What are closing costs?
“Closing costs” is a broad term referring to a laundry list of transaction fees involved in the transfer of a real estate asset from one owner to another.
Whether or not you get a mortgage to purchase your home, you will have to pay some closing costs. While what's included varies by location, most often closing costs include:
- Transfer taxes
- Deed recordation fees
- Lender fees (if applicable)
- Title or settlement company administrative fees
- Funds wiring charges
- Attorney fees
- Utility escrows for water
- Homeowner's association fees
How do you calculate closing costs?
It's not “one size fits all” with closing costs. There are lots of reasons your actual closing costs may be higher or lower than anticipated. And it's nearly impossible to calculate the exact cost until a few days prior to settlement.
You can, however, come up with a reasonable estimate by plugging some key numbers into an online closing cost calculator. Input your purchase price, down payment, and interest rate, for example. Your real estate agent, lender, or title company can also provide a fairly accurate estimate as well.
Your mortgage lender provides you with a preliminary closing disclosure, called a Loan Estimate. This details the anticipated closing costs. Federal law requires that your lender send you a revised closing disclosure three days prior to settlement. Always check to ensure the numbers on the preliminary and revised closing documents are in line, and no unexplained costs have crept in.
Seven ways to reduce your closing costs
1. Apply for grants and loans
If you are a first-time homebuyer, you may be eligible for federal, state, and local government grants. I live in Maryland, and the Maryland Department of Housing and Community Development offers assistance to both homebuyers and homeowners. For homebuyers, it offers mortgages and down payment assistance. To homeowners, it provides loans and grants for home repairs and energy efficiency improvements.
For example, Baltimore County's Settlement Expense Loan Program (SELP) provides up to $10,000 to income-eligible purchasers. You can use this money to help pay closing costs required in the purchase of an existing home within the designated Community Conservation Areas of Baltimore County. The assistance comes in the form of a deferred loan that is forgivable if the homeowner occupies the property as their principal residence for 15 years.
There are many local and state programs available. Do a local internet search to find programs offered in your state and county. But do it before you go house shopping. Some programs require applicants to take a class and complete paperwork before putting a purchase offer contract on a home.
2. Ask for seller help with closing costs
Sometimes the seller is willing to contribute to the buyer's closing costs to get the deal done. I did this a few years ago when I was selling a property I flipped. Looking for a quick sale, I intentionally priced the home below market value and received an offer from a buyer who needed help to purchase it.
The home appraised for $10,000 over my listing price. The buyer increased the offer price $10,000, and I provided that amount as a seller credit for closing costs. I got the price I wanted, and in essence, she was able to finance her closing costs as part of her loan.
Of course, this type of strategy typically works only in a buyer's market where there are many homes listed to sell, and sellers are incentivized to give a little more to entice buyers to choose their home amid the market competition. Don't expect the same in a hot market where inventory is scarce, and sellers are getting multiple purchase offers.
3. Comparison shop
As you can see, you shell out a substantial amount of money for closing costs. So you have a good reason to shop around.
Fees vary by lender. So ask for a closing cost estimate as part of your due diligence when evaluating your lender choices. Some mortgage lenders offer help with closing costs. And if you're already moving forward with a lender whose costs are high, ask your lender to match low closing costs offered elsewhere.
Shop around for lower-cost services too. You don't have to go with the provider your lender suggests. Try to find a lower price elsewhere. Do some research, make some calls, and see if you can find less expensive options.
Make sure you know what you're getting charged for. Also, check that you need or want those services. There are some optional charges — such as a pest inspection or property location survey — that you might not need and want to skip.
4. Check if you can save on title insurance
I jokingly refer to title insurance as a “necessary evil” when buying a house. Title insurance protects lenders and homebuyers from financial loss due to defects in a property title. These defects include outstanding lawsuits and liens that were not uncovered prior to ownership transfer at closing.
- If you take out a mortgage loan when you buy your property, your lender will require a loan title insurance policy. This protects the lender's interest in your property until you refinance your loan or pay it off. In many cases, the homebuyer actually pays the cost of the lender's policy.
