Closing Costs: What They Are and How to Lower Them

What Are Closing Costs?

Closing costs are expenses paid in addition to the price of a home to complete its purchase. They may include (but are not limited to) lawyer or title company fees, home insurance premiums, prepaid property taxes, loan origination fees, and home appraisal costs. 

Once your initial mortgage application is submitted for approval, your lender estimates closing costs, so you know what to expect. These costs can change based on your loan program, or if rates and other fees increase before you purchase a home.

When Setting Your Homebuying Budget, Don’t Forget Closing Costs

Between searching for a great property, calculating your homebuying budget, and making a downpayment, it can be easy to forget about closing costs. Closing costs are one-time expenses required to purchase a home that varies by location, loan type, and lender. Most of these expenses concern the processing and administration aspects of purchasing a property.

Because they are variable, and sometimes obtuse, homebuyers may neglect these costs until their home purchase is nearly complete and then find themselves owing thousands of dollars to close the deal. Equipped with knowledge about what’s included in closing costs and how much you may spend, homebuyers can avoid unnecessary spending stress.

What Is Included in Closing Costs?

Closing costs are payments made to lenders, law firms, home appraisal companies, and other providers that assist in purchasing your home. These costs are due in full before home titles are transferred to new owners. Until this transfer occurs, the home is still owned by the previous owners or the lending institution, depending on the circumstance. 

The mix of costs and fees you pay may vary by state and by city or town. For example, homebuyers in Delaware paid $17,859 on average in closing costs in 2021, while those in Vermont paid $7,906, and buyers in North Dakota paid just $2,501. While there’s no set standard for closing costs across the country, there are some common costs for both homebuyers and sellers.

Common Closing Costs for Homebuyers

Closing costs for homebuyers come in three broad categories: lender, legal, and service. Lender fees are paid to the financial institution that issues your mortgage, while legal fees go to the law firm or title company handling title searches, transfers, and document recording. Finally, service fees cover other costs, such as home insurance policies or home inspection fees. 

Read on to view some common closing costs for buyers, broken up by category.

Lender Fees

Lenders fees for closing costs on a house are the fees charged by a mortgage lender to process and approve a home loan. These fees can vary depending on the lender and the type of loan and typically include the following:

• Loan origination fees: Loan origination fees are the fees lenders charge for processing a new loan or mortgage application. This fee varies by lender but typically falls between 0.5% and 1% of the total amount of the loan. 
• Property taxes: Property taxes are paid to the city or municipality where your home is located. Monthly tax payments are usually made as part of your mortgage payment, but this is in addition to taxes due at closing.
• Mortgage discount points: Purchasing mortgage discount points allows you to reduce the interest rate on your mortgage in exchange for an upfront payment due at closing. The value of these points varies by lender, but each point may reduce your interest rate by up to 0.25%.

Legal Fees

These are fees charged by a real estate attorney or a title company to handle the legal aspects of the home purchase and ensure that the property title is clear and transferable to the buyer. They may include:

• Title search: Homebuyers pay law firms to conduct a title search and verify that the home’s legal owner is the seller and that there are no other loans or liens on the property. 
• Escrow fees: Escrow accounts hold money for specific purposes, such as protection of an earnest money deposit or preserving money for property taxes and home insurance. Setting up and managing these escrow accounts comes with a fee due at closing. 
• Recording fees: Legal firms also charge a fee for recording and documenting transactions related to buying and selling homes and providing you with a copy of these documents. 
• Attorney fees: Buyers also pay attorney fees for the time, and effort lawyers spend conducting title searches and drafting legal documents.

Service Fees

Service fees as part of closing on a house can refer to various fees charged by service providers involved in the home purchase process. These fees can vary depending on the service provider and the location of the property and typically include charges for services such as:

• Appraisal fee: Appraisals estimate a home’s market value and are carried out by licensed professionals. While these fees are considered closing costs, they’re generally due at the time of the appraisal, which happens near the start of the mortgage application process. These fees vary by state and city but can range from $300 to $500. 
• Home insurance: The purchase of home insurance policies may include initial setup fees along with monthly premiums. These fees are variable and depend on various factors, including the home’s value, construction type, and location.
• Home inspection fee: Home inspections may be optional for homebuyers but are a good idea to identify potential problems. These fees are also usually paid upon completion and may vary from $200 to $500. 
• Mortgage Insurance: If you make a downpayment of less than 20%, your lender may require that you purchase mortgage insurance to cover potential payment defaults. Mortgage insurance is usually part of your monthly payment and includes an upfront fee due at closing. 
• VA and FHA loan fees: Department of Veterans Affairs (VA) and Federal Housing Administration (FHA) loans may come with fees paid as part of the closing process.

Common Closing Costs for Sellers

Sellers also pay closing costs. Some common examples of seller costs include:

Legal Fees

As part of the closing costs, the seller usually incurs legal fees charged by their attorney or title company to manage the legal procedures involved in the sale of the property and transfer the ownership title to the buyer. These include:

• Attorney fees: Sellers also pay attorney fees for legal resources and research.
• Escrow fees: Escrow accounts hold mortgage funds until closing is completed. Then, these funds are dispersed to sellers and come with a fee for sellers.
• Recording fees: Just like buyers, sellers pay document recording fees.

