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What Are Closing Costs?

Michele Lerner, Bob Musinski

Whether you're a first-time homebuyer or have bought and sold multiple homes, closing costs can complicate your home purchase because you need to budget for the costs at the same time you're trying to put down the largest possible down payment.

The term "closing costs" includes a variety of expenses above the purchase price of your property, such as fees for an attorney, a title search, title insurance, taxes, lender costs and some upfront housing expenses such as homeowners insurance. Some of those costs are nonnegotiable, such as recording or transfer taxes charged by your state or local government. Others, such as your lender's fee, can be negotiated.

The amount a buyer will pay in closing costs varies based on the size of the loan and local taxes and fees, but a general rule is that they average 2% to 5% of the purchase price. For example, if you're buying a $300,000 house, the total closing costs could range from $6,000 to $15,000. The national average for closing costs on a single-family home in 2018 was almost $5,800 including taxes, according to a report from data company ClosingCorp.

What's Included in Closing Costs?

By law, if you're buying a home, you receive a loan estimate within three days of your lender receiving your loan application. That document includes an estimate of closing costs. Three days before your scheduled closing, you should receive your closing disclosure, a document that provides final details about your loan and your closing costs.

"There are essentially three sections of closing costs that buyers need to pay, including lender fees, title company fees and prepaid costs," says Henry Brandt, branch manager of Planet Home Lending in Irving, Texas.

Lender fees. Some lenders wrap all of their costs into an origination fee, and others break them out into a list of things like courier fees, appraisal costs, administrative fees, processing fees, a credit check, transfer taxes, a flood certification if one is required and underwriting fees, says Brandt.

An optional closing cost is a discount point, equal to 1% of the loan amount. Discount points can be used to lower your interest rate. You can consult with your lender to discuss the pros and cons of paying discount points. In general, if you're cash-poor, you're less likely to want to pay extra upfront to bring down your interest rate.

[Read: Best Mortgage Lenders.]

Title fees. About 70% of closing costs are title-related, says Todd Ewing, founder of Federal Title & Escrow in Washington, D.C., which is why he recommends that buyers shop for title services if they can. Those costs include a title search, title insurance and settlement services.

"Title insurance premiums don't vary much, but the settlement fees can vary by several hundred dollars from one company to another," says Ewing. "To compare fees, make sure you understand what's covered, including a title search and courier fees."

Lenders require buyers to purchase title insurance that covers the lender up to the amount loaned. Most real estate experts recommend that buyers also purchase optional owner's title insurance to protect their own investment in the home. Both types of title insurance provide protection if someone claims he or she has an ownership right to your home or has not been paid for work on the property and has a lien against it. Title insurance can protect you if the previous owners failed to pay taxes on the property.

"Some people foolishly decide to opt out of owner's title insurance to save money, but it can be costly," says Ewing. "One buyer of a $1 million property in Washington, D.C., decided to save $2,000 and skip it, but three months later it turned out a lien on the property hadn't been properly recorded, and he had to pay about $50,000 in attorneys fees to straighten it out."

Prepaid costs. Most lenders require borrowers to set up an escrow or impound account to collect homeowners insurance and property taxes, although if you make a down payment of 20% or more, you can sometimes be exempt, says Brandt.

"At the closing, you'll pay one year of your homeowners insurance plus two months of homeowners insurance premiums to be kept in reserve," says Brandt. "Usually you're also required to pay two to six months of property taxes depending on when the tax bill is due. In states with high property taxes, that can add up to thousands of dollars at the closing."

Who Pays Closing Costs?

Both buyers and sellers have expenses to pay at the settlement table, but what they pay depends on negotiations between buyers and sellers. Sellers typically pay the real estate agents' commissions at the closing, but in some areas, they pay other fees, too.

[Read: Best Mortgage Refinance Lenders.]

Buyers usually pay for the majority of closing costs, but there can be exceptions.

"First-time buyers often don't know about closing costs, and they'll say, 'My friend bought a house, and the sellers paid all of the closing costs,'" says Sam Grogan, a real estate agent with Coldwell Banker Residential Brokerage in Charlotte, North Carolina. "We explain the process so they understand that usually means the buyers have negotiated with the sellers to finance the cost."

How Can I Avoid Paying Closing Costs?

You're not likely to avoid paying closing costs entirely. While some costs such as transfer taxes and property taxes can't be changed, there are several ways to lower your out-of-pocket expenses at the closing. The two most common are lender-paid or seller-paid closing costs.

"Buyers get confused when we talk about seller-paid closing costs, so I think this should be called 'buyer-financed' closing costs," says Grogan.

Essentially, buyers can ask sellers to allow them to raise the purchase price in exchange for a credit at the settlement table to cover closing costs.

"For example, if the seller wants $200,000 for the house and closing costs are estimated at $5,000, you can offer $205,000 and get a credit for the closing costs," says Grogan. "The seller gets the same net profit, and the buyer finances the closing costs into the transaction, lowering the buyer's total out-of-pocket expenses."

Grogan says this is common for properties in a lower price range, although in a competitive market some buyers try to avoid asking for closing cost help because it can make them look weak.

"In 2008 to 2010, when it was a buyer's market, it was common across all price ranges to ask sellers to pay closing costs outright and not even raise the price to cover them," says Grogan.

A potential problem for buyer-financed closing costs is that the home must appraise at the full purchase price, including the extra for a closing cost credit. Your real estate agent can help you assess whether you could face appraisal problems.

Buyers can also request lender-paid closing costs, which means the lender will pay the closing costs and charge a slightly higher interest rate to recoup the money, Brandt says.

[Read: How to Get a Mortgage With No Down Payment. ]

"Whether it's seller-paid or lender-paid closing costs, basically the buyer is financing those closing costs either with a higher balance or a higher mortgage rate," says Brandt.

You can also negotiate some closing costs, but most are hard fees that can't be changed.

"The closing costs that a buyer may be able to shop for would include things like property survey, home inspection, pest inspection and homeowners insurance," says Tom Parrish, head of retail lending product management at BMO Harris Bank.

How Can You Manage Cash Flow and Closing Costs?

People with low to moderate incomes could get homebuyer assistance in the form of a grant or loan.

"The loans associated with those programs sometimes have slightly higher interest rates, but it's a great option to get some or all of your down payment and closing costs covered so you can keep more of your cash in reserve for emergencies," says Brandt.

Programs are available through nonprofits, state and local government agencies and from some employers.

Brandt estimates that about 25% of the loans his company handles have some form of closing cost assistance, either from the sellers, the lender or a homebuyer assistance program.

If cash flow is an issue, try to negotiate the settlement date, which can affect the amount you pay in closing costs.

"If you close at the end of the month, the lender will only charge one or two days of prepaid interest, but if you close on the first of the month, you'll pay the full 30 days of interest," says Ewing. "But it's really only a cash-flow difference since your closing date also impacts the date your first mortgage payment is due."



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