What Are Closing Costs in Real Estate?
Closing costs are the payments that are paid at the end of a real estate transaction. They are paid by both the buyers and sellers, but which costs and how much they pay vary. This article will break down and explain them.
On average, closing costs account for 2-6% of the total purchase price of a home. Closing costs are determined largely by the amount of the home loan (if the buyer is not paying in cash), the property’s location (since some states & cities have specific requirements that others don’t. More on that below), the buyer’s credit score, and a few other factors.
Many of the closing costs are negotiable between the buyers, sellers, and lenders. In fact, buyers willing to pay for some or all of the seller’s closing costs is an effective strategy to get the winning bid. Below is a list of the closing costs for buyers and sellers. These lists seem exhaustive, but they are usually presented as a total and broken down. This article is an explanation of the fees.
Closing costs for home buyers
- Application fee – Lenders may charge a fee to apply for a mortgage with them. As you shop around for a lender, ask them if they charge an application fee and what it covers
- Appraisal fee – When buying a house, getting an appraisal is helpful to assess whether or not the home is getting sold for fair market value. In a super hot market like Boise where homes are selling for well over asking, a lender may want an appraisal to make sure they are not giving out too much money for a home.
- Attorney fees – 21 states and the District of Columbia require an attorney for real estate closings. In all other states (Idaho included), having an attorney present is optional.
- Courier fees – Your lender may use a courier service to deliver the closing documents in order to speed up the closing process. If this happens, the lender may have the buyer pay the courier fees.
- Credit report fee – Your lender will run a credit report of the three major credit report companies in order to determine your loan amount. They will likely charge a fee to cover this cost.
- Escrow deposit and fees – Unless you are purchasing the home outright in cash, you will need an escrow account to hold funds until the transaction is complete. The title company, lawyer, or escrow company will charge fees for opening the account and handling the money.
- Flood hazard determination – The federal government requires all real estate transactions to undergo a flood risk assessment. A third party will be used and the buyers will pay the fee. If your home is in a flood-prone area, you will need to pay for flood insurance.
- HOA dues – If the home or condo you are buying has a homeowners association (HOA), you may have to pay the upcoming dues. This may be prorated depending on the payment structure of the HOA and when you purchase the home. Talk to the seller about the possibility of splitting this cost.
- Home inspection fee – A home inspection should already be a part of the home-buying process because you should know the status of the house before you buy it.
- Homeowner’s insurance – While homeowner’s isn’t required by law, most lenders require it in case there is damage to the property. It’s common to pay the first year’s premium at closing.
- Lender title insurance – Your lender will often require you to pay for insurance to protect the lender in case there is a problem with the property’s title. Buyers usually pay this, but many sellers will cover it as a show of good faith.
- Lead-based paint inspection fee – If you are buying a home built before 1978, it is a good idea to check for lead-based paint. This is required by most states for multi-family buildings, but not single-family homes. Considering the health risks associated with lead-based paint, this is worth paying for.
- Loan discount points – “Points” represent money you pay your lender at closing to receive a lower interest rate. 1 discount point equals 1% on your home loan in exchange for the lender dropping your interest rate by 0.25 %. For example: by paying $1,000 at closing on a $100,000 loan at 4% interest, your lender will drop your rate to 3.75%. Speak with your lender about details specific to your loan.
- Loan origination fee – Lenders may charge an origination fee when processing your loan. This amounts to about 1% of the total loan amount. Not all lenders charge an origination fee, so ask them about it when shopping around.
- Mortgage broker fee – You can hire a mortgage broker to help you with your loan. A broker acts as a middleman between you and your lender. They will change a commission based on a percentage of your loan amount—usually between 0.5% and 2.75% of the property’s purchase price.
- Owner’s home title insurance fee – This insurance covers you in the event that someone challenges your property’s title after you assume ownership. Cases of this are rare, but it helps to be covered, just in case. Like lender title insurance, sellers may pay it as a show of good faith.
