442 Chapter 10 Consumer Mathematics
Appraisal. The lender will require an appraisal of the property’s value. Since the
property is their security for the loan, the lender wants to make sure that you are not
overpaying for the property.
Title search and insurance. If the seller is not the true owner of the property, even if
you buy it in good faith you may lose out when the actual owner seeks to reclaim the
property. A title insurance company researches the ownership history to make sure that
the seller has a clean title to the property, and provides an insurance policy to cover
you and/or the lender in case a mistake is made that they don’t catch. Problems with
titles can arise from lost or improperly completed paperwork, inheritance, divorces,
fraud, or simple errors.
Inspections. A house that is structurally damaged by a termite infestation is worth less
than one that isn’t. The lender may require certain inspections to make sure that there
are no such hidden problems.
Flood check. Damage from fl oods is not covered by homeowners’ insurance. The
lender will require a check to make sure that the property does not lie in an area where
fl ooding is a risk, and if it is, will want to know about it to make sure that a separate
fl ood insurance policy is in place.
Recording fees. Local governments maintain records of who owns what properties,
and charge fees to record changes in these records.
Mortgage taxes. The state, county, city, village, and/or town in which the property
is located may assess taxes on mortgage loans, as well as other taxes on the sale of a
property. Mortgage taxes are currently charged in Alabama, Florida, Georgia, Hawaii,
Kansas, Maryland, Minnesota, New York, Oklahoma, Tennessee, and Virginia.
Application and origination fees. The mortgage lender may charge various fees for
processing a mortgage application, running credit checks, and so on.
Miscellaneous other fees and expenses. This includes fees for notaries, overnight
postage, and various other expenses.All together, these up-front expenses can add up to a lot of money. These costs (excluding
the down payment) are often referred to collectively as closing costs. Closing costs can run
anywhere from several hundred to several thousand dollars on a typical property.
Another demand for up-front money comes from what are commonly known as prepaids.
The best way to see what these are is by means of an example. Suppose that you close on
the purchase of a house on October 1, 2006. The annual property taxes are $3,600, and
they are due on January 1. Property taxes are paid in advance, so the people you bought the
house from paid the taxes for 2006. Since you will own the house for the last 3 months of
2006, you must reimburse them for 3 months’ worth of the taxes.
You also have a problem with your escrow payments. You will be making payments of
$3,600/12 $300 into your escrow account with your November, December, and January
payments, but that adds up to only $900. The taxes due on January 1 are $3,600. The prob-
lem is that you need a full year of escrow payments to accumulate the full year’s taxes,
and so when you close on the house, you need to make a payment to catch up for those
9 months’ payments. And so, you will need to come up with 9 months’ worth of taxes for
your escrow account.
Putting these two figures together, you will need a total of 3 9 12 months, or
one full year, of taxes. With a moment’s thought it should be clear that if you had bought
the house on another date, the split between reimbursing the previous owner and escrow
catch-up would be different, but the total would still be a full year of taxes. For example,
if the closing had been on May 1, 2006, you would have had 8 months of taxes reimburs-
ing the seller, and 4 months worth of catch up. But in any case, you will need a full year’s
worth.
Because insurance premiums must also be paid in advance, you will also need to come
up with a full year of homeowners’ insurance as well. The monthly payments to your escrow
account will pay for next year’s premium, but they don’t help with the current year.- • • • • • • •