What Are Closing Costs?
Molly Grace8-Minute Read
July 20, 2020
There’s no way around it: on closing day, your savings account is going to take a hit. For the most part, home buyers are prepared to fork over a lot of cash to get the keys to their new home. But while you may have spent months or even years tucking away money for a sufficient down payment, you may not have spent too much time thinking about how to save for the fees that will make up your eventual closing costs.
Closing costs, which include things like appraisal fees, title insurance and origination fees, typically range from 3% - 6% of the home’s purchase price and must be paid on closing day. Three days prior to closing, a home buyer will receive a closing document which will enumerate all the anticipated costs and fees due at closing.
Common Closing Costs
Here are some common line items that may make up your overall closing costs.
This fee covers the cost for a third-party appraiser to evaluate the property and determine its market value.
If you live in a state that requires you to have an attorney prepare the paperwork for your closing, you’ll pay this fee.
This fee is paid to the entity that conducted the closing on your home. This could be a title company, escrow company or attorney.
Your lender may charge a small fee to cover the cost of transporting your mortgage documents.
Credit Report And Monitoring
The lender will also charge fees to cover the cost of obtaining your credit report as well as the cost of a credit monitoring service that alerts the lender if your credit changes at all during the process.
This is an optional cost you’ll incur should you choose to purchase discount points from your lender in exchange for a reduced interest rate. The cost of one discount point is equal to 1% of your loan amount.
You may be asked to put a certain amount of money upfront into escrow for things like property taxes or insurance premiums. For example, your lender may require two months’ worth of property taxes to be paid at closing.
If you’re buying in an area that’s been designated by FEMA as at-risk for flooding, you’ll likely need to pay a small fee to certify its flood zone status.
Lenders typically require borrowers to carry homeowners insurance on their mortgaged property. At closing, you may be required to pay your annual or semiannual premium upfront.
Mortgage Insurance Premium
MIP, the mortgage insurance program for FHA borrowers, requires an upfront payment equal to 1.75% of your loan amount at closing.
This fee goes to your lender to cover the cost of processing and underwriting your loan.
At closing, you may have to pay for the interest that will accrue on your loan between the time that you close on the loan and the date of your first mortgage payment.
Private Mortgage Insurance
Conventional loan borrowers will have to pay PMI if they put less than 20% down. Typically, this will be paid each month as a portion of your mortgage payment, but you may also have the option to pay all or part of the cost of PMI upfront at closing to lower your monthly payments.
Your lender may require you to pay a certain amount of your property taxes upfront to be held in an escrow account.
Rate Lock Fee
If your lender charged a fee to lock in your interest rate prior to closing, you’ll pay this cost at closing.
This fee goes to your local government to cover the cost of recording your home purchase in its public records.
If you’re required to get a land survey to confirm where your property’s boundaries lie, you’ll pay for that service at closing.
This type of insurance protects you from issues that may arise around the property’s title, which shows who has a legal claim to the property. Mortgage lenders require borrowers to purchase a lender’s policy, which is charged as a one-time premium at closing. Borrowers have the option to purchase an owner’s policy for themselves, which is often paid for as part of the seller’s closing costs.
A title search is completed prior to closing to find out if any other parties have a legal claim to the property. This includes making sure there are no unpaid liens on the property.
This is the cost to have the property title transferred to you.
USDA Guarantee Fee
The guarantee fee is the USDA loan program’s version of mortgage insurance. USDA loan borrowers will pay 1% of their loan amount at closing to cover this fee.
VA Funding Fee
Most VA loan borrowers must pay a funding fee as part of their closing costs unless they are exempt. The amount you’ll pay will be a percentage of your loan depending on how much you put down.
How Can I Estimate What My Closing Costs Will Be?
Exactly how much you’ll pay in closing costs will depend on a variety of factors, including where you live and the type of loan you’re getting. Every state and locality has its own rules and requirements regarding home buying, including the types of fees and services that must be included in a home purchase transaction. This is part of the reason why average closing costs can vary from one state to another.
Additionally, different types of loans can have different costs associated with them. For example, FHA loans require you to pay MIP at closing, which can add to your costs. Conventional loan borrowers who are required to have mortgage insurance won’t pay for it at closing unless they’re paying for their PMI upfront.
