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What are Closing Costs?: What You Need to Know Before Buying a Home

Nick Briggs, Realtor

Buying a home is a significant milestone in anyone’s life, often marked by excitement and anticipation. As you embark on this journey, it’s important to be well-informed about the various expenses associated with a real estate transaction, and one key aspect to consider is closing costs. In this blog post, we’ll delve into what closing costs are, how much they typically amount to, and how to prepare for them. This article is purely meant to inform, it is not financial advise whatsoever.

What Are Closing Costs?

Closing costs refer to the fees and expenses that buyers and sellers incur during the process of transferring ownership of a property. These costs are separate from the property’s purchase price and can vary widely depending on factors like location, property value, and the terms of the transaction. Closing costs can include a diverse range of fees, covering services from various parties involved in the real estate transaction. Keep in mind, these are just examples and the actual closing costs can vary widely, but these are some common closing costs.

Common Buyer Closing Costs (3%-6% of Loan)

  • Appraisal Fee ($400-$600): Appraisal fees are charges for assessing a property’s value by a professional appraiser during a real estate transaction. Lenders use appraisals to gauge if the property’s value aligns with the loan amount. These fees cover the appraiser’s services and vary based on property specifics. They’re a standard part of closing costs, ensuring fair property valuation for buyers and lenders.
  • Escrow Account Fund (~2 Months of Expenses): An escrow account fund is a separate account managed by a third party, holding money for real estate expenses like property taxes and homeowners insurance. It’s used to ensure timely payment without requiring direct involvement from buyers or sellers. This arrangement offers convenience and predictability, benefiting both homeowners and lenders.
  • Home Inspection ($300-$500): A home inspection is a thorough evaluation of a property’s condition, conducted by a certified professional. It examines various aspects like structure, systems, and safety. The inspection report helps buyers understand potential issues and make informed decisions before purchasing.
  • Homeowners Insurance: ($50/Month Per Each $100K In Home Value): Homeowners insurance safeguards your home and belongings from damage caused by perils like fire, theft, and natural disasters. It covers dwelling repairs, personal property replacement, liability costs, and living expenses during home repairs. Lenders often require it for mortgages. Premiums vary based on factors like location and coverage.
  • Home Warranty ($400-$600/Year): A home warranty is a service contract that covers repairs or replacements for major home systems and appliances due to normal wear and tear. It’s different from homeowners insurance and focuses on mechanical breakdowns. Homeowners select coverage plans, request service for issues, pay a service fee, and have service providers repair or replace covered items. Home warranties offer peace of mind for unexpected repairs, but it’s important to review terms and exclusions before purchasing.
  • Loan Origination Fee (~1% of Loan): A loan origination fee is a charge from lenders to cover processing costs when creating a new loan. Paid by borrowers, it compensates lenders for tasks like application review, underwriting, and document preparation. Typically a percentage of the loan amount, it’s separate from the interest rate and varies among lenders and loan types. Comparing origination fees along with interest rates helps borrowers make cost-effective loan decisions.
  • Lender’s Title Insurance (0.5%-1% of Loan): Lender’s title insurance is a policy that safeguards a mortgage lender’s interests in a property transaction. It’s usually required by lenders to protect against unforeseen title issues, like defects, fraud, or disputes. The insurance covers the lender’s investment and is paid by the borrower as part of closing costs. However, buyers may also consider owner’s title insurance to protect their own equity in the property.
  • Owner’s Title Insurance (~1% of Loan): Owner’s title insurance is a policy protecting a homeowner’s investment in a property purchase. Unlike lender’s title insurance, it covers the buyer’s equity and ownership rights. It safeguards against title defects, fraud, unrecorded liens, and ownership disputes. The one-time premium, paid at closing, is based on the property’s purchase price. While optional, owner’s title insurance can provide valuable financial protection and peace of mind.
  • Mortgage Insurance (FHA, USDA, and VA Loans): Mortgage insurance for FHA, VA, and USDA loans is a protection required by these government-backed loan programs. It safeguards lenders against borrower defaults, enabling more accessible homeownership. For FHA loans, it involves an upfront and ongoing premium. VA loans have a funding fee, while USDA loans require an upfront and ongoing guarantee fee. These insurance measures allow for lower down payments and more inclusive lending criteria, helping a wider range of homebuyers access loans.
  • Prepaid Daily Interest Rates (Varies in Cost): Prepaid daily interest rates are the upfront interest payments made by borrowers on a mortgage loan when they close in the middle of a month. It covers the interest that accrues between the closing date and the end of that month. This is a part of closing costs and ensures the lender receives interest for the partial month when the loan begins. The regular monthly mortgage payment starts the following month after the prepaid interest period.
  • Prorated Property Tax (Varies in Cost): Prorated property tax is the fair division of property tax between the buyer and seller in a real estate sale. Taxes for the whole year are divided into daily amounts. The seller pays for the portion they owned, and the buyer pays for their ownership period. This practice ensures equity and accurate tax distribution in the transaction.
  • Recording Fee (Varies in Cost): A recording fee is a charge by local authorities for registering real estate documents like deeds and mortgages in public records. This ensures an accurate history of property ownership and rights. The fee covers processing and archiving costs and is part of closing costs in real estate transactions.

