What are closing costs?
Most homebuyers end up paying additional fees required at the end of the transaction called closing costs. Closing costs are due when transferring the title from a seller to a buyer and are necessary to close the deal. They can include charges for appraisals, prepaid property taxes, and loan origination fees.
Both buyers and sellers can be subject to closing costs, but buyers usually have more closing costs than sellers. Mortgage lenders must include these additional costs in their loan estimates.
How much are closing costs?
First-time homeowners are rarely familiar with closing costs, so the price tag can be a bit of a surprise. The fees range anywhere from 2% and 5% of the purchase price, and the average homeowner pays $5,749 in closing costs when you include taxes. This varies depending on where you live and the type of home you purchase. At $25,800, the District of Columbia has the highest average closing cost if you include taxes. The lowest average with taxes is Indiana at $1,909.
Note, too, the percentage estimate for closing costs is based on the purchase price, not the loan value. Mortgage lenders don’t always cover the entire cost of your home, so these amounts are often different.
That said, some closing costs can be rolled into your loan. For example, let’s say you want to buy a $200,000 home using a $190,000 loan, and your closing costs are 3% of the purchase price. That means you’re going to pay $6,000 at closing. If your lender allows you to finance your mortgage closing costs, then your final loan amount is $196,000.
Adding your closing costs to your mortgage can seem like a good idea, but you should remember that you still have to pay the money back. Plus, you’ll have to pay interest on the money borrowed.
Types of closing costs
We’ve counted nearly 20 different types of closing costs that the typical homebuyer may run into, and grouped them by which aspect of the transaction they relate to. You should note, however, that this is not a complete list. Depending on your situation, you may see other mortgage closing costs.
Property-related fees are costs directly tied to buying the property. These will include:
- Appraisal fee: This is a report that gives an estimate of what the value of the home is based on market conditions. The appraisal could be higher or lower than the selling price.
- Home inspection fee: Buyers need to know if there are any problems with the property, and that usually requires hiring a home inspector. Home inspections are required for many government-backed mortgages such as an FHA loan.
Loan-related fees are costs associated with originating and closing the loan. They include:
- Application fee. Lenders often charge this fee to cover the cost of processing your loan, including paying for a credit check.
- Assumption fee. This fee is only charged when the seller has an assumable mortgage, and it’s based on the balance of that mortgage.
- Prepaid interest. Lenders usually require buyers to prepay the interest that will accrue between your closing date and your first mortgage payment.
- Loan origination fee. This is sometimes called an underwriting or processing fee, and it covers the cost of preparing your mortgage. Whatever it’s called, it’s approximately 0.5% of the loan value.
- Discount points. You can elect to pay discount points that reduce the interest rate on the loan. One point is 1% of the loan amount.
- Mortgage broker fees. Those who work with mortgage brokers typically pay a commission that ranges from 0.5% to 2.75% of the home’s purchase price.
Mortgage insurance fees
Lenders may require you to get private mortgage insurance (PMI), especially if you put down less than 20% on your home, and it usually comes with some extra fees, such as:
- Mortgage insurance application fee. This fee covers the cost of processing your PMI application.
- Upfront mortgage insurance. You may be asked to pay your first year’s mortgage insurance premium at the time of closing. This can range anywhere from 0.55% to 2.25% of the loan. A Federal Housing Administration loan works a little differently. In that case, you’ll have to pay an upfront premium that’s 1.75% of your loan amount, plus monthly premiums.
- Guarantee fees. Mortgages backed by the federal government, namely those coming from the Department of Veteran Affairs (VA) and the US Department of Agriculture USDA, charge guarantee fees. The VA charges between 1.25% and 3.3% of your loan amount, and the USDA charges 1%.
Other prepaid fees
This next group consists of fees you’ll most likely continue to pay as long as you own your home, but that you may be asked to pay upfront at closing, such as:
- Property taxes. If property taxes are due within 60 days of buying a house, the buyer may have to pay them at closing.
- Homeowner association (HOA) assessments. HOAs often impose an annual fee and ask the buyer to pay it upfront.
- Homeowners insurance premiums. Lenders typically require you pay for first year of homeowners insurance at closing.
The following fees cover the costs lenders and escrow agents incur while making sure the house can be sold:
- Title search fee. The cost to run public records on the chain of title for the house may cost around $200, but this varies by location.
- Lender’s title insurance. Lenders get a policy that protects them in case something was missed in the title search that allows someone to claim ownership of the house.
- Owner’s title insurance. You might also want a policy to protect you if there are problems with the title or someone claims ownership after the closing date. Owner’s title insurance usually costs up to 1% of the purchase price.
Understanding what your fees will be
Your lender must disclose your mortgage closing costs with a loan estimate within three days of taking your application, according to the Real Estate Settlement Procedures Act. Additionally, your lenders must provide a final disclosure statement three days prior to closing indicating any potential changes to the costs.
Both the estimate and the final disclosure statement are important legal documents that you need to read closely. Not only does your signature indicate that you agree, but the information in these documents help you better budget for your new home.