A pricey housing market and higher interest rates have made it harder to afford a house, but related expenses known as closing costs also add to the homebuying challenge.
Typical loan closing costs when completing a home purchase — for items like loan origination fees, discount points, appraisal and credit report fees, and lender title insurance — rose almost 22% from 2021 to 2022, according to a report that the Consumer Financial Protection Bureau highlighted in a recent blog post.
Borrowers typically paid about $6,000 for such costs in 2022, up from about $4,900 in 2021. That was on top of a down payment and other costs.
The average monthly payment for a 30-year fixed-rate mortgage rose 46%, to $2,045 at the end of 2022 from $1,400 a year earlier, the bureau found. The median price of a single-family home in January was $383,500, up 5% from a year earlier, the National Association of Realtors reported.
Often, lenders simply add loan closing costs to the mortgage amount, increasing the borrower’s costs over time. Homebuyers can pay closing costs out of pocket, but that may eat into their cash for a down payment and end up costing them more in other ways — such as higher premiums for private mortgage insurance, which protects the lender if you fail to pay. (Typically, a 20% down payment is needed to avoid mortgage insurance.)
One likely factor in higher closing costs, the bureau’s report said, was a rise in the use of discount points — optional fees that homebuyers pay upfront to reduce the interest rate charged over the life of the loan. This is known as “buying down” the rate.
In 2022, half of homebuyers paid at least some discount points, up from roughly a third the year before, the bureau said. That was the largest proportion of buyers using discount points since the government began collecting data on them six years ago. The typical amount paid for discount points in 2022 was $2,370, up from $1,225 in 2021.
One discount point costs 1% of the mortgage and generally reduces the interest rate by 0.25 points, although the amount can vary by lender. On a $300,000 mortgage, one discount point would cost $3,000. If the interest rate was 3.5%, paying for one point would lower the rate to 3.25%. The number of points that borrowers can buy also varies by lender.
The bureau said in the blog post that it was monitoring the rise in discount points as part of its campaign against what it calls “junk” fees. How points are sold to borrowers, and whether they reduce costs as much as people think, “causes us some concern,” said Diane Thompson, a senior adviser to the bureau’s director, Rohit Chopra. “There is not a lot of transparency in the market about discount points,” she said in an interview.
Thompson pointed to research from mortgage financing giant Freddie Mac, which found that the difference in average rates between homebuyers who pay discount points and those who don’t is very small. That “seems to suggest that paying discount points may not be worth it from the consumers’ point of view,” Freddie Mac said in a recent report.
Adam DeSanctis, a spokesperson for the Mortgage Bankers Association, a trade group, said in an email that with loan rates and home prices high, it wasn’t surprising that more buyers would purchase discount points. Few borrowers “felt the need to ‘buy down’” their rate in 2021, when mortgage rates were around 3%, he said. The average rate on a 30-year fixed-rate mortgage fell to 6.74% from a week earlier, FreddieMac reported earlier this month. Despite the recent dip, mortgage rates remain high, the report said.
The association, in a statement objecting to the consumer bureau’s labeling of closing costs as “junk” fees, deemed the post “politically motivated.” Fees associated with mortgage closings pay for services that are “integral” to the home loan market, the statement said, and “are clearly disclosed to borrowers well before a home purchase” on forms developed by the bureau.
The bureau’s post also highlighted the cost of lender title insurance. The coverage, which buyers are usually required to pay for, protects the lender in case of potential claims against the property, including from previous liens or back taxes. The cost is typically 0.5% to 1% of the home’s purchase price.
Some housing experts say the cost of title insurance is often high in relation to the risk of a claim. Sharon Cornelissen, director of housing at the Consumer Federation of America, said claims under title insurance were “very uncommon.” About 5% of title insurance premiums go toward payment of claims, compared with 70% or more for other types of insurance, an Urban Institute report noted.
Real estate agents and lenders typically suggest loan settlement providers and insurance agents they are familiar with, but borrowers don’t have to go with their recommendations and can shop around, Cornelissen said.
Steve Gottheim, general counsel with the American Land Title Association, which represents the title insurance industry, said the cost of the insurance had fallen about 8% nationally over the past two decades. Most of the cost of title insurance pays for searches of county deed records, he said.
The consumer bureau’s post also said higher fees for credit reports, for which mortgage lenders have recently reported steep fee increases, “warrant further scrutiny.” Homebuyers have no say over these fees, which credit bureaus charge to lenders.
Here are some questions and answers about loan closing costs:
What is the best way to hold down homebuying costs?
The most effective thing that homebuyers can do is to shop for mortgage quotes from multiple lenders, Thompson of the consumer bureau said. “Most people don’t,” she said. But research shows that if they do, they can get lower rates, saving up to several thousand dollars over the life of their loan.
How can I tell if it’s worth paying for discount points?
Calculate the “break even” point for your loan. On a $300,000 fixed-rate mortgage at 6.5% over 30 years, your monthly payment for principal and interest would be about $1,896. If you bought one discount point for $3,000 and lowered your rate to 6.25%, you would pay about $1,847, saving $49 a month. Dividing $3,000 by $49 means you would need to own the home roughly five years before selling or refinancing for the extra fee to pay off.
Are discount points tax deductible?
Costs for discount points are generally deductible, according to TurboTax. You must itemize deductions on your return, however, rather than taking the standard deduction.