You’ve found your first flip, and you start doing the math:
The property is valued at $500,000, and you plan to renovate it for an extra $50,000. A private lender has offered you $350,000 towards the purchase price, and the $50,000 to renovate it, making the total loan amount $400,000. To proceed with the deal, you need to provide the remaining $150,000 towards the purchase.
| Sources | Uses | ||
|---|---|---|---|
| Debt | $400,000 | Purchase | $500,000 |
| Equity | $150,000 | Rehab Costs | $50,000 |
| Total | $550,000 | Total | $550,000 |
Pro Tip: When starting a project, always start with a Sources & Uses table to get a clear understanding of where cash is coming from, and where it is going.
But is $150,000 all you really need at closing?
No. There are a series of different charges you must be ready to cover either by or at closing in order to proceed with the deal. These costs are collectively referred to as upfront costs.
To save yourself from any surprises (or embarrassments), it is important to know what to expect. Let’s walk through them. You can follow along on our sample worksheet here.
Note: This post is intended to be a guide for you to start thinking about various type of costs and expenses involved in closing. Actual costs will vary according to your individual circumstances and the service providers involved in your closing.
1. Prepaid Interest Reserve
Most lenders will require an interest reserve if there is lack of significant liquidity or steady cash flow. This generally consists of three to six months’ worth of interest payments. The sum will be held in a collateral account, and is just one of the protections lenders put in place for the risks they are incurring by giving you a loan.
In addition, you may have to bring some short interest to the table, depending on which day of the month you close. This is generally calculated on a per diem basis.
Pre-paying interest is a normal course of business with a private loan, but the amount required upfront may vary between lenders, depending on their independent evaluation of the project.
2. Common Upfront Costs / Fees
Now let’s cover some of the fees you should expect to incur when closing on a property. Not only is there a cost to process a loan, there are several additional expenses to ensure the project is actually viable, and that everything is logistically in order – collectively known as project review costs.
| Cost / Fee | Description | Expected Cost |
|---|---|---|
| Loan Costs | ||
Lender’s Closing Fee (generally in points) |
Most lenders charge fees for processing and servicing your loan, due in full at closing. | Generally range between 1% – 3% of the loan amount. For a $400,000 loan, that can be $4,000 – $12,000. |
| Land Survey | Provides a detailed picture of the property’s boundary lines, as well as an accurate measurement of the property size. | Average ~$500, can range from $100 – $900 |
| Title Search / Services Fee | An independent title agent will have to ensure the property title is “clear,” and no one can claim a right to it. | ~$200 |
| Flood Certificate | If the property is in a flood zone, you may need to get a flood certification, which is filed with the Federal Emergency Management Agency (FEMA). | ~$15 – $35 |
| Background and Credit Checks | This covers the cost of the lender obtaining your credit score. | ~$100 / borrower |
| Government Recording Charges | This fee is charged by your local city or county government to update public land ownership records. | $125 |
| Legal Fees | By state law, you’ll typically need to engage an attorney to document the mortgage. | $1,500 – $2,500 |
| Courier Fee | Most states require original signatures. These will need to be sent via certified mail to the lender so they have proof that the transaction is complete. | $7.50 – $20 |
| Wire Fee | This is a fee that the lender is charged by the bank to send you funds, and simply passed on to you. | $30 |
| Project Review Costs | ||
| Appraisal | An appraisal is an unbiased, professional opinion of the value of the property, required by the lender so that they have validation that the property’s contract price is appropriate given the location, features, and condition. The appraisal can be integral to the closing of the loan, and the closing will likely be contingent on it. Properties with a lower appraised value than expected may not seem so attractive to lenders. |
Appraisals can start around $300 – $500 for residential properties, and $2,000+ for commercial properties. This is a broad estimate that will inevitably vary between appraisers and locations. |
| Home Inspection | A thorough examination of a property to determine its present condition; includes examination of the structure, roof, ceilings, walls, windows, attic, basement, electrical systems, and plumbing. * Note: Not all lenders will require this. |
This is largely dependent on the size of the property, and typically range from $300 – $600. |
| Pest Inspection | Some home inspectors will offer this service as one of their offerings, or you may have to obtain one through a pest control company. The inspector will provide a detailed report of previous / current pest activity, construction faults which may result in pest issues, and areas of damage (as through termites). * Note: Not all lenders will require this. |
Typically ~$100 |
| Budget Feasibility Review | For projects involving construction or renovation, the lender will need to ensure that the estimated costs of the project make sense. | ~$250 |
3. Insurance
Borrowers will likely be required to show proof that insurance is paid through the term of the loan. Failing to do so may affect the closing, or force the lender to hold the equivalent amount in escrow.