The Loan Estimate document you received when you applied for your mortgage should include a section that goes over your costs at closing and will have an estimate for your total closing costs. This number isn’t set in stone and may change depending on the actual costs of the services you’ll need, but it does give you a good idea of about how much you’ll need to bring to the closing table.
At least 3 days prior to your closing date, your mortgage lender will provide you with a document called a Closing Disclosure that itemizes all the fees and costs you’ll be expected to pay for on closing day. The number likely won’t be radically different from the quote you were given in your Loan Estimate, but may go up or down several hundred dollars or more.
As you go through the process, stay involved and keep track of the expenses you’ll incur at closing. You even have the option to shop around to help lower your costs on certain services – more on that in a minute.
Do Sellers Also Have Closing Costs?
It’s not just the buyer that who owe something at closing. In fact, seller closing costs are often higher than buyer closing costs.
What costs a seller will be responsible for at closing can vary depending on what the buyer and seller have agreed to. However, there are some closing costs that have become standard for the seller to pay. Here are some costs that a seller may be expected to cover:
- Buyer’s and seller’s real estate agent commission
- Seller’s attorney fees
- Transfer tax
- Buyer’s title insurance policy
- Escrow fees (sometimes split 50/50 between buyer and seller)
- Property taxes (prorated for the portion of the year they’ve owned the house)
- Credits toward closing costs
Typically, sellers won’t have to actually bring a check to the closing table; their closing costs will simply come out of the proceeds of the home sale.
Can I Reduce My Closing Costs?
Most of the closing costs you’ll incur are services that are necessary for completing the mortgage application and home buying processes, so there aren’t too many, if any, costs you can completely cut from the list. However, have the ability to shop around and find your own providers for certain services, which can help reduce your costs.
When you receive your Loan Estimate form at the beginning of this process, be sure to look for a list of services you can and can’t shop for. The appraisal is one of the larger costs that you typically won’t be able to shop around for. Fortunately, lenders will often let you shop for many of the other larger costs.
For example, the costs related to protecting the title of your new home, including a title search and your lender’s title insurance policy, can make up a significant portion of a buyer’s closing costs. Fortunately, buyers can typically shop around for these services.
According to the Consumer Financial Protection Bureau, buyers who shop around for their closing services could save as much as $500 on title services alone.
Your lender will provide you with a list of companies that you can choose from, but you can also look at companies that aren’t on the list and see if your lender would be willing to work with them.
As you go through the process of choosing your service providers, do some research on the companies you’re considering and ask if they can provide references from previous customers. Just because a company gives you the lowest quote for the job doesn’t mean they’re the best choice – you want to work with a company that’s going to be responsive and do a good, thorough job.
Buyers who are looking to reduce their costs may also be able to get the seller to pay for some closing costs that they ordinarily wouldn’t. This is more likely to happen in a buyer’s market, where sellers are more inclined to negotiate with buyers and offer concessions as a way to entice the buyer to close.
Your real estate agent can help you with the details if you decide you want to ask for seller concessions.
Sellers who are looking to reduce their closing costs typically look to their largest expense: agent commissions. To reduce this cost, sellers might try to negotiate their agent’s commission to a smaller percentage or even sell their home on their own as a for sale by owner property.
What Can I Do To Avoid Closing Costs?
Closing costs are a necessity to purchasing a home. One way or another, you’ll pay them.
Some lenders offer “no closing cost mortgages” that let you roll your closing costs into the loan or take on a higher interest rate in exchange for the lender paying the closing costs. With these loans, you’ll still pay your closing costs, but you’ll be adding additional interest that you’ll pay over the life of the loan, potentially costing you significantly more than if you’d paid your closing costs in cash at closing. However, you may be able to refinance into a lower rate down the road, mitigating the cost of financing your closing costs.
Summary: Be Prepared For Closing Costs
Don’t go into the home buying process without thinking about what your potential closing costs will be, and if you can afford them along with your down payment.
If you’re worried about your closing costs, consider all the ways you can reduce them. Talk to your real estate agent about whether market conditions are right for you to ask the seller for concessions. Talk to friends or family members who have recently purchased in your area about which service providers they worked with and whether they were satisfied with the cost and the quality of their services. If you’re considering a “no closing cost mortgage,” be sure to do the math on how much extra interest you’ll pay over the life of the loan and whether this option makes sense for you.
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