If you’re considering purchasing a home, you’ve probably set aside a down payment. You will need considerably more than that down payment: if you aren’t prepared, closing costs can be quite a shock.
But what exactly are closing costs?
Closing costs are fees, taxes, and other expenses you must pay when completing your home purchase.
To demystify this part of the home-buying process, we’ll look at common closing costs, detail who pays what, and explore how you can eliminate some of these expenses.
Common Closing Costs
Your specific closing costs will be outlined in the closing disclosure that your lender provides. Let’s take a look at some of the more common expenses you might see listed on this document.
- Points – As a buyer, you can pre-purchase an interest discount by purchasing points. Each point will cost 1% of the loan value. So, for a home loan of $300,000, a discount point will cost you $3,000.
You can purchase multiple points up to your lender’s limit, and the discount lasts for the duration of your loan. Purchasing points is optional.
- Rate-Lock Fee – Most lenders will lock in your APR for a set period for free. This can be a few weeks up to a few months. If you need additional time to complete your home purchase, some lenders may offer to extend this time period for an additional fee.
- Appraisal – The lender will require an appraisal to determine the home’s value. This value will be used to calculate the maximum amount that you can borrow.
This is separate from the home’s sale price, which can be lower or higher than the appraisal value.
- Attorney Fees – Depending on your state, you may be required to have a real estate attorney review documents or be at closing.
For instance, Delaware, Georgia, and New Hampshire require a real estate attorney to preside over closing. While Louisiana, Mississippi, and North Dakota only require the attorney to examine/certify the title.
There are also several states, such as Alaska and Florida, that do not require attorney participation.
- Closing Fee – If you live in a state that doesn’t require an attorney to be present for closing, then your escrow company or title company will preside over closing. They may charge a closing or escrow fee that is charged separately from title fees or escrow funding fees.
- Loan Origination Fee – This is the fee that the lender charges for underwriting your loan. Not all lenders will charge this fee, and those that do might consider waiving it if you ask them.
- Application Fee – Similar to an origination fee, the lender can charge you this for simply filling out the application. Most reputable lenders don’t charge this fee or are willing to waive it.
- Underwriting Fee – This fee goes to the lender to cover the paperwork cost of underwriting your loan.
- Title Insurance – This insurance helps protect the buyer (owner) if an undisclosed lien from the previous owner is discovered on the title. The policy covers you for the duration of home ownership.
- Lender Title Insurance – This protects the bank/lender if there is a title claim. This is separate from the owner’s title insurance.
- Inspection Fees – Depending on state regulations and loan requirements, you may need pest inspections, flood inspections, and other inspections. These are separate from a home inspection but can often be performed at the same time.
- Survey Fee – A few states, such as Florida and Texas, require a property survey before closing. This survey tells your lender where the property lines are and if you are in a floodplain.
A lender can often accept the previous homeowner’s survey with a signed affidavit.
- Escrow – You can pay your mortgage, taxes, homeowner’s insurance, and mortgage insurance through an escrow account. If you choose to do so, you’ll need to prepay a few months of payments and premiums at closing.
- Taxes – In addition to funding an escrow account, some lenders may request up to a year’s worth of property taxes upfront at closing. You can check your local county’s website for more information on their current property tax rates.
- Real Estate Commission – Both the buyer’s and seller’s agents receive a commission when a home sells. These commissions are charged to the seller at closing.
- Title Search & Transfer Fee – Sometimes called a recording fee or title services, this expense covers the research of liens against the home and the transfer of ownership on the home title.
- Home Warranty – Home warranties can cover unexpected repairs like AC issues, plumbing problems, and appliance breakdowns. If the seller purchases a home warranty for the buyer, it can be included in their closing costs.
- Credit Report Fees – This fee is charged for pulling your credit reports to make lending decisions. Many lenders will cover this cost themselves or roll the expense into another fee. Still, they could choose to pass this fee on to you.
