What Are Closing Costs? Here's What Home Buyers Should Know


Credit: Andy Beecroft via geograph.org.uk.

What are closing costs? Are they part of your down payment? Who gets the money? Who pays it -- the buyer or the seller?

These are all questions you might be asking if you're starting to look for a home. Considering that closing costs can be as much as 2% to 5% of the purchase price, it's pretty important to go into the home buying process armed with as much actionable information as possible. Let's take a look at what closing costs are and what you can do to minimize them if you're a home buyer.

What are closing costs?

Closing costs are usually paid up front and in addition to the down payment.

In short, closing costs are the fees paid at the closing of a real estate transaction that cover the costs of services provided to the buyer and seller both. This could include any of the following:

  • Appraisals
  • Property and pest inspections
  • Attorney's fees
  • Prepaid insurance premiums

These are just a few examples, and the expenses can differ from state to state and transaction to transaction. For example, in my home state of California, real estate transactions are typically processed by an escrow company, while in my former home of Massachusetts, a real estate attorney often handles the closing process.

Have a conversation with your real estate professional early in the process to determine what sorts of closing costs you can expect based on the properties you will be considering and what expenses the buyer and the seller will be responsible for, respectively. It's also best if you plan to pay many (or even all) of your closing costs out of pocket, rather than trying to bundle them into your loan or reducing the amount of cash you will put toward your down payment because you hadn't planned for these additional expenses.

Using closing costs as leverage

Buyers and sellers can both use closing costs as a negotiating tool. Sellers may offer to rebate a buyer the cost of an inspection or to cover attorney's fees in lieu of a cash discount. Similarly, the buyer might be able to get a seller to cover part or all of the closing costs that are the buyer's responsibility. The point? Using closing costs as a negotiating tool may help you get a slightly better deal and save out-of-pocket costs at the same time. Just don't be let down if the seller refuses; instead focus on the total price you're getting and not the individual parts. 

A good rule of thumb is to consider how you would respond to a request if you were on the other end of the transaction, looking to find an amenable deal for both parties. Don't try to "win" so much as try to reach a deal that works for both you and the seller. There's nothing wrong with asking service providers like home inspectors or attorneys for a discount as well. 

Keep your eye on the big picture

Often, a house is the single largest purchase people make in their lives. But as with any other investment, you can't get too caught up in the short term and lose track of your goals. Closing costs are just part of the equation, and they often pay for the services of the people who make home ownership a reality. Take advantage of the services they provide and their expertise. Get your money's worth.

Most importantly, go into your purchase fully aware of the costs and be prepared to pay them. If you find the perfect property for you, you need to be ready and willing to pay those closing costs. Your real estate and mortgage professionals can be a wealth of information about the specific costs in your area. Use their knowledge to go into your search fully prepared and with the necessary cash on hand.

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Read/Post Comments (3) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 10, 2014, at 12:33 PM, Pghprincess wrote:

    Disagree with the comment 'there's nothing wrong with asking service providers ... For a discount'. It seems like 80-90% of borrowers/buyers want a discount for someone's services. All of us in the real estate/mortgage/inspections industry work hard and shouldn't have to discount our services. It's not just one or two that are asking, therefore, we end up discounting for almost everyone if we say yes. That's not fair to us or to the ones that get charged full price because they don't ask. If you can't pay the costs involved with buying a home, wait until you can or buy a lower priced home.

  • Report this Comment On August 11, 2014, at 2:21 AM, TMFVelvetHammer wrote:

    Pghprincess,

    I think most people would say that they work hard for their money, so thats a straw man argument that consumers shouldn't ask real estate professionals of all kinds for a discount.

    You don't have to say yes if you can justify what you charge, after all.

    Heck, you could even turn it into an opportunity for more business by offering a referral bonus to your customers in lieu of a discount.

    The point is, if your fees are reasonable and fair, or you have a measurable competitive advantage versus your competition, then you can confidently stand firm on your price.

    Respectfully,

    Jason Hall

    Article author

  • Report this Comment On October 15, 2014, at 2:24 PM, calebhart54 wrote:

    I have been wondering what exactly real estate attorneys do and if I need one. I didn't know that you can use closing costs as leverage when you are buying a home. You can get the seller to rebate you the closing costs to pay for the attorney's fees. I think it's important to work closely with your attorney because he knows a lot more than the average person about real estate. http://www.iarlaw.com/practice-areas/real-estate

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