| Cost / Fee | Description | Expected Cost |
|---|---|---|
| Dwelling Insurance | To protect the value of the various structures within the property. These policies typically do not cover any personal belongings which may be inside. Lenders will customarily require you to pay for a year’s worth of property insurance at closing. |
As a general rule, expect to pay ~$35 for every $100,000 in home value. |
| Vacant Home Insurance | Vacant homes pose a higher risk to theft, vandalism, fire, and water damage. You’ll probably want to consider this if you expect the property to sit empty for 30 – 60 days. | Start at $250 / year for fire-only coverage, and go up from there. Typically paid for up front on an annual basis, but you can be reimbursed for the portion you don’t use. |
| Title Insurance | Title Insurance is an additional cost, broken down into a Lender’s Title Policy and an Owner’s Title Policy. Each one protects each respective party in case of a loss due to a title claim. While title insurance is optional, it will cover you for the amount of your policy if a lien on the property is discovered after you have completed the purchase. * Note: Refinancings usually don’t require the purchase of an Owner’s Title Policy, since it is assumed that the owner already has it. |
Average of 0.5% – 1.0% of the purchase price |
| Flood and / or Earthquake Insurance | May be required depending on the risks associated with the property location. | Average cost is $700, but may range widely. |
| General Liability Insurance | For projects involving construction / renovations, you’ll need to get coverage in the event an injury occurs on the property. | ~$90 / month |
| Builder’s Risk Insurance | For projects involving construction / renovations, this policy will cover the costs invested into the project. | Typically range between 1% – 4% of the total construction costs. |
4. Taxes
Yes, one of the two things certain in life . . . remains certain in real estate investing. Taxes are expected to be paid off in full through the term of the loan, and no taxes should be outstanding at closing.
| Cost/Fee | Description | Expected Cost |
|---|---|---|
| Property Taxes | Your lender will likely require that property taxes are paid off in full (usually through the term of the loan). Note: Real estate taxes are often based on the “millage rate,” where one mill is equal to one-thousandth of a dollar -- so the tax rate may be expressed as some number of mills. |
This is an expense that can vary between states and property value. To calculate, multiply the taxable value of your property by the current tax rate for your property’s tax class. |
| Transfer Taxes | Tax that is charged by the state or local government to complete the sale of a property from one owner to another, and typically based on the value of the property (includes inheritance taxes, for example). Some states do not impose transfer taxes, or have very low flat fees. |
See this table, courtesy of the The National Association of Realtors, for a summary of real estate transfer taxes by state. |
If all of this sounds like a lot, it’s because . . . well, it is. For our fictional $400,000 loan, adding upfront costs to the down payment could mean that you’ll need to provide over $190,000 yourself to close it – a trivial ~25% increase in the equity requirement.
| Sources | Uses | ||
|---|---|---|---|
| Debt | $400,000 | Purchase | $500,000 |
| Equity | $190,000 | Rehab Costs | $50,000 |
| Closing Costs | $40,000 | ||
| Total | $590,000 | Total | $590,000 |
Most costs are covered by the buyer out of pocket, although some of these can be factored into your loan if permitted. Ultimately, all costs may vary widely, and will depend on factors like the lender, the borrower, and the specific deal. The only way to know how much you’ll need exactly is to speak with your lender and all other associated parties.
But think of each one of these costs as extra measures to protect your investment and ensure its viability. If you believe you’ve found something valuable, these initial expenses will most certainly pay off over time.
The lesson here is that when evaluating a real estate investment, you need to be prepared to have additional funds beyond the down payment to ensure the deal can go through. You can manipulate the inputs within the accompanying worksheet to get a sense of what upfront costs may be like for the property you have in mind.
Good luck! If you have any questions on any of the above or on what to expect throughout the closing process, do not hesitate to email us at contact@rdadvisorsre.com. Expert real estate investors are always just an e-mail away and available to help.