Closing Costs Explained: What They Are, What’s Included, and Who Pays
Buying a home is always more than it seems. Even if the home is listed at $200,000, chances are, it’s going to end up costing you more in taxes, insurance, escrow, and real estate agent fees. But what are all the hidden expenses that you may have to pay, and how can you properly prepare for those closing costs before you finalize your new home purchase?
Closing costs are the additional expenses that you may pay for a home, that are in addition to the actual cost of the home. Both buyers and sellers will have to pay certain closing costs, so it’s important that you’re aware of what’s expected of you before you can finalize a home sale.
Let’s investigate what exactly closing costs are, why they’re important, and who is expected to pay what before the sale is complete.
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What Are Closing Costs?
Buying a home is an expensive endeavor unto itself, but closing costs can certainly add onto an already expensive price tag. Typically, the average closing costs are about 2-5% of the overall price of the loan, so if your home is about $200,000 you may pay anywhere from $4,000 to $10,000 in closing costs. Preparing ahead of time is essential in order to have a positive home-buying experience.
It’s important to keep in mind that the total you pay will vary greatly depending on the exact price of your home and your lender. Luckily, your lender is required to supply you with a “good faith estimate” or closing disclosure that should outline all the closing costs within three days of your home loan application. Your escrow agent will ask for this early on in the escrow process, so you should have time to fully prepare and the closing costs won’t surprise you.
However, some closing costs may be negotiable, and depending on your lender, they may be able to work out a deal with you that covers many of those extra fees. Some of the administrative fees, courier fees, and mailing fees are avoidable and gratuitous, but you’ll have to shop around before you find a lender that is willing to waive those excessive charges. There are also no-closing costs mortgages that you can find, but these often have higher interest rates, and the lender may include the closing costs in the mortgage itself, which means you’re paying high interest on closing costs. These loans may end up costing you more over time.
Additionally, closing costs won’t just affect you when you’re buying a new home — they may also affect you when you’re refinancing a mortgage on a home.
How Much Are Closing Costs, and What’s Included?
Closing costs may include a variety of different charges, but to simplify, you can group them into four distinct sets. It’s important to understand the definition of these terms and why they might be applied to your closing costs, so that if you do notice a mistake on your paperwork or unexpected fees you can discuss it with your lender. Here are those four types of charges or fees that may be included:
- Property-based fees: These can include your home inspection fees, appraisal fees, and home insurance costs.
- Appraisal fees: An appraisal is done by a specified appraisal company to determine the fair market value of the home. These can range from $300 to $400 dollars on average.
- Home insurance fees: Your first year of insurance is often paid during closing to ensure the protection of the bank’s loan and your home. Not all lenders will require this, but if they do it can be anywhere from 0.55% to 2.25% of the purchase price of your home.
- Homeowners insurance premiums: Your lender requires that you purchase homeowners insurance before you reach a settlement on the home, and it will help protect the property from vandalism, natural disasters, and more. The amount varies depending on the insurance provider, your general location in relation to natural disaster zones, and your home’s value.
- Inspection fees: There are a few inspections that you may get on the home, but almost every home gets a general inspection to ensure that the home and property is in good condition. This inspection is often performed by the bank to ensure that their loan is not exceeding the overall value of the home, and they may reject the loan if the home is found in poor condition. The average price of an inspection is about $300 to $500. Other inspections include pest inspections, lead-based paint inspections, and more.
- Loan fees: These can include your application fee for applying to your home loan, an assumption fee, attorney fees, any prepaid interest on your loan, loan origination fees, and more.
- Application fee: When you apply for a new loan, you have to pay for the process of your request. This normally covers the cost of running a credit check and any administrative fees that may apply to your application. The fees will vary in price depending on your lender and the amount of work involved in the process, and some lenders may be able to negotiate or waive this fee.
- Assumption fee: When you purchase a home from someone else, you sometimes have to “assume” the remaining balance of their mortgage when you purchase the home. The amount of this fee will depend on the lender and how much of the mortgage is remaining.
- Attorney fees: Depending on where you live, some states require an attorney to be present at closing. The fee is variable and dependent on the attorney and how many hours they work on your case.
- Loan origination fees: This fee, also known as an underwriting fee or processing fee, is rather substantial. The fee is charged by the lender for evaluating and preparing your mortgage loan and is about 1% of the amount that you’re borrowing. This typically covers things such as administrative services, notary services, lender’s attorney fees, and more.
- Mortgage broker fees: If you utilized a broker to secure your loan, then the broker may charge you a commission fee that is about 1-2% of the loan amount.
- Mortgage insurance: Depending on your down payment, you may have to get private mortgage insurance if it is below 20% of the overall mortgage amount. This is used to cover the lender in case you default on the loan, but does not cover the home.
