Mortgage 101

What are closing costs?

Closing costs include a multitude of expenses on top of your property's purchase price.


Nearly everyone who's trying to buy a home understands the importance of saving for a relatively sizable down payment. A higher down payment will allow you to avoid private mortgage insurance while also helping you obtain a lower interest rate. However, there are some expenses that are often overlooked but can add up to thousands of dollars. These expenses are referred to as closing costs, which must be paid on the closing date. While you're navigating the home-buying process, the following guide should help you understand what costs you'll need to pay at closing.

 

What Are Closing Costs?

 

Closing costs are the fees that you pay for a wide range of services that are provided to you throughout the entire home-buying process. The only way to effectively finalize a mortgage is to pay the closing costs that are owed. The seller of the home will also have some closing costs that they must pay. However, a majority of the closing costs are paid by the buyer.

Because of how important it is that you pay the closing costs when they are due, you should start saving up for these expenses before you even begin searching for a home. While the exact costs that you'll need to pay won't be known until a few days before closing day, an accurate estimate will be given to you early on in the process.

 

How Much Are Closing Costs?

 

The standard amount of closing costs that buyers are expected to pay can be anywhere from 2-5% of the total loan amount. If you purchase a $400,000 home, your closing costs could be anywhere from $8,000-$20,000.

Likely the best method for paying for your closing costs is to do so as a one-time charge on closing day, which will allow you to get these costs out of the way before you move in. There's a possibility that you will be able to roll these expenses into the total loan amount. The downside to this option is that you would invariably pay interest on these expenses, which doesn't occur if you pay them right away.

When you're purchasing a home, you may be able to negotiate a few of your fees, which might help you reduce the total closing costs that you pay. Certain cities, states, and counties provide people who are purchasing a home with grants or low-interest loan programs that are designed to assist with closing costs. Keep in mind, however, that these programs are usually only available to first-time buyers.

 

Types of Closing Costs You Could Pay

 

There are a wide range of different closing costs that you will invariably need to pay when buying a home. These costs are designed to cover all of the services that are administered while the mortgage is being approved. Along with standard closing costs like homeowners insurance and title insurance, there are also some more specialized costs like HOA fees that you should be aware of when you're trying to estimate what your closing costs will be.

 

Understanding the Closing Disclosure and Itemized Costs

 

A few days after you apply with a lender for a mortgage loan, you will receive a loan estimate, which includes an accurate estimate of the total closing costs that you will be expected to pay. You won't receive a final tally of your closing costs until 3-4 days before the closing day occurs.

Keep in mind that all of these fees will be itemized on your closing disclosure document, which means that they can be fully deducted from your taxes during the year in which you close on the home. However, it's important to understand that this tax benefit only applies to people who itemize their taxes.

 

Standard Closing Costs

 

The many standard closing costs that you may be required to pay when closing occurs include:

  • Basic closing fee - Also referred to as the escrow fee, this fee must be paid to the party that handles the closing, which can include your escrow company, your attorney, or your title company.

  • Credit report fee - This is a relatively small charge that occurs when a lender pulls your primary credit reports. This fee might not be shown on your closing disclosure if your lender received a discount from the various reporting agencies.

  • Escrow deposit - You may be required by your lender to provide two months of mortgage insurance payments property tax payments that will be deposited into your escrow account.

  • Flood determination - This fee is charged in the event that a flood inspector must come out to the property to determine if it's in a flood zone. If it is, you may need to purchase flood insurance as well.

  • HOA transfer fee - When you purchase a townhouse, condominium, or similar property, you will likely be required to join the homeowners association for that specific community. This transfer fee covers the expenses that result from switching ownership of the property. While the buyer is usually tasked with paying this fee, there are times when the fee must be paid by the seller.

  • Homeowners insurance - Your lender will likely require you to pay the first homeowners insurance premium when closing takes place.

  • Title insurance - Title insurance will protect you in the event that another entity makes a claim that challenges your ownership of the property. While this form of insurance is typically optional, it's highly recommended.

  • Points - Discount points are upfront payments you can make to effectively reduce the interest rate that you pay on your loan. A single discount point will lower your interest rate by 0.25%. The standard cost of a discount point is 1% of the loan amount.

  • Origination fees - This charge will cover the administrative costs that your lender takes on to process your fee. The origination fee usually adds up to 1% of the total loan amount.

  • Property taxes - You may be expected to pay property taxes for the time period that begins on closing day and concludes at the end of the year.

  • Recording fee - The local recording office may charge a recording fee to process public land records, which will likely be around $100-$125.

  • Title search fees - This specific fee occurs when your title company looks at public property records to determine if any ownership discrepancies exist. You should expect to pay around $200-$350 for this fee.

  • Transfer fees - These fees may be administered when the title is transferred over to the buyer from the seller.

Some of the additional fees that you might be tasked with paying depending on your situation include attorney fees and assumption fees, the latter of which must be paid if you assume another mortgage when purchasing the home.

 

Additional Points to Consider Before Paying Closing Costs

 

While you should now have a firm understanding of the types of closing costs that you'll be expected to pay once closing day arrives, there are a couple additional points that you should consider early on in the home-buying process. The two main points of consideration involve comparing your closing cost documentation and potentially rolling your closing costs into your mortgage.

 

Compare the Closing Disclosure and Loan Estimate Forms

 

You will receive an initial loan estimate form around three days after you apply for a mortgage. This form will include a detailed overview of the exact fees that you will be expected to pay on closing day. Before you move forward with the home-buying process, it's highly recommended that you heavily review this document to make sure you understand every fee.

If you need some clarification, contact your lender. While your closing costs will likely fluctuate to some degree when you receive your closing disclosure form, there shouldn't be any unexpected additions or sizable jumps in how much you're paying.

 

Roll Closing Costs Into Your Mortgage

 

There's a possibility that your lender will consider rolling your closing costs directly into your mortgage, which means that you wouldn't have to pay these costs immediately. It's also possible for lenders to pay for closing costs altogether. If a lender offers to absorb these costs, they will likely charge a higher interest rate, which would invariably be beneficial to them on a long-term basis.

As mentioned previously, when closing costs are placed into your mortgage, your total loan amount will increase, which means that you will be stuck paying interest on these costs. This option should only be used as a last resort in the event that you're unable to pay these costs at closing.

Whether you're buying your first home or your third, closing costs are part of every real estate transaction. The work that lenders and other companies do while the closing process is ongoing must be covered, which is why you'll invariably notice numerous fees on your closing disclosure. Since closing costs are almost always between 2-5% of the loan amount, you should be able to anticipate what these costs are, which will allow you to save up for them well before the closing date arrives.

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