Closing costs are to home sales what fruitcakes are to Christmas: spoilers of an otherwise good time.
You start out excited ― you’re buying a home after begging, borrowing and draining every nickel out of every possible source ― and then wham! Along come closing costs, and the next sound you hear is the pfft of air escaping the joyously inflated you.
Closing costs are expenses incurred when you buy or sell a house. They have a nasty way of sneaking up on you, even though everyone connected with the transaction will remind you repeatedly that they add between 3 percent and 6 percent to the price of the sale and you need to be ready to pay for them. Here is what every first-time buyer needs to know about closing costs:
How to find out what your closing costs will be
On closing day ― or a few days before ― you will be given a slew of important documents to sign. Among those papers will be your closing disclosure statement, which outlines all the who-pays-for-what expenses involved in the home sale. Another is a copy of the loan estimate, which should spell out the terms of your loan so you can double-check they are what you agreed to.
The closing disclosure statement will look like a balance sheet showing what you’ve already paid and what you agreed to pay as per the sales contract. It will include your full down payment, loan origination fees and points (loan discount fees), the cost of any home inspections or appraisals, deed recording, notary fees, private mortgage insurance premium if your lender requires it, and prorations. What are prorations, you ask? Find out below.
You might hear people talk about a good faith estimate, but it’s no longer used in the lending industry. The HUD-1 settlement statement, which was the standardized form used to itemize services and fees charged to the borrower by the mortgage lender, is also gone. The Consumer Financial Protection Bureau discontinued both forms in 2015, when it overhauled the way mortgages are processed and disclosed to borrowers.
You may owe the seller prorated expenses, or the seller may owe them to you
There is an excellent chance that the home seller has already paid the property taxes, and possibly has even filled up the propane tank a few months in advance. As the buyer, you will need to pay back the seller for the money he shelled out. This is handled through the closing, which is also sometimes called the closing of escrow. If you are buying a property with a homeowner association that charges fees the seller paid in advance, you may be asked to repay those as well.
Prorations are actually a two-way street, and there may be instances where the seller must pay the buyer. For example, the electrical company usually sends a bill for the electricity used during the previous month. But if you take ownership of the house on the 10th of the month, the seller will owe you for the first nine days. The closing costs statement should prorate the bill to reflect the number of days in the month each person was the owner.
Your lender may require you to pay property taxes and insurance up front
Some lenders collect funds for taxes and insurance with the mortgage payment, hold that money in an escrow account, and then use it to pay those bills for you. It’s not an act of benevolence. It is the lender wanting to protect its investment.
If you don’t have homeowner’s insurance, your house could burn down, leaving it worth less than you owe to your lender. And if you don’t pay your taxes, a lien can be placed on the home, and taxes will be collected at the time it is sold or foreclosed. Should that happen, the lender can only collect its share after the taxes are paid and the lien satisfied.
So basically, your mortgage company is making sure you pay your bills on time by collecting the money early and paying them for you. The amount collected each month comes from adding up your annual taxes and insurances and dividing by 12. Lenders are also allowed to collect a minimum balance amount ― generally two months worth of payments ― to allow for future increases.
Escrow accounts are established at the time of closing, and can often pack a wallop. The buyer may have to cough up the dough for a proration of taxes the seller already paid, plus fund his own newly established escrow account.
Some lenders won’t require an escrow account if the borrower puts a 20 percent down payment on the property. And nobody will insist you set up a separate account to save up for your taxes if you pay cash for the house.
Closings are different state-to-state, and closing costs vary based on where you are buying
In California, real estate closings are handled through escrow companies that are usually chosen by the seller. It really doesn’t matter who picks the escrow company, because the role of the escrow officer is to maintain third-party neutrality and make sure all conditions of the sale are properly met.
In about 20 states, including New York and Florida, a lawyer is required to close a real estate transaction. Even if your state doesn’t require you to consult with an attorney, you might consider doing so anyway ― but it will add to your closing costs.
Here is a comparison tool that shows average closing costs by state.
Some closing costs can be negotiable, but not many of them
The fee for a title search is the fee for a title search, and you don’t want to skip that because you definitely want to know that the home you are buying has a clear title. And taxes are taxes, so you won’t find any wiggle room there. But you might find some mortgage origination fees that are less expensive if you shop around for a mortgage.
You may also find some savings if you schedule your closing for the last day of a month. Your loan interest will be billed per diem, so you would only pay interest for that one day.
But about the only surefire way to reduce closing costs is to pay cash for a house. And even then, you will still likely pay for an appraisal, home inspections, local, county and state government fees, escrow fees, bank transfer fees, taxes and insurance premiums. But you will spare yourself loan costs.
If you aren’t paying cash, fool around with a closing costs calculator to see what fun awaits you.