Closing Costs Explained: A Guide for Homebuyers

If you’re thinking of buying or selling a house there may be one gloomy aspect that’s haunting you and keeping you up at night: closing costs. For both buyers and sellers, understanding these costs is essential for a smooth and transparent transaction. 

At Education First Federal Credit Union, we believe that knowledge empowers our members, so we’re here to ease your mind and break down payments for both parties involved.

Understanding Closing Costs

First things first, what are closing costs? Closing costs encompass various fees and expenses incurred during the final stages of a real estate transaction. These costs are separate from the down payment and can vary significantly depending on factors like the property's location, purchase price, and the terms of the mortgage. It's crucial to anticipate these expenses to avoid any surprises and adequately budget for them.

Buyer's Perspective: Breaking Down Costs

First, let’s break down what costs a buyer can expect during the home-buying process: 

• Loan Origination Fee
  This fee covers the lender's administrative costs for processing the loan application. Typically, it's around 0.5% to 1% of the loan amount. This fee is essential for the lender to manage the paperwork, background checks, and other procedures involved in evaluating and approving a loan. By paying this fee, borrowers contribute to the operational expenses incurred by the lender during the loan origination process.
  
  
• Appraisal Fee
  Before finalizing a mortgage, lenders require an appraisal to determine the property's market value. An appraisal fee covers the cost of hiring a professional appraiser. By conducting this appraisal, the lender ensures that the property is worth the amount being loaned, providing a level of security for both the borrower and the lender. Without a satisfactory appraisal, the lender may not proceed with the mortgage, making it an important piece of the puzzle in the home buying journey.
  
  
• Home Inspection Fee
  Buyers often opt for a home inspection to identify any potential issues with the property. This fee varies depending on the size and complexity of the home but typically ranges from a few hundred to a thousand dollars. Buyers frequently choose to proceed with a home inspection as part of the home buying process to uncover any underlying issues with the property. The cost of a home inspection can fluctuate based on factors such as the size, age, and intricacy of the home. Typically, these fees can span from a few hundred dollars to upwards of a thousand dollars.
  
  
• Property Survey Fee
  These fees cover the costs of conducting a property survey. A property survey is a geographical description of the boundary of a particular piece of property. A survey will display your property lines, easements, and any other permanent structures such as a swimming pool, concrete slab, or driveway.
  
  
• Title Insurance
  Title insurance is a crucial component in the home buying process that protects both the lender and the buyer against any potential issues with the property's title, such as liens or ownership disputes. The cost is based on the home's purchase price and varies by location. The cost of title insurance is typically calculated based on the purchase price of the home and can fluctuate depending on the specific location of the property. 
  
  
• Escrow Fees
  Escrow accounts play a crucial role in real estate transactions as they hold funds until all conditions of the sale are met. Buyers may need to pay fees for setting up and maintaining the escrow account.
  
  
• Property Taxes and Insurance
  At the time of closing a real estate transaction buyers are often required to prepay property taxes and homeowners insurance for the first year at closing. This upfront payment ensures that these essential expenses are covered in advance, safeguarding the property and providing financial security to the new homeowner. 
  
  
• Recording Fees
  Recording fees are an essential component of closing costs when finalizing a real estate transaction.  These fees cover the cost of recording the deed and other documents with the appropriate government office. Without completing this crucial step, the property transfer cannot be legally recognized. This cost is non-negotiable and is an obligatory part of the closing process, ensuring that all transactions are properly documented and legally binding. Homebuyers should be aware that recording fees vary depending on location and can significantly impact the overall closing costs.

Seller's Perspective: Breaking Down Costs

Closing costs aren’t something that only a buyer can expect, selling a home comes with a variety of costs as well, these include: 

• Real Estate Commission
  Sellers typically pay a commission to both their own agent and the buyer's agent. This commission is typically a percentage of the final sale price, usually around 5% to 6%.
  
  
• Transfer Taxes
  In some areas, sellers are responsible for paying transfer taxes, which are levied by the local government when transferring ownership of a property. 
  
  
• Title Insurance
  While the buyer usually purchases title insurance to protect their interests, sellers may also need to pay for title insurance to ensure a clear title transfer.
  
  
• Outstanding Liens or Judgments
  Before the sale can proceed, sellers must settle any outstanding liens or judgments against the property. These can include unpaid property taxes, HOA dues, or contractor liens.
  
  
• Prorated Property Taxes and HOA Fees
  Sellers may be responsible for reimbursing the buyer for any prepaid property taxes or homeowners association fees.
  
  
• Home Warranty
  Some sellers choose to offer a home warranty to the buyer as an incentive. The cost of the warranty is typically borne by the seller.

Negotiating Closing Costs

Closing costs are anything but cut and dry. Both buyers and sellers have some flexibility when it comes to negotiating closing costs. For example, buyers may be able to negotiate with the seller to cover some of their closing costs, while sellers may offer to cover certain expenses to sweeten the deal. Additionally, some lenders offer programs that allow buyers to roll closing costs into their mortgage, though this may result in a slightly higher interest rate.

Planning Ahead for Closing Costs

To avoid any last-minute financial stress, it's essential for both buyers and sellers to plan ahead for closing costs. This means carefully reviewing the estimated closing costs provided by their lender or real estate agent and ensuring they have enough funds set aside to cover these expenses. It's also wise to shop around for different service providers, such as title companies and home inspectors, to find the best value for their money.

Average Closing Costs

So now you understand what closing costs are and what they consist of, but what is the average total of closing costs home buyers pay? Closing costs typically range from 2% to 5% of the loan amount. On average, closing costs amount to around $5,749 for a $200,000 loan. This is just the average but is dependent on all of the things discussed above. For a better understanding of what you can expect, utilize a closing cost calculator or work with your lender to help calculate what you can expect. 

No Closing Cost Mortgage

A no closing cost mortgage is a type of mortgage where the borrower does not have to pay the closing costs upfront at the time of closing on the loan. Instead, the closing costs are either rolled into the total loan amount or the lender will cover them in exchange for a slightly higher interest rate on the loan. This can be an attractive option for homebuyers who are looking to minimize their out-of-pocket expenses when purchasing a home.

When opting for a no closing cost mortgage, it is important for borrowers to carefully consider the long-term financial implications. While not having to pay closing costs upfront can provide short-term financial relief, it may result in paying more over the life of the loan due to the higher interest rate. Additionally, borrowers should be aware that including closing costs in the loan amount will increase the overall amount borrowed and potentially impact the loan-to-value ratio of the property.

One of the key advantages of a no closing cost mortgage is that it can make homeownership more accessible to individuals who may not have the funds available to cover upfront closing costs. By spreading out the costs over the life of the loan, borrowers can ease the immediate financial burden of buying a home. However, it is essential for borrowers to compare the total cost of a no closing cost mortgage versus a traditional mortgage to determine the most cost-effective option in the long run.

It's important to note that while a no closing cost mortgage can be beneficial in certain situations, it may not be the best choice for everyone. Borrowers should weigh the pros and cons of this option carefully and consider their financial goals and circumstances before committing to a loan. By understanding how a no closing cost mortgage works and its potential impact on overall costs, borrowers can make an informed decision that aligns with their homeownership needs.

If you have any doubts or uncertainties about the closing costs or any other aspect of the home buying process, don't hesitate to reach out. Our team of experienced home loan lenders is here to provide you with the guidance and support you need. Schedule an appointment today to discuss your options, ask any questions you may have, and gain clarity on the steps ahead.