Understanding Real Estate Closing Costs

When discussing home buying, many home shoppers focus on the down payment and then the subsequent mortgage payments. Yet often overlooked or misunderstood is the associated closing cost-and the dollar amount it can add up to. Closing costs are simply those fees and expenses associated with closing a real estate transaction. Knowing these costs, how to compute them, and who pays them is fundamental for homebuyers and sellers. The article deconstructs parts of closing costs, estimation, and how to effectively manage these costs.

What Are Closing Costs?

Closing costs are a collection of fees that both buyers and sellers must pay in order to complete the deal within real estate. These costs vary between lender charges and title insurance as well as property taxes and appraisal costs-all of which ensure that the ownership of the said property is transferred legally. Both parties share a few closing costs, but it usually lies with the buyer. These closing costs are paid for at the closing, which is the final meeting at which point the property is transfered over to the new owner. This is 2 percent to 5 percent of the home's purchase price, but it may vary according to the location of the property, the type of loan, and a few other factors.

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Components of Closing Costs

Closing costs consist of various fees. Most probably, the charge for the origination fee paid by the lender for processing the mortgage is the most important among those. This charge generally pays for administrative costs and underwriting service, usually around 0.5% to 1% of the loan amount. Other charges buyers will incur beyond the origination of the loan will be an appraisal fee. A lender needs an appraisal to establish the market value of the home in relation to the loan being raised, making sure it is sufficient for the loan amount. The fees are generally seen in the range of $300 to $500 for an appraisal.

Yet another component of the closing costs is the title insurance. This kind of insurance offers security against title disputes over the property, both to the lender and the buyer. Lender's title insurance and owner's title insurance are the two types. Owner's title insurance is optional but extremely recommended. Title insurance could cost up to $1,500 or as little as $500 depending on the property and location. In other transactions, buyers will also face escrow fees, covering the escrow company's charges in charge of overseeing the transfer of funds and documents. Escrow fees run in a range of $500 to $2,000.

Buyers frequently need to pay a part of the property taxes when closing. These are prorated because they consider when the sale takes place compared to the local tax calendar. Depending upon when the seller last paid property taxes, purchasers may also have to reimburse the seller for their pro rata share of prepaid taxes. Finally, lenders generally insist that their customers pay the first year of homeowner's insurance at time of closing. Homeowners' insurance varies with the location, size, and value of the property, but it typically ranges between $1,000 and $2,000 per year.

For those buyers who place less than 20% down on a traditional loan, PMI is usually mandatory. PMI insulates the lender against potential default by the borrower, and although this product is typically tacked on to the monthly mortgage payment, the first premium may be due at closing. Another type of closing costs includes recording fees. Such fees will be made by the local government when there's the need to update public records about new ownership details. Attorney fees may also be needed in some states since a real estate transaction needs to be represented by an attorney. These vary but it's usually added a few hundred dollars to the total closing cost.

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Who Pays for Closing Costs?

The buyer and seller will both be responsible for some closing costs, but most closing costs fall on the buyer. Some of the buyer's costs usually include loan origination fees, appraisal fees, title insurance, property taxes, and homeowner's insurance. Unless buying a home with a mortgage, PMI and escrow fees would add to those charges. The other way around, the commission is usually paid by the seller for the real estate agent, which would be 5% to 6% of the home's sale price. In some cases, the seller agrees to pay part of the closing costs of the buyer, especially in a buyer's market or if the seller really wants to close the deal.

How to Estimate Closing Costs

Although closing costs vary depending on the location, the lender and their requirements, and specifics of the transaction, it is common to budget 2% to 5% of the home's purchase price. Using such a guideline, you might estimate your closing costs at $300,000 as ranging from $6,000 to $15,000. To get a better estimate, home buyers can request a Loan Estimate from their lender, which should reflect the estimated closing costs. The lender is legally obligated to provide this document three business days after the lender has received the loan application. Before closing, the buyer will receive a Closing Disclosure that details the final closing costs and adjustments and credits.

Some Ways to Minimize Closing Costs

Closing costs are not something one would ideally have to pay for owning a house. However, there are ways to minimize them. One option is to shop around for lenders. Loan origination fees and interest rates will vary among lenders. Quotes from several lenders can then be compared to find the one with the best deal. A slight difference in interest can add up to thousands of dollars saved over the course of a loan. Third option: the negotiation with the seller. Sometimes, sellers will agree to pay some of the closing costs of the buyer especially when it's a buyer's market or for a highly motivated seller who wants to close the sale quickly.

Moreover, buyers should also look into the down payment and closing cost assistance programs that are offered at the state and local levels. Most of the assistance programs are for first-time homebuyers, and some cover parts of the closing costs, which really lifts much of the cost burden. Some lenders also offer credits in exchange for a slightly higher interest rate, which pushes the monthly mortgage cost up but lowers the costs at closing.

Conclusion

Closing costs, of course, refer to the cost of any property transaction; for any buyer and seller, it is a crucial knowledge acquisition; loan origination, title insurance, property taxes, homeowner's insurance-cost will, of course add up, but with proper planning and negotiation, it can be managed. By educating yourself on what to expect and how to manage costs, a buyer can plan accordingly and be prepared for no surprises at closing. Regardless of whether you are purchasing your first home or selling a property, knowing the details of closing costs will ensure that your real estate transaction is as smooth as possible.

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Sources:

Consumer Financial Protection Bureau. "What are Closing Costs?" https://www.consumerfinance.gov

U.S. Department of Housing and Urban Development (HUD). "Closing Costs Explained." https://www.hud.gov

Source: Investopedia. "Closing Costs: What Are They and How Much?" Accessed Feb 2021 https://www.investopedia.com

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