Buying a home is a major investment. Besides potentially paying for it over decades, it also comes with a significant upfront cost. Buying a home doesn’t require you to pay your real estate agent, but most home loans require a down payment.
But what other costs come with home buying?
Closing costs — and they can really add up. While they may not make you change your mind about buying a home, they should be in your thoughts. That way, you can prepare yourself both financially and strategically when putting in a home offer.
Here’s everything you need to know about mortgage closing costs to avoid any last-minute surprises.
Who pays closing costs?
Most closing costs are paid at the time of settlement when a real estate property is being purchased. They’re an accumulation of various closing fees paid to multiple parties, oftentimes for services rendered leading up to the transaction. They can be paid either by the buyer or the seller (or sometimes, both).
Your mortgage lender is required to provide you with an estimated breakdown at multiple points in the loan process. The loan estimate outlines the estimated closing costs and lists out all the different fees, as well as who is responsible for paying them.
In the end, you’ll see the total amount of money you’re expected to bring to closing. This amount includes your down payment and subtracts any seller or lender credits.
What fees are included in closing costs?
Mortgage closing costs can be broken down into a few different categories: lender fees, real estate fees, and mortgage insurance fees.
These fees may vary depending on the lender you choose. Here’s a basic rundown of each closing cost to give you an idea of what you can expect.
Application fee – Lenders generally charge an application fee for processing your mortgage loan application. There may also be a credit report fee, which the lender charges for pulling your credit report from one of the three major credit bureaus.
Attorney fee – In some states, an attorney must review the paperwork on behalf of the buyer and lender. The fee can either be charged hourly or as a flat rate so talk to your lender about what to expect.
Broker fee – If you use a mortgage broker to secure your mortgage, they may charge a commission fee. Usually, this costs between 1% and 2% of your home’s purchase price.
Origination fee – Some lenders charge an origination fee, while others may not. It compensates the lender for administrative tasks and typically amounts to 1% of the loan amount.
Discount points – You can choose to pay points as prepaid interest to qualify for a lower interest rate and, typically, decrease your monthly payment. A point refers to one percentage point of your loan. The more points you purchase, the lower your interest rate will be. Discount points can help you save money over the life of the loan, but they are not always the best option.
Prepaid interest – Slightly different from paying discount points. You generally don’t start making mortgage payments right after your loan closes. This fee covers interest accrued between the closing date and the first monthly payment due date.
Recording fee – A recording fee is a fee charged by a municipal or county government for the recording of documents such as deeds, mortgages, and liens. Recording fees are charged to cover the administrative costs of filing and maintaining the records in a public office.
Underwriting fee – An underwriting fee is a fee charged by an underwriter for the services provided in connection with issuing and selling securities. This fee covers the underwriter’s costs, such as due diligence, legal fees, and other costs associated with the underwriting process.
Real Estate Fees
Real estate fees are related to costs surrounding the property itself. Some are one-time fees, while others are recurring.
Appraisal fee – An appraisal is required to determine the market value of the home you’re purchasing to make sure it’s worth the purchase price. Depending on your lender, you may have to pay before the appraisal occurs, or it may be rolled into your closing costs. Expect to pay around $500 to $600.
Property tax – Property taxes are usually an annual or biannual payment to your local city or county. However, you prepay the bill as part of your monthly mortgage payment. However, most lenders require at least two months prepaid into your escrow account at closing.
Homeowners’ insurance policy – Your homeowners’ insurance premium is another annual cost that is required to secure a home loan. Typically, the total annual bill is paid as part of closing. Then, you’ll start paying towards the next year’s bill as part of your mortgage bill.
Title search and insurance – The title search ensures you’ll be able to own the property outright and that there are no outstanding liens from other parties. Lender’s title insurance protects the lender in case someone else tries to stake a claim on the property. You can also purchase owner’s title insurance, which protects you in case any issues arise after you close on the home.
Transfer tax – Transfer taxes are taxes imposed by a state, county, or local government when a home is sold or transferred. The amount of the tax can vary from one jurisdiction to another, but typically, it is a percentage of the home’s sale price.