- Points: “Points” are also known as “loan discount points” and they refer to a percentage of your home loan amount: one point is 1%. You have the option to pay points on your home if you wish, and it can make your monthly payments lower for the lifetime of your loan. Typically, this is a good idea if you plan to live in your home for a long time.
- Prepaid loan interest: This fee will depend on your loan size, lender, and agreed upon interest rate, but some lenders require you to pay the first month of loan interest. This is the month between your date of settlement and when your first monthly payment is due.
- Sponsored mortgage insurance for FHA, VA, and USDA loans: This is only applicable for specific sponsored loans, such as the Federal Housing Association (FHA), the Veterans Association (VA), or the U.S. Department of Agriculture. Each may have a seperate mortgage insurance fee that you’ll have to pay in order to secure the loan. These can range from 1-3% of the overall loan amount, depending on your down payment.
- Title fees: Title fees may include the charges accrued for searching for the title, as well as insurance on the title, both for you and your lender.
- Lender’s title insurance: This form of title insurance is sometimes called a loan policy, and it’s put in place to protect the lender in case someone comes forward to claim the property after it’s already been sold. The title search is supposed to eliminate that possibility, but mistakes happen, so this insurance covers that potential issue. The cost of this insurance depends on your lender and the overall value of the home.
- Owner’s title insurance: This insurance is optional, but it’s a good idea to purchase for yourself in case there are title issues or mistakes that happen on the title after the home sale has closed. The cost can vary, but averages at about $850 for a $200,000 home.
- Title search fees: Title searches are conducted to ensure that the person selling the house actually owns it, and to ensure that the home doesn’t have any government-issued liens or other claims on the property.
- Bureaucratic or Government Fees: These fees can include property taxes, recording fees, and more, and are dependent on the state and location where you are buying the new home.
- Annual assessment: Depending on where you live, you may have homeowners association fees that you will be required to pay. Many areas request a full lump sum upfront payment for the year. The seller may also have to pay a transfer fee.
- Recording fees: This is typically a small fee that the local records office of your city or county will charge you for the recording of your new home ownership.
- Property taxes: At closing, buyers may be requested to pay about two month’s worth of city and county property taxes.
Who Pays Closing Costs?
It’s not just the buyer that will be left with closing costs; sometimes the seller will also have to pay certain fees for transferring ownership. Additionally, some sellers may agree during negotiations to pay all closing costs if the buyer agrees to pay more for the home or if they have more bargaining power in the current housing market. These fees can vary depending on the value of the home, the loan amount, any outstanding mortgage amount, negotiations, and the state where you are purchasing a home.
Closing Costs for Buyer
In general, the buyer pays for the majority of closing costs. There are only a few fees that the buyer may have to pay out of pocket, such as the escrow fees and transfer fees (for homeowners association, if applicable).
However, some loans do allow sellers to cover all closing fees. FHA loans, for example, require that the seller cover no more than 3% of the closing costs if they agree to cover the closing costs. VA loans allow the seller to cover all closing costs, if they wish. Both of these loans have very specific criteria, and if the seller agree to cover the closing costs, then you may be able to avoid them. However, the seller still has the ability to say “no” when it comes to covering the costs — in which case, you may have to try purchasing from a different seller or may have to pay the closing costs if you’re intent on purchasing that home.
Closing Costs for Seller
During negotiations, the buyer may ask the seller to pay closing costs. If the seller agrees, then this process is called “seller concession,” but it’s important to be aware of the market before you ask for this during negotiations. If the real estate market in your area is favoring sellers (also known as a “seller’s market,” characterized by low inventory, short time on market, and rising prices due to high demand), then there may be little room for negotiations, as they probably have multiple offers and can pass up yours to sell the house to someone else.
However, if you have more negotiating power in a “buyer’s market,” (characterized by high inventory, low prices, lower market turnover, and generally depressed demand) then sellers may be more amenable to paying closing costs in order to close the sale. Your real estate agent may be able to counsel you on the state of the market and your chances of getting a seller’s concession.
In all, there is never a guarantee that sellers are going to pay closing costs, and depending on your market, you may not be able to ask them at all without losing out on the home. It’s best to research your housing market and prepare to pay closing costs yourself. If luck and bargaining power is in your favor, then you may be able to avoid closing costs altogether — or at least get most of them paid.
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Katie McBeth is a researcher and writer out of Boise, ID, with experience in marketing for small businesses and management. Her favorite subject of study is millennials, and she has been featured on Fortune Magazine and the Quiet Revolution. She researches SEO strategies during the day, and freelances at night. You can follow her writing adventures on Instagram or Twitter: @ktmcbeth
This post was updated December 18, 2018. It was originally published November 26, 2018.