Understanding Home Buyer Closing Costs

by Rocky Lall on December 31, 2010

If you are considering buying a home, then you may have heard the word “closing costs.” So what are closing costs and how much will it cost you? 

In addition to the price of the home, there are additional costs that buyers must pay, which are known as buyer closing costs.  These costs are charges by companies who provide required services during the home buying process, which is called the escrow period.  In total, these charges can run about 3% of the cost of the home if you are buying a home in California.  For example, if you are buying a home priced at $300,000, the closing costs can run about $9,000. So in addition to the down payment you are putting on your home loan, you should have another $9,000 available to pay buyer closing costs on a $300,000 home.

Many buyers do not have the funds available to both put a down payment on a loan and pay these closing costs.  In this situation, the buyer may request that the seller pay for the buyer’s closing costs.  The likelihood that a seller will agree to pay a buyer’s closing costs depends on several factors.  For example, if the seller receives multiple offers and other bidders do not ask the seller to pay buyer closing costs, then the chance of getting the seller to pay buyer closing costs is low.  The chances increase if you are the only person making an offer on a house, and if your offer price is in a reasonable range.

Listed below are some common charges that buyers pay in closing costs.  However, for any given home purchase, there may be charges that are not listed below.  Buyers should request from their lender a Good Faith Estimate (GFE), which itemizes the costs of the loan and estimates closing costs.  Closing cost charges for home buyers are categorized into seven categories: Real Estate Commissions, Items Payable in Connection with the Loan, Items Required by Lender to be Paid in Advance, Reserves Deposited with the Lender, Title and Escrow Company Charges, Government Recording and Transfer Charges, and Adjustments for Items Paid by the Seller in Advance.

Real Estate Commissions.

  • In most real estate transactions in California, the seller pays for the cost of real estate agents so there are usually no charges to a buyer.

  Items Payable in Connection with Loan

  • Lender origination charge.  A fee charged by a lender to process a loan for a borrower. The fee is often represented as a percentage of the loan, which is referred to as a “point” (1 point origination fee is equal to 1% of the loan amount). For example, on a $300,000 loan, 1 point would equal a fee of $3,000; two points would equal a fee of $6,000 dollars, and so on.  The amount of the origination fee can vary dramatically between lenders so it’s best to shop around.  Many borrowers with a strong credit history, good income, minimal debt, and a large loan down payment often do not pay any origination fees.
  • Lender charge for specific interest rate chosen.  There may be times when a borrower wants a lower interest rate than they qualify for given their credit history and financial situation. In these situations, some lenders will offer the borrower a lower interest rate in exchange for paying more fees up front. For example, let’s say that a borrower qualifies for a 5.4% interest rate based on their income, debt, and credit history. However, the buyer would like to get a 5% interest rate. In this example, some lenders may give the borrower the 5% interest rate, if the borrower agrees to pay 1% of the loan amount up front. This process is known as “buying down the rate.”  The fee a lender charges to lower a borrower’s interest rate varies from lender to lender, so it’s wise to shop around to get the best deal.
  • Adjusted origination charges.  A lender may add or subtract other fees based on the borrower’s financial situation.  These additional fees can vary dramatically from one lender to the next, so it’s best to shop around.
  • Appraisal fee.  A fee charged by an independent appraiser to evaluate the value of the property being purchased.  Lenders use this information to determine if value of a property is sufficient to justify the loan.
  • Credit report fee.  A fee charged by a lender to obtain a borrower’s credit report. 
  • Tax service fee.  A fee charged by a lender to set up or maintain a property tax escrow account.
  • Flood certification fee.  A fee charged by a lender to determine if the property being purchased is located in a flood zone.

