What Are Closing Costs: A Complete Guide to Understanding the Fees

Closing costs can be one of the most confusing aspects of the homebuying process.

Whether you’re a first-time homebuyer or an experienced investor, understanding these fees will help you budget more accurately and avoid surprises at the closing table.

In this guide, we’ll break down what closing costs are, the average closing costs and how they vary by location and loan type, and strategies to reduce your costs.

Understanding closing costs is crucial for budgeting and managing expenses during the homebuying process.

What Are Closing Costs?

Closing costs are the fees and expenses associated with finalizing a real estate transaction. These costs cover a wide range of services, from loan origination to title insurance.

Both buyers and sellers are responsible for paying different portions of closing costs, and the exact amount can vary depending on location, the property’s value, and the type of loan.

Closing costs typically include:

• Loan origination fees
• Discount points
• Appraisal fees
• Title searches and title insurance
• Taxes and deed recording fees
• Credit report charges
• Homeowners Association (HOA) transfer fees
• Mortgage points: Prepaid interest used to lower the mortgage interest rate

Under federal law, lenders are required to provide buyers with a closing disclosure at least three business days before the scheduled closing date. This document outlines the final closing costs and gives buyers time to review the details.

How Much to Save for Closing Costs?

Closing costs generally range between 3% and 6% of the total purchase price, although this can vary by location and loan type. Conventional loans may have different closing cost requirements compared to other loan types. For example, in 2021, the national average for closing costs was $6,905 when including transfer taxes and $3,860 when excluding them.

Here’s an estimate of what you might pay based on the property price:

• For a $200,000 home, you could expect to pay between $6,000 and $12,000 in closing costs.
• For a $400,000 home, the closing costs might range from $12,000 to $24,000.

While the buyer pays most closing costs, sellers are also responsible for some, such as real estate agent commissions and transfer taxes. In certain situations, buyers can negotiate for the seller to cover part of their closing costs through seller concessions.

Who pays closing costs?

In a typical real estate transaction, buyers pay the bulk of the closing costs, but sellers cover certain fees as well.

Here’s a breakdown of the most common expenses for both parties:

Buyer’s Closing Costs:

• Loan origination fees: Typically 0.5% to 1% of the loan amount, charged by the lender for processing the mortgage.
• Appraisal fees: $300-$600 to assess the market value of the property.
• Title insurance: protects against ownership disputes; costs range from 0.5% to 1% of the property value.
• Prepaid property taxes: vary depending on local tax rates. Property tax is calculated based on the home value and location, funding local public services such as schools and infrastructure. Buyers should estimate future property tax obligations based on previous payments by sellers.

Seller’s closing costs:

• Real estate agent commissions: Around 5% to 6% of the home’s sale price, typically split between the buyer's and seller’s agents.
• Transfer taxes: These vary by state but usually amount to a small percentage of the sale price.

In some cases, sellers might agree to cover part of the buyer’s closing costs to facilitate a sale. This is particularly common in a buyer’s market, where properties may sit on the market for an extended period.

What’s Included in Closing Costs?

Closing costs encompass a wide array of fees related to both the property and the mortgage loan. Here's a breakdown of the typical costs:

• Application Fee: Charged by the lender to process your mortgage application.
• Appraisal Fee: Covers the cost of a professional evaluation of the property’s value.
• Title Search and Title Insurance: Ensures that the property’s title is clear of any legal claims or disputes.
• Origination Fee: A fee charged by the lender to process your loan, typically 0.5% to 1% of the loan amount.
• Underwriting Fee: Pays for the lender’s evaluation of your creditworthiness.
• Credit Check Fee: Covers the cost of pulling your credit report to assess your ability to repay the loan.
• Prepaid Property Taxes and Insurance: These may be required upfront and placed in escrow to ensure timely payments in the future.
• HOA Transfer Fee: Required if the property is part of a homeowners association.

