The Full Guide to Closing Costs and Reducing Them
When you buy a home, the sale price isn’t the only number you need to think about. You’ll also need to cover closing costs. These are the fees you pay to finish the home-buying process—everything from getting your mortgage set up to taking care of legal paperwork and taxes. If you’re new to this, closing costs might catch you off guard because they can add up quickly. So, here’s everything you need to know about closing costs.
What are Closing Costs?
Closing costs are all the different fees and payments you have to make when you finalize the purchase of a house. These costs show up right when you’re about to complete the deal, and they cover all the services needed to close on the property. That includes things like getting the house appraised, paying your loan origination fees, title insurance, taxes, and even legal fees.
Typically, closing costs are around 2% to 5% of the home’s total price. This can feel like a lot on top of the down payment, but it’s necessary to finish the deal and legally transfer the property to you. It’s always a good idea to ask your lender or real estate agent for a breakdown of what you’ll be paying upfront so there are no surprises at the last minute.
Closing costs cover essential steps like making sure the home’s value is accurate, securing the property’s title, and paying taxes and insurance. It’s all part of making sure everything is in order before the property becomes yours.
Who Pays for Closing Costs?
Both buyers and sellers share the responsibility for closing costs, but who pays for what can vary based on your agreement and location. Buyers typically cover costs like loan origination fees, appraisal fees, and title insurance—basically, anything tied to their mortgage or the value of the home. Sellers, on the other hand, often handle fees related to transferring ownership, like paying off any liens or handling the title transfer.
That said, these costs are negotiable. In some cases, a seller might offer to cover some of the buyer’s closing costs to sweeten the deal, especially in a competitive market. It’s important to ask your real estate agent what’s common in your area and to negotiate these costs as part of your overall offer. The specifics can also vary depending on the type of loan you’re getting and where you’re buying.
The Common Types of Closing Costs
There are several types of closing costs that come up when you’re buying a home. Here’s a breakdown of the most common ones:
Loan Origination Fees
Loan origination fees are what the lender charges for setting up your mortgage. It covers the cost of processing your application, checking your credit, and making sure all the paperwork is in order. These fees usually range from 0.5% to 1% of the total loan amount. It’s basically the cost of getting your loan ready to go.
Discount Points
Discount points are optional fees you can pay upfront to lower the interest rate on your mortgage. Each point costs 1% of your loan amount, and it can reduce your interest rate by about 0.25%. This is a way to save money over time, especially if you plan on staying in the home for a long period. Think of it as paying more now to pay less later.
Appraisal Fees
The appraisal fee covers the cost of having a professional appraiser check the value of the home you’re buying. Lenders require this to make sure the home is worth the amount of money they’re lending you. Appraisals usually cost between $300 and $500. This fee helps ensure you’re not overpaying and the lender isn’t lending more than the property is worth.
Title Insurance
Title insurance is a one-time payment that protects both the buyer and the lender in case there’s a problem with the property’s ownership after the sale. For example, if someone claims they still own part of the property or if there’s an unpaid lien, title insurance has you covered. This typically costs around $500 to $1,000, depending on the value of the home.
Private Mortgage Insurance (PMI)
If you’re putting down less than 20% on your home, your lender will probably require private mortgage insurance (PMI). This protects the lender in case you default on the loan. PMI can either be paid monthly or in one lump sum at closing. The cost depends on how much you borrow, but it typically ranges from 0.3% to 1.5% of the loan amount annually.
Prepaid Costs
Prepaid costs are upfront payments for things like property taxes and homeowner’s insurance. These aren’t technically “closing costs” but are still part of what you pay when you close on your home. Prepaid costs make sure that taxes and insurance are taken care of for the first few months after you buy the house. This helps the lender make sure the property is protected and current on taxes right from the start.
How Much Do Closing Costs Typically Cost?
Closing costs usually range between 2% and 5% of the total loan amount. This can be a significant expense depending on the price of the home. For example, if you’re buying a home for $300,000, you might expect to pay between $6,000 and $15,000 in closing costs. These costs cover various fees like loan processing, appraisals, title insurance, and more.
The amount you pay depends on the services required, the type of loan you have, and even where the home is located. It’s important to factor these costs into your overall budget when planning your home purchase. Some buyers are surprised by how much these fees can add up, so understanding what you’ll be paying upfront helps avoid any last-minute stress.
National Averages for Closing Costs
Nationally, closing costs typically fall between 2% and 5% of the loan amount. For example, if you’re purchasing a $250,000 home, you can expect closing costs to be anywhere from $5,000 to $12,500. However, these costs can vary based on where you are in the country, the type of loan you choose, and specific lender fees. In general, closing costs in the U.S. average around $6,000, but they can be lower or higher depending on factors like property value and local regulations.
