What are closing costs?
The anticipation of becoming a homeowner for the first time is exciting. After years contemplating renting vs buying, saving and paying down debt, you're finally ready to close the deal on the home of your dreams. But even with all the budgeting you've done, closing costs are often that extra expense that could take you by surprise if you're not prepared.
Closing costs are fees that must be paid in order to close your loan. While items can vary widely depending on where you live, the type of home you buy, charges that typically go into your total closing costs include miscellaneous administrative and processing fees, escrow and recording fees, tax and title services, certifications, and inspections.
What's included in closing costs?
Here are some examples of fees commonly included in your total closing costs.
- Application fee — The application fee covers the cost of administering the transaction and handling the documentation.
- Appraisal fee — A licensed appraiser inspects the home to determine its worth. This appraisal fee typically costs a few hundred dollars.
- Credit report — As part of the due diligence to determine your credit worthiness and determine the interest rate for your loan, the lender will pull your credit report. This fee is rolled into your closing costs.
- Homeowner’s insurance — Homeowner’s insurance is typically required to protect the home from loss or damage. Up to one year’s worth of insurance is due at the closing.
- Private mortgage insurance (PMI) — PMI is designed to protect the lender in case you default on your loan. Until you own a certain percentage of the home, private mortgage insurance may be required by your lender.
- Property taxes — Depending on your location, you may be required to pre-pay 60, 90 or 180 days worth of property taxes when you close on your house.
- Transfer tax — Typically a percentage of the sales price or fair market value of the house, this tax fee is collected and paid when the title passes from the seller to the buyer.
- Underwriting fee — Also known as a loan origination fee, this fee is charged by the lender for preparing the mortgage loan.
These are just a few examples of the fees that can be rolled up in your closing costs.
How much are closing costs for the buyer?
Zillow reported that, on average, homebuyers pay approximately $3,700 in closing costs.1
If you are borrowing money to buy a home, you can shop around for the lowest closing costs and rates. There are also several factors that are under your control that can help lower closing costs. For example, by making a larger down payment, you can reduce closing costs. The location of your home also impacts closing costs and taxes, so choosing a home in a state or area with lower taxes can also help reduce closing costs.
What are typical closing costs?
According to Zillow.com, home buyers should expect to pay between 2 – 5% of the purchase price of their home in closing costs. So, if your home costs $150,000, you could pay anywhere between $3,000 and $7,500 in closing costs.
Closing costs can vary significantly depending on what state you are in. CoreLogic and Closing Corp’s Purchase Mortgage Closing Cost Report 2021 outlines average closing costs by state.
Closing cost calculator
It may be useful to estimate your closing costs prior to purchasing a home. Using some basic information such as the purchase price of the house, your down payment, the term and interest rate associated with your loan, a closing cost calculator can estimate the amount of your closing costs, which can be helpful from a budgeting and preparation perspective. To get a better idea of what you may be looking at concerning closing costs, you can try myFico's closing cost estimator.
How to lower closing costs
Closing costs are a significant expense associated with buying a home. The first critical step is to understand that closing costs will be part of the expenses that you will need to budget for. Also, there are strategies to reduce closing costs.
- Share closing costs with the seller — Although it's typically the home buyer who foots the bill for the closing costs, it's not unrealistic to make a deal with the seller to either split or pay a portion of the total closing costs - especially if it's a deal breaker.
- Negotiate — Lenders have different fees and expenses. Ask lots of questions when choosing a lender and prepare to negotiate down line items that are flexible. While some costs, such as taxes and appraisal fees, are likely fixed and non-negotiable, the loan origination fees are definitely up for discussion.
- Consider different locations — Home ownership can be significantly more expensive in one city than another, and even from county to county within a city. Since property taxes and transfer taxes are imposed by local jurisdictions, selecting a home in a one location may make a significant different in closing costs as well as the long-term costs of owning your home.
- Choose a no-closing-cost mortgage — There's also something called a no-closing-cost mortgage, where you can actually avoid paying closing costs altogether. However, the tradeoff is often paying a higher interest rate. For example, your lender may offer you a mortgage rate of 3.50%, or give you the option of paying zero closing costs (a no-closing-costs mortgage) but offer it to you at a higher rate such as 4% or higher. This type of mortgage loan might be a good choice if you don't have enough cash to cover all of your closing costs upfront and if it means the difference between being able to buy the home you've set your heart on and letting it go to another buyer.
You will put significant effort into looking for your new home and understanding the amount you can afford on that new mortgage payment. Be sure to spend some time understanding and budgeting for closing costs as well. A good rule of thumb when shopping for your first home is to always create a budget for buying a house, build a buffer into your budget, and plan ahead for unexpected costs