When buying a home, it's important to factor in all of the associated costs into your budget. One important category of expenses to keep in mind are the closing costs.
Closing costs are funds, in addition to a loan down payment, paid at settlement. These costs typically total 3% to 7% of the home's purchase price. Costs vary among states, but cash transactions may have fewer costs than financed purchases. If you're set to buy, here's what you need to know about closing costs.
What Are Closing Costs and Who Pays Them?
Although many of the costs are associated with financing, others may be independent of the mortgage loan. Some charges are normally associated with either the buyer or the seller, but anything is negotiable. In a buyer’s market, when properties are slow to sell, anxious sellers frequently agree to pay part of the buyer’s closing costs. This is less likely to happen in a seller’s market when properties sell quickly.
Seller Closing Costs
Some costs are clearly the responsibility of the seller. For example, the seller typically pays the total real estate commission; this is a closing cost to the seller. The amount is deducted from the proceeds of the sale, and the closing agent writes a check to the listing and selling real estate companies. Likewise, the seller pays for his own real estate attorney, if he has retained one. If the seller has not yet paid the annual property taxes, the seller credits the buyer for the number of days the seller owned the home that year. This credit reduces the amount of money the buyer needs at closing.
Buyer Closing Costs
The buyer usually pays for the mortgage fees—application, origination points, discount points, mortgage insurance, credit report, mortgage broker fee. Lenders don’t normally charge all of these fees for every transaction. An origination point compensates the lender or mortgage broker for their work; a discount point lowers the interest rate. Each point costs 1% of the loan amount.
Speak to your loan officer about the possibility of amortizing—including in the loan—some of these fees. This will increase your monthly mortgage payment, but decrease the amount of money you need to bring to the closing table.
Other Closing Costs to Consider
Closing costs encompass a wide range of fees.
Title insurance protects against past defects in the property's title, such as forged documents, undiscovered heirs or undisclosed liens.
There are two different policies, usually issued at the same time prior to closing on a mortgage. One is a lender’s policy, which is mandatory if you're receiving a mortgage and protects your lender against financial losses associated with title defects.
The second is an optional, but highly recommended, homeowner’s policy which would protect you in the event of a title issue. Local customs affect who pays, but buyers and sellers often negotiate title insurance payment. The policy typically costs less than 1% of the purchase price of the home.
Document Recording Fees
Document recording fees are charged for the deed and the mortgage or deed of trust. Recording is typically the final step in the homebuying process and makes the sale of the property officially legal. The state may also assess transfer fees on new and assumed mortgages—typically paid by the borrower—and on the deed, paid by the seller.
Lenders also require you to have homeowner’s hazard insurance to protect against things like fire damage or theft. These annual policies are effective on the day of closing, but the homeowner may pay for them ahead of time. Costs vary widely among providers, so shop around for the best pricing that meets your needs. The full year’s premium is due by closing.
Flood insurance and other insurance against water damage is typically not included in basic homeowner's insurance policies. Additional flood, wind or earthquake coverage may also be mandatory, but need to be purchased separately, depending on the location of the property.
Lenders often require a property appraisal that the buyer normally pays at the time of the inspection. This appraisal is used to determine the home's value to ensure that the mortgage lender is loaning you the proper amount. Costs vary depending on the size of the home, and FHA appraisals cost more than conventional appraisals.
Lenders also collect a two-month payment cushion for escrowed items that are included in your mortgage payment, such as hazard insurance and property taxes. These expenses would also be due at closing.
Understanding Your Good Faith Estimate
Before closing, your lender should provide you with a Good Faith Estimate breaking down your closing costs and what you'll need to bring to close. Here is a fairly comprehensive list of typical closing costs, which should be highlighted in a Good Faith Estimate or your loan estimate and closing disclosure:
- Loan origination fee (1% of the amount borrowed, or $100 for every $10,000 borrowed)
- Loan discount fee
- Loan application fee ($75 to $400)
- Points (to "buy down" the interest rate: between $100 and $300 for every $10,000 borrowed)
- Lender's attorney fees
- Buyer's attorney fees
- Appraisal fee
- Credit report fee
- Lender's inspection fee
- Mortgage broker commission or fee
- Tax service fee
- Processing fee
- Underwriting fee
- Wire transfer fee
- Interest from the day of settlement to the date of the first mortgage payment
- Private mortgage insurance premiums to protect your lender ($750 to $1750)
- Hazard insurance premiums
- Property taxes from the day of settlement to the end of the tax year
- Settlement or closing/escrow fee
- Document preparation fee
- Notary fee
- Title search and title insurance to protect your lender ($400 to $600)
- Title insurance to protect you
- Recording fees
- Tax stamps
- Pest inspection
The Real Estate Settlement Procedures Act requires that loan officers send applicants a Good Faith Estimate (GFE) of expected closing costs within three business days of signing the loan application. These estimates will be very close to the final charges and typically arrive about 30 days before closing.
If you need more time to prepare, ask a loan officer to pre-qualify you for a loan before you start looking at homes. Be sure to request a GFE of estimated charges. FHA loans allow closing costs to be paid with gift money, and your state or city may have first-time homebuyer programs available that assist with closing cost funds. Discuss the possibilities with a local loan officer or real estate broker.