- You'll also want to purchase an owner's title insurance policy. This ensures your ownership rights to the property. Even though you pay for this policy only once, your coverage lasts as long as you own your home. This policy costs an average of $4.50 per thousand dollars. So, you pay $1,125 to purchase a title insurance policy on a $250,000 home.
- Here's where you may be able to save. Most insurers offer a “reissue rate.” If the seller provides you with the insurance policy, they purchased when they bought the home, and you may be able to essentially renew that policy. Reissue rates are much lower, typically running around $2.50 per thousand, a savings of $500 on a $250,000 home purchase.
- Don't be tempted to forgo purchasing a title insurance policy. While coverage seems quite expensive, the risk of not purchasing title insurance could be far more expensive if a lien is uncovered after you've moved into your new home.
5. Schedule your closing at the end of the month
If you take out a loan to buy your home, save money by scheduling your closing at the end of the month. You pay interest on the loan beginning on settlement day. As part of closing costs, you pay the amount of interest that will accrue between closing and your first mortgage payment. So if your payment is the first of each month, you save by scheduling settlement day toward the end of the month.
Let's say, for example, you close on December 4. You pay 27 days' worth of your monthly interest expense at closing. But if you close on December 29, you pay for only two days' of monthly interest. It's a simple way to reduce your cash outlay at closing.
To find out how much you can save, multiply your loan amount by the interest rate. This figures your annual interest expense. Then divide that by 365 to calculate your daily interest charge. And multiply that figure by the days left in the month to see how much you can reduce your closing costs.
If you're borrowing $250,000 at 4%, you pay $10,000 in the interest the first year. That's $27.40 per day. Closing on December 4 costs you $739.73 at settlement. But closing on December 29 costs you only $54.79 in interest.
6. Don't buy “discount” points
Your lender may offer you the option to purchase “discount,” or mortgage, points, which are fees paid to the mortgage lender in exchange for a lower interest rate. One point equals 1% of the total amount being borrowed, and the cost is added to the closing costs. But this one point does not lower your interest rate by 1%. It lowers it by maybe 0.25%, for example.
If you're buying in a low interest-rate environment — like the one we've enjoyed for the past few years — it probably makes no sense to pay extra to buy an even lower interest rate. And not buying points keeps your closing costs down.
Another reason to forgo buying points is if you're uncertain how long you intend to stay in your home. For each point you buy, you must stay in the home longer to break even on the upfront cost.
7. Wrap the closing costs into your loan amount
If your lender allows it, you could roll your closing costs into your loan balance. You simply borrow more to cover the cost of closing. Or you might get “free” closing costs, paid by your lender, in exchange for a higher interest rate on your loan.
Both of these “no-cost” options — Financing your closing costs or having your lender cover the fees in exchange for a higher interest rate — can be helpful if you're short on cash now. Just keep in mind that either option will mean larger mortgage payments for the entire duration of your loan. And this likely ends up costing you more in the long run.
What are the average closing costs on a house?
Typically, as a homebuyer, you pay between 4% and 5% of the home's purchase price in closing costs. So for a $250,000 home purchase, the costs probably run between $10,000 and $12,500. This disparity in closing costs exists because different states and local governments have different legal requirements — and fees — for the sale of a home.
Who pays closing costs — buyer or seller?
The answer is both typically pay a portion of the closing costs.
- The buyer bears most of the costs. And that makes sense because much of the cost is related to securing the mortgage loan that the buyer needs to purchase the home. The buyer typically pays 4–5% in closing fees, and the seller pays 1–2%.
- The seller also pays the commissions (not considered a “closing cost”) of both the buyer and seller agents. This typically costs between 5% and 7% of the purchase price.
- Some expenses — fees for a home inspection and appraisal, for example — are paid when the services are actually rendered, before closing. But the bulk of the fees are paid on settlement day. This is when ownership is officially transferred, and you get the keys to your new home.
There are several ways to save on closing costs
In summary, buying a home is a huge financial investment with transaction costs. While taxes and deed recordation fees are inevitable and fixed, there are some ways to reduce your closing costs. Check each option to see which ones work for you. You can probably use more than one way to save!
And for even more saving tips, check out our article on ways to save when buying a home.