It’s always a good idea to ask for a Loan Estimate early on so you have a clearer picture of the exact costs.
State-Specific Variations
Closing costs can vary widely depending on the state you’re buying in. For instance, some states have higher property taxes or require certain services that others don’t, which can increase your costs. In states like New York or California, where housing prices are typically higher, closing costs can also be on the higher end. On the other hand, states like Indiana and Missouri tend to have lower closing costs due to fewer state-specific fees and taxes.
Each state has its own set of regulations that can affect fees like title searches, recording fees, or transfer taxes. If you’re buying in a high-tax state, be prepared for higher closing costs, but if you’re buying in a state with lower taxes or fewer regulations, you might be able to keep your costs down. It’s important to research these differences to better plan for your purchase.
When Do You Pay Closing Costs?
Closing costs are usually paid right at the end of the home-buying process, but there are some expenses that might pop up earlier. Most of the costs are due when you officially “close” on the house, meaning the day you sign all the paperwork, get your keys, and the property officially becomes yours.
However, certain costs might need to be handled before closing. For example, inspections and appraisals often happen earlier in the process to make sure everything is in order before the sale goes through. It’s important to keep track of these pre-closing expenses so you don’t get caught off guard.
At Closing
Most closing costs are due on the day of closing, which is the final step of buying your home. This is when you’ll pay all the fees, sign the necessary documents, and officially take ownership of the house. On this day, you’ll usually provide a cashier’s check or arrange a wire transfer for the total closing costs amount. Once everything is signed and the payments are made, the keys to your new home are handed over.
It’s important to know the exact amount you’ll need to bring to closing, so check with your lender or real estate agent ahead of time to avoid any last-minute surprises.
Pre-Closing Expenses
Some costs come up earlier in the home-buying process, even before the closing day. For instance, you may need to pay for a home inspection, which ensures the house is in good condition. An appraisal, required by the lender to confirm the home’s value, is another expense that usually happens before closing. These pre-closing expenses typically aren’t covered by your lender and need to be paid out-of-pocket.
It’s helpful to budget for these upfront costs as part of your overall home-buying expenses, so you’re prepared to handle them when they come up.
Can You Roll Closing Costs into Your Mortgage?
Yes, in some cases, you can roll closing costs into your mortgage, meaning you don’t have to pay them all upfront. This option can make it easier for buyers who might not have the cash on hand to cover both the down payment and closing costs. However, it’s not always available, and whether or not you can do this depends on your lender and the type of loan you’re getting.
Rolling closing costs into your mortgage can increase your monthly payments and the total amount of interest you’ll pay over time, so it’s important to weigh the pros and cons.
How to Roll Closing Costs into the Mortgage
To roll your closing costs into your mortgage, you’ll need to check with your lender to see if it’s an option. Some loans allow you to add these costs to the total loan amount, so instead of paying them upfront, you pay them off over time with your mortgage. This option is more common with refinancing loans, but it can sometimes be done with new home purchases, too.
Keep in mind that adding closing costs to your mortgage means borrowing more money, which will slightly increase your monthly payment and the total interest you pay over the life of the loan.
Pros and Cons of Rolling Closing Costs into the Mortgage
One big advantage of rolling closing costs into your mortgage is that it saves you from having to pay a large amount of money upfront. This can be helpful if you’re tight on cash or need to keep your savings intact for other expenses.
However, the downside is that you’ll be borrowing more money, which increases both your monthly mortgage payment and the amount of interest you’ll pay over time.
In short, while it might save you some money upfront, it’s important to consider the long-term financial impact of adding those costs to your loan.
Best Ways to Reduce Closing Costs
Closing costs can add up quickly, but there are a few practical strategies to help minimize them. Reducing these costs can make a big difference, especially if you’re already stretching your budget. Here are some ways to potentially lower what you’ll owe when closing on your home:
Shop Around for Services
One of the simplest ways to save money on closing costs is by shopping around for services. Many fees, like title insurance, home inspections, or attorney services, vary from one provider to another. Just like you compare prices for everyday purchases, it pays to get quotes from different companies for these services. Lenders usually have preferred providers, but you’re not obligated to use them. By taking the time to shop around, you could end up saving a few hundred dollars or more on services you’ll need to close the deal.
Negotiate with the Lender
It’s always worth asking your lender if they’re willing to negotiate some of their fees. Origination and underwriting fees, which cover the cost of processing your loan, might not be set in stone. In competitive markets, lenders may be open to reducing or waiving some of these fees to earn your business. Even a small reduction in fees can make a difference, so don’t be afraid to have that conversation. You might also be able to negotiate a lower interest rate by offering to pay more upfront in discount points.
