Closing costs: What are they and how are they estimated?

You are about to make one of the biggest decisions in your life: becoming a homeowner. But there is one last thing you have to do before the deal goes through—which is to pay closing costs. While the closing cost is paid for by both the home buyer and the seller, the brunt of the payment comes from the buyer to numerous entities.

It is therefore important that you know what you are getting yourself into.

Who pays for what? What is the seller’s responsibility? What is the buyer on the hook for? Here are the answers to those questions and everything else you need to know about closing costs, including manoeuvres you can make to avoid them.

Closing costs: What are they and how are they estimated

Closing costs are extra fees that you pay at the end of the home buying process. The term “closing” refers to the transaction that takes place when the property title is officially transferred from the home seller to the home buyer. It is during this closing period that taxes and fees that came from the home purchase are assessed. Typically, closing costs range from 2% to 6% of the home’s purchase price, and are subject to national, state, and local tax rates, which fluctuate.

Simply put, closing costs pay for everything that went into the real estate transaction, above and beyond the purchase price. For instance, mortgage origination will usually add to the costs, with the lender charging a fee to create the loan. This is usually 1% of the amount of the mortgage.

Common closing costs

Here is a list of closing costs that you can expect to pay:

• Real estate agent fees.
• Loan origination.
• Survey fee.
• Property appraisal fees.
• Home inspection fees.
• Cost of running a credit report.
• Cost of completing title search.
• Escrow deposit.
• Attorney fees.
• Private mortgage insurance.
• Taxes on home loan amount.
• Document recording fees on the deed and mortgage.
• Mortgage points.

Closing costs: In-depth

Here is a breakdown of some of the more common closing costs:

Loan origination. Usually between 0.5% and 1% of the loan, this fee is for processing and underwriting the loan. Underwriting is a part of the process of approving the loan, providing lenders with information such as your credit history and therefore proving that you can repay the loan. Loan origination is also subject to changes in market conditions.

Survey and appraisal fees. These fees will help you to confirm the fair market value of your property. While the cost of these fees varies, they typically a few hundred dollars.

Private mortgage insurance (PMI). You will likely need private mortgage insurance if your down payment is less than 20%. This type of insurance protects the lender in case you cannot afford to repay your loan.

Escrow deposit. Usually between 1% and 2% of the sale price, this deposit goes to the agent who helped you close the deal. The amount of money you spend here will vary based on the location of your property and the escrow company you go with.

Attorney fees. In certain areas, you are required by law to have an attorney throughout this process. Attorney fees can be paid as a flat fee separately or included in your closing cost.

Because the closing costs run between 2% and 6% of the loan, you could pay anywhere from $6,000 to $15,000 on a $300,000 loan, above and beyond the down payment. The best way to pay for those closing costs is as a one-time, out-of-pocket expense. If your lender okays it, you could finance those costs by including them in your loan. However, you will have to pay interest on it throughout the life of the loan. 

Your real estate agent will likely help you estimate your closing costs based on the property’s price and the area. After applying for a mortgage, your lender will provide you with a loan estimate document outlining your projected closing costs. These documents are typically sent three business days after you apply.

Paying for closing costs? Everything your client needs to know

In terms of closing costs, it is critical to know who is paying for what, the buyer or the seller. Since the payment for closing costs goes to numerous entities—such as pre-payment of taxes to fees you will be required to pay to the local authorities—this can be somewhat confusing.

Buyers and sellers split up the closing costs. It is common for the home buyer to pay more of those costs, with sellers typically having to pay municipal fees and local taxes. In fact, it is equally as important the home sellers conduct their own thorough research of the process. Questions they will need to answer are: do buyers and sellers split the closing costs evenly? And who pays title fees?

If the seller decides he or she wants to use escrowed money to pay for home improvements or repairs, they are going to have to find the money using either the profits of the home sale or out of their own pocket.

Seller expenses

While it is possible to negotiate who pays for what, here are some of the more common expenses a seller will have to pay for the closing costs:

• Agent commission.
• Seller attorney fees.
• Any escrowed money promised to the home buyer.
• Credits toward closing costs.
• HOA fees.
• Prorated property taxes.
• Title insurance.
• Transfer tax.

Closing costs: What should your clients know about?

Closing costs can get pricy and are subject to increases. If you want to help your clients avoid closing costs when buying a home, there are some approaches you can take. While it is impossible to cut out all closing costs entirely, you can negotiate to minimize some costs. It is common for buyers to pay most of the closing costs, but buyers are also able to negotiate with sellers to reduce fees.

How to avoid closing costs

Here are a few ways to avoid closing costs:

Negotiate on the mortgage

The smartest place to start waiving closing costs is with your lender. Occasionally, buyers can negotiate a mortgage that does not have closing costs at all. Since closing costs have to be paid at some point, however, lenders can then usually raise your interest rate or add the closing cost to the overall cost of your mortgage.

Negotiate with the seller

Loan payoff costs, commission fees, and transfer taxes (among others) add up to increase closing costs. You do have the option, however, to negotiate with the seller so that they pay rather than you. Occasionally, certain loans let sellers take up these closing costs in the form of a credit, which encourages finalizing the deal and can also be tax deductible.

Comparison shop

Service fees make up the brunt of closing costs. Title insurance, home inspection companies, and homeowners’ insurance are popular examples of this. Buyers would be well-advised to shop for different service providers and loan products to get the best possible rate.

Negotiate origination fees

To off-set some of your closing costs, you should work with your lender and ask about fee reductions, waivers, or credit options. When lenders provide you with a loan estimate when you’ve finished your mortgage application, it is a great opportunity to scrutinize line items, like attorney fees or application fees. But remember to be aware that your lender may offset your closing costs by raising your interest rate or adding them to your overall mortgage cost. 

Timing

It would be more beneficial for you to close the deal nearer the end of the month. The reason timing matters is that closing a loan mid-month usually means the first mortgage payment will be made at the beginning of the following month, when per diem interest fees start adding up. By closing the deal at the end of the month, you will avoid paying more in those per diem interest fees.

Check for discounts

Discounts may be available for anyone who is in the military or in a union. These discounts are usually in the form of rebates for closing costs, so it is important to research to see which benefits may be available to you.

Closing costs: What buyers and sellers should know

Whether you are a home buyer or a seller, you are on the cusp of making a major life decision. Prior to sealing the deal, both buyers and sellers have to pay closing costs. If you are a buyer, you can negotiate with the seller to help cover some of those closing costs, although the buyer typically ends up paying more. Those negotiations are sometimes called seller concessions.

If you believe you will have difficulty paying the money you need to close, seller concessions can be extremely useful. While there are limits to how much a seller can pay toward the closing costs, it is usually a percentage of your mortgage value, varying by down payment, occupancy, and loan type.

Closing costs will vary for each buyer, even the most popular types of loans can vary widely. Some of the costs will be required by your lender, others will be required by governments, and other still may be optional. It will depend on your specific situation. Factors that dictate this will be where you live, your lender, and what kind of loan you take out.

Have experience with closing costs? Let us know in the comment section below.