By JAMES CHEN, Investopedia
What Are Closing Costs?
Closing costs are the expenses, over and above the price of the property, that buyers and sellers normally incur to complete a real estate transaction.
Costs incurred may include loan origination fees, discount points, appraisal fees, title searches, title insurance, surveys, taxes, deed-recording fees and credit report charges. Prepaid costs are those that recur over time, such as property taxes and homeowners’ insurance. The lender is required by law to state these costs in a “good faith estimate” within three days of a home loan application. Gifts of equity still incur closing costs.
Understanding Closing Costs
Closing costs occur when the title of property is transferred from the seller to the buyer. The total dollar amount of closing costs depends on where the property is being sold and the value of the property being transferred. Homebuyers typically pay between 2% to 5% of the purchase price, but closing costs may be paid by either the seller or the buyer. A real estate transaction is a somewhat complex process with many players involved and numerous moving parts. Some states (and some loan products) require certain inspections beyond the basic inspection you pay directly to a home inspector of your choice. Then there are property and transfer taxes, as well as insurance coverage and various additional fees.
Homebuyers in the U.S. pay, on average, $5,749 for closing costs, according to a 2019 survey from ClosingCorp, a real estate closing cost data firm. The survey found the highest average closing costs in parts of the Northeast, including District of Columbia ($25,800), Delaware ($13,273), New York ($12,847), Maryland ($11,876) and Pennsylvania ($10,076). Washington is the only state outside the northeast to fall among the highest closing costs ($12,406). The states with the lowest average closing costs included Indiana ($1,909), Missouri ($2,063), South Dakota ($2,159), Iowa ($1,194) and Kentucky ($2,276).1
Laws require lenders to provide a loan estimate that reveals the closing costs on the property. Under the Real Estate Settlement Procedures Act (RESPA), lenders are required by law to provide this estimate, also known as a good faith estimate, within three days of the lender taking a borrower’s loan application. At least three days prior to the closing, the lender should also provide a closing disclosure statement outlining all closing fees. The listed fees may have changed from the loan estimate.2
- Closing costs are fees and charges due at the closing of a real estate transaction, in excess of the purchase price of the property. Sellers may also be subject to closing costs.
- Examples of common closing costs include fees related to the origination and underwriting of a mortgage, real estate commissions, taxes, insurance, and record filing.
- Closing costs must be disclosed by law to buyers and sellers and agreed upon prior to a real estate deal can be completed.
Examples of Closing Costs
Origination fees are fees charged by the bank for the creation of a loan. The fee typically amounts to 1% of the mortgage. The buyer can purchase discount points up front to reduce the interest rate charged by the bank. Although the bank requires a credit report and loan application, these fees are negotiable and can be covered by the bank. Private mortgage insurance is an additional fee applied to any purchase with a down payment less than 20%.3
Title insurance protects the lender from claims against the house and protects the buyer from past contractors making claims against the property. Lenders often require an appraisal, which can cost up to $400 in most areas. Local governments charge recording fees and taxes to record the sale of property. These transfer taxes vary from state to state.
All of the closing costs will be itemized on the loan estimate and closing disclosure. Here are the standard fees you can expect to see:
- A fee charged by the lender to process your mortgage application. Ask the lender for details before applying for a mortgage.
- A fee charged by a real estate attorney to prepare and review home purchase agreements and contracts. Not all states require an attorney to handle a real estate transaction.
- Also known as an “escrow fee,” this is paid to the party who handles the closing: the title company, escrow company or an attorney, depending on state law.
- If you’re signing paper documents, this fee helps expedite their transportation. If the closing is done digitally, you might not pay this fee.
Credit Report Fee
- A charge ($15 to $30) from a lender to pull your credit reports from the three main reporting bureaus. Some lenders might not charge this fee because they get a discount from the reporting agencies.
- Some lenders require you to deposit two months of property tax and mortgage insurance payments at closing.
FHA Mortgage Insurance Premium
- FHA loans require an up-front mortgage insurance premium (UPMIP) of 1.75% of the base loan amount to be paid at closing (or it can be rolled into your mortgage). There’s also an annual MIP payment paid monthly that can range from 0.45% to 1.05%, depending on your loan’s term and base amount.4
Flood Determination and Monitoring Fee
- A fee charged to a certified flood inspector to determine whether the property is in a flood zone, which requires flood insurance (separate from your homeowner’s insurance policy). Part of the fee includes ongoing observation to monitor changes in the property’s flood status.
Homeowners’ Association Transfer Fee
- If you buy a condominium, townhouse, or property in a planned development, you must join that community’s homeowners’ association. This is the transfer fee that covers the costs of switching ownership, such as documents. Whether the seller or buyer pays the fee may or may not be in the contract; you should check in advance. The seller should provide documentation showing HOA dues amounts and a copy of the HOA’s financial statements, notices and minutes. Ask to see these documents, as well as the bylaws, covenants, conditions, and restrictions (or CC&Rs) and rules of the HOA before you buy the property to ensure it’s in good financial standing and it’s a place you want to live.
- A lender usually requires prepayment of the first year’s insurance premium at closing.
Lender’s Title Insurance
- An up-front, one-time fee paid to the title company that protects a lender if an ownership dispute or lien arises that it didn’t find in the title search.
Lead-Based Paint Inspection
- A fee paid to a certified inspector to determine if the property has hazardous, lead-based paint.
