What are my closing costs when buying a home?
Congratulations, you have scrimped and saved enough for a downpayment on a home. But before you leap into purchasing one, you need to be aware of the closing costs when buying a home. Sit down (or Zoom) with your real estate agent or mortgage broker to understand ALL of the costs associated with purchasing a property.
The financial aspect of the home purchase process can be a little confusing for many buyers. It can feel like money is flying out of your pockets and bank account in all directions. And to be honest, money will actually be flying out of your pockets in all directions.
What are closing costs on a house?
Closing costs are fees and expenses you pay when you purchase a home that is in addition to your downpayment. For a median-priced Seattle single-family home of $780,000 (as of January 2021), with a 20% downpayment ($624,000 loan), the buyer's closing costs will include a $700 appraisal fee, $1,500 for Title Insurance, $1,200 Escrow company fee, a $1,240 loan origination fee plus pre-paid items.
Obviously, Seattle is a higher-priced market than many parts of the US and the closing process and fees will vary from state to state, but this article will give you an overview of what you can expect. Adjust accordingly for your local price range.
When buying a home, you will need funds to cover the following:
- The downpayment: the amount of money you are putting down on the home. You borrow the rest by getting a mortgage.
- Fees and costs associated with getting the loan and closing the sale which includes the loan origination fee, the appraisal, the credit report, and a flood report.
- Third-party fees for Title Insurance and the Escrow Company service.
- Pre-paid items are expenses that you have to pay upfront at closing for items like property taxes and insurance that you will be paying on a regular basis as a homeowner.
- Other expenses like paying for a property inspection and moving costs.
Who pays closing costs?
Both the home buyer and the seller will pay closing costs, however, they will be different for each party. The main difference between the two sides is that buyers will usually be relying on getting a mortgage to buy the home and so will have loan-related fees.
The sellers on the other hand may have to pay some taxes on any profit they make on the sale of their home. Here's another guide that specifically looks at the costs and expenses when selling your home.
What is included in closing costs for a buyer?
There are a number of different costs and fees but these are the most common/largest ones.
Loan origination fee.
A fee charged by a lender to cover certain processing expenses in connection with getting a loan. The fee is usually a percentage of the amount being borrowed. For Washington State at least, the loan fee is the same regardless of the size of the loan.
Note that there is a difference between getting a home loan through your bank versus using a mortgage broker. The bank has a set portfolio of loan products whereas a mortgage broker can shop around and pick the best mortgage from hundreds of different lenders.
It is advisable to shop and round to compare not just interest rates but how much each lender will be charging you in fees to get that loan.
The buyer has the option of paying points to reduce their interest rate. This is sometimes called buying down the rate. Each point the borrower buys costs 1 percent of the mortgage amount.
The rate reduction you actually get for one point will vary from day to day. Somedays a point will reduce the mortgage rate by 1/4th and another day by just one 1/8th. It all depends on what the loan market is doing at that particular time.
Is paying points worth it? First of all, points are not cheap. For example, buying down the rate by one point (usually 0.25%) on a $624,000 loan would cost you S6,240 at closing. Secondly, it will take about 5 years before the buyer sees the benefit of the reduced interest rate.
As part of the mortgage approval process, the lender will want to ensure the home is worth the sale price agreed to by the buyer and seller. The lender wants to know that in the event that the buyer stops making monthly mortgage payments, the lender will be able to repossess the home, sell it and get their money back.
An appraiser is an independent 3rd party who visits the home and writes up an appraisal report detailing the current market value of the home. For the Seattle area, an appraisal will cost between $400 and $1,000 or more, depending on the type and size of the home; condo, single-family home, multi-family, or waterfront homes for example.
The escrow company is an independent/neutral 3rd party that coordinates the closing of the transaction between the buyer and the seller. On closing day they make sure that the title to the property is transferred from the seller to the buyer and that the buyer's downpayment and loan safely go to the seller's side.
The size of the escrow fee is based on the sale price. For a Seattle median-priced home the escrow fee will be around $1,250.
Title insurance fees:
If you get a mortgage to purchase a property, the lender will require a loan policy of title insurance. This protects the lender's interest in your property until your loan is paid off or refinanced. Also, an owner's title insurance policy insures the buyer's rights to the property after closing. You only pay for this policy once but the coverage lasts as long as you own your home.
The fee is based on the loan amount. For the home in this example, the buyer can expect to pay around $1,200.
Note that title and escrow fees are referred to as settlement costs.
What are Pre-Paids when buying a home?
As the name suggests, pre-paids are expenses that you have to pay upfront, in advance at closing for items that you will be paying on a regular basis as a homeowner. The lender will require that the buyer deposits advance payments at closing that will cover the first few weeks, months, or first year of ownership.
The lender wants to make certain that the home is adequately insured and that property taxes are paid on time. Some of these pre-paids are added to the buyer's escrow account (see below).
As mentioned earlier, the funds the buyer brings to closing for pre-paid items do not go to the lender. Those funds go into the buyer's own escrow account that will be used to pay future property taxes and insurance. Consider them as your initial escrow payment at closing.
Here are some possible pre-paid costs that a buyer will encounter. The number of months of pre-paids will depend on the loan, the type of property being purchased, and the time of year you are closing.
