at a matrix of rates. The lower the interest rate the more the Discount Points to get that rate, The higher the interest rate, the lower the Discount Points or cost will be. It is quite often possible to accept a rate that is higher than the current market in order to get an offsetting lender credit to cover some or all of the closing costs. There are strategies here that a good VA Loan Officer can present to you.
- Escrow Fee - this fee is charged by an Escrow Company. The escrow company is a neutral third party in the transaction whose primary role is to protect the interests of all parties involved in the sale, including the buyer, seller, buyers agent and the sellers agent. The escrow company handles the funds between the buyer and seller, making sure the buyer doesn't receive title to the property until all conditions of the purchase are met and making sure the seller doesn't receive funds from the sale until those same conditions are met. The escrow fee can range from $500 to several thousand dollars. Most escrow companies use a formula to determine the cost. For example, they may have a base fee of $500 plus $3 per $1,000 of price. So a $500,000 purchase price would have an escrow fee of $2,000 using this formula. The escrow fee is considered by VA to be a "non-allowable" fee. This just means that the escrow fee, combined with the Origination Fee and other Non-Allowable fees can't be more than 1% of the loan amount. The escrow company it typically chosen by the seller or sellers agent.
- Title Insurance - this protects the lender and the borrower from financial loss from defects on title. Title insurance is quite often an afterthought, but there have been nightmare stories in Mexico where a home is bought with no title insurance, only to find after closing that the property was improperly deeded to the seller 20 years prior. The buyer in that case would lose the property and the money they used to buy it. Fortunately, the US has title insurance and any home buyer using financing will have it. Fees for title insurance range from $500 to $3,500 depending on the sales price of the home. The title insurance company is typically chosen by the seller or sellers agent.
- Inspection fees - these include the termite inspection, Home inspection, and in some cases the well inspection, septic inspection, etc. In California you will always have a termite inspection. And while a Home Inspection is not required by VA, it is highly recommended. A termite inspection is typically in the $125 range. Repairs required by the termite inspection are typically paid by the seller but everything is negotiable. The Home Inspection can cost between $400 and $1,000 depending on the property.
- Recording Fee - fee paid to the county recorder for the recording of the Grant Deed and Deed of Trust.
- Home Warranty - this is not required by the lender but is recommended. The home warranty covers things that go wrong with the home in the first 12 months after the purchase. Not all Home Warranty's are the same so it's important to do some research. But they will typically cover things like plumbing, appliances, etc.
- HOA transfer fee - If the home is a Condo or in a Planned Unit Development (PUD) then there will be a Home Owners Association. Most HOA management companies will charge a transfer fee when a home sells.
Recurring Costs - AKA Prepaid Expenses
Recurring costs are also know as Prepaid Expenses. These are expenses/costs that will continue after the closing of the purchase. For examples, there will be a fee for the annual Home Owners Insurance premium. This fee will be ongoing for as long as the home is owned. There are several Recurring Costs.
- Homeowners Insurance Premium - the buyer will prepay for the first 12 months. The Homeowners Insurance protects the homeowner if the home is damaged by fire or some other catastrophe. Not all policies are the same. For example, if the property is near an earthquake fault then it may be important to pay extra to get earthquake coverage. If the property is in a flood zone then there will be an extra charge for the risk of flooding. The homeowners insurance will be chosen by the buyer.
- Property taxes - and the time of closing taxes will be paid. Depending on the month of the closing, there may be prorated taxes due to the seller, or there may be prorated taxes due to the county. The escrow company will provide the correct estimate of the prorated taxes.
- Escrow account for property taxes and insurance - VA loans will have an escrow account (also known as an impound account) for property taxes and insurance. An escrow account is essentially a savings account the lender holds on the homeowners behalf from which property tax and insurance bills are paid when they come due. The number of months of property taxes initially deposited into the escrow/impound account is determined based on the closing month and first payment month. As an example of how this works, assume the closing date is April 15. Even though the annual homeowners insurance policy was paid through the closing, 2 to 3 months of insurance are deposited into the impound account. And 1/12 of the insurance premium is paid each month as part of the mortgage payment. Also, approximately 4 months of property taxes are deposited into the impound account, and 1/12 of the annual estimated property tax bill is paid into the impound account along with the monthly payment. This is the T&I part of the PITI. Principal, Interest, Taxes and Insurance.
- Prepaid Interest - this covers the initial interest due on the home loan that will not be part of the first payment. It's important to understand that mortgage payments are made "in arrears", are at the end of the month. This is the opposite of rent payments, which are made for the upcoming month. In the example above, where the closing date was April 15, the first payment would not be due until June 1, or 45 days after the closing of the loan. The June 1 payment will cover interest from May 1 through May 31. But what about the interest due from the closing date of April 15 through April 30? This interest is paid at the closing and is known as Prepaid Interest.
- HOA Dues - these are prorated. The escrow company will provide the breakdown, which will initially come from the HOA Management company. If the transaction closes on April 15, then there would be a prorated HOA payment covering April 15-April 30. The buyer will most likely also be billed the May 1 HOA payment. Some HOA's bill semi-annually.
Know Your Numbers Before You Close
It is important to know your numbers before the day of closing. The more time you have to educate yourself on the numbers and what to expect the less surprises you will have. A good place to get a solid estimate of the costs in a purchase is from your VA Loan Officer. The VA Loan Mortgage Specialist should be able to provide a solid estimate and breakdown during the initial Prequalification stage. Don't wait until your have an accepted offer to educate yourself.
Authored by Tim Storm, a California VA Loan Officer