- Pest inspection fee – Some states require home buyers to pay for a termite inspection. Even if it isn’t required, it will give you peace of mind to know the status of your new home before you move in.
- Prepaid interest charges – Most lenders require buyers to pay for the interest on your mortgage loan upfront. This is to cover the interest that your loan accrues between the closing date and your first mortgage payment.
- Private mortgage insurance (PMI) – Lenders require PMI for homebuyers who put less than 20% down. This usually applies to first-time homebuyers who are using FHA or Fannie Mae/Freddie Mac loans. PMI covers your lender if you miss a payment. PMI costs between 0.5% and 2.3% of the total loan value. PMI can go away if you are using a conventional lean and reach 20% loan-to-value. If using an FHA loan, the PMI stays until the loan is repaid in full. There are 4 ways to pay your PMI:
- Upfront – Pay the entire cost of PMI at closing. Doing this will keep you from making PMI payments on top of your monthly loan payments, but you will need more money at closing. However, you won’t get any of that money back if you refinance your loan
- Split – Pay part of the PMI costs upfront, and the remainder gets tacked onto your monthly payments.
- Monthly – Pay nothing at closing and the whole PMI amount is added to your monthly payments.
- Lender-paid – The lender will pay the PMI amount in exchange for a higher interest rate. This will save you money at closing but will cost you a lot more over the life of the loan.
- Property taxes – You will owe taxes on the property you buy from the closing date until the end of the year.
- If the sellers already paid their property taxes for the year, you will owe a prorated amount from closing until the year’s end.
- If the sellers have not paid their property taxes for the year, the buyers will get credited for the days before closing.
- Recording fees – The local government requires a copy of the property title before it recognizes you as the new legal owner. The title company will take care of this but will charge you for the service.
- Survey fee – This applies mostly when buying plots of land. This fee covers hiring a professional surveyor to verify the borders of the property you are buying.
- Tax service fee – Most lenders require buyers to pay for a third-party tax company to make sure that the taxes on the property are current and paid. This is typically paid by the buyer but may be negotiable with the lender.
- Title search fee – A title search fee is to make sure that nobody but the current owners has a legal claim to the property. This service is performed by the title company and ranges from $200-$1,000.
- Underwriting fee – Some lenders charge an underwriting fee to process your loan application. Keep in mind, if the lender charges an underwriting fee, they do not also charge an origination fee. It’s one or the other.
Closing costs for home sellers
Some of these fees can be paid by either the buyer or seller. It is up to those parties to sort out who pays for what in closing.
- Closing cost credits – Credits can be extended to buyers to lower the purchase price. These can be concessions for repairs or inspections to incentivize buyers to buy the home now.
- Escrow fee – Same as above
- HOA dues – Same as above, but, as the current owner, make sure that your dues for the payment period are paid before selling the home.
- HOA transfer fees – You may be required by your HOA to pay to transfer ownership to the buyer.
- Lender title insurance – Same as above
- Owner title insurance – Same as above
- Property taxes – Same as above
- Real estate agent commission – Sellers usually pay the commissions for the buyer’s and seller’s agents. This typically amounts to 4-6% of the purchase price but can be lowered at the agent’s discretion as an incentive.
- Transfer taxes – A transfer tax is assessed by your local government when you sell or transfer a property from yourself to a new owner. The amount varies by state and city.
Loan-specific closing costs
Certain home loans have unique closing costs associated with the stipulations of the loan. Here are three of the most common.
- Home equity lines of credit (HELOC)/home equity loans – Lenders may charge fees for home equity loans. These typically amount to 2%-6% of the loan value.
- Home loan refinancing – These fees vary by lender but are usually 2%-6% of the loan value.
- VA loans – VA loans are supported by the U.S. Department of Veterans Affairs and are open to eligible military and service personnel. The VA charges between 1%-5% of the loan amount to pay for the program. Your down payment amount and service type impact your fee. The VA also exempts some lenders from charging a fee, so it is worth shopping around.