glancing through real estate listings to the moment you sign the last piece of closing paperwork, the process of buying a house typically takes months. Much needs to happen during that time: showings, making an offer, completing a loan application, appraisal, and inspection. It’s enough to overwhelm even the most organized buyer.
Buying a home isn’t cheap – and not just because your house is likely to be the largest single purchase you ever make. Closing on a home is a costly endeavor too. According to Zillow, U.S. closing costs typically range from 2% to 5% of the sale price. A Bankrate survey found that combined mortgage closing, origination, and third-party costs – which can all be lumped together under the “closing cost” umbrella – average $5,078. In the survey, Texas reports the highest mortgage closing costs, while Nevada has the lowest.
The good news is that closing costs aren’t solely determined by geography, nor completely set in stone from the moment you choose a lender. It’s possible to comparison shop for some individual components of your total closing bill, such as title insurance, and to meaningfully reduce the cost of items that you aren’t permitted to shop around for. At the same time, you’re responsible for paying some items up front at closing, before they’re technically due. These are known as “prepaids,” and they typically include escrow expenses such as private mortgage insurance, homeowners insurance (hazard insurance), and property taxes. You need to bring sufficient funds to closing to cover your prepaids.
Key Definitions and Terms
Before getting into the nitty-gritty aspects of residential real estate closing costs, some definitions are in order:
Loan Estimate: This is a plain-language document that your lender is legally required to provide you prior to closing. The loan estimate outlines all your closing items with best-guess estimates or estimated ranges for their actual costs. It also clearly indicates which items you’re permitted to shop for.
Settlement Statement: This is the official summary statement of the real estate transaction, typically presented at least one business day prior to closing. Also known as a HUD-1 statement, the settlement statement includes all closing costs, plus the purchase price, down payment amount, and broker commissions.
Paid Outside Closing: This term, usually abbreviated “P.O.C.” on the settlement statement, indicates that the buyer paid the cost sometime prior to closing. Certain costs, including the first year’s homeowners insurance premiums and home inspection fees, are frequently paid outside closing. There is some ambiguity as to whether fees paid outside closing can properly be termed “closing costs,” but this post does not distinguish between costs paid outside closing and costs paid at closing.
Earnest Money: When you put an offer in on a house, it’s customary to include an “earnest money” check to underscore your intent to actually purchase the property. Earnest money is typically a small percentage (less than 1%, often 0.5%) of the home’s list (or your offer) price. If the seller accepts the offer, the earnest money is deposited into an escrow account. If the transaction closes without incident, the earnest money is applied toward closing costs, reducing your out-of-pocket expense on closing day. If the transaction falls through, you usually – but not always – get the earnest money back.
Commissions: Broker commissions aren’t considered closing costs, even though they account for a significant chunk of the transaction value – usually 6%, split evenly between buyers’ and sellers’ agents. Commissions are taken out of the sale price before the seller receives the proceeds, so buyers aren’t ultimately responsible for paying them.
There are numerous closing items your loan estimate is likely to outline, as well as some general tips to reduce your closing costs individually or in the aggregate. While this is meant as a comprehensive guide, your closing items and cost ranges could vary significantly from what’s described below, so it’s best to speak with a real estate agentor real estate attorney in your area before diving head-first into the buying process.
Closing Costs You Can Shop Around For After Choosing a Lender
Before you choose your lender, you theoretically have total control over your closing costs. Your choice of lender is therefore of great consequence – though, as your loan’s interest rate and terms are likely to impact your home’s final cost more than your closing costs, you shouldn’t choose a lender offering less-favorable rates or terms simply because they don’t charge as much for a home appraisal or happily waive the origination credit check fee.
These are the common closing costs that you can shop for after choosing your lender. Many are listed in Section C on page two of your loan estimate:
Home Inspection. While many lenders don’t absolutely require buyers to get ahome inspection, they are strongly encouraged. A home inspection is your best shot at catching a potentially costly defect or safety issue that wasn’t apparent during prior walk-throughs. If your inspection catches a serious problem (or multiple problems), you can reduce your offer price, amend your offer to compel the seller to fix the issue, or walk away entirely. The home inspection industry is fairly competitive, so there should be numerous inspectors working in your area. Find candidates by asking your real estate agent (remembering that agents often have friends in the inspection business and thus aren’t guaranteed to be impartial), or by checking with an industry association such as the American Society of Home Inspectors. Look at online reviews and testimonials for each, check references, and interview finalists if you’re on the fence about who to select. Be sensitive to cost, but remember that a lower price sometimes means lower quality. Make your final decision based on the optimal combination of cost and experience. Cost: $300 to $500 for an average-sized house (1,500 to 2,500 square feet); more for larger homes. Payment is usually made directly with the inspector on the inspection date.