Items Required by Lender to be Paid in Advance

  • Daily interest rate charge.  Most lenders usually charge interest due on a loan from the day it closes escrow to the end of that month. For example, if your escrow closes on March 15th, most lenders will charge, as part of the buyer’s closings costs, the interest due on the loan from March 15th to March 31st.  The good news for borrowers is that the first payment due on the mortgage loan normally skips a month.  For example, if you closed escrow on March 15th, most lenders would not require your first mortgage payment until May 1st.
  • Mortgage insurance premium.  A borrower who puts less than 20% down payment on a home loan normally has to pay a mortgage insurance (MI) fee.  Mortgage Insurance is a product required by a lender and is paid for by the borrower. MI protects the lender in case the borrower defaults on a loan.  If a borrower defaults on a loan, MI will step-in and reimburse the lender for some of the losses the lender incurs as a result of the borrower’s default.  Depending on the type of loan, mortgage insurance fees can include both an upfront fee that is paid by the buyer as part of the closing costs, as well as a monthly recurring fee (which is discussed below). For example, if a borrower is using an FHA loan, the upfront mortgage insurance fee is 2.25% of the loan amount as of April 2010.
  • Homeowner’s insurance.  Also called hazard insurance, homeowner’s insurance covers a home for perils such as fire, vandalism, and other damages to a home.  Many lenders require that the first year’s premium for homeowner’s insurance is paid upfront as part of the buyer’s closing costs.

Reserves Deposited with Lender. Most lenders require that an escrow account be established to collect funds on a monthly basis to pay for subsequent year’s bills for homeowner’s insurance, mortgage insurance, and property taxes.  While each of the accounts described below are usually separate accounts, most borrowers make one combined mortgage payment to their lender, and the lender allocates the funds as required.

  • Homeowner’s insurance.  As part of the buyer’s closing costs, many lenders require that a borrower deposit into an escrow account several months worth of insurance premiums to get the escrow account started.  The account accumulates funds and pays the homeowner’s insurance when the premium is due.
  • Mortgage insurance.  In addition to the upfront fee described above, most mortgage insurance companies require a monthly fee.  This insurance covers the lender in case the borrower defaults on making mortgage payments.
  • Property taxes.  Most lenders require that borrowers contribute three months of property taxes into an escrow account to get that account started.  Then each month, a portion of the mortgage payment is allocated to pay the following year’s property taxes.  Using this method, this tax account has sufficient funds to pay the property tax bill when it becomes due.

Title Company and Escrow Company Charges

  • Title insurance.  Required by most lenders, title insurance covers lenders and buyers against problems in the ownership history of a property (called title defects) that were not revealed during a title search.  There is a separate policy that covers the lender’s interest and the buyer’s interests.  All title policies have exceptions to coverage.
  • Escrow settlement or closing fee. The Escrow Company handles the buyer’s deposit, processes documents for the buyer, seller and lender, and ensures that a property is transferred from the seller to the buyer. The Escrow Company is an independent party in the transaction and charges a fee for their services.

Government Recording and Transfer Charges

  • Government recording charges.  Fees charged by local government agencies to process the change of ownership documents from the seller to the buyer.
  • Deed recordation. A fee charged by a local government agency to acknowledge receipt of ownership change from a seller to a buyer. 
  • Transfer taxes.  Taxes imposed by government agencies for selling or buying real estate.
  • City/County tax/stamps.  Fees charged by local government agencies for transferring property from a seller to a buyer.
  • State tax/stamps. Fees charged by a State to process change of ownership documents in real estate transactions.

Adjustments for Items Paid by the Seller in Advance.

  • City/County property taxes.  Prorated property taxes due from the buyer starting on the date of ownership to the end the County’s fiscal year.
  • HOA assessments. Prorated HOA dues (if any) due from the buyer from the date of ownership until the end of that month.

The items described above are most common closing costs charges that buyers face.  However, for any given home purchase, there may be other fees that are not listed above.   When a buyer applies for a home loan, the buyer should request, from their lender, a Good Faith Estimate (GFE), which itemizes anticipated closing costs, as well as the lender’s interest rate and fees.

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