- FHA Loan Fees – FHA loans often come with additional document and inspection requirements. This could result in extra fees charged by your lender.
Additionally, FHA loans require mortgage insurance which is paid with an annual premium plus an upfront fee of 1.75% of the loan value due at closing.
- VA Loan Fees – VA loans charge a funding fee instead of mortgage insurance. The amount will depend on your downpayment and whether this is your 1st home purchase with the VA. This fee can be waived in certain situations, like having a service-related disability or being awarded the purple heart.
VA loans can also come with other requirements/fees based on your state. This can include pest inspections, septic system certification, and more.
Who Pays Closing Costs?
There is no even split when it comes to paying the closing costs associated with a home purchase. Most of the costs are the buyer’s responsibility. Still, some are the seller’s responsibility, and who pays what can differ by state.
Let’s take a closer look at who is responsible for what on closing day.
Buyer’s Closing Costs
The buyer is responsible for the majority of closing costs. This includes lender fees such as origination, underwriting, and appraisals. It also includes most government and 3rd party fees, such as taxes, escrow, and attorney fees.
As a buyer, you have several options for paying your closing costs.
- Pay for closing costs separately (i.e., a written check on closing day)
- Roll closing costs into the loan, thereby increasing the loan value.
- Apply any earnest money paid towards covering your closing costs.
- Obtain low-income homebuyer grants to cover closing costs and/or downpayment.
- Ask the seller to cover some or all of your closing costs.
It is worth noting that discount points must be paid upfront by you and cannot be rolled into the loan.
Seller’s Closing Costs
The seller is responsible for paying the real estate commissions, title insurance, and transfer fee. Additionally, the seller can reserve and pay for their own attorney, separate from the closing attorney.
When negotiating the sale of the house, the seller can also make concessions, including money towards the buyer’s closing costs or money towards renovations.
All of the seller’s closing costs and concessions are taken directly out of the funds they receive for the sale of the house. The seller could choose to prepay some of their expenses.
How Do You Pay Closing Costs?
All of the seller’s closing costs are taken directly out of the funds they receive for the sale of the house. If they make any concessions, i.e., paying the buyers closing costs, this is also taken from the money they receive for the sale.
In contrast, as a buyer, you can pay your closing costs upfront or roll some of them into the loan value. Some closing costs, i.e., discount points, cannot be rolled into the loan value.
How Much Are Closing Costs?
Closing costs differ for each buyer. The location of the home, the value of the home, loan type, and more can all influence how much your closing costs will be.
It is often recommended that you estimate between 2% and 4% of the home’s value for your closing costs.
However, high tax rates or government-backed loan fees can quickly inflate closing costs. Because of this, you’ll want to look closely at your homebuying situation to determine how much you’ll need to pay.
How to Reduce Closing Costs
Let’s look at a few ways to lower or eliminate your closing expenses.
- Shop around for lenders – not all lenders charge the same fees. Avoid lenders who charge for loan origination, credit reporting, rate lock, etc.
- Choose the best type of loan – government-backed loans tend to come with extra fees. Choosing a conventional loan could save you money.
- Put more money down – putting more down can help lower your VA funding fee.
- Have the seller chip in – negotiate with the seller to see if they will cover some of your closing costs.
- Refinance – skip purchasing discount points and refinance your home loan later when your credit has improved and/or rates have gone down.
- Decrease your taxes – many states allow you to file for exemptions to lower your property tax rate, i.e., disability, age-based, homestead, etc.
- Negotiate with your agent – real estate agents that charge lower commissions will decrease the seller’s closing costs.
Even a few dollars saved can significantly reduce your total closing costs.
Closing costs are numerous and often confusing. Not all home purchases come with the same closing costs, and not all parties use the same term for the same closing costs.
If any costs listed on your disclosure seem confusing or unfamiliar, don’t be afraid to ask the lender, title service company, etc., what the fee covers. Not only is it educational, but it could also help you eliminate unnecessary fees.