Closing Costs, or settlement costs, are the expenses paid in addition to the sales price to complete a real estate transaction. These costs may include property taxes, a recording fee, and the cost of a title search. I have been investing in real estate for over 15 years, have bought nearly 100 properties, and even sold some properties. I’ve paid a small fortune in closing costs and am here to share this information with you.
The average closing cost for residential real estate is 2%-5% of the total selling price of the home. While this does not include the down payment, it may include loan origination fees, property taxes, and attorney fees. Some costs are owed by the seller, some by the buyer, and some are prorated.
As long as there have been real estate transactions, there has been debate about what exactly qualifies as closing costs. Furthermore, there is often a disagreement on who pays the closing costs; the buyer or the seller. In this article, I will teach you everything you need to know about the customary closing costs of a residential real estate transaction.
What is a Closing?
A real estate closing is the final step in a real estate transaction. In this step, the buyer and seller will sign all necessary documents to transfer ownership of the property from the seller to the buyer. In some jurisdictions, a real estate attorney must perform this closing; in others, a title company can close the sale. It is common for both the buyer and seller to meet on the closing date to finalize the transaction; however, it is possible to perform a real estate closing remotely.
At closing, the closing agent will ensure all documents are correctly signed. This agent will also collect funds and put them in escrow until all conditions of the home sale are met. Once the deal is finalized, the funds in escrow will be distributed to the appropriate parties.
Escrow
Escrow is a legal concept in which a third party holds money or assets until a transaction is completed. With a real estate transaction, the purpose of escrow is to protect both the buyer and seller by ensuring that the deal is completed or terminated in its entirety. With a mortgage loan, an escrow account holds the buyer’s funds for taxes and insurance and is later used to pay these fees. In rare instances, escrow fees may be charged with a real estate transaction, but that cost is usually rolled into the attorney fees.
What are Closing Costs?
Closing costs are any costs, other than the property’s selling price, that must be paid for the transaction to complete. Some closing costs may not apply to your transactions. For example, you won’t have a loan origination fee if you are not getting a mortgage. Below is a list of expected closing costs, but there could be additional fees in unique situations.
- Application Fee: A fee charged to apply for a home loan. Sometimes this is paid upfront, and other times it’s settled at the closing table.
- Appraisal Fee: If you are financing this purchase, the bank will order an appraisal as part of the lending process. The appraisal fees will usually be paid at closing, but in some cases, the mortgage lender collects them upfront.
- Attorney/Title Company Fees: The attorney or title company will charge a fee for handling the transactions.
- Garbage Fees: In cases where the property owner is responsible for garbage collection, these fees may be collected as closing.
- HOA Fees: Past due, and current year, homeowners association fees will be paid at closing.
- Home Inspection Cost: In cases where there is a property inspection, the cost is often paid at closing.
- Homeowners Insurance: Homeowners insurance is traditionally billed monthly or annually; sometimes, it is paid from the mortgage’s escrow account. The initial premium is often paid at closing.
- Mortgage Insurance: Sometimes, a home loan may require the buyer to purchase private mortgage insurance (PMI). The initial premium of such charges will be collected at closing.
- Mortgage Origination Fee: Most mortgages have an origination fee, a charge for processing the loan.
- Points: Discount points are a percentage of the loan amount paid to the mortgage lender to buy a reduced interest rate. If the buyer pays points, the charge is often collected at closing.
- Property Taxes: The property taxes for the current year are prorated and paid at closing. When the due date is far away, the seller pays a prorated credit to the buyer as a closing cost. In addition, any property tax arrears are settled at closing.
- Realtor Commissions: The real estate commission paid to an agent is a closing cost. This is usually a percentage of the selling price and is charged to the seller. In most cases, the amount is held back from the seller’s proceeds and paid to the agent; rarely is it additional funds that must be paid at closing.
- Recording Fee: The recording or transfer fee is paid to the municipality for recording the transaction. This will include documenting the deed changes and filing liens required by a lender.
- Title Insurance: Title insurance protects the buyer in case of title problems. A lender policy, which only protects the lender, is often required when there is a mortgage. The owner’s title insurance policy is optional, but I recommend getting it because the price is low compared to the asset’s value.
- Title Search: Before closing, a thorough title examination is conducted to ensure ownership and discover any outstanding liens on the property. Any liens must be resolved before the closing can be completed.
- Miscellaneous Fees: Real estate transactions often contain other small fees based on the specific situation. For example, I was charged courier and E-filing fees in my last closing. The courier fee was for hand delivery documents for my rushed closing, and the E-filing fee was a change to file property tax documents electronically.
