What Goes Into Closing Costs When Buying a Home?

When purchasing a home, buyers encounter a range of expenses known as closing costs, which are separate from the down payment. These costs are a collection of fees necessary to finalize a real estate transaction and typically amount to 2% to 5% of the total loan amount. The funds cover services from mortgage lenders, title companies, and government agencies.

All buyers receive a Loan Estimate three days after submitting a mortgage application, which outlines these anticipated expenses. A final version, the Closing Disclosure, is provided at least three business days before the scheduled closing date. Understanding these charges is part of budgeting for a home purchase, as they represent a significant out-of-pocket expense.

Loan-Related Fees

When securing a mortgage, lenders charge specific fees for creating and approving the loan. The most common is the loan origination fee, which covers the administrative costs for processing the application. This fee is calculated as a percentage of the loan amount, commonly ranging from 0.5% to 1%.

Another charge is the underwriting fee, which pays for the risk assessment of the borrower’s financial profile. Underwriting is the process where the lender verifies your income, assets, and credit to determine your ability to repay the loan. Some lenders may bundle this cost into the origination fee, while others list it separately.

An application fee may also be charged at the beginning of the process to cover the initial costs of processing the request. Buyers also have the option to pay for mortgage points, also known as discount points. These are a form of prepaid interest paid to the lender at closing in exchange for a lower interest rate on the loan. One point costs 1% of the loan amount and can result in a lower monthly mortgage payment.

Property-Related Service Fees

As part of the mortgage approval process, lenders require several third-party services to evaluate the property and confirm it is adequate collateral for the loan. The buyer pays for these services, which are included in the closing costs.

• An appraisal fee pays a licensed appraiser to determine the home’s fair market value, assuring the lender they are not lending more money than the property is worth. This can cost between $350 and $600.
• A credit report fee is charged to pull the buyer’s credit history and scores from the major credit bureaus. This typically costs between $30 and $60.
• A home inspection fee covers a detailed examination of the property’s condition. While not always required by the lender, an inspection helps the buyer identify potential issues before finalizing the purchase and costs between $300 and $500.
• A flood certification fee is charged to determine if the property is in a federally designated Special Flood Hazard Area. If the property is in a high-risk zone, the lender will require the buyer to purchase separate flood insurance.
• A survey fee may be required to pay for a professional surveyor to verify the property’s legal boundaries and ensure there are no encroachments.

Title and Settlement Fees

A portion of closing costs is dedicated to title and settlement fees, which cover the work required to ensure and transfer legal ownership of the property. These services are performed by a title company or real estate attorney. The process begins with a title search, which is a fee charged to examine public records for any ownership issues like outstanding liens or claims.

Following the search, the lender requires the buyer to purchase a lender’s title insurance policy. This one-time premium, paid at closing, protects the lender’s financial interest in the property against any future title defects. The coverage amount is based on the loan amount.

Separately, homebuyers have the option to purchase an owner’s title insurance policy. This policy protects the buyer’s equity and ownership rights for as long as they or their heirs own the property. It safeguards the owner from financial loss associated with defending their title against unforeseen claims.

The closing process is managed by a settlement agent, who may be a title company representative or an attorney. A settlement or escrow fee is charged for these services. This fee covers the administrative tasks of handling the exchange of funds, ensuring documents are properly signed, and seeing that the new deed is officially recorded.

Government Recording and Transfer Taxes

When a property changes hands, government entities impose fees and taxes to make the transaction a matter of public record. One of the primary charges is the recording fee, paid to a local government agency like the county clerk’s office to record the deed and mortgage documents. This legally documents the transfer of ownership.

In many jurisdictions, a transfer tax is also levied on the sale of real estate. This is a tax imposed by a state or local government on the transfer of property from one owner to another. The tax is typically calculated as a percentage of the home’s sale price. The responsibility for paying the transfer tax is determined by local custom and can be a point of negotiation.

Prepaid Items and Escrow Account Funding

Distinct from fees for services, a portion of closing costs consists of prepaid items. These are advance payments for recurring homeownership expenses that are held in a lender-managed escrow account. Lenders require these funds at closing to ensure obligations like taxes and insurance are met on time.

One of the most common prepaid items is homeowner’s insurance. Lenders require proof that the property is insured and mandate that the buyer prepay the first full year’s premium at or before closing. Property taxes are another prepaid expense. At closing, the buyer is required to pay for any property taxes due from the closing date through the end of the current tax period.

Buyers must also pay prepaid daily mortgage interest. This charge covers the interest that accrues on the loan from the date of closing to the end of that month. Since the first regular mortgage payment is not due until the first day of the second month after closing, this payment ensures the interest for the initial partial month is paid.

Finally, the buyer makes an initial deposit to fund their escrow account. This deposit establishes a cushion, typically a few months of property tax and homeowner’s insurance payments, to ensure sufficient funds are available when these bills come due. Each month, a portion of the buyer’s mortgage payment is directed into this account.