Understanding each of these fees can help you avoid surprises on closing day. Some of these costs, such as discount points, are optional and can help you reduce your mortgage’s interest rate over time.

Mortgage Closing Costs

Mortgage closing costs are the fees associated with the processing and finalization of a mortgage loan. These costs can vary widely depending on the type of loan, lender, and location. On average, mortgage closing costs range from 2% to 6% of the loan amount. For instance, if you’re taking out a $300,000 mortgage, you could expect to pay between $6,000 and $18,000 in closing costs. These fees cover various services, including loan origination, appraisal, and title insurance, ensuring that all aspects of the mortgage process are handled professionally and legally.

Private Mortgage Insurance (PMI)

Private Mortgage Insurance (PMI) is a type of insurance that lenders require borrowers to purchase when they put down less than 20% of the purchase price as a down payment. PMI protects the lender in case the borrower defaults on the loan. The cost of PMI varies depending on the lender, loan amount, and credit score, but it typically ranges from 0.3% to 1.5% of the original loan amount annually. For example, if your loan amount is $250,000, your PMI could cost between $750 and $3,750 per year. While PMI adds to your monthly mortgage payment, it enables you to buy a home with a smaller down payment.

How to calculate your closing costs

Calculating closing costs ahead of time can help you avoid surprises and prepare a more accurate budget. While the exact amount varies depending on your location and loan, here are a few ways to estimate your costs:

1. Loan Estimate: After applying for a mortgage, you’ll receive a loan estimate from your lender. This document provides an itemized list of closing costs, which can give you a fairly accurate idea of how much you’ll owe.
2. Closing Cost Calculators: Online tools like closing cost calculators allow you to input information such as the property’s price, loan amount, and your location to get a rough estimate of closing costs. These calculators are useful for early planning but should be used as a supplement to your loan estimate.
3. Ask Your Real Estate Agent: A local real estate agent familiar with the market can also provide insights into typical closing costs based on recent transactions. They may be able to offer you a more personalized estimate.

Closing Cost Estimates and Changes

Closing cost estimates are provided by lenders to borrowers before closing, outlining the expected costs associated with the loan. However, it’s important to note that closing costs can change between the estimate date and the settlement date. Borrowers should review their loan estimate carefully and ask questions if they notice any changes or unexpected fees. Lenders are required to provide a revised loan estimate if the closing costs change by more than 10%. Staying informed and proactive can help you avoid surprises and ensure you understand all the costs involved in your mortgage.

Reducing your closing costs

There are several ways you can reduce your closing costs and save money during the homebuying process. Here are some strategies that can help:

1. Negotiate with the Seller: In many cases, you can negotiate with the seller to cover some of your closing costs, especially if the property has been on the market for a while. Seller concessions can range from covering part of the loan origination fee to paying for the title insurance.
2. Shop for Lenders: Not all lenders charge the same fees, so it’s worth shopping around for the best deal. Comparing loan offers can save you hundreds or even thousands of dollars. Be sure to ask about discount points and whether they’re required as part of the loan.
3. First-Time Homebuyer Programs: Many states and cities offer down payment assistance programs or grants for first-time homebuyers that can help cover closing costs. Research what’s available in your area to see if you qualify.
4. No-Closing-Cost Mortgages: Some lenders offer no-closing-cost loans where the fees are either rolled into the loan balance or covered by the lender in exchange for a slightly higher interest rate. This can reduce your upfront costs but may result in higher long-term payments.

