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Mortgage closing costs: what they are and why they're important

Closing costs are an important part of buying a home, and they need to be considered when you’re determining your home-buying budget. But what are they, exactly? Even if you’ve bought a house and paid closing costs before, you may not have fully understood what they include.

In this article, you’ll find:

  • What are closing costs?
  • How much are closing costs?
  • Who pays for closing costs?
  • What’s included in closing costs?
  • Lender fees
  • Title fees
  • Prepaid costs

What are closing costs?

It’s important to note that “closing costs” is a catch-all term encompassing a wide variety of fees payable at or before loan closing. These fees vary depending on the type of mortgage you have, where you live, and other factors.

How much are closing costs?

Average closing costs usually add up to two to five percent of the home’s purchase price, which is why it’s important to take them into consideration when buying a house.

Who pays for closing costs?

Sometimes it’s possible to negotiate for the seller to pay some or all the closing costs as part of the offer process. Whether or not a seller agrees to this usually depends on how much leverage you have as the buyer.

What’s included in closing costs?

Broadly speaking, closing costs fall into three groups: fees from the lender, fees related to the titling of the property, and prepaid costs. Not all of these fees are required; the ones included in your closing costs can vary quite a bit by lender, so be aware. Let’s take a look at what you can expect to see in each of these groups.

Lender Fees

Origination fees. These are charged by the lender to account for a number of costs associated with creating the loan. Mortgage origination fees, also known as underwriting fees, are typically one percent of the purchase price of the home.

Application fees. This is a cost from the lender to cover the processing of your mortgage application.

Courier fees. Legal documents are often transported via courier, which results in fees that land in your closing costs. One advantage of signing all documents electronically is that these fees aren’t incurred.

Appraisal fees. The home appraisal determines the fair market value of the house and allows lenders to know if it’s being sold for a price the market will support. The appraisal takes place early in the home-buying process, but the fee for it gets paid at closing. Home appraisal costs generally start at around $450, and can increase from there based on the property’s location, value, and other factors.

Credit check. Lenders need to verify your credit before issuing you a mortgage, and this typically requires a small fee.

Lead-based paint and pest inspection fees. In most cases, a home must be inspected for lead-based paint as well as termites and other destructive pests. You pay for these inspections at closing.

Survey fees. This is a fee charged by a surveyor to review the dimensions of the property you’re buying and provide a report that confirms the boundaries and whether there are any issues related to them, such as a structure that crosses them improperly.

Points.
Most lenders will offer you the option to pay an extra fee that reduces the interest rate on your mortgage. These fees are called points, and each point equals one percent of the home’s purchase price. If you’ve chosen this option, you’ll pay for the points at closing. Paying for points may be helpful if you’re planning on staying in the house for a long time; otherwise, they may not make enough of a difference to be worth it. Use our points calculator to see if paying points on a loan makes sense for you.

Title Fees

Title search costs. These costs account for the title company’s search for any competing claims to the property being sold, as well as any liens.

Title insurance. There are two types of title insurance. One protects the lender in the event there are problems with the title (for example, old back taxes, liens from a home equity loan, lost/flawed records, or erroneous surveys) that weren’t discovered during the title search. Basically, it protects the lender from title-related issues that may be expensive to resolve. The cost for this insurance is usually included in closing costs. The second type of title insurance is to protect you, the buyer. It’s optional, but is widely considered to be worth buying. In most cases, this type of title insurance is paid for by the seller of the property.

Recording fees. This is a charge from your city and/or county government to update their records to reflect your ownership of the home. These fees vary by state, and not all states charge for this service.

Closing fees. This fee accounts for the services of the company that handles your actual closing. In many cases, this is a title company, but sometimes it’s an escrow company or attorney.

Prepaid Costs

Escrow. Buying a home typically involves establishing what’s known as an escrow account. The funds in this account are used to pay your homeowners insurance and property taxes. The benefit of an escrow account is that it’s funded by your monthly mortgage payment, ensuring that these important bills are always paid, and paid on time. Just keep up with your mortgage payments, and the rest is handled for you.

Insurance and taxes.
When you close on your mortgage, you are usually required to pay 14 months’ worth of homeowners’ insurance premiums, plus anywhere from two to six months’ worth of property taxes. These funds will go into your escrow account. However, if your mortgage doesn’t involve an escrow account, you as the buyer a responsible for directly paying the homeowners insurance premiums and property taxes.

Interest prepayment. Buyers are typically required to prepay the mortgage interest that will accrue between the day of closing and the first mortgage payment.

Association fees. If the property being bought is a condo or part of a homeowners’ association and they have an annual fee, you may be required to pay for up to a full year’s fee upfront.

This is not a comprehensive list of all possible items included in closing costs, but these are among the most common. Regardless of your specific homebuying situation, it’s always a good idea to stay in close contact with your real estate agent about the potential closing costs you’re likely to incur. And while many closing costs are fixed, others can be negotiated, or you can lower them by shopping around a bit.

It’s also a good idea to closely review the closing disclosure forms that you’ll receive three business days before you sign all the closing paperwork. It shows you all the final closing costs, interest rate and payment. It’s provided three days before closing to give you time to compare it to the loan estimate the lender provided you shortly after submitting your loan application. Don’t be afraid to ask questions about any of the numbers. The more you understand your closing costs, the better off you’ll be.

To learn more about the homebuying process and mortgage options, contact our mortgage team or stop by your nearest Commerce Bank Branch.

Also See:

How to determine the right mortgage for you

The true cost of home ownership