If you’re a first-time homebuyer, it’s easy to get caught up in the excitement of making plans for your new space. Even as you dream about color schemes, furniture placement, and what the ideal layout of your new home will be like, you’re probably also keeping a close eye on interest rates and what your future mortgage payment will be. However, there are other transaction details you may easily overlook, such as the myriad of additional fees and costs charged to buyers as part of their home purchase transaction, also known as closing costs. These costs can add up quickly, so keep reading to find out more about closing costs, what to expect, and how much you may need to pay.
What are closing costs?
As your closing date approaches, your lender will provide a closing disclosure for you to review. It may be the first time you see an itemized list of one-time fees you are expected to pay on closing day, these will be in addition to your down payment. These standard closing costs are used to pay the various parties involved in transferring ownership of the house from the previous owner to you.
Your lender should provide the closing disclosure at least three days before your final closing date. You should review this disclosure for accuracy and to understand the various charges. This is the time to ask any questions before the deal is finalized. Here is a sample closing disclosure to familiarize yourself with the form.
What does closing disclosure include?
Your disclosure will itemize your loan terms and the breakdown of the purchase price, principle, interest, and payment amounts, along with any fees associated with securing the loan.
- You’ll see line items for costs for the title process, any county or state fees for taxes and utilities, and any interest rate points or closings costs you prepaid.
- The disclosure will break out the calculations from your purchase price, payments, and how that amount gets divided up to cover all of those fees and costs.
The closing disclosure outlines every single cost associated with your loan and ownership transfer. You want to make sure you understand the math and run through it yourself to double-check the numbers. No matter how professional and experienced your lender’s team is, mistakes do happen now and then.
For a first-time homebuyer, closing costs may come as a big surprise. As you’ve seen from the closing disclosure statement, the amounts can be significant enough to have you scrambling at the last minute if you’re not prepared. Your lender should provide both timely and reliable estimates, but you can get ahead of the curve by calculating your own estimates so you’ll have a good idea of what to expect.
How do I estimate closing costs?
Several factors influence your closing costs, and as a result, these costs are not set in stone and will vary from one home purchase to the next.
Factors to include in your closing costs:
- The purchase price of the home
- Your down payment amount
- The type of loan you choose
- Any adjustments you negotiate with the seller
Typically, closing costs run between 2% and 5% of the price of your home. On a home purchased for $300,000, closing costs could range from $6,000 to $15,000, which is a significant range.
For more context, the median value for a single-family home in January was $330,485. So the average closing costs for such a home could range between $6,609 and $16,524 (2-5% of the purchase price). This amount covered taxes, bank fees, and third-party fees such as those charged by the title company.
Estimate your closing costs by preparing for an amount at the higher end of the range, this will hopefully leave you with extra money if your closing costs come in lower.
How do closing costs affect a home purchase?
This is an excellent question, one that more homebuyers need to ask. Before closing on the property, you have likely paid several fees already.
As part of your contract, you paid earnest money to secure the property. This payment showed the seller that you were a good-faith buyer who planned to move forward with the home purchase. Earnest money usually applies to the downpayment but can also be used for the closing costs.
To secure a mortgage, the lender requires an appraisal. An appraisal fee ranges from $400-$550 depending on the home’s size, purchase price, and distance the appraiser must travel. You may pay this separately ahead of time, or it may show up as an item on the closing disclosure statement, which will become payable on the day of closing.
If your contract included a home inspection contingency, a home inspector would have performed a home inspection which you’ll also have to pay for. During this process, the inspector checks the home’s systems (plumbing, heating, and electrical) and structural items (roof, siding, windows, and foundation.) Home inspections can cost upwards of $500, depending on the home’s size. You may have paid this upfront, but most likely, it will be a charge listed on the closing disclosure statement.
Most of these contingencies and fees should be satisfied to fulfill your purchase contract. If you paid them directly to the service provider, they should not show up on the closing disclosure. If you didn’t pay them ahead of time, they will be payable on the final closing day.
Here are the most common closing-related costs payable on the day of closing
Lender fees
Lender fees include credit report fees, points, flood determination, homeowners insurance, and private mortgage insurance (if applicable).
There are two types of points in a mortgage process, origination points and discount points. Homebuyers can prepay discount points as a way to lower their interest rate. In some cases, you can use points money toward closing costs. Origination points are the fees your lender charges for the upfront work done to secure your loan.
Lenders may also require a flood determination to ascertain if the property lies in a flood plain. The borrower pays the cost of the determination. If it is discovered that the home exists within a flood plain, your lender will require you to get special flood insurance for the property.
