Estimating Closing Costs in Pennsylvania

5 Replies

Hello Investors,

I am looking at 1-4 unit deals in South East PA outside of Philly. My question is about estimating total settlement costs as the buyer. The settlement charges consist of 2 main categories: closing costs and prepaid/escrow items. The closing costs are all one-time fees and the pre-paid/escrow items are all representative of on-going expenses like insurance, taxes, and interest. When estimating my initial investment calculation for the purposes of estimating ROI, should I factor in just the closing costs into the equation or should I factor in closing costs plus all pre-paid/escrow items. The reason I ask is it seems as though I would be double counting on-going expenses (insurance, taxes, and interest) if I also incorporate them into the initial investment calculation as well as in the NOI calculation. In the real life examples I have, total closing costs equal about 3.2% of the $200,000 purchase price, but when I add in pre-paid/escrow items the total settlement charges equal about 6% of the total purchase price. Which number is correct to use as part of the initial cash investment calculation: just closing costs or total settlement charges?

Steve

@Steve Uhlig

It depends on how you set up your underwriting but I agree that you are double counting it if you do it the way you describe. The way I have it set up, the pre-paid/escrow items do not belong in my "closing costs" column. Now if you are doing a monthly profit and loss as part of your underwriting, you do want to account for that. But that shouldn't really affect your ultimate returns in any meaningful manner even if you use IRR method.

Long story short, I wouldn't worry about including the pre-paid/escrow items as long as you don't forget to bring the money to the closing. :) 

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it for legal advice. Always consult with your attorney before you rely on the above information.

Originally posted by @Steve Uhlig :

Hello Investors,

I am looking at 1-4 unit deals in South East PA outside of Philly. My question is about estimating total settlement costs as the buyer. The settlement charges consist of 2 main categories: closing costs and prepaid/escrow items. The closing costs are all one-time fees and the pre-paid/escrow items are all representative of on-going expenses like insurance, taxes, and interest. When estimating my initial investment calculation for the purposes of estimating ROI, should I factor in just the closing costs into the equation or should I factor in closing costs plus all pre-paid/escrow items. The reason I ask is it seems as though I would be double counting on-going expenses (insurance, taxes, and interest) if I also incorporate them into the initial investment calculation as well as in the NOI calculation. In the real life examples I have, total closing costs equal about 3.2% of the $200,000 purchase price, but when I add in pre-paid/escrow items the total settlement charges equal about 6% of the total purchase price. Which number is correct to use as part of the initial cash investment calculation: just closing costs or total settlement charges?

Steve

I would suggest NOT including prepaid taxes/insurance in your math. If you're putting 20% or 25% down, you can waive the impound account entirely and pay your property taxes on your own when the bill comes, but this is just kicking the can down the road... your CoC ROI and Cap rate and all the other measures didn't actually change, you'd be "tricking" yourself if you calculated it such that they did.

The same logic behind lenders using gross income for our math instead of net, for W2 people. Getting a crappy health insurance plan, or underpaying your income taxes, to increase your "net" income on each pay-check isn't actually a pay raise, since when you get sick now your deductible just tripled, and your April income tax bill went up as well! This is just kicking a can. 

Steve, 

remember, your closing costs are a one time cost and the taxes you pay are pro rated, so they would not be your full tax amount. you are correct in your percentages for closing costs, I have come up with about the same % on average. when you do your calculations, the closing costs will be included as a one time expense but your NOI will be based on a full year of taxes, not the pro rated tax.