Closing Costs – Definition, Calculation and Examples

Closing costs are defined as the additional expense that either or both the seller as well as the buyer has to pay to close the transaction. These are one of the most common expenses that are associated with transactions related to real estate and are generally estimated between 2% to 6% of the cost of a property.

What are closing costs?

It is a fact that estimated costs as the name suggests are just estimated from the lender’s viewpoint and the actual closing cost is quite different. It varies with each transaction and also from one state to another depending upon the terms of sale and laws of that particular place.

A real estate transaction is a complex deal where lots of players are involved. As per the law it is the responsibility of the lender to reveal an estimated closing cost on a property within three days prior to the closing outlining all the closing fees.

It is imperative to get approximate of the closing cost because at the end of the day it is part of the total cost. From the viewpoint of the seller closing costs includes his obligation for the sale and transfer of property and is estimated at 1% to 3% of the sales price.

It includes the tax on the sale, title transfer fees, and fees for the seller’s attorney and commission. Some of the lenders insist on additional fees for a pest inspection, prepaid interest, hazard insurance, flood certification, and private mortgage insurance.

From the viewpoint of the buyer, it is he who pays the larger share of the closing costs and is estimated at 3% to 4% of the purchase price. The closing costs of the buyer include appraisal fees, home inspection fees, survey costs, and title search fees.

If the buyer is using a mortgage to purchase a property he will have to pay additional closing costs and that includes mortgage tax, underwriting fee, the fee for determining the credit report of the buyer and loan origination fee.

Examples of closing costs

If a person purchases a house for 200,000 dollars, as per the market rate his closing cost must be estimated at 2% to 6% of the total amount and that will vary between 4000 dollars to 12000 dollars.

The actual amount depends upon the various people who he has to pay as part of the closing costs, for instance, he might have to pay attorney fees 1000 dollars, commission 1500 dollars, to the real estate agent 2000 dollars and the appraisal fees at 500 dollars.

The total closing cost then will amount to 5000 dollars which is within his estimated amount.

Types of closing costs

The numerous categories of closing costs are as follows-

1. Mortgage origination fees

The fees charged by the mortgage lender or a bank to create a loan is known as mortgage origination fees. Generally, it amounts to 1% of the total mortgage amount but the best part is that it is negotiable and is dependent upon the creditworthiness of the borrower.

A person can negotiate for the loan fees if his FICO score is high or he can offer something as collateral.

2. Application fees

The lender charges a non-refundable and upfront deposit on your application.

3. Inspection fees

It is paid by the buyer at the time of service rendered and not at the closing.

4. Origination fees

This fee is charged by the lender from the borrower to make a mortgage loan. The services under origination include administrative services, funding and underwriting the loan and processing the loan application and are chargeable.

5. Title insurance

This fee is paid to insure against loss from defects in the title for instance mortgages and outstanding taxes. It is required by a mortgage lender and is paid as a one-time payment during the closing transaction.

In some states, it is the buyers who have to pay title insurance whereas in other states it is the seller who has to shed the fee amount from his pocket.

6. Home warranties

This fee is paid by any of the two parties. It is the seller who offers a home warranty to the buyer as an assurance. It is actually insurance against replacement or repair of a vital household system and is applicable within the first year of the sale.

7. Appraisal fees

The amount paid to a professional appraiser in order to assess the value of a property is known as appraisal fees. These are included in the closing costs of the buyer and costs in between of 300 dollars to 500 dollars.

Appraisal fees are dependent on the size, location, and type of property. It is important to appraise your property even if the lender does not require the appraisal fees as it will give the buyer a fair market value and stop him from overpaying for it.

8. Discount points

It is a kind of prepaid interest and is included in the buyer’s closing costs. These are negotiable and the buyer can buy the discount points to minimize the rate of interest charged by the bank. In some cases, the discount points are covered by the bank.

9. Prepaid Costs

This is part of the buyer’s closing cost and is required by the lender to pay in advance. Prepaid costs are charged when asking for a loan and include rental property insurance and mortgage interest. These costs are part of the estimate which a lender submits to the buyer within three days of applying for a loan.

10. Recording fees and taxes

These are also known as transfer taxes and are levied by the local government for recording the sale of the property. The recording fees and taxes vary from state to state at 0.4% to 2.0%.

11. Brokerage commission

This fee is paid by the seller to the broker for his services that include marketing, assisting in the purchase negotiations and finding a buyer. The commission is written in the listing agreement and is estimated as a percentage of the sales price. Brokerage commission is the largest closing costs.