- Points (or “discount points”) refer to an optional, up-front payment to the lender to reduce the interest rate on your loan and thereby lower your monthly payment. One point equals 1% of the loan amount. In a low-rate environment, this might not save you much money.
Owner’s Title Insurance
- This policy protects you in the event someone challenges your ownership of the home. It is usually optional but highly recommended by legal experts.
- This charge covers the lender’s administrative costs to process your fee and is typically 1% of the loan amount. Some lenders do not charge origination fees, but usually, charge a higher interest rate to cover costs.
- A fee that covers the cost of a professional pest inspection for termites, dry rot or other pest-related damage. Some states and some government-insured loans require the inspection.
Prepaid Daily Interest Charges
- A payment to cover any interest on your mortgage that will accrue from the date of closing until the date of your first mortgage payment.
Private Mortgage Insurance (PMI)
- If your down payment is less than 20%, your lender might require PMI. You might be required to make the first month’s PMI payment at closing.3
Property Appraisal Fee
- A required fee paid to a professional property appraisal company to assess the home’s fair market value used to determine your loan-to-value (LTV) ratio.
- At closing, expect to pay any property taxes that are due within 60 days of the home purchase.
Rate Lock Fee
- A fee charged by the lender for guaranteeing you a certain interest rate for a limited period of time, typically from the time you receive a preapproval until closing.
Got a Good Mortgage Rate? Lock It In! gives you the details.
- A fee charged by your local recording office, usually city or county, for the recording of public land records.
- A fee charged by a surveying company to check property lines and shared fences to confirm a property’s boundaries.
Tax Monitoring and Tax Status Research Fees
- A third-party fee to keep tabs on your property tax payments and to notify your lender of any issues with your property tax payments, such as late or failed payments.
Title Search Fee
- A fee charged by the title company to analyze public property records for any ownership discrepancies. The title company searches deed records and ensure that no outstanding ownership disputes or liens exist on the property.
- A tax levied to transfer the title from the seller to the buyer.
- A fee charged by the lender for underwriting your loan. Underwriting is the research process of verifying your financial information, income, employment and credit for final loan approval.
VA Funding Fee
- If you’re a VA borrower, this fee, charged as a percentage of the loan amount, helps offset the loan program’s costs to U.S. taxpayers. The amount of the funding fee depends on your military service classification and loan amount; the fee can be paid at closing or rolled into your mortgage. Some military members are exempt from paying the fee.
Another big fee: real estate commissions. Buyers don’t pay this fee, though; sellers do. Typically, the commission fee is 5% to 6% of the home’s purchase price, and it’s split evenly between the seller’s agent and the buyer’s agent.
How to Reduce Closing Costs
It might feel like you can’t afford all of these fees on top of the down payment, moving expenses, and repairs to your new home. However, there are ways to negotiate these fees.
- Shop around. This applies to lenders and third-party services, such as homeowner’s insurance policies and title companies. Many homebuyers don’t realize they can save significant money on closing costs if they compare fees from lender to lender. Also, you don’t have to use the title company, pest inspector or homeowner’s insurance agent your lender suggests. Do some homework, and you could save some serious cash on those fees.
- Schedule closing at the end of the month. A closing date near or at the end of the month helps cut down on prepaid daily interest charges. A lender can run this scenario for you to figure out how much you might save.
- Appeal to the seller for help. You might be able to get a seller to either lower the purchase price or to cover a portion (or all – if you’re really lucky) of your closing costs. This is more likely if the seller is motivated and the home has been on the market for a long time with few offers. In many hot housing markets, though, conditions favor sellers so you might get pushback or a flat-out “no” if you ask for a seller’s help. It doesn’t hurt to ask.
- Compare the loan estimate and closing disclosure forms. When you get your initial loan estimate, review it with a fine-tooth comb. If you’re unsure about what a fee entails or why it’s being charged, ask the lender to clarify. A lender who can’t explain a fee or pushes back when queried should be a red flag. Likewise, if you notice new fees or see noticeable increases in certain closing fees, ask your lender to walk you through the details. It’s not uncommon for closing costs to fluctuate from pre-approval to closing, but big jumps or surprising additions could impact your ability to close.
- Negotiate loan-specific fees. If you suspect a lender is adding on unnecessary fees, known as “junk fees,” on your loan, speak up. Ask the lender to remove or reduce fees if you notice duplication. Comparison shopping can be your ally in reducing closing costs, as well as finding competitive terms and rates. Be especially wary of excessive processing and documentation fees.
- Roll closing costs into your mortgage (as a last resort). In some instances, lenders will offer to pay your closing costs or roll them into your loan. But you’re not off the hook; lenders tend to charge higher interest rates to pay themselves for absorbing your closing fees, which means you ultimately end up paying interest on your loan – and on closing costs.
No-closing-cost mortgages eliminate all upfront fees for the buyer upon closing. These types of mortgages are beneficial in the short term but likely result in higher interest rates. The closing costs can also be buried into the total mortgage, which means the buyer pays interest on the closing costs over time. Therefore, while no-closing-cost mortgages are helpful in reducing initial capital outlay, there are long-term financial ramifications to consider.
There’s Never Been A Better Time To Refinance Your Home
Finally, some good news in 2020. Refinance rates are at a historic low. Rates on a 30-year fixed mortgage recently hit 2.26% APR. If there was ever a good time to see if you could lower your monthly payment, it would be now. Go to LendingTree to calculate your potential monthly savings. Experts are saying rates could rise by 30% next year, so now really is the time to act.