Buying a house. It is likely going to be the biggest financial investment you will ever have to make in your life. Once you own the house, you are likely going to be there for the new few decades.
Because this is such a big investment for an individual or couple, there is a lot of paperwork and a lot of time that goes into this process compared to a normal purchase. The average closing time on a house varies from 30 to 75 days.
One thing new home buyers struggle with is how to read a closing disclosure. Some buyers may not even know what this is.
While it can admittedly be a lot to take in at one time, this is not as complicated as you might think to understand once you start to break it down.
Do you want to know how to understand a closing disclosure before you are ready to lock down your dream home? This is the closing disclosure explained.
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What Is a closing disclosure?
Before we can break down a closing disclosure for you, you need to understand what a closing disclosure even is. To put it quite simply, it is an overview of all of the expenses, rates, and fees that come with your loan and for buying a house.
These can include but are not limited to the loan rate and interest fees, what you will make in mortgage payments each month, finance charges, and any other closing costs that you might incur for your mortgage.
How long do you have to respond to disclosure?
When you receive a closing disclosure, you will have three days to respond to it and review it.
Why three days? This is the requirement under the TILA-RESPA. It helps protect buyers from being pressured into an immediate purchase without going over all of the details.
The time gives buyers a chance to review all of the documents and review all of the charges. Then, they can decide if they are willing to accept all of the payments agreed upon and all of the rates agreed upon.
A buyer needs to look this over thoroughly because once they sign a disclosure, they cannot change the mortgage rates and interest that were agreed upon.
Be careful with how long you take to do this though. If you take the full three days, there are some instances where the price of say a mortgage rate can be changed by the lender. Also, you could possibly lose the home to another bidder in that stretch.
Loan terms
Ok, so you have the closing disclosure and you are going over the overview of costs. Something you need to make note of is the loan terms that are going to be in the documents.
Some of the biggest examples of this include the loan amount, the interest rate, the monthly principal and interest, plus any other additional payments or penalties.
With the loan amount, the closing disclosure will lay out how much money you are going to receive from the lender. This is the money that should pay for the purchase of the house besides the down payment that you put up. It can also potentially cover other fees that may come up during the purchase.
The interest rate is essentially how much the mortgage rate is going to be from the lender. This can vary significantly depending on when you get a mortgage.
In 2022, the average mortgage rate is over 5%. This time last year, the average mortgage rate was less than 2.9%. It is important that you look at this closely because when it comes to the mortgage rate, the difference between 2% can be thousands of dollars. Make sure you know what the average rate is before you sign any disclosure papers.
As for principal and interest monthly, these are the expected payments that you will make to your lender every month. This will be put towards your total mortgage plus the interest on top of it for not being able to pay all of the mortgage off in one payment.
Make sure you know what both of these numbers are before you sign anything and make sure that the principal and interest payments are ones that you can afford to make monthly compared to your expected monthly income after taxes.
Possible additional payments
Besides the explanation in the loan terms above, there may be some additional payments there that you need to be aware of.
One of those payments is a possible prepayment penalty. Some lenders charge this if you pay off your mortgage earlier than what was outlined in the closing disclosures.
This can arguably be used as a way for lenders to ensure that they are going to keep getting the interest payments along with your payments towards the principle of the mortgage. Luckily, this practice seems to be phasing out from lenders compared to past years.
Another possible payment that you need to be aware of is something called a balloon payment. Again, this is not something that all lenders do these days, but it is a possibility with certain lenders.
Basically, with balloon payments, you would be required to pay one large lump sum payment at the end of your mortgage payments. If this is the case with your mortgage payment plan, you may have to pay less per month on your monthly payments leading up to it.
Be careful if this is in your disclosures without realizing it. While it may benefit you in the short term, you will need to save up the money to pay that balloon payment off in the long term because you can escape your debt with the lender.
These are not usually ideal payments for a buyer to have in a closing disclosure. Some may have no choice if they want a mortgage to be accepted in the short term. However, if you have a problem with these items in your disclosure, do not be afraid to send them back to the lender and see if you can get them removed.
Possible payments
The next section on how to read closing disclosure focuses on other payments that you may have to make regarding your mortgage. Here, the lender will break down everything that goes into the payments mentioned above plus any possible payments that relate to that.
One section is going to estimate the total monthly payment that you are going to have to make. That section will mention the monthly principal agreed upon along with the interest payment on the mortgage that was mentioned above.
Along with those two, you will have to factor in mortgage insurance plus a possible escrow payment. When it comes to mortgage insurance, this will most likely only be a factor if you are paying a low percentage of the mortgage off on a down payment.
Usually, the baseline for this is to pay around 20% of the mortgage as a down payment to avoid mortgage insurance payments.
The other part of this payment that may be outlined here is the escrow payment you could be responsible for. For those unfamiliar, the escrow is the amount of money a buyer will set aside to pay initial homeowner’s insurance payments along with the initial property tax payments.
In other words, you are paying those taxes and insurance plans in advance. The sellers and the lenders want to make sure that you have the financial means to live in this home after your loan.
However, it is not mandatory to put those payments in escrow. If you do not do this, then estimated expenses such as homeowner’s insurance and property taxes will be laid out in this section.
Closing costs
When you are closing a deal to buy a home, do not forget that there is a closing cost fee to wrap all of this up. That fee usually covers the work done by real estate agents and even real estate attorneys to get all of the paperwork set up for purchase as soon as possible.
It can even cover other things such as application fees to get this home purchase through smoothly.
So, how much should you expect to have to pay in closing costs? Well, the answer varies from 3-6%. In most cases, the more expensive areas such as New York and Washington D.C. are going to have higher closing cost percentages than moving to states such as Oklahoma or New Mexico.
Additional costs
In case you are not tired of seeing additional small costs that go into purchasing a home, we have a few more to throw your way.
Because this is everyone’s favorite thing to deal with, you need to factor in the possible taxes that come with making this purchase. The main one is the minor transfer fees that are involved when you are purchasing the deed of a house from somebody.
The government is going to want their piece of the pie, and you are going to have to pay a tax to have the deed transferred over to your ownership.
Depending on where you live, you could see a lot more additional taxes on top of this. If you live in a state like California, New York, or New Jersey, the state and property taxes on a deal like this can be significant.
On top of this, you have to think about taxes on top of state taxes if you are buying a condo in a big city such as New York City. There, you could get hit with significant city taxes.
Then, there are smaller additional costs that you may end up being responsible for such as homeowner’s association fees. This is relevant if you live in a neighborhood where a homeowner’s association already exists.
In addition to that, you need to prepare money for things such as a home inspection fee and a home warranty fee.
Disclosures in loan
This part of the closing disclosure will outline the exact agreements that you made as terms of your loan. An example can be a situation where you end up being late on a monthly payment. This section will outline if the lender has the right to kick you out of your house immediately or give you a certain timeline to come up with the money for your payment.
Another example can be coming up with an agreement if you do not have all of the money for a monthly payment to pay at one time. With this, you can have a disclosure that says that partial payments of a monthly payment are accepted if a minimum amount is met and there is a set timeline to come up with the rest of the money.
Then, you need to be aware of what happens if you are late on a payment. Will the lender take your home from you? Or will they charge you a significant amount in interest as a late fee to make you not want to be late again?
Also, with these types of disclosures, a lender can put one in there that can require a buyer to come up with the entire loan balance anytime they choose.
Learn more about how to read a closing disclosure
These are just some of the things that you need to know about how to read a closing disclosure. Make sure that the terms are what you agreed upon, read all of the clauses and rates, plus be prepared for all additional costs.
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