What are closing costs? Avoid surprises when you buy a new home

Closing costs catch a lot of first-time home buyers off guard. These buyers are not only surprised they have to pay closing costs, they're also surprised how much they cost.

For some buyers, closing costs exceed the home's down payment.

Knowing what to expect can help buyers prepare for these costs so they don't delay homeownership.

What are closing costs?

Closing costs pay for a variety of fees needed to complete a home purchase. The down payment is not included in closing costs because it pays for part of the home.

And unlike the loan's interest rate and monthly payments, closing costs are paid only once at the beginning of the loan term.

Still, like the down payment, closing costs can be estimated as a percentage of the loan amount. For instance, closing costs typically range from 3 to 6 percent of the loan amount. For a $300,000 home, that's $9,000 to $18,000.

Definition of closing costs

Mortgage closing costs include fees paid to lenders, attorneys, government agencies, and third-party service providers during the home buying process.

These include loan origination fees, credit reporting fees, attorney fees, appraisal fees, processing fees. They also include discount points paid to lower an interest rate, prepaid property taxes or insurance premiums, and even fees required to operate the escrow account that distributes all the closing costs to the right places.

When you pay closing costs

Most mortgage closing costs are paid at closing or settlement, the final meeting where you officially become a homeowner or accomplish a refinance.

But the payment process unfolds in stages throughout the mortgage application:

– Early in the process: The lender provides a Loan Estimate within three business days of your mortgage application, detailing expected closing costs.

– Three days before closing: You receive the Closing Disclosure, which shows your final closing costs and allows you to compare them against your original estimate.

– At closing: You and the seller sign final paperwork and transfer funds to cover your respective closing costs to complete the transaction.

How much are closing costs and how to estimate them

Accurate estimates help home buyers avoid scrambling for additional funds at the last minute.

Typical range: 3% to 6% of loan amount

Most homebuyers pay between 3% and 6% of their loan amount in closing costs. On a $300,000 mortgage, expect $9,000 to $18,000 in closing fees. For a $400,000 loan, that's $12,000 to $24,000.

Why the wide range of possible costs? Location plays a big role. Buyers in states like New York and California typically see higher percentages, while states with lower transfer taxes land closer to 3%. Your loan type also matters: FHA loans include additional mortgage insurance premiums, while VA loans have funding fees that affect your total.

How to calculate closing costs using a loan estimate

Federal law requires lenders to provide a Loan Estimate within three business days of receiving your application. This three-page, standardized document breaks down expected costs, giving you a roadmap for budgeting.

Page two of the Loan Estimate shows the breakdown. Look for loan origination charges (industry averages about 1% of the loan amount), appraisal fees ($300-$600), title insurance (averages 0.5%-1% of home price), and government recording fees (averages around $125). These core costs appear in virtually every transaction.

Pro tip: Save this document and compare it against your final Closing Disclosure. Significant increases require explanation from your lender.

Factors that affect your total closing costs

Several variables can push closing costs higher or lower than the typical range:

– Location matters most: Transfer taxes vary dramatically by state and county. Some areas charge minimal fees, while others can add thousands to your bill.

– Loan type influences costs: FHA loans require 1.75% upfront mortgage insurance. VA loans have funding fees based on your down payment and military status. Conventional loans do not require upfront mortgage insurance.

– Timing affects prepaid interest: Close early in the month and you'll pay more prepaid daily interest charges. Close near month-end to minimize this expense. Timing also affects the amount due for prepaid property taxes.

Property specifics: Homes in flood zones need flood certification ($15-$25). Properties built before 1979 may require lead paint testing ($300+). Condos often have additional transfer fees from homeowner associations.

What's included in closing costs?

Closing costs fall into five main categories. Each serves a specific purpose in finalizing your home purchase and protecting your investment.

Lender fees: application and origination fees

Your lender charges origination fees. These vary by lender but average about 1% of your loan amount, to process and underwrite your mortgage. For a $300,000 loan, that's $3,000. Application fees cover credit reports and initial processing, usually running $10 to $100 on average. Lenders often charge rate lock fees which vary by lender. 

Title-related fees: search and insurance

Title searches ($75-$200) verify that the property has clean ownership with no outstanding liens or disputes. This protects you from inheriting someone else's legal problems with the property.

Title insurance comes in two forms: lender's title insurance (required) and owner's title insurance (optional but recommended). Together, they typically cost 0.5% to 1% of your home's price. For a $400,000 home, expect $2,000 to $4,000 for both title insurance policies.

