What are closing costs?
Closing costs, according to a Home Ownership Guide provided by the University of Missouri, are defined as a variety of fees that complete the transaction between the buyer and the seller. Closing costs can range from 2-9% of the value of the home, which increases the risk that you run over budget.
Remember that there will be other costs associated with new homeownership so make sure that you budget enough money prior to purchasing a home to comfortably cover closing costs with money left over.
There are typically six categories associated with closing costs. According to the National Association of Insurance Commissions, these are the components of closing costs. Now there is a lot of information in that link so we broke this down for you below.
What is included in closing costs?
- Real Estate Broker/Agent Fee
- Loan Costs
- Charges by Lender
- Title/Settlement Charges
- Government Charges
- Additional Charges
Let’s take a closer look at what each category consists of since closing costs are one of the most confusing parts when buying a home. Remember closing costs are incurred by the seller and the buyer and your share of closing costs can be negotiated. The following information will mostly be for buyers, but we included some information for sellers as well.
1. Real Estate Agent/Broker Fee
A. Agent Fee: The broker that brings the buyer to the deal gets paid and so does the real estate broker who is listing the property. Typically, the total fee is split 50/50 between the agents. If you are looking to avoid this fee when selling a home, especially in South Jersey then you may remember that we buy houses in South Jersey and Philadelphia.
- How to use this?You can save this money by not using a real estate agent, but this is not something that we recommend. These guys know what needs to get done to make sure you don’t end up in trouble.
2. Loan Costs
A. Application Fee: When you apply for a loan the lender will charge you a fee.
- Cost: $25-150
- How to use this? You can shop around to compare rates.
B. Underwriting Fee: (AKA Processing Fee) The amount a lender charges to arrange financing.
- Cost: Usually 1% of Loan – usually nothing you can do about this.
C. Discount Points: A fee you can pay at closing to decrease interest rates on the loan
- Cost: One discount point usually is 1% of the loan value.
- How to use this? You can pay a lump sum up front to have a lower interest rate during the life of the loan. Talk to an advisor and find out if this is something you should consider.
D. Wire Fee: Yup, the lender charges you to actually send the money for your mortgage.
- Cost: $100
- How to use this? You can negotiate to have this waived so talk with your realtor.
E. Appraisal Fee: The amount of money you pay to have your house appraised by the bank.
- Cost: Up to $1,000
- How to use this? Get a copy of this. You are paying for it so you might as well get a copy.
- Pro Tip: The bank is just going to look at comparable home sales near your new home. Check out our Philly Neighborhood Map and see what the comparables will be.
F. Lender Required Inspection Fee: After you make an offer, the bank wants to make sure that the house is structurally sound before they make a loan. The bank wants to make sure that you get the home inspected by a professional.
- Cost: Up to $500 (You may be required to get termite and pest inspections as well, which may add up to $500 more to the cost.)
- How to use this? You have a lot of options here. When you get a house under contract, you want to make sure that your contract has a contingency clause for inspection. If the inspector finds any issues and you have a contingency clause, then you can just pull your offer and save yourself thousands of dollars and countless headaches.
G. Property Survey: The property map that shows the borders of the properties. This can have an impact on potential renovations.
- Cost: Up to $600
- How to use this? Make sure you know how the property boundaries will affect what you can do in the future. You also may get to the surveyor.
H. Private Mortgage Insurance (PMI): This is an insurance policy that the lenders take out. It protects the lenders in case you stop paying your mortgage.
- Cost: Variable. Usually less than 1% of the loan and included in your mortgage payments. This may or may not affect your closing costs. Make sure you ask.
- How to use this? If you can put down more than 20%, then you may be able to avoid this altogether.
I. Credit Report: The fee for a credit report that lenders will want to have.
- Cost: $50
- How to use this? Try to get a copy since your paying for it.
3. Charges by Lender
A. Prepaid Interest: Since you may not pay your mortgage for a few weeks after closing, the bank charges you for the interest that you will accrue during that time.
- Cost: Based on your loan details.
B. Homeowner’s Insurance: Insurance that is required on all homes.
- Cost: Premium costs are variable so shop around.
4. Title/Settlement Charges
A. Escrow: Lenders require you set up an account that is used to pay property taxes, homeowner’s insurance, and PMI.
- Cost: Variable, check the terms of your loan. An initial deposit is usually required to open this account.
B. Lender’s Title Insurance: A policy issued to the mortgage lender. This is assigned to the mortgage and follows the mortgage as it is sold. This protects the lender in case there are multiple claims on the title of the property in the future.
- Cost: Varies by loan details.
C. Owner’s Title Insurance: A policy that covers the purchase with regards to title defects and liens. Basically, this pays the purchaser of a property if the title is not solely owned by the old property owner.
