Buying a house is often considered one of the most stressful times in a person’s life for a number of reasons. But a significant part of this is the amount of money changing hands. Undoubtedly, what adds to that stress are the mysteriously dubbed “closing costs” that pop up during this transaction. What are closing costs? How are closing costs calculated?
What are closing costs?
This term is somewhat misleading in real estate. Ultimately, closing costs include many different things that occur throughout the transaction of buying a house. It’s often confusing because not all of these costs are related to the actual closing process itself.
With that, there are a number of items that real estate agents typically refer to as closing costs. Some of these costs can be surprising and confusing, particularly if you are a first time homebuyer and are new to this process. Most home buyers know they’ll need a downpayment to buy a home. However, not everyone knows they’re going to have to pay closing costs in order to purchase a home.
How much are closing costs?
Closing costs can be considerable, averaging roughly 2-5% of the home’s purchase price. For example, on a $300,000 house, that could be $6,000 to $15,000. How are these closing costs calculated?
Within 3 business days of receiving your completed loan application, your lender will give you a loan estimate. This includes what the closing costs on your future home will be. Remember, this is just an estimate, and many of the listed closing costs can change. If this happens, you should receive a revised loan estimate ensuring there are no surprises along the way, particularly at closing.
What factors affect closing costs?
Many fees and costs can arise throughout the house-buying transaction. These are the closing costs you may see, but it’s unlikely you’ll see all of them when you close:
- Appraisal costs – A home appraisal protects the buyer, ensuring the selling price matches the market value of the home you’re buying. Cost: $300-$400
- Credit report fees – This is pulled to get the buyer’s credit history and score. Cost: $30-$50
- Endorsements fees – Expands title insurance (Cost: $25 each) for the buyer to cover a variety of circumstances:
- Indirect Access and Entry for a property that’s not adjacent to a public street and needs to cross somebody else’s property
- Encroachments for structures built too close to another property
- Covenants, Conditions and Restrictions adds coverage for contemplated improvements on the property that may be allowed per zoning regulations, but conflict with specific subdivision restrictions.
- Reconveyance fee – With closing costs, this is paid by the seller and will be enough to cover the charges for recording the mortgage and deed. Cost: $50-$65
- Survey fee – This goes to a survey company to verify all property lines and things like shared fences on the property, but it’s not a requirement in all states. Cost: $350
- Wire and courier fees – This covers the cost of transporting/wiring the buyers documents to complete the loan transaction as quickly as possible. Cost: $25-$50
- Origination fee – The lender will charge the buyer for starting up, evaluating and preparing your mortgage loan. Expect to pay roughly 0.5-1% of the amount you’re borrowing to buy a house.
- Home Owners Association (HOA) transfer fees – The seller pays for this transfer which will show that the dues paid are current, what the dues are, a copy of the association financial statements, minutes and notices. Cost: Varies based on amenities.
- Homeowners’ insurance – Covers possible damages to the buyer’s home. Cost: Expect to pay roughly $35 per $100,000 of home value per month.
- Lender fees for processing and underwriting – Drawing up the paperwork, fact-checking and organizing something as big as a 30-year mortgage loan takes a lot of work. This behind-the-scenes work is covered by underwriting and processing fees. Sometimes these are included for the buyer in the origination fee, but not always. Cost: When charged apart from origination, can be $400-$900.
- Private Mortgage Insurance (PMI) – If you’re making a down payment that’s less than 20% of the home’s purchase price, you’ll be required to pay PMI. With that, you may need to pay the first month’s PMI payment at closing. Cost: 0.5%-1% of total mortgage loan amount per year.
- State government document transfer – This is paid by the buyer when the title passes from seller to buyer. Cost $250
- Title insurance – Title insurance protects you against issues that may come up connected to the title of the property you’re buying. Since the home and the land it’s on have likely changed hands several times, it’s possible that over time, something went wrong. Whether it’s a forged signature or a tax evasion issue, title insurance makes sure you won’t be responsible for someone else’s legal issues. Cost: Averages $1,000 but varies based on value of house.
- Pest inspection – Covers the cost to inspect for termites or dry rot, which is required in some states and required for government loans for the buyer. Cost: $100
- Lead-based paint inspection – Evaluates lead-based paint risk at the buyer’s home. Cost: $300
- Flood certification – Where necessary, paid to a third party to determine if the property is located in a flood zone. If it is, you’ll need to buy separate flood insurance. Cost: $600
- Home inspection – The buyer verifies the condition of a property and checks for necessary, pre-closing home repairs for the seller to pay. Cost: $300-$400
- Property tax – Typically, lenders will want any taxes due within 60 days of purchase by the loan servicer to be paid at closing by the buyer. Cost: Varies by area.