Pre-paid hazard insurance, aka homeowner's insurance: The lender will usually require the buyer to pre-pay homeowners insurance upfront at closing to ensure their investment is protected. The buyers may have to pay a full year's coverage directly to the insurance company at closing plus an additional 1 to 3 months into an escrow account.
Prepaid property taxes: the lender will require that the buyer prepay property taxes and that amount will depend on the month of closing. Taxes are paid twice per year in April and October so if you close in April, you will need to pay 6 months of prepaid property taxes at closing. For areas with higher property taxes, that can be a chunk of change. For this Seattle example, the buyer would need about $4,500 to cover prepaid taxes.
Pre-paid HOA dues: if you a buying a property that is part of a Home Owners Association (HOA) like a condo or townhome, and there are monthly HOA dues, the HOA will require that you pre-pay a certain number of months of dues in advance.
Per diem is pro-rated mortgage interest that will be charged based on the day you close on the property. If, for example, you close on the 20th of March you will have about 11 days of interest due at closing and your first payment would be May 1st. You must have a minimum of 30 days between your funding date and the 1st mortgage payment date.
What is an Escrow Account?
If your downpayment on the home will be less than 20%, the lender will require you to pay private mortgage insurance. The lender will also require that the buyer maintains an escrow account to ensure that the home's property taxes and insurance gets paid on time and is kept up to date.
The escrow account is a pool of money that buyers pre-pay into each month and from which the lender draws twice a year to pay property taxes and hazard insurance....to protect their investment.
When you have an escrow account your monthly mortgage payment will include the following:
- Principal (P)
- Interest (I)
- Taxes (T)
- Insurance (I)
Which together make PITI. I know, PITI me!
And if you are buying a condo or a home that is part of a homeowners association (HOA), your monthly payment will be PITI + HOA. However, you will pay the monthly HOA dues directly yourself, they do not come out of the escrow account.
Buyers using a downpayment of 20% or more are not required to maintain an escrow account. However, the lender may offer a slightly lower interest rate if such buyers agree to maintain an escrow account.
Not that an escrow account is different from the escrow company that coordinates the closing of the home sale. The escrow account lives on after closing but the latter disappears.
Can closing costs be included in the loan?
You cannot roll those costs into your loan unless it is a Government loan. But remember, say you are getting a 30 years loan, for example, then you would be paying interest on those loan costs for 30 years.
Can the seller pay the buyer's closing fees?
Yes, the buyer can negotiate with the seller to have certain costs paid but are limited to allowable closing costs and pre-paids. If the downpayment is less than 10%, the seller can contribute 3% to allowable closing costs, up to 6% when the downpayment is 10 -25%, and 9% for loans with 25% or more down.
What about closing costs for cash buyers?
Since cash buyers are not relying on a loan to buy the home, they will have a lot fewer closing fees. Basically, these buyers only pay Title and Escrow fees.
Request a Loan Estimate so you can see estimated closing costs.
When you are either getting pre-approved for a home loan before making an offer or applying for a mortgage once you have an offer accepted, your lender will give a document called a Loan Estimate.
This document is really important and will give you a clearly stated picture of all the closing costs associated with getting the loan and losing on the home. It also lists the interest rate, your monthly payment, your prepaid items, plus the terms of the loan.
A few before your escrow signing appointment and closing the lender will send you a Closing Disclosure which is essentially an updated Loan Estimate. There should be a close agreement between these two documents. Read them as if your life depended on it
Here's a link to a handy Closing Costs Calculator where you can plug in your numbers and get an idea of your closing costs.
Advice from a Mortgage Broker.
I asked a local Seattle mortgage broker, Liz Fudacz, what advice she would have for homebuyers when it comes to closing fees.
1. Be prepared not only to pay a downpayment and closing costs but also taxes and insurance. In some cases, as many as 8 months of taxes need to be collected, plus 14 months of Homeowner’s Insurance. Additionally, in many cases, the bank/lender will want you to have at least 2 months of your full new housing payment in the bank after closing.
2. It is important to have your funds ready and accessible. It makes things much easier if your funds are in one account. If you need to move them from another account(s), be prepared to show the source of those funds, including bank statements from the other account(s) and proof of the transfer.
Any deposit that is more than 50% of your monthly income will need to be sourced. For example; If you make $10,000/month and you have a recent deposit of $5025, you will have to prove where those funds originated. Be sure the funds are in an account that is easy to access. Some banks will not wire funds and it can take weeks for them to send a check to you.
Here are some additional home buyer resources for closing costs:
How To Avoid Sticker Shock on Closing Day from Paul Sian advises home buyers on ways to reduce their closing costs like using an FHA or VA loan and having the seller pay some of their closing costs.
How to Improve Your Chances of Getting That Home from Vicki Moore where she offers solid advice on improving your chances of getting your offer on a home accepted.
Common Home Loan Misconceptions from Kyle Hiscock is an excellent article looking at many of the confusions buyers have when it comes to getting a mortgage and whether they can qualify for one.
What Is PMI And How To Get Rid Of It from Bill Gassett provides a detailed explanation of what exactly PMI is and how you can go about getting rid of this dreaded aspect of home loans.