Breaking Down Examples of Closing Costs

Closing costs encompass various fees related to both the property and the loan. Here’s a breakdown of the most common closing costs you'll encounter:

• Loan Origination Fee: This fee is charged by the lender for processing the loan and is typically around 0.5% to 1% of the loan amount. It compensates the lender for the time and resources spent creating your mortgage.
• Appraisal Fee: The appraisal fee covers the cost of having a professional appraiser evaluate the market value of the property. Appraisals are required to ensure the home is worth the loan amount. You can expect this fee to range from $300 to $600, depending on the location and property type.
• Title Search: A title search is performed to confirm the property’s ownership history and to check for any outstanding liens, judgments, or other legal claims that might prevent the sale. The fee for a title search typically ranges from $75 to $200.
• Title Insurance: Title insurance protects both the lender and the buyer from any claims or disputes over property ownership. This insurance is usually a one-time fee paid at closing, and the cost ranges from 0.5% to 1% of the loan amount. There are two types of title insurance—lender's title insurance (required) and owner’s title insurance (optional but recommended).
• Credit Check Fee: The lender will pull your credit report to evaluate your creditworthiness and assess the risk of lending to you. This fee is relatively small, usually ranging between $30 and $50.
• Prepaid Property Taxes: Buyers may need to pay prorated property taxes at closing. These taxes are based on the time period in which you’ll own the home, from the closing date until the next tax payment is due. The amount will vary depending on local tax rates and the property's assessed value.
• Homeowners Insurance: Most lenders require the buyer to prepay the first year of homeowners insurance at closing. Homeowners insurance protects the property against potential damage from natural disasters, theft, or other incidents. The cost of this insurance will depend on the value of the home and the location, but it’s typically paid upfront and placed in escrow.
• Escrow Fees: These fees are collected at closing to set up an escrow account, which will be used to pay future property taxes and insurance premiums. The lender typically requires 2 to 3 months' worth of payments to be deposited into the escrow account upfront.

Closing Costs and the Homebuying Process

Understanding closing costs is essential to ensuring a smooth homebuying process. By estimating these costs early, you can create a budget that accounts for them and avoid unexpected expenses. Work with your real estate agent and lender to get a clear idea of what you’ll need to pay.

• Loan Estimate: Once you apply for a mortgage, your lender will provide you with a loan estimate. This document outlines the projected closing costs and terms of your loan.
• Closing Disclosure: Before the closing day, you will receive a Closing Disclosure. This is the final breakdown of your closing costs, which you should review carefully to ensure accuracy.

Navigating closing costs

Closing costs are a necessary part of buying a home, but they don’t have to be overwhelming. By understanding what these costs cover, who pays them, and how to reduce them, you can approach the home buying process with more confidence.

Review your loan estimate and closing disclosure carefully, ask your lender questions about fees, and consider negotiating with the seller or shopping for lenders to minimize your expenses.

With the right preparation, you’ll be ready to close on your new home without any surprises.

Closing Cost FAQs

What are closing costs?

Closing costs are fees associated with the processing and finalization of a mortgage loan.

How much are closing costs?

Closing costs typically range from 2% to 6% of the loan amount.

What is included in closing costs?

Closing costs include fees such as origination fees, title insurance, appraisal fees, and mortgage insurance premiums.

Can I negotiate closing costs?

Yes, some closing costs may be negotiable. Borrowers should review their loan estimate carefully and ask questions if they notice any changes or unexpected fees.

Who pays closing costs?

Borrowers typically pay most closing costs, but sellers may agree to pay some or all of the closing costs as part of the sale.

Can I roll closing costs into my mortgage?

Yes, lenders may offer to roll closing costs into the mortgage, but this means borrowers will owe more on the loan and have to pay interest on those closing costs over time.

What is the difference between closing costs and down payment?

Closing costs are fees associated with the processing and finalization of a mortgage loan, while the down payment is the amount of money borrowers pay upfront to purchase a home.

How much should I save for closing costs?

Borrowers should aim to save 2% to 6% of the loan amount for closing costs, depending on the type of loan and lender.

What is the average closing cost for a home?

The average closing cost for a home varies depending on the location and type of loan, but it typically ranges from 2% to 6% of the loan amount.

Can I avoid paying closing costs?

No, closing costs are a necessary part of the mortgage process. However, borrowers can try to negotiate with the lender or seller to reduce the costs.

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