- Escrow deposit for property taxes and mortgage insurance – Sometimes, the buyer is asked to put down two months of property tax and mortgage insurance payments at closing. Cost varies with regard to your taxes and mortgage.
Additional Factors to Consider:
- Veterans Administration (VA) funding fee – If you have a VA loan, you may be required to pay a VA funding fee at closing. You can choose to roll this fee into the cost of the loan if you prefer. This fee is a percentage of the loan amount that the VA assesses to fund the VA home loan program. However some borrowers are exempt from this fee. Cost: 2.15% of the loan with 0 down payment.
- FHA up-front mortgage insurance premium (UPMIP) – If you get an FHA loan for your house, you’ll be required to pay the UPMIP of 1.75% of the base loan amount. You are also able to roll this into the cost of the loan if you prefer.
- Prepaid interest – Most lenders ask the buyer to prepay any interest that will accrue between closing and the date of your first mortgage payment. Cost: Depends on the value of your mortgage.
- Discount points – Also called mortgage points, this is a form of prepaid interest available for the buyer when obtaining a loan. One point equals one percent of the loan amount. Borrowers can offer to pay a lender points as a method to reduce the interest rate on the loan. Thus obtaining a lower monthly payment in exchange for this up-front payment. Cost: 1 point costs 1% of your mortgage amount, or $1,000 for every $100,000.
What can people do to decrease closing costs?
Many closing costs are negotiable, and some aren’t even necessary. It’s important to understand that you can shop around to find lenders willing to offer you a loan with lower fees at closing. Here are some other things to consider:
Participate in a loyalty program
Some banks offer help with their closing costs for buyers if you use that bank to finance your purchase. This is the bank’s way of offering a reward for being a customer.
Close at the end of the month
If you close at the beginning of the month, say April 6 (a month with 30 days), you have to pay the per diem interest from the 5th to the 30th. However, if you close on the 29th, you pay for only one day of interest.
Bake the closing costs into the loan
Mortgage lenders charge more for this, but if you don’t have the cash, it’s a way to get into the house with less cash upfront. You may want to consider a no closing cost mortgage. With this type of mortgage loan, the lender covers the fees, but you’ll be paying a higher interest rate for the duration of the loan. This ultimately results in mean larger mortgage payments.
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Consider your benefits
Service members and veterans may qualify for funds to help them purchase a home. These benefits are not limited to the VA loan.
AFL-CIO Union members can get help purchasing or refinancing a home with closing-cost discounts and rebates from the Union Plus Mortgage program.
Apply for a Federal Housing Administration (FHA) loan
Buyers with lower incomes can apply for an FHA loan and get help from interested third parties. This includes real estate agents, sellers, and mortgage brokers, who pay up to 6% of the new loan amount. FHA loans are also more lenient with credit scores. Borrowers with a credit score of 580 or higher are likely to qualify. While traditional lenders require a credit report to be 620 or higher.
Consider Gemtrago and Signloc
Buyers can minimize costs working with lenders like Gemtrago. Gemtrago doesn’t charge origination, application, or appraisal fees while still offering the lowest rates and highest level of service. Additionally, Signloc has some of the lowest title and escrow rates in the country.
How are closing costs paid?
As a buyer, you’ve already paid some of these costs. Next, you’ll pay the remainder of the costs at your closing appointment when you submit your downpayment.
These costs are typically paid with a cashier’s or certified check, since they’re both guaranteed funds. However, your lender should provide specific instructions regarding form of payment and the amount of money to bring to closing.
Brady Miller, CFA is Chief Executive Officer at Trelora, Inc. Brady joined Trelora in August, 2018 as Chief Financial Officer. He moved into his current role later that year and is responsible for all daily operations and growth of the broader real estate business. Prior to joining Trelora, Brady was Chief Financial Officer of Leeds West Groups which is one of the largest, and fastest growing automotive retailers in America. Brady managed their real estate portfolio, financing, human resources, and accounting. He earned a Charted from the CFA Institute in 2016 and holds a bachelor’s degree from the University of Colorado, Boulder where he majored in Finance and Real Estate.