Title Search. Title searches, conducted either by title companies or real estate attorneys, ensure that sellers are legally able to sell their properties. Title searches review events throughout the property’s history, from its initial platting or subdivision to the present, to identify liens, covenants, easements, and other items that affect the seller’s interest in the property or its use to the buyer going forward. Though title search costs are typically bundled into title insurance costs, they’re itemized on the loan estimate and closing statement. The best way to reduce them is to shop around for title insurance companies or attorneys, or negotiate directly with these service providers. Cost: $150 to $400, but can be higher if the property’s history is more complex.
Title Insurance. There are two main types of title insurance: lender (loan) and buyer policies. Buyers customarily pay for both. Both cover the cost of fixing any defects uncovered by the initial title search. Both also protect lenders’ and buyers’ interests in the property in the event that title defects, covenants, or third-party claims are found to exist after the transaction closes. Lender and buyer policies remain in force until the respective parties no longer have interests in the property – usually when the home is sold or, for lender policies, the mortgage is fully paid off. Lender title insurance is mandatory, while buyer title insurance is highly recommended – without it, buyers have no financial recourse in the admittedly rare event that a legitimate claim arises against the property. Lenders procure their own policies from preferred insurers. Title companies, real estate attorneys, and lenders recommend buyers’ insurers, frequently the same company that insures the lender’s policy. However, buyers are free to shop around for their own policies – in fact, it’s illegal to compel a buyer to use a particular insurer. The American Land Title Association is a good comparison-shopping resource. Cost: One-time title insurance premiums range from as little as $500 to more than $2,000 total for lender and buyer policies, depending on geography and the complexity of the property’s history. $1,000 is a good ballpark estimate.
Settlement Fee. The settlement fee pays for your title company’s or escrow agent’s services on closing day. The best way to reduce this fee is to shop around for title companies or agents, though settlement fees may not vary much within markets. Cost: Typically $2 per $1,000 in sale price (e.g., $400 on a $200,000 house), but can be higher.
Closing Costs You Can’t Shop Around For
Once you choose your lender, you cede some control over your closing costs. These are the common closing costs you typically can’t change after choosing your lender. Many are listed in Section B on page two of your loan estimate:
Loan Application Fee. Sometimes known as a “processing fee,” the application fee covers the cost of the initial loan application processing. Ask your lender directly whether its application fee includes the cost of a credit check. If it does, make sure you’re not charged separately for your credit report. Also, the application fee is sometimes bundled into the origination fee and not listed separately, so don’t be surprised if you don’t see it – just know that your origination fees will likely be higher as a result. Cost: $200 to $500.
Loan Origination Fee. The loan origination fee covers the lender’s costs (and then some) during the underwriting process. It’s sometimes indicated as a single line item, and other times broken into several pieces (including application and processing). Most loans have origination fees, though some lenders offer “no cost” loans that make up for a lack of origination fees with higher interest rates. Cost: Usually 0.5% to 1.5% of the home’s purchase price. Fees are typically expressed as “points,” with one point equivalent to 1% of the purchase price.
Loan Discount Fee. Lenders sometimes offer to reduce interest rates slightly in exchange for a sizable one-time payment – known as the loan discount fee – which is also expressed as “points.” If your lender offers a discount fee, carefully calculate whether it makes sense to take the deal, as the upfront payment amount could be higher than what you’d save over the life of the loan. Cost: Usually 0.5% to 4% of the loan value. As with the origination fee, one point equals 1% of the loan value. Keep in mind that one point does not necessarily reduce your interest rate by 1% – the difference is usually much more modest.
Credit Report. Lenders often require buyers to pay for any credit reports ordered during the origination process. However, they’re sometimes willing to relent when buyers confidently and forcