If you have ever bought or sold a home, you probably know that mortgage closing costs are the fees you pay when you secure a loan for the home purchase. These costs also come into play when you refinance a loan. Closing costs are generally 2% and 5% of your property’s purchase price, or of the amount of the loan you are refinancing. Even if you have not yet purchased your first home and obtained your first home loan, you have likely heard this term mentioned as a standard part of the cost of buying a new home. Whether you are a prospective first time homebuyer or an experienced purchases, you may still be a bit unsure as to what all is rolled in to these costs.
What Components Make up Closing Costs?
Before we talk about how much you will pay in closing costs and how to reduce this amount, it may be helpful to explain what some of the costs are that make up the overall amount known as closing costs:
Appraisal Fee: An appraisal is generally required by the lender before they will issue you a mortgage, because they need to now that the property is worth more than they are lending. Appraisals may be paid separately, or their cost can be added to your the loan balance.
Inspection Fee: An inspection is similar to an appraisal, in that your lender wants to make sure the property they are lending against is in good condition. Their costs can also be paid separately, or rolled into the loan balance.
Loan Origination Points: These are fees calculated as a percentage of the loan value, that borrowers pay in order to secure their loan. These points cover the loan original fee, application fee, and broker fees.
Mortgage Discount Points: These don’t so much represent a discount, as the ability to lower a loan’s interest rate by prepaying some of the loan’s interest. For every 1% of interest that borrowers prepay, they can usually lower the interest rate for the term of their loan by about 0.25%.
Mortgage Insurance: This is often abbreviated as PMI (Primate Mortgage Insurance), and is required by lenders if your down payment is less than 20% of the loan balance.
Prorated Real Estate Taxes: When a property is sold, the seller is usually required to pay the real estate taxes for the portion of the year for which they owned the property. The buyer will then pay taxes for the full year when they get their property tax bill. The seller usually credits back the real estate taxes due for the portion of the year they owned the property.
Real Estate Commissions: These are usually paid by sellers, and typically range from 5% to 6% of the purchase price, but can be as much as 10%, depending on the property type.
Recording Fee: Whenever a property changes ownership, a new deed showing this must be filed with the local county recorder. Counties typically charge a nominal fee for filing the new deed.
Stamp Tax: This is the name for the transfer tax owed when real property transfers from a seller to a buyer. The amount of these taxes is usually small, but they can be more substantial in some parts of the country.
Survey Fee: A property may need a new survey showing the property lines and outlining legal boundaries and land features before it can be sold, especially if a survey has not been done in quite some time. A new survey is also needed if a buyer is purchasing part of a larger parcel of land, or if multiple parcels are being combined into one sale.
Title Fee: An attorney or title company will charge this fee for doing a title search on the property. This is a required step to make sure the seller can legally convey the property to another party, and that there are no liens or encumbrances on the property.
Title Insurance: This protects the buyer in case something fraudulent occurs with the title at a later date. One common form of fraud is when someone files a fake deed to try and take possession of someone else’s home. Title insurance covers the new owner should something like this happen.
How Much are You Likely to Pay?
Closing costs include all of the fees associated with the business of purchasing a home – this means application fees, attorney’s fees, real estate commissions and taxes. While the ingredients that go into determining the closing costs are pretty standard, the amounts can vary wildly from property to property. The reason for the variation has to do with everything from the home’s purchase price to your loan type, to which lender you decide to use. In some simple cases, closing costs can be as low as 1% or 2% of the purchase price of a property. However, in most real estate transactions where loan brokers and real estate agents are involved, the total closing costs can exceed 15% of a property’s purchase price.
This is the total amount of closing costs though – you will normally see that the costs are split between the seller and the buyer based on whatever agreement has been set forth during the sale negotiations.
Buyer’s Costs
Most buyers should expect to may anywhere from 2% to 5% of the home’s selling price in closing costs. A typical breakdown of the costs would be:
- One or two origination points – this is the industry term for lender fees. Lender fees generally equates to 1% to 2% of the loan amount, along with any loan origination fees. The origination fees are normally between $750 to $1,200.
- Loan underwriting fees for things like the home inspection, home appraisal, land survey and property title work. This amount is normally somewhere around $1,000.
