What Are Closing Costs?

By: , Contributor

Published on: Feb 26, 2020

A look at what line items are included in the big lump-sum payment that isn't the down payment but is due before you can close on a home purchase.

Even more than the down payment, closing costs are the hurdle that many buyers stumble over on the path to purchasing a home. The lump sum includes fees, certain insurance costs, and certain taxes. Unlike the down payment amount, closing costs can't be reduced based on a credit report or the type of mortgage you get. And, very few of the line items included in closing costs are negotiable with your lender, because most of them are taxes, insurance, or specialized service fees.

The good news, insofar as there is any, is that sellers and buyers are each responsible for part of the closing costs and that it is sometimes possible for a buyer to negotiate so the seller pays for part or offers credit against the buyer's closing costs

Closing costs vary based on the home's price, and estimated closing costs are listed on a home purchase contract. Here's a closer look at them.

What are closing costs?

Closing costs are expenses over and above the purchase price of a property which must be paid before the transaction can be considered complete. They are comprised of fees to the vendors that work on the transaction, government fees, taxes related to the transaction, and some prepaid insurance costs. Most are paid for by the buyer. However, the seller pays for some -- including the real estate agent's commission. And, don’t worry, first-time buyers, many of the responsibilities are negotiable, with buyer and seller responsibilities outlined in the contract.

Common closing costs covered by the buyer can be organized into a few main categories:

Insurance

There are a few types of insurance that buyers may be required to purchase and pay the first year upfront before closing on a home loan.

Homeowners insurance

With any insurance policy, upfront payment of the first annual homeowners insurance premium is industry standard.

Title insurance

Title insurance provides extra protection in case of title disputes or encumbrances, undiscovered liens, or other defects that were present before the home purchase transaction but not uncovered by the title search. When required by the lender to protect the lender, it's known as lender's title insurance.

Flood insurance

All federally regulated lenders require flood insurance for properties in high-risk flood areas -- the standard is to pay the first year's premium at closing.

FHA Upfront Mortgage Insurance Premium

This is only required for FHA loans.

Loan-Related Fees

Fees also vary according to the lender, state laws, insurance company practices, and other variables. After applying for a mortgage, you’ll be able to see a loan estimate that gives a good picture of the total costs of your loan. Listed are some of the major/standard fees.

Loan application fee

This is the processing fee that a lender charges on a mortgage application.

Appraisal fee

This is the fee for the lender's appraiser to come look at the property. It is not always included in closing costs because often, the lender will require this fee to be paid before scheduling the appraisal.

Attorney fees

These can include fees for the buyer's attorney or the lender's and vary according to the contract and the state.

Credit report fee

The cost to pull a credit report is so small that the lender will often offer to cover it -- and won't need to actually pay anything due to having a long-term partnership with a credit screening company.

Closing fee

This is paid to the attorney, escrow company, or title company that handles the closing.

Origination fee

The origination fee is the payment that the lender receives for processing a loan and is typically 1% or less of the total loan amount. Some lending institutions charge a flat fee.

Recording fee

This is the fee to put the new owner's deed and title on record legally.

Title examination fee

The title examination fee is the cost for a title insurance company to review a title and issue a policy. This is part of title service fees -- often split between buyer and seller.

Taxes

Taxes vary according to state and jurisdiction -- and change often. They typically account for a large percentage of overall closing costs. They pretty much all fall into the category of property taxes.

The standard is for property taxes (city and county) to be paid upfront for the prorated amount of time left in the year or for six months of property tax to be paid upfront.

Sometimes separately, there will be a further requirement for a few months' worth of property taxes and homeowners insurance to go into an escrow account.

Points

If you pay points upfront on your mortgage to lower the interest rate on your loan, this cost will also be tacked onto your closing costs and can increase the closing costs dramatically, but it won't be a surprise. You'll have discussed the pros and cons of "discount points" with your lender and decided to add them on, knowing exactly how much each point costs based on the amount of your mortgage. We'll revisit discount points again later.

Closing costs covered by the seller

Title search fee

The cost to pull the public property records and deed records and review them to make sure there are no existing liens or other encumbrances on the title is the title search fee, paid to the title company.

Municipal lien search charge

This is the fee that the municipality charges to pull the title.

Transfer tax

A transfer tax is levied when a property title changes owners.

Recording and other fees to cure title

If there are liens, judgments, easements, or other encumbrances on a title, fees to clear them are typically due before or upon closing. The process of making a title clean is known as "curing title defects."

HOA estoppel fees

This is a fee only assessed if the property is within an association-governed development. It's the fee the homeowners association (HOA) charges to make sure your account is in good standing, with dues paid and no special assessments owed.

Real estate agent fees

The largest part of closing costs for the seller, real estate agent fees typically include commission on the sale for both the buyer's and seller's agents.

How much are closing costs?

There are no set amounts for typical closing costs -- they generally come out to 2% to 5% of the home's purchase price. The factor that causes the most variance state to state on homes with similar purchase prices is the tax.

States with the highest closing costs

To get a more accurate picture of states with high closing costs versus low, the American Land Title Association (ALTA) determined average home prices per state, and then figured out the average closing costs on an average single-family home with and without taxes included. Among the five states with the highest and lowest closing costs, most states (but not all) kept a place on the list both with and without tax included -- but there were some discrepancies. There was also a general correlation of high average home prices and high closing costs -- and vice versa -- but again, this was not absolute.

According to ALTA's 2019 report, the highest average closing costs in the nation with taxes included were found in:

State or District Closing Cost Amount
District of Columbia $24,613
New York $13,581
Delaware $13,309
Washington $12,667
Maryland $11,395

The highest average closing costs in the nation without taxes figured in were found in:

State or District Closing Cost Amount
District of Columbia $5,694
New York $5,586
Hawaii $5,318
California $5,284
Washington $4,701

When do you first see estimated closing costs?

You get your first (estimated) breakdown of closing costs within the home purchase contract, after an offer has been officially presented and accepted and the earnest money deposit (EMD) is in escrow.

How does the EMD affect closing costs?

Whatever EMD a buyer puts into escrow actually is applied toward closing costs -- so if the total closing costs are $12,000 and the EMD is $6,000, only $6,000 more is due upon closing.

Can closing costs be negotiated lower?

Yes, there are a couple of ways for a buyer to negotiate lower closing costs, although in truth the buyer won't be saving money. You can sometimes get the seller to contribute -- although in all but rare circumstances, they will simply roll the amount of the contribution into the mortgage principal. Lenders also can sometimes be convinced to reduce the closing costs by adding the amount as points on the interest rate.

Finally, you can make small reductions by shopping around for lower insurance rates on homeowners or title insurance or by forgoing attorneys in states where they're not required. However, these savings are so minimal that it's debatable whether the savings incurred are worth the hassle.

Why/when would you want higher closing costs?

Perhaps more common than lowering closing costs by adding the amount to the mortgage is the lender practice of letting borrowers reduce their mortgage loan rate by paying mortgage points upfront. These are also called "discount points," as discussed earlier, as the practice lowers the amount of the monthly mortgage payments a buyer will pay over the life of the loan.

Typically it costs $1,000 per 1% of the total loan amount, and each point lowers the rate by 0.25%. So, if you are looking at a 4.25% rate on a $300,000 loan, you can buy two points at $6,000 to reduce your rate to 3.75% for the life of the loan.

Closing costs are the final thing standing between you and homeownership

While many people don't factor in the closing costs expenses the same way they worry about down payments, both must be covered, and often on the exact same day, in order for your home purchase to be complete. Get your estimated closing costs as soon as possible from your lender, and make sure to budget for them from the beginning.

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