Buying a home is usually one of the biggest financial decisions you’ll make in your lifetime, but what many new homebuyers overlook are closing costs. Closing costs are funds, in addition to a loan down payment, paid at settlement. Closing costs vary, but cash transactions will have fewer costs than financed purchases.
Although many of the costs are associated with financing, others are independent of the mortgage and the lender. Some charges are normally associated with either the buyer or the seller, but anything is negotiable. It also depends on the current real estate market. In a buyer’s market, the buyer has more leverage and can often get the seller to foot some or all of the closing costs. On the contrary, in a seller’s market they may be entertaining many offers and are less likely to make concessions on closing costs.
Some costs are clearly the responsibility of the seller. For example, the seller typically pays the total real estate commission to their agent/broker. The amount is generally deducted from the proceeds of the sale. If the buyer is also using an agent, there are typically agreements in place for splitting the commission and it not a fee paid by the buyer. Likewise, the seller pays for his own real estate attorney, if he has retained one. If the seller has not yet paid the annual property taxes, the seller credits the buyer for the number of days the seller owned the home that year. This credit reduces the amount of money the buyer needs at closing.
The buyer usually pays for the mortgage-related fees: application, origination points, discount points, private mortgage insurance, credit report, mortgage broker fee, and so on. These fees will vary from lender to lender. An origination point compensates the lender or mortgage broker for their work; a discount point lowers the interest rate. Each point costs one percent of the loan amount. Speak to your loan officer about the possibility of amortizing some of these fees into the loan. It isn’t always a good idea to roll fees into the loan as it can end up costing more money in the long run, but if money is tight it can help so that these fees aren’t out of pocket.
Title insurance protects against past defects in title such as forged documents, undiscovered heirs, or undisclosed liens. There are two different policies usually issued at the same time. One is a lender’s policy that’s mandatory if you’re receiving a mortgage. The second is the optional, but highly recommended, homeowner’s policy. Local customs affect who pays, but buyers and sellers often negotiate title insurance payment.
Document recording fees are charged for the deed and are typically paid to a local municipality or the county. The state may also assess transfer fees or taxes on new and assumed mortgages – typically paid by the borrower – and on the deed, paid by the seller.
Lenders require homeowner’s insurance. Additional flood, wind, or earthquake coverage may also be mandatory, depending on the location of the property. These annual policies are effective on the day of closing, but the homeowner may pay for them ahead of time. Costs vary widely among providers, so shop around for the best pricing that meets your needs. The full year’s premium is due by closing and may be a part of the closing fee package.
Lenders require a property appraisal that the buyer normally pays at the time of the inspection or loan application. Costs vary depending on the size of the home, and FHA appraisals may cost more than conventional appraisals. If you are doing a cash sale, an appraisal isn’t required, but it is still in a buyer’s best interest to get their own appraisal to make sure the purchase price of the property is fair.
Lenders also generally collect a two-month payment cushion for escrowed items. That means you pay 2 months of hazard insurance and property tax at closing, and going forward part of your mortgage payment will be allocated to escrow to cover these recurring charges.
The Real Estate Settlement Procedures Act requires that loan officers send applicants a Good Faith Estimate (GFE) of expected closing costs within three business days of signing the loan application. These estimates will be very close to the final charges and typically arrive about 30 days before closing. If you need more time to prepare, ask a loan officer to pre-qualify you for a loan before you start looking at homes. Request a GFE of estimated charges. FHA loans allow closing costs to be paid with gift money, and your state or city may have First Time Homebuyer programs available that assist with closing cost funds. Discuss the possibilities with a local loan officer or real estate broker.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.