Most closings will provide a document called a HUD-1 form; this document discloses the closing cost paid by each party. In some cases, this form is optional, but both home buyers and sellers will receive some form of settlement statement with all the charges accounted for. On the HUD-1, the buyer’s closing costs will be on the left, and the seller’s closing costs will be on the right.
Below is a HUD-1 form for a house I am closing on today. The buyer’s charges are on the left, while the seller closing costs will be on the right. Line 211 reveals the proration of property taxes mentioned above. Line 303 on the left shows the amount I must bring to closing, and line 603 on the right shows how much the seller is getting. In this case, I am not getting a loan, and the seller has a loan to pay off.
Why do Closing Costs Exist?
Closing costs are necessary because they cover various expenses associated with purchasing or refinancing a property. These costs typically include fees for services rendered by third-party providers such as title companies, appraisers, attorneys, and government agencies involved in the transfer of ownership of the property. In most closings, the attorney or title company will collect the monies due and make disbursements to the affected entities. Here are some reasons why closing costs are necessary.
Transactional Costs
Closing costs are necessary to facilitate the transaction. For example, the seller may need to pay for a title search to ensure that they have a clear title to the property, while the buyer may need to pay for an appraisal to determine the property’s value. These costs are necessary to complete the sale.
Administrative Costs
Closing costs also cover administrative costs associated with the sale, such as document preparation and notary fees. These fees are typically paid to third-party service providers, such as title companies and attorneys.
Lender Requirements
Lenders often require that borrowers pay closing costs to protect their investments. These costs help ensure that the property has a clear title, that the home has been appropriately appraised, and that there are no liens or other legal issues that could affect the property’s value or the borrower’s ability to repay the loan.
How Much are Closing Costs?
Average closing costs are generally 2%-5% of the sale price of the home. Some fees, such as the mortgage origination fee, are based on the selling price. Other fees, like a title search charge, are usually a set amount. Freddie mac has a closing costs calculator that will estimate the costs for your specific situation.
In my latest closing, the house’s selling price was $94,750, and the total closing costs were $2,072. In this case, the closing costs were 2.19% of the selling price. This percentage is on the lower end of the range because there was no mortgage to purchase the property. When a mortgage is involved, the transaction often has origination, appraisal, and inspection fees which run up the closing cost.
Who Pays Closing Costs?
The buyers and sellers may both pay closing costs, and the settlement statement will reflect this. However, the closing costs are negotiated between the participants. In some cases, seller concessions may be offered in exchange for the buyer paying some closing costs. In other cases, the closing costs are prorated.
Prorated
Come closing costs may be prorated. For example, if the closing occurs mid-year, the seller is responsible for property taxes for the year’s first half, while the buyer owes the taxes for the latter half. The property tax amount is split between the buyer and seller. If the seller has already paid the taxes, the buyer will pay the second half as a closing cost to be disbursed to the seller. If the taxes have not been paid, the seller will pay a closing cost to cover the year’s first half year.
Seller Concessions
Seller concessions are closing costs that the seller has agreed to pay. This concession may include items that may be the buyer’s responsibility, such as a loan origination fee. The seller may agree to pay certain charges, a specific dollar amount, a percentage of closing costs, a percentage of the selling price, or nothing. Sometimes, the seller may reduce the home’s total purchase price instead of contributing to the closing cost.
Sellers, watch out for points!
Mortgage points are fees that the buyer pays directly to the lender in exchange for a reduced interest rate. If a seller offers a concession and doesn’t specify the costs they are paying, they may have to pay points. For example, if the seller offers to pay half of the closing costs, the buyer could add points to the loan, increasing the closing costs and reducing their interest. The inclusion of points will have a significant impact on the total closing cost amount.
Conclusion
Closing costs are the costs, above the selling price, required to complete a real estate transaction. These costs include the fees charged by the closing attorney or title company, the lender fees, and property taxes. There may be additional costs depending on each situation. For further information, please read my comprehensive article that explains the difference between using an attorney and a title company.
Closing cost fees average 2%-5% of the selling price, with purchases using a mortgage being near the higher end of that range. When there is no mortgage, the costs are mainly attorney charges and local government filing fees. These costs are split between the buyer and seller, but that split can be negotiated between both parties.
Before closing, each party should get a preliminary settlement statement detailing all the charges. This statement, often called the HUD-1, will break out who is paying what. Be sure to scrutinize this form before closing to avoid any surprises.