Service Fees

Service fees as part of closing on a house can also apply to sellers and may include various fees charged by service providers involved in the home sale process. These fees can differ depending on the location of the property and the provider and typically comprise charges for services such as:

• Real estate agent commissions: Commissions for both seller and buyer real estate agents are paid by the seller. These fees vary from 3% to 6% of the total purchase price.
• Title insurance: If arranged as part of the mortgage terms, sellers pay for owner’s title insurance, which protects buyers against potential title fraud. This is typically .5% of the value of the property.
• Property taxes and prorated HOA fees: Before moving out of their home, sellers pay any remaining property taxes or prorated homeowners association (HOA) fees as part of closing costs. This varies depending on the home’s location, and not all properties are managed by HOAs.

Transfer taxes: Sellers are also responsible for title transfer taxes, which vary by city and state.

How Much are Closing Costs?

Closing costs for homebuyers depend on several factors. These include the home’s total purchase price, the downpayment amount, property taxes, mortgage points, and any loan fees owing to assistance programs such as FHA or VA loans.

On average, closing costs for buyers fall between 3% and 4% of the total purchase price. Those for sellers, meanwhile, can range from 8% to 10% of the total price. Using the high end of these ranges allows buyers to anticipate potential costs and make sure they have the funds on hand.

Some costs, such as home inspection, may be due at the point of service, while others are due when mortgage documents are finalized. These include costs such as loan origination fees or mortgage points.

How To Estimate Your Closing Costs

Lenders provide buyers with an estimate of closing costs once the mortgage has been submitted to underwriting for approval which provides a general idea of what to expect. This number may vary, however, depending on the services used.

For example, while your lender may recommend a real estate law firm, you may opt to use a company you’ve worked with previously or one that offers reduced rates on closing costs. Additionally, you may pay more for a home inspection if the homeowner is motivated to sell and the inspection needs to be done as soon as possible.

How To Pay Your Closing Costs

Closing costs are due when you sign your mortgage documents. When it comes to paying these costs, homebuyers have several choices, such as:

Paying Out of Pocket

You may choose to pay your closing costs directly from your bank account using a wire transfer so long as your account has enough to cover the balance. If you’re transferring funds from another account to your checking account, make the move a few days early to provide enough time for the funds to clear.

Rolling Costs into Your Mortgage

You may also opt to roll some of your closing costs into your mortgage. This saves you from having to write a check up-front but means you pay interest on these costs over time, though you will end up paying for them down the line.

Applying for Government Assistance

In some cases, you may be able to apply for government assistance to help with your closing costs. Check the National Council of State Housing Agencies to find programs in your area.

Asking Sellers for a Credit

Sellers may be open to covering some or all of your closing costs. This approach is market-dependent: In the case of a buyer’s market, where there are more properties for sale than buyers who want them, sellers may be motivated to cover these costs. 

Where Are Closing Costs in the Homebuying Journey?

Closing on a house is the final step in the purchase process. Once closing costs have been paid, homebuyers are prepared to take ownership of their new home. While the possession date may differ from the closing date, paying these costs covers critical aspects of the purchase process, such as the transfer of titles and the creation of escrow accounts. 

It may be possible to defer some of these costs later, but this comes with potential risk. For example, if the payment of title transfer costs is delayed, the home may remain in possession of the lender until these fees are paid. During this period, homeowners could end up paying rent to the bank on a home they own.

Preparing for Closing Day

Here’s a quick checklist to help you prepare for closing day.

1. Collect Key Documents

First, collect your documents. These include your closing paperwork, such as home inspection reports, home appraisal documents, and wire transfer confirmation documents. Other documents include proof of homeowners insurance and photo identification. 

2. Contact Your Closing Agent

Next, contact your closing agent; this agent may be assigned by the real estate company you’re working with or by your lender. Their job is to handle closing costs and documents, so it’s worth reaching out before closing day to see if there are any special instructions or additional documents to bring.

3. Review the Closing Disclosure

Before closing day, double-check the details of your loan and closing costs with your lender, which is called a closing disclosure. This will include the spelling of names and addresses along with your monthly mortgage payment and interest rate, all closing costs, the down payment amount, and the amortization of your loan over time.

To Lower Closing Costs, Plan Early

Closing costs are necessary for buying a home. However, it is possible to reduce the total amount you pay. You may find potential savings opportunities by taking steps early in the process.

First, take time to compare multiple lenders and their loan options. Depending on your home’s purchase price and downpayment amount, certain lenders may offer reduced loan origination rates or mortgage interest rates for fixed terms. It’s also worth asking lenders for estimates of closing costs. While these estimates may change, they can usually provide a ballpark figure before committing to a mortgage.

Buyers may also work with sellers to see if they’re open to covering some or all of the closing costs. The success of this approach depends on the market. If sellers have multiple offers at or over the list price, they have no reason to pay closing fees. If they have just one or two offers, meanwhile, they may be open to negotiation.

Putting It All Together

Closing costs cover lender, legal, and service fees and are typically between 3% and 4% of the total purchase price, but can vary based on market conditions, the amount of your down payment, and the lender your choose. Once you complete a mortgage application, you can receive an estimate of closing costs. Using this as a guideline can help you budget for spending over the purchase process, but it’s worth having some financial flexibility as costs may deviate from the initial estimate.

By keeping track of costs as they happen and choosing how to pay them when closing day arrives, you can streamline the closing process and focus on getting into your new home.