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?
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:
- 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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