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Most people know that there is a cost to closing on a house. Many first time buyers, however, have no idea what those costs are and how they are determined. "Sticker shock" is not uncommon when the final bill arrives. In fact, closing costs can total between 2% and 5% of the purchase price. This is a substantial amount, and it's important to understand what these closing costs are paying for. The term actually covers a variety of fees and costs, which your lender has to outline in both a loan estimate and a closing disclosure. Here are some of the fees covered:
- The appraisal fee. Your lender will have ordered an appraisal to make sure that your mortgage amount is correct for the value of the appraisal. This is generally $400 to $500 but can be even higher in higher priced homes/mortgages.
- Title fees. These include the title search fee to verify it's a legitimate sale. This protects you from scammers. They also include title insurance to protect your lender if there was an error in the search.
- Application (sometimes referred to as origination, processing, underwriting, junk, etc) fees. There's generally a fee for the loan application due at closing. If you are taking over the seller's mortgage, there may be a fee associated with that too. This fee could range around 1% of the loan amount, which covers all of the costs of preparing the mortgage, including the cost of the credit report, the cost to review all the paperwork, etc.
- Interest. The cost of the interest accrued between the date of settlement and the date of your first payment.
- Insurance. If your down payment is small, you may have to get mortgage insurance and you may have to pay for part of it up front. Insurance fees, called guarantee fees, are also payable on government loans such as FHA or VA loans.
- Discount points. It may be worth paying a bit more up front to get a lower rate. This works out only if you stay in the home for a while, though...
These fees are collected by your lender at closing. Some lenders may allow you to add them to the first monthly payment but that can depend on the loan product you are choosing. In some cases, you can negotiate for the seller to cover some of the costs. You may also face a few other costs at closing:
- HOA fees. If you are moving into a property with a HOA or condo association, they may require you to pay your annual dues up front.
- Property tax. Yes, your first property tax comes due at closing. Usually you have to pay two months' worth.
- Insurance. Your lender will expect you to get homeowners' insurance and, if needed, flood insurance before closing. It's best to find an insurance broker before you sign on the house.
Closing costs can be substantial, but most of them are to protect you or to cover expenses that will come due anyway, such as insurance. Understanding how they work will help you better read the bill. In some cases, you may be able to argue specific line items on your lenders' bill, such as courier fees, but for the most part you will have to pay the bills before taking possession.