Steadfast FinancesHomebuyers Should Be Thankful About Paying Large Closing Costs

Why Homebuyers Should Be Thankful About Paying Large Closing Costs

Filed in Economy , Real Estate 3 comments

An under-reported study conducted by the St. Louis Fed reveals a very different narrative with regards to the causes of the recent housing crisis. Researchers studied national foreclosure demographics to determine if predatory lending played a crucial role in the recent housing collapse. Economists were able to hone in on two demographics that made up a large share of foreclosures, but the findings were quite the opposite from what you’d expect.

The two wealthiest socio-economic demographics made up the largest share of foreclosures during the housing bust. These individuals had the highest average salary, highest level of average educational attainment and the greatest amount of financial promise. How do the most promising Americans lead a foreclosure tsunami?

No doubt the reasons for the Great Recession will be argued for decades. However, judging from the political narratives that have already taken hold, you probably never would have thought low closing costs were a major contributor.

The Importance of Closing Costs in a Mortgage

All first-time homebuyers should be thankful for those giant, upfront cash requirements banks establish as a requirement for a mortgage. I know. It’s a lot of money and a massive one-time expense. I’m certain that there are plenty of people who think it’s overly burdensome or even unfair. However, there is a very good reason the bar is set so high.

First of all, coming to the closing with a hoard of cash is a benchmark for soon-to-be homeowners. Like a test, banks make the initial investment requirements large to see if you have the ability to come up with the money. If you struggle saving for down payments and origination fees, how can you expect to weather a mortgage payment and additional costs associated with homeownership?

Additionally, by putting up a large chunk of your own cash when buying a house, you are putting skin in the game. If you paid no costs at the time you bought the house, what would you lose if you decided to never make a mortgage payment? Putting your own money on the line makes it harder for you to walk away from the house. It does one more thing, too:

The motivations above are effective enough to decrease your chances of foreclosure.

Few People Have to Front Closing Costs Anymore

Now that I’ve explained the importance of closing costs in preventing foreclosure, you should know that many homebuyers no longer pay them out of their own pockets.

Many opt to bargain for the seller pay their closing costs instead of asking for a price reduction. A survey by a California realty firm listed seller paid closing costs as the most common concession offered to buyers in purchase agreements. Nearly 66% of all home sales included these provisions. HUD found that homeowners with FHA loans where sellers paid closing costs were three times more likely to end up in foreclosure.

If it’s not the seller paying the closing costs, it is mom and dad. The same California realty survey reported that on one in four homebuyers receive assistance from their parents to pay closing costs.

I commiserate with prospective home buyers that large initial cash requirements are a tough nut to crack, but an important one to tackle on your own.

But, Is Making Closing Costs Even Higher the Answer?

So if paying large sums of money through closing costs is somehow good, requiring two or three times the current minimal down payment must be extra good for prospective homebuyers?

New financial regulations enacted by the recently passed Frank-Dodd bill aim to make it more costly for homebuyers with less than a 20% down payment to obtain a mortgage. While I’m clearly a proponent of going it alone in obtaining money for your closing costs, I think the new regulations are taking this concept too far.

It isn’t necessary to raise the amount of money people need to pay at closing. Homebuyers just need to pay the rates, as they currently are, on their own.

Shaun is the author of the blog Smart Family Finance, a site dedicated to exploring the challenges of family finance; from starting a marriage to starting a family, from teaching your children about finance to helping them pick a college, from single income to multiple income. The intricate world of family finance unlocked, one post at a time.

If you enjoyed this post, make sure you subscribe to my RSS feed!
Posted by CJ   @   27 January 2012 3 comments
Tags : ,

3 Comments

Comments
Jan 27, 2012
6:33 pm

I didn’t know that about closing costs. Congrats from Yakezie.

Jan 29, 2012
8:26 am

Congrats on the site. Good article. I worked in the mortgage industry when I was younger, and I have a slightly different point of view. Closing costs are necessary, but you need to do your research. If you go with a big lender (Citi, Chase, BofA) then your costs will be high. They like to think they are charging you more because they are more “stable” than the smaller banks. In my opinion that is BS, the smaller banks/credit unions do a good job, not only that but your loan normally gets sold to a big bank anyways after you close.

Feb 3, 2012
10:22 am
#3 Lucas :

So closing costs are like a bride price, huh?

First, you need to address whether closing costs are fair. Some of them are like car dealers’ spurious add-ons. Some are higher than the cost of what they purport to pay for.

If a buyer brings a 20% down payment, that is plenty of financial commitment. The issue is not the closing costs, per se. You are confusing causation with correlation. The population in question is homeowners with FHA loans. The down payment was probably no more than 3.5%. The point is that home buyers with little to no down payment, no closing costs and interest-only loans have no more “skin in the game” than if they were renters, and therefore no incentive to keep paying for a house they foolishly offered too much for in the first place.

Bubble prices never reflected true, healthy or sustainable value because true value is related to wages since wages pay for houses. The local median wage needs to qualify for a local median turn-key house. Too many home buyers had no equity but all the responsibility. Of course, they gave the house back to the bank. And if they took out a huge home equity loan using all that pseudo-appreciation as collateral, they made out like bandits because they effectively sold the house back to the bank.

I began looking for a house in 2001. The first thing I did was check the wage demographics of the community. When I saw that asking prices outpaced the wage demographic, I balked at making offers. Real estate agents constantly tried to overcome my objections by pointing to comps and persuade me to buy anyway. I kept looking, asking prices kept rising, I kept saying the prices were unsustainable. If I could know that and I was just an ordinary person, surely the real estate professionals (agents and lenders) knew it too, but just wanted to make hay while the sun shined.

They should just take their lumps, release their shadow inventories, let the housing market return to healthy prices. You see, the housing market is still sick, but at least the fever is dropping. Stabilization or price increases now would simply indicate that a sick market is in relapse.

Leave a Comment

Name

Email

Website

Previous Post
«
Next Post
»