12. Real estate agent fees

It is a part of the seller’s closing costs if the property has been listed by a real estate agent. The fees are between 2% to 6% of the selling price of the property in question and include the amount payable by both selling agent and listing agent’s commissions although it is up to the listing agent to determine the share of the split.

13. Private mortgage insurance

It is a part of the buyer’s closing cost and acts as a protection for the lender against loss of money in case of foreclosure. Private mortgage insurance is applied for the purchase of residential property through conventional loans and includes less than 20% of down payment.

The applicable fees are between 0.3% to 1.5% of the original loan every year and are also dependent on the credit score of the borrower and the amount o down payment.

14. Underwriting fees

The underwriter is the decision-maker on the loan and the fees are paid to the staff involved in giving final approval o the application.

15. Attorney fees

It is paid by either or both parties for the recording of official documents

16. Survey fees

The survey fees can be paid by either party to confirm the dimension and size of the lot or land including any structures on it.

17. Credit report

The closing cost is estimated at 20dollars to 50 dollars. It is the lender who runs a credit report on the purchaser with either one or more credit reporting bureaus.

18. VA funding fee

If a person has a VA loan he will have to pay a VA funding fee to fund the VA home loan program.

How to Calculate Closing Costs?

The term closing costs include numerous expenses that are calculated above the purchase price of the property one is buying. The closing costs are negotiable and some of them are split between the buyer and the seller. The share is negotiable and is decided by an agreement between both the buyer and the seller.

The closing costs from a buyer’s viewpoint is the additional costs that he has to pay besides the price of the property and includes-

• Appraisal fees- estimated at 300-500 dollars and is paid upfront
• Lender fees – estimated at 1% – 2% and include a credit report, wire transfers, underwriting fees, discount fee, and application fee
• Property insurance- estimated at an average of 1,228 dollars
• Transfer taxes – estimated at 0% – 2%
• Property tax reserves – estimated to pay the amount due for 2 – 3 months in advance
• Title fees- estimated at 1% and includes title insurance, title search fees, and notary fees

The closing costs from a seller’s viewpoint is the additional costs that he has to bear during the settlement of a property transaction and includes-

• Real estate commissions – Estimated at 2% – 6% of the selling price
• Property taxes – in case the seller has not paid the property taxes then the due amount is the total up to the closing date
• Any liens on the property – A buyer will want to purchase a clear title hence all the liens on the property for instance line of credit and mortgage should be paid either by or from the seller’s proceeds at the time of the settlement.
• Past-due utility bills – If any of the utility bills are unpaid the seller has to pay them until the closing date
• Transfer taxes – estimated at 0% – 2%
• Title fees – estimated at 1% and include title insurance and notary fees.

The seller has to pay to both his own and the buyer’s agent and is included as part of his closing costs.

How to reduce closing costs?

Closing costs are not fixed and hence need to be negotiated if you want to reduce it for your benefit.

A buyer can save a significant amount by comparing fees levied by different lenders. The buyer is not bound to use the third-party services like insurance agent, pest control of hazard insurance agents that he lender has suggested. He can hire other people for evaluation who are charging less. A little effort on the buyer’s part can minimize his closing costs considerably.

Schedule your closing near or at the end of a month as it will reduce the prepaid daily interest charges. Ask your lender about it and figure out the amount you are saving in closing costs.

The buyer should be ready to negotiate on loan-specific fees and if he thinks that the lender is adding unnecessary fees on the loan then it is imperative that he speaks up against it. The buyer can insist to remove any fees that he thinks are duplicated. Excessive processing can cause duplication so beware. Find competitive rates and negotiate the terms again and again to reduce closing costs

When the buyer receives the initial loan estimate it is imperative that he reviews it to the fine print. Never ever trust the other person to give you the exact amount as it is your responsibility to carve out the best deal for yourself. If you are unsure of any point in the estimate ask for clarifications. Ask your lender about every detail and make sure to bargain so that the actual closing cost is reduced considerably.

Ask the seller to cover a portion of the closing costs or lower the amount somewhat so that you can minimize your portion of the closing costs. Sometimes a property is in the market for a long time and the seller is desperate to sell it. In such circumstances, he is open for negotiations and you can reduce your closing cost.

When a lender offers to pay your closing costs by rolling them into your loan then beware. Remember a lender will in such circumstances levy a high rate of interest for including the closing fees and at the end of the day the buyer will end up paying more than he was supposed to pay.

Save on points because when the rate of interest is low the buyer will not have to pay for points to lower the interest rate.

If the buyer has the necessary cash available to him then he should opt for paying cash for a property. This will eliminate all the lender fees.

If a buyer is a regular client and he uses the same vendor you can ask for a reduction in fees because of repeat business.