Seller Contributions
In some cases, you can negotiate for the seller to cover a portion of your closing costs. This is known as a “seller concession” and can help reduce your upfront expenses. The seller might be willing to offer this if it helps close the deal faster or if the property has been on the market for a while. This is something you can bring up during negotiations, and depending on the market conditions, you could save a significant amount by having the seller pitch in toward these costs.
Closing Cost Assistance Programs
For eligible buyers, there are grants and assistance programs designed to help with closing costs. These programs are often available to first-time homebuyers or low-income buyers and can cover part or all of the closing costs. Some programs are offered by state and local governments, while others come from nonprofit organizations. Be sure to research these options early in the home-buying process, as they can significantly reduce what you’ll need to pay out of pocket.
Closing Costs vs. Prepaid Expenses
It’s easy to confuse closing costs with prepaid expenses, but they’re actually two different things. Closing costs are the fees and services you pay to finalize your home purchase, while prepaid expenses are costs that need to be paid in advance, like taxes and insurance.
What are Prepaid Expenses?
Prepaid expenses are payments you make upfront for things like property taxes and homeowner’s insurance. These are not closing costs, but they’re still part of the total amount you need to bring to the closing table. The lender collects these prepaid expenses to ensure that your taxes and insurance are covered for the first few months after you buy the home. Think of it as a way for the lender to protect their investment in the property.
How Prepaid Expenses Affect Closing Costs
While prepaid expenses aren’t technically considered closing costs, they still add to the total amount you need to pay at closing. For example, the lender might ask for several months’ worth of property taxes or homeowner’s insurance to be paid upfront. These prepaid amounts are collected in advance to ensure you’re up-to-date on taxes and insurance right from the start. It’s important to factor in these costs when budgeting for your home purchase, as they can easily add a few thousand dollars to what you owe at closing.
Special Considerations and Factors Affecting Closing Costs
Closing costs aren’t the same for everyone, and several factors can make them higher or lower. Here are some key considerations that can affect the total cost:
Location
Where you buy your home has a big impact on your closing costs. In states with high property taxes or more regulations, you might pay more in fees. For example, states like New York and California tend to have higher closing costs because of higher taxes and local laws. On the other hand, in states with fewer regulations, like Indiana or Missouri, closing costs are generally lower.
Loan Type
The type of loan you choose can also affect your closing costs. For example, FHA loans usually have lower down payments but come with higher upfront fees. VA loans, available to veterans, often have lower closing costs and no requirement for private mortgage insurance (PMI). Conventional loans may offer more flexibility, but the closing costs can vary based on the lender and your credit score.
Down Payment Size
The amount of your down payment can influence certain fees, especially if you’re putting down less than 20%. In that case, you may be required to pay private mortgage insurance (PMI), which is an added cost. The bigger your down payment, the less likely you’ll need to pay PMI, and it could also reduce some of the fees associated with securing your loan.
Wrapping Up
Closing costs are an essential part of buying a home, and while they might seem overwhelming at first, understanding them can make the process smoother. From loan origination fees to title insurance, there are many moving parts, but with the right strategies, you can reduce what you owe. Shopping around, negotiating with lenders, and exploring assistance programs can all help lower your costs. It’s also important to keep in mind that prepaid expenses are separate but still add to the total amount due at closing. By preparing in advance and knowing what to expect, you’ll be better equipped to handle closing costs without feeling stressed. Take the time to ask questions, compare services, and plan ahead so that when it’s time to close on your home, you’re ready to go.
FAQs
What is calculated in closing costs?
Closing costs include a variety of fees such as loan processing, home appraisal, title insurance, and government taxes. It also covers any prepaid expenses like property taxes and homeowner’s insurance.
What are the biggest closing costs usually paid by buyers?
The largest costs typically include loan origination fees, appraisal fees, and title insurance. Buyers may also have to pay for private mortgage insurance (PMI) if they’re putting down less than 20%.
Who pays closing costs in the US?
In the U.S., both buyers and sellers share the closing costs. Buyers usually cover fees related to the mortgage, while sellers handle costs associated with transferring the property title. However, these can sometimes be negotiated.
Can closing costs be included in the mortgage?
Yes, in some cases, closing costs can be rolled into the mortgage, but this depends on the lender and loan type. Keep in mind, though, that this increases your loan amount and monthly payments.
Are closing costs tax-deductible?
Some closing costs, like mortgage interest and property taxes, may be tax-deductible. However, most fees like appraisal or title insurance are not eligible for deductions. It’s a good idea to consult a tax professional for details.
