When it comes to buying a home or refinancing a mortgage, there's more to consider than just the price of the property or the interest rate. Enter: closing costs. In the context of real estate, closing refers to the final stage of a property transaction where ownership of the property is transferred from the seller to the buyer. The costs associated with this process, collectively referred to as closing costs, are essentially the fees and charges that facilitate this transfer of ownership.
What Are Closing Costs?
As a homebuyer, think of closing costs as the final step in your homebuying journey.
When you purchase a home, a lot of work happens behind the scenes to ensure the process goes smoothly. This includes checking your credit, appraising the home to confirm its value, conducting a title search to make sure no one else has a claim to the property, handling the paperwork to legally transfer the property to you and more. Each of these services comes with a fee, and when combined, they're known as closing costs.
Closing costs are one-time fees paid at the end of the homebuying process or at closing. Depending on the real estate market and your negotiations with the seller, the seller might agree to cover a portion of these closing costs. This can significantly reduce the amount you'll need to bring to the closing table.
How Much Are Closing Costs?
On average, closing costs range from 2% to 5% of the home's purchase price. If you're buying a home priced at $300,000, your closing costs may be between $6,000 (2%) and $15,000 (5%). The exact amount will depend on several factors, including the property's location, the type of mortgage and the particulars of your agreement with the lender and seller.
According to ClosingCorp, a well-known provider of residential real estate closing cost data, the national average closing costs for a single-family property in 2021 were $6,837 including taxes and $3,836 excluding transfer taxes. By state, the District of Columbia incurred the highest average closing costs including taxes at $29,888, followed by Delaware at $17,859. Missouri, on the other hand, had the lowest average closing costs including taxes at $2,061.
What Do Closing Costs Include?
Closing costs encompass a range of services and processes that help facilitate the transfer of property from seller to buyer. These costs typically include:
Origination Fee: Think of this as a processing fee for your loan. It covers administrative work, like application processing and underwriting, charged by your lender.
Discount Points: This is an optional charge you can pay to lower your interest rate. Essentially, you're buying down your rate — a strategy that might make sense depending on how long you plan to own the home.
Appraisal Fee: This pays for a professional estimate of the home's market value, ensuring that the lender isn't loaning you more money than the property is worth.
Credit Report Fee: This is how the lender covers the cost of accessing your credit history data to evaluate your creditworthiness. Note that your lender will likely make a hard inquiry, which may affect your credit score.
Title Search and Insurance Fee: This two-part fee includes a deep dive into public records to ensure no one else has a claim to your property and an insurance policy that protects your ownership rights.
Survey Fee: In some cases, you'll need to confirm property boundaries. This fee covers the cost of that verification.
Home Inspection Fee: A professional home inspection can uncover hidden problems with a property. The cost for this service often falls under closing costs.
Pest Inspection Fee: Depending on where the home is located, you may also need a separate inspection to check for bugs and pests.
Escrow Deposit: This is where you prepay some of your property taxes and homeowners insurance into an escrow account.
Prepaid Interest: This covers the interest that will accrue from the time you close the deal to when you make your first mortgage payment.
Property Tax: Typically, you'll need to cover property taxes from the day you become the homeowner.
Homeowners Insurance: Lenders generally require you to secure and prepay the first year's insurance premium at closing.
Recording Fees: Your city or county government will charge a fee to officially note the change in property ownership.
Underwriting Fee: This fee compensates the lender for the work of researching and verifying your ability to repay the loan.
Flood Determination and Monitoring Fees: These cover the cost of determining whether the property is in a flood zone and keeping track of any changes.
Ultimately, closing costs vary based on location, the type of loan, the property itself and even the time of year. Understanding these fees and planning for them can help you budget wisely and ensure a smoother homebuying process.
How to Plan for Closing Costs
Planning for closing costs involves a series of steps, from conducting your own research to negotiating with the seller.
Do your research
Understand what closing costs are and what fees they might include. Costs can vary depending on the location, type of loan and specifics of your agreement with the lender or seller.
Get an estimate
Early in the loan application process, your lender will give you a loan estimate, which includes an estimated closing cost. Use this as a baseline for your budgeting.
Start setting aside funds for closing costs in addition to your down payment. If possible, save more than the estimated amount to create a buffer for unexpected costs.
Review the closing disclosure
A few days before closing, your lender will provide a closing disclosure. This document gives a detailed breakdown of your final closing costs. Compare this with your Loan Estimate to ensure there are no significant discrepancies.
Sometimes, you can negotiate with the seller to pay a portion of the closing costs. This strategy, known as seller concessions, can help to lessen your financial burden.
Consider other financing options
Some lenders offer to finance closing costs, meaning they'd add these costs to your total loan amount. While this reduces the amount you need to pay upfront, it will increase your long-term costs due to interest.
Why Is It Important to Budget for Closing Costs?
Budgeting for closing costs is essential in the homebuying process because these additional expenses can add up to a significant amount. If you don't account for these costs in your budget, you could find yourself short on funds at a crucial moment in the buying process.
The financial impact of closing costs is twofold. First, they directly affect how much money you need to close the sale. Second, they indirectly influences your budget for other expenses related to your new home. If you have to put more money toward closing costs, you might have less to spend on moving expenses, home improvements, furniture or emergency savings for unexpected home repairs.
Common Misconceptions About Closing Costs
Navigating the homebuying process can be complex, and closing costs are often misunderstood. Below, we debunked some common misconceptions about closing costs.
Closing costs are the responsibility of the buyer only
While it's true that buyers often pay a significant portion of the closing costs, sellers can also bear some of these expenses. For example, sellers usually pay the real estate commission. They may also agree to cover some of the buyer's closing costs as part of the negotiation process.
Closing costs are a single, fixed fee
Closing costs are not a single fee but rather a collection of various charges related to your home purchase. They can include loan origination fees, appraisal fees, title insurance and more. Additionally, the amount can vary widely depending on factors like the home's purchase price, location and the specifics of your loan.
You don’t need to budget for closing costs because you can roll them into your mortgage
While some lenders do offer the option to roll closing costs into the mortgage, this can have long-term financial implications. Doing so will increase your loan amount and, subsequently, your monthly payments and the total interest paid over the life of the loan. It's essential to consider these factors and not just the short-term advantage of reducing upfront costs.
Lenders make a profit from closing costs
While some closing costs, like loan origination fees, do go to your lender, many of the costs are for third-party services such as appraisals, title searches and legal documentation. The lender doesn't profit from these fees.
Closing costs and down payments are the same thing
While both closing costs and down payments are significant expenses paid at the time of purchasing a home, they serve different purposes. The down payment is a portion of the home's purchase price that you pay upfront, which reduces the loan amount. In contrast, closing costs are fees associated with the mortgage and home purchase process, including appraisal, underwriting and legal fees.
Frequently Asked Questions
We answered some commonly asked questions about closing costs to help you better navigate your homebuying journey.
About Christopher Boston
- ClosingCorp. "Average Closing Costs for Purchase Mortgages Increased 13.4% in 2021, CoreLogic’s ClosingCorp Reports." Accessed July 21, 2023.