HOA fees – If your new home is part of a homeowners association, you may be required to pay a homeowners association transfer fee. Your annual assessment may also be required upfront, depending on the specific HOA.
Mortgage Insurance Fees
When you pay less than 20% of your home purchase price as part of your down payment, you’re usually required to pay mortgage insurance. Your private mortgage insurance (PMI) premium is typically assessed as a monthly fee within your mortgage payment. However, you may also have some costs at closing.
Upfront mortgage insurance fee – Depending on your loan type and lender, you may have to pay an additional application fee for a loan with mortgage insurance. Additionally, some loans require that you pay a one-time fee at the time of closing on top of your annual fee throughout the mortgage.
Government-backed loan fees – If your loan is from the FHA, USDA, or VA then you may have extra mortgage insurance fees if your down payment is under 20%. FHA loans require an upfront mortgage insurance premium (MIP) of 1.75% and a monthly fee. The VA and USDA don’t charge mortgage insurance but instead have guarantee fees. VA fees fall between 1.25% and 3.3% while USDA fees are a flat 2%.
How is the closing cost on a mortgage calculated?
That list may seem huge and overwhelming. However, before making an offer on a house, you can estimate your closing costs using some shortcuts. Average closing costs are usually about 2% – 5% of the loan amount.
Let’s look at that in real numbers.
Say you buy a home for $200,000. You can realistically expect your closing costs (not including your down payment) to extend anywhere between $4,000 and $10,000. That’s a pretty big range, so use that as a starting point when you begin to compare loan offers.
But don’t wait until you’ve fallen in love with a house to financially plan for closing costs.
Instead, use an online closing costs calculator early in the process to get a more specific estimate. You will want to use real information like average property taxes in your area and the costs associated with your type of loan.
A good mortgage lender can walk you through the variables, including how different loan types affect your closing costs.
Can you negotiate closing costs?
As you can see from the listing of the fees, some closing costs are negotiable while others are set in stone. The major ones to compare across loan offers are the lender variables, like origination fees, application fees, and broker fees. Don’t assume that a broker is automatically more expensive. You may be able to negotiate a lender credit to help lower your closing costs.
The other way to negotiate your closing costs is with the seller of your new home. It’s becoming more common for sellers to cover closing costs because many eligible homebuyers cannot save enough money to purchase a home.
Your negotiation strategy with the seller really depends on the real estate market in which you live. If you buy a house in a slower area (or time of year), then you’re more likely to get a seller to pay your closing costs.
But if you’re in a much more competitive area with low housing inventory, it may be more difficult to get the amount you want. Still, even partially paid closing costs can be helpful in saving money at settlement.
Can closing costs be included in a home loan?
In some cases, you can roll your closing costs into the mortgage, but you have to meet some basic requirements. First, it depends on your type of loan since not all loans allow you to do this. Most government-backed loans, like FHA and USDA loans, do offer the possibility to add them into your home loan.
What’s the downside to this idea?
A higher loan amount means a higher monthly payment and a larger amount of interest paid over the life of your mortgage. Furthermore, your new home needs to appraise for the higher amount you want to finance. Plus, your debt-to-income ratio needs to be able to support that larger payment to qualify for such a loan.
If you’re getting a loan that doesn’t allow for closing costs to be rolled into the mortgage, you can still get around it. However, you must meet those criteria we just talked about.
Simply ask the seller (through your real estate agent) to pay for closing costs in exchange for paying the extra amount as part of the purchase price. Here’s an example.
If your $200,000 offer is accepted, but closing costs are $5,000, ask the seller to contribute $5,000 and change your offer to $205,000. At the end of the day, the seller still walks away with the same amount of money.
Again, this strategy is contingent upon the numbers working for you, your financial situation, and your mortgage application.
How to Pay for Closing Costs at Settlement
When you finally get to closing day, it’s almost time to relax and move into your new home. But first, don’t forget to set up a way to pay closing costs.
You can ask your lender or settlement company for the preferred payment method. However, in most cases, you can either get a cashier’s check from your bank or set up a wire transfer. There’s usually a minor fee associated with each one. It’s a quick and easy process, but it shouldn’t be forgotten before you get to closing.