- One or more mortgage discount points. These only come into play if you choose to lower your interest rate by prepaying some of the interest.
- Up to 2% of the loan amount to be used as your initial mortgage insurance premium. If you decide to use insurance or a government-issued loan, (such as an FDA or FHA loan), you will be required to pay this with your closing costs.
In recent years, these closing costs are more often than not the responsibility of the buyer in a real estate transaction, the specifics of which are always outlined in the disclosure sections of a purchase agreement, and determined by the lender and loan type you select when you decide on financing. You can also find your mortgage closing costs in the loan estimate and the closing disclosure. Your lender is required by law to provide you with these documents. Disclosures vary from lender to lender, but they all must include the total loan amount, your interest rate, the annual percentage rate, and your monthly payment schedule.
When Do Seller’s Have to Pay?
Buyers alone are not stuck with the full amount of the closing costs during a real estate transaction. There are certain aspects of the costs that sellers are always responsible for. This includes real estate agent commissions, prorated real estate taxes and transfer taxes. In some cases, sellers may also pay for the cost of a home warranty if one is being provided, along with the fees for any associations that their property belongs to. The seller is also responsible for paying for any property title preparation fees.
These are not hard rules though, only guidelines for how the costs are paid for the majority of real estate transactions. Ultimately, though, the party responsible for paying each cost is largely at the discretion of negotiations between the buyer and seller. Of course, in the event of a mortgage refinance, you are responsible for all closing costs since you are the only party involved in the transaction.
Ways to Reduce Your Closing Costs
Even if you are aware of the presence of closing costs, their amount might still be an unwelcome surprise. When you’ve spent months or even years saving for a down payment, searching for just the right home, and then negotiating a purchase price you can commit to, along with securing your financing, once you factor closing costs into the transaction, you may find that it is much more difficult to afford your new property.
That is why a lot of people look for ways to reduce or altogether avoid closing costs. It’s not possible for you to eliminate your closing costs entirely, but there are a few things you can do to reduce your expenses. This includes:
- Paying for Your New Home in Cash. Of course we realize that for most people, paying for your new home in cash is not a practical option. However, if you are selling one home and purchasing another, or if you have saved up a significant amount of money, you might find that you are actually able to buy your next home without financing. If you can afford it, by paying cash for a home you can lower your costs significantly, often by as much as 1% of the purchase price. Without a loan, you’ll eliminate loan origination fees and appraisal costs, among others fees.
- Using Seller Financing. Seller financing is a term used when the seller of the property acts as the bank by holding a mortgage and letting the buyer pay off the property over time. Financing in this matter doesn’t usually involve origination fees, and could also allow buyers to skip things like surveys and appraisals, as there is no authority overseeing the loan who may require them. A buyer could also skip inspections with this type of financing, but we never recommend this, because it is important for buyers to still know the state of the property they are purchasing before they close on the deal.
- Avoiding Discount Points. Many mortgage lenders offer borrowers the opportunity to lower their interest rate by prepaying interest on their loan. These amounts are known as discount points. This strategy can look attractive in the long term because you can significantly lower the total interest you will pay over the life of your loan. In fact, this makes financial sense and is often something we advise buyers to do. However, discount points can represent a significant increase in your upfront costs, so it is important to look at the bigger picture including both your finances now and your long term plans before you decide how to proceed.
- Avoiding Mortgage Insurance. If you are able to make a down payment of 20% of the purchase price of your home, conventional mortgage lenders will not require mortgage insurance. So, if you cannot pay for your home using cash, making a sizable down payment is your next best option. Mortgage insurance will be required if you are using an FHA or USDA loan and you do not put down at least 20% down payment.
- Rolling Closing Costs into Your Loan. This is not an option for all of the amounts that go into your closing costs, and it is not an option that is offered by every lender. But, it is worth researching to see if it could be an option for a portion of your closing costs. Things you may be able to roll into your loan include origination fees, appraisal costs, and inspection fees or title fees. Keep in mind that while doing this may lead to some initial cost savings, it will actually increase your total mortgage cost, as you’ll pay interest on these expenses over the life of the loan.