Your lender will also require proof of homeowners insurance before releasing funds for the purchase. The lender will need the first year’s worth of insurance to be paid by the closing date. You can make future payments through escrow if you set your mortgage payments up to collect that from you monthly.
You will also see charges for documents and processing fees or loan origination fees. These fees can include loan application processing, underwriting, and other services.
Third-party fees
These are fees charged by the title company to complete all of the necessary background checks on the property. The title company will perform a title search to ensure the seller is the actual owner of the property and to make sure there are no liens against the property or other issues that may prevent the sale. As part of this process, the title company issues title insurance to protect against past defects in the property’s title, such as forged documents, undiscovered heirs, or undisclosed liens—to allow for a clear title for purchase.
Your title company will also check local tax records to ensure the previous owner has all taxes paid up to date. If not, the seller must settle all payments before closing on the home. The tax information allows the title company to prorate the new buyer’s taxes. For example, if you close in September, the previous owner will be credited taxes paid through the last three months of the year. As the new buyer, you will see a tax charge for the last three months of the year.
The title company also checks for unpaid utility charges and homeowner association fees, unpaid charges show up as part of the tax bill. The previous owner will have to clear any outstanding fees before closing.
Real estate commissions are also paid out to your agent and the seller’s agent at the final closing. These fees will show up on the closing disclosure statement. If you negotiated with your real estate agent for a reduced commission, be sure to double-check those commission numbers.
Other potential homebuyer fees
If you are buying the property without a real estate agent’s help, you may want to hire an attorney to review your contract or represent you throughout the purchase process. Attorney fees are typically paid directly, but if you don’t, then you will need to pay them at the closing.
By now, you know that purchasing a home is a dynamic process that demands your careful attention. Many moving parts need to fall into place to determine the final closing amount. If you paid for a fee at any point along the way, keep track of it and examine your closing disclosure statement closely. This way, you won’t pay twice.
Possible seller credits
For some home purchases, certain repairs identified in-home inspection reports do not get completed, or the seller offered an allowance for the new owner to complete the work after closing. These items will show up on your closing disclosure statement as a credit from the seller. In effect, such credits lower the purchase price and reduce closing costs. A typical allowance might be for new carpeting or new appliances.
Is it possible for closing costs to change?
Yes, your closing costs could change at the last minute. For example
- If the home appraises for less than the sales price, the buyer and seller may have to renegotiate the price.
- A title search could turn up a problem such as a lien on the property.
- If the interest rates jump, you may want to change the type of loan you take out as the buyer. You may also decide to pay more or less for a downpayment.
- Before releasing final funds, the lender may find a new issue with your credit history. A situation like this could change the closing costs if you need to pay down a credit line with loan funds or if the credit issue affects your interest rate and points.
Are closing costs set in stone, or can we reduce them?
As a buyer, you can negotiate prices and fees with any party involved in the purchase process to reduce closing fees. In some cases, the seller may be willing to cover some or all of the closing costs to finalize the purchase.
You can also shop around for a new lender and possibly a different home insurance company to find better rates and terms.
If you want to reduce your closing costs, it may take some leg work but it’s possible, especially in today’s competitive housing market. You may find you are better off in the long run by investing time before closing to negotiate lowering your costs wherever you can.
Homebuyers should plan for closing costs
As the clock ticks down to your closing date, the last thing you want is an issue popping up and causing the sale to fall through. When you prepare properly for closing costs, you can eliminate this last-minute stressor.
Conventional loans require a downpayment of 20% of the home’s purchase price to eliminate private mortgage insurance (PMI). If it’s going to be challenging to come up with an additional 2-5% for closing costs, it may be worth making a smaller downpayment. You can then put the difference towards the closing costs and finalize the purchase of the home. Though you will have a slightly higher mortgage payment with PMI, you’ll still be able to close on the home.
Can homebuyers receive assistance for closing costs?
There are many first-time homebuyer programs that can assist homebuyers with down payment and closing costs assistance. Many of these programs specifically serve first-time homebuyers, especially buyers with moderate and lower incomes. A first-time homebuyer is anyone who has not owned a home in the last three years. So, if you’ve owned a home previously, you might still qualify for one of these programs as long as you have not owned a home recently.
As a homebuyer, you can also use monetary gifts from friends and family to pay for closing costs. Ask your lender about any gift letter requirements and limits on amounts.
There are many fees and costs that make up the final closing costs when buying a home. Don’t let all of the numbers intimidate you. If you have questions, ask your lender, ask the title company, and ask your real estate agent to clarify. It is their job to help buyers and sellers finalize a property transfer. Just like you, they want the transaction to proceed smoothly – so you can move into your new home and begin enjoying your new space.
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