Government and legal requirements

Recording fees update public property records to reflect your ownership. These run about $125 and ensure your ownership is legally documented. Some states require attorney representation at closing, with fees varying by location and complexity of the transaction.

Transfer taxes vary significantly by jurisdiction. Some areas charge the buyer, others charge the seller, and some split the cost.

Prepaid expenses and escrow deposits

Lenders require you to prepay some ongoing expenses at closing. Property taxes and homeowners insurance typically cost about $50 monthly per $100,000 of home value. You'll usually deposit two months' worth into an escrow account, which your lender uses to pay these bills on your behalf.

Property evaluation fees

Home appraisals ($300-$600) confirm your home's value matches your loan amount, protecting both you and your lender from overpaying.

Home inspections aren't technically required but are highly recommended. General inspections cost about $500, while specialized inspections add extra fees. Pest inspections run about $100, and homes built before 1978 may need lead paint testing costing $300 or more.

Properties in flood-prone areas require flood certification ($15-$25) to determine insurance requirements.

Who pays closing costs? The buyer or the seller?

Home buyers carry most of the financial load for closing costs, but sellers can help. It's best for real estate agents to negotiate who pays what before the buyer and seller go under contract on the home. 

What closing costs does the buyer pay?

Buyers handle most mortgage-related expenses since they're the ones obtaining financing. Buyer-paid fees include:

• Loan-related fees
• Title and insurance costs
• Government fees
• Prepaid items
• Inspection fees

What closing costs does the seller pay?

Sellers face their own set of expenses, often more substantial than buyers realize:

– Real estate commissions: The biggest expense for sellers—combined agent commissions average 5%-6% of your home's sale price. For a $400,000 home, that's $20,000-$24,000.

– Property taxes: Sellers pay prorated property taxes up to the closing date.

– Transfer taxes: These vary significantly by location but can add thousands to seller costs in high-tax jurisdictions.

– Title insurance: Some regions require sellers to provide owner's title insurance policies, ensuring smooth title transfer to buyers.

– Repair credits: Negotiated credits for repairs discovered during inspections come out of seller proceeds.

Negotiable fees and seller concessions

Market conditions heavily affect who pays what. When inventory is high and buyers have options, sellers often sweeten deals with concessions. They may even cover all of the buyer's closing costs. 

In competitive markets with multiple offers, buyers might agree to cover traditionally seller-paid expenses to strengthen their offers. Some buyers even waive inspection contingencies, though this increases their risk significantly.

Local customs also matter. Some regions expect sellers to provide owner's title insurance, while others place this burden on buyers. Your real estate agent should know these local practices and help you negotiate accordingly.

What about no-closing costs loans?

Some lenders advertise mortgage and refinance loans with no closing costs or with lender-paid costs.

Typically, the borrower still pays closing costs, but instead of paying upfront, they pay through a higher interest rate or by financing part of the upfront costs.

Borrowers should study these offers closely to see how much more they may pay by delaying closing costs.

How to lower closing costs

Closing costs might seem set in stone, but savvy buyers can reduce these expenses by planning ahead:

– Shop lenders: Compare fees beyond interest rates. Origination fees, typically about 1% of your loan amount, often have wiggle room when lenders compete for your business. On a $300,000 loan, negotiating this fee down by even 0.25% saves $750.

– Request seller concessions: Sellers facing slow sales or long listing periods may agree to cover a portion of your closing costs. 

– Check every line item on your Loan Estimate: Title insurance, home inspections, and survey services have competitive pricing. Shopping for title insurance alone could save $200-$500, while comparing inspection companies might cut costs by $100-$200.

– Time your closing strategically: Schedule your closing near month-end to minimize prepaid daily interest charges. For a $300,000 loan at 6.5% interest, closing on the 30th versus the 1st could save roughly $650 in prepaid interest.

– Skip discount points: If cash flow matters more than long-term savings, avoid paying discount points to lower the loan's mortgage rate. Each point costs 1% of your loan amount upfront but reduces your interest rate. On a $300,000 loan, one point costs $3,000, money you might prefer to keep liquid.

Take control of your closing costs

Buyers should factor closing expenses into the home buying budget from day one. Buyers who succeed are those who plan for closing costs alongside their down payment and monthly mortgage payments.

When you know what to expect and have your funds ready, closing day becomes what it should be, an exciting milestone rather than a financial scramble.

Working with a lender that readily shares costs can also help borrowers take control of their closing costs.

Start with a. no-obligation preapproval. 

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