Common Seller Closing Costs (6%-10% of Sale Price)

  • Agent Commissions (~6% of Sale Price): Agent commission fees are payments to real estate agents for their services in property transactions. Listing agents help sellers sell their property, while buyer’s agents assist buyers in purchasing. Both receive a percentage of the sale price, typically split between them. The total commission is usually around 5-6%, but it can vary. The fee is deducted from the seller’s proceeds at closing. Buyers don’t directly pay agent commissions; it’s factored into the sale price.
  • Seller Concessions, If Applicable (3%-9% of Sale Price): Seller concessions are when the seller agrees to cover a portion of the buyer’s closing costs or other expenses in a real estate transaction. It’s a negotiation tactic to attract buyers and facilitate sales. For example, the seller might pay a percentage of the sale price toward closing costs. This can make the deal more appealing to buyers and broaden the pool of potential buyers. There are limits and guidelines depending on the loan type. Seller concessions are outlined in the purchase agreement and closing statement.
  • Home Warranty ($400-$600/Year): A home warranty is a service contract that covers repairs or replacements for major home systems and appliances due to normal wear and tear. It’s different from homeowners insurance and focuses on mechanical breakdowns. Homeowners select coverage plans, request service for issues, pay a service fee, and have service providers repair or replace covered items. Home warranties offer peace of mind for unexpected repairs, but it’s important to review terms and exclusions before purchasing.
  • Prorated Property Tax (Varies in Cost): Prorated property tax is the fair division of property tax between the buyer and seller in a real estate sale. Taxes for the whole year are divided into daily amounts. The seller pays for the portion they owned, and the buyer pays for their ownership period. This practice ensures equity and accurate tax distribution in the transaction.
  • Transfer Tax (Varies in Cost): A transfer tax is a fee charged by governments when real property changes ownership. It’s based on the property’s sale price or assessed value. The tax generates revenue for local governments, documents transactions, and can help regulate real estate activities. The amount varies by location and is paid by the buyer, seller, or both parties, depending on local rules. Understanding transfer tax laws is crucial for budgeting in real estate transactions.
  • Outstanding Liens, If Applicable (Varies in Cost): Outstanding liens are unpaid debts or claims on a property that grant creditors the right to take action if the debt isn’t repaid. These can arise from unpaid taxes, bills, mortgage payments, and more. Liens are recorded in public records and impact property sales. Clearing liens is crucial for a smooth sale, ensuring a clear title for the buyer. Both buyers and sellers need to address liens in real estate transactions.

Estimating Closing Costs

While the exact amount of closing costs can vary significantly, a general rule of thumb is that they typically range from 2% to 5% of the home’s purchase price. For instance, on a $300,000 home, closing costs might amount to $6,000 to $15,000. However, it’s essential to consult with professionals in your area to get a more accurate estimate based on your specific circumstances.

Preparing For Closing Costs

1) Research and Estimates: You can begin by researching the average closing costs in your area. You can consult real estate agents, lenders, and even online calculators to get an idea of what to expect.

2) Requesting Quotes: When obtaining mortgage quotes from lenders, you could ask for estimates of their closing costs as well. This will help you compare not only interest rates but also the associated fees.

3) Budgeting: As you plan your home purchase, ensure you budget for closing costs in addition to the down payment and other expenses.

4) Negotiation: Depending on the negotiation dynamics, you might be able to negotiate with the seller to cover part of the closing costs or include them in the purchase agreement.

In Conclusion

Understanding closing costs is a crucial aspect of navigating the real estate market. By being aware of these expenses and factoring them into your budget, you can ensure a smoother and more financially prepared home buying experience. Remember that these costs can vary, so seeking guidance from real estate professionals and experts is advisable to make well-informed decisions.

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This picture shows myself, Nick Briggs. I answer the question: What are closing costs?

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