- Cost: Variable. Check to see what you would be covered for if there were any issues. We have found that title insurance will be just under $2000 for a $250,000 house in the area, which should include lender’s and owner’s title insurance.
D. Closing Fees: These will include payment to a closing agent who ensures the documentation is correct. Also, it will include the cost for a notary and a closing attorney.
- Cost: Up to $3,000. You can shop around, but you want to make sure that the paperwork is done right.
5. Government Charges
A. Recording Fee: Issued by the local governments to record the change in ownership.
- Cost: Check the charges itemized here.
B. Transfer Tax: Payable tax to transfer titles from one owner to another.
- Philadelphia: 3.1%
- PA: 1%
C. Tax Certification: A form to prove that you paid property taxes. Check Phila.gov to find out where to complete this.
6. Additional Charges
A. Homeowner’s Warranty: Usually covers things like appliances.
- Cost: Optional and Variable
Who pays closing costs?
Typically, closing costs are paid for both by the seller and the buyer of the property. Buyer closing costs are usually less than 8% of the purchase price in PA. The latest regulations introduced by the Consumer Financial Protection Bureau require a Good Faith Estimate (GFE) or a Loan Estimate form to be supplied by lenders within 3 days of loan application.
This will give you an accurate estimate of what you can expect to pay in closing costs. Armed with this information, we usually recommend having 6-8% of the purchase price of the home as a closing cost reserve to be safe. Utilize Loan Estimates in order to shop for the deals with regards to closing costs. Preparation is key. Remember, you don’t have to take a loan just because you got a quote from them.
Can you Finance Closing Costs?
The short answer is yes, you can finance closing costs. You won’t pay them at the closing table, but they will be included in your mortgage and you will end up paying them plus interest later. This can be a beneficial tool if you are low on cash up front.
Also, you may be able to negotiate with the seller so that he or she covers the closing costs. This will most likely come with a higher price tag for the house so be aware.
How can I save money on closing costs?
We read the Smart Consumer’s Guide to Reducing Closing Costs and summarized the finding here to help you save money on closing costs.
The first way to save money is simple. Shop around. Your realtor may have pre-arranged business relationships for different aspects of the purchasing process, but you have the right to make sure that you get the best rates. Saving money can happen all along the purchasing process, but we know it will be very time consuming to shop around for everything that goes into buying a home. You just spent weeks searching for a home and you definitely didn’t do that just to start calling title companies for quotes.
So in order to save the most money for the least amount of work we recommend shopping for Title Insurance because it can save you up to 35% off closing costs. Also, if you are feeling extra ambitious we recommend shopping for lenders, which we mention below.
What is Title Insurance?
Title insurance is often the largest portion of closing costs. We mentioned this above, but it’s worth repeating. Title insurance covers you for events that have already happened. The property and the land you are buying have most likely been transferred multiple times, which means that if paperwork was missed in the past then there may be claims for multiple owners of the property. This can get messy, but insurance can help protect you. When you purchase title insurance you want to make sure that you use a reputable title company to help you purchase a property without any issues.
Title Insurance can help protect you from things like:
- Mistakes in recording of legal documents
- Unpaid Taxes/Liens
- Incorrect Interpretation of wills
NOTE: Lender’s Title Insurance Policies are often required, but an owner’s policy is not always required. Remember you will not be covered under a lender’s policy if anything does come up.
The key to saving money on closing costs can be found by shopping for title insurance. You will be able to start shopping for title insurance as soon as you begin looking for a mortgage. With that in mind, The Consumer Report suggests searching for “title insurance save 35%” in order to compare rates, which will lead you to companies such as Entitle Direct Insurance.
You will want to let the lender know that you will be looking for your own Title Insurance. Before you choose a title insurance company to be sure to visit Demotech – a company that provides Financial Stability Ratings. This helps you pick a financially strong insurance company. We don’t want your insurance company to run out of money during the lifetime of your mortgage.
Shopping for Lenders
Another way to save money is to utilize Good Faith Estimate forms in order to compare closing cost estimates provided by lenders. This is where you can gain some bargaining power. You will be able to get estimates on closing costs from multiple lenders and begin to negotiate for better deals. Just FYI for tips on negotiating, we recommend Never Split the Difference – an amazing book on negotiating tactics.
Factors to Consider when choosing a lender:
- Lender Fees
- Third Party Fees
- Loan Structure (specifically the points on your loan)
- Fixed Fees
When purchasing a home and choosing to buy your own title insurance be sure to know your deadlines. You are going to get a ton of paperwork and this can get confusing quickly. Missing deadlines will cost you money.