What Are Closing Costs?

Closing costs are fees that are paid at closing in addition to the down payment amount.  While closing costs are typically considered a buyer’s expense, sellers also incur them. However, the buyer’s closing costs are often covered out of pocket or financed, whereas the seller’s closing costs are deducted from the proceeds of the deal.

Several factors impact total closing costs, including the type of loan you are obtaining and what state you live in. For instance, FHA loans and conventional mortgages involve a few slightly different closing costs.

What Is Included in Closing Costs?

Closing costs are not a single expense; they are the cumulative total of multiple expenses.

Property Taxes

Many lenders will require you to make a deposit toward the property taxes for the home. Buyers may need to provide up to a year’s worth of taxes, but mortgage lenders have different requirements. When a buyer is purchasing their house is also a factor in how much property tax is due based on the property tax schedule.

Property tax deposits will be wired to an escrow account at the time of closing. The lender will maintain the escrow account. Part of your mortgage payment will include funds for this account. Each year, your lender will draw from the account to pay your annual property taxes.

Application Fees

Mortgage applications are complex sets of documents. Naturally, processing these documents, verifying income, and taking other steps to determine loan eligibility is a labor-intensive exercise. That is why lenders charge an application fee to process your request for a mortgage.

When speaking to prospective lenders, ask what their application fee is. While this can be a relatively minor expense, rates vary from lender to lender. Some lenders could even waive your application fee if you meet certain requirements.

Title Searches

Title companies will review public records for the property you are buying to ensure that there are no liens or ownership disputes. The title company charges for this service. This expense is referred to as a “title search fee” on your itemized list of closing costs.

Loan Origination Fees

Loan origination fees cover a financial institution’s costs of processing a mortgage. Traditionally, origination fees are 1% of the total loan amount. For example, if your loan amount is $450,000, then your origination fee will likely be $4,500.

Keep in mind that this fee can vary from lender to lender. Some lenders will waive this fee but charge you a higher interest rate.

Deposits for Escrow Accounts

Funds for your property taxes are not the only monies that are held in escrow. Your lender will also require you to deposit funds at the time of closing to cover private mortgage insurance and your homeowners insurance.

Private mortgage insurance is required if your loan amount exceeds 80% of the home’s appraised value. If you have a conventional loan, you will no longer need PMI after your mortgage balance drops below the 80% threshold. All mortgages require you to have a homeowners insurance policy.

A portion of your monthly mortgage payment will be deposited into the escrow account to cover homeowners insurance, PMI, and property taxes. All three of these fees are paid annually.

Appraisal Fees

Lenders want to ensure that they can recoup their losses in the event that you default on a loan. That is why they require an appraisal before finalizing a real estate deal. A third-party appraiser will determine an approximate value for the home based on local comparable properties and other data.

Typically, buyers can cover appraisal fees out of pocket. However, there are instances where buyers pay these fees as part of their closing costs.

Home Inspection

Like the appraisal, the home inspection is usually paid for by the buyer before closing. In most real estate deals, buyers request an inspection period as a contingency for purchasing the home. If the inspection uncovers concerns about the home, the buyer can back out of the deal without repercussions.

Although you will likely pay for the home inspection before closing, it is important that you are aware of this additional expense. Generally, you should budget $400–$800 for a home inspection.

Pest Inspection

Certain states and some types of mortgages require a pest inspection as part of real estate deals. The inspector will look for evidence of wood-destroying organisms (WDOs) like termites. They will check for signs of wood rot and other damage. Pest inspection fees can be covered upfront or as part of closing costs.

Real Estate Agent Fees

The real estate agent fee is one of the costs covered by sellers during a transaction. The seller will pay a commission for both the buyer’s agent and their own agent if they are using one.

Each real estate agent’s commission fee ranges from 2.5% to 3% of the home’s total purchase price. Therefore, sellers can expect to pay 5% to 6% of their home’s purchase price toward real estate commission. The fee is always divided evenly between both agents.

Who Pays Closing Costs?

Both parties in a real estate transaction pay closing costs. Sellers usually pay more total closing costs, but these expenses are deduced from their profits from the transaction.

A seller’s closing costs usually range from 8% to 10% of their home’s purchase price. These figures include 5% to 6% real estate agent commission fees as well as taxes and other miscellaneous fees. A seller’s closing costs may be higher if they agree to cover a portion of the buyer’s out-of-pocket expenses.

Buyers will pay 2% to 5% of the total purchase price toward closing costs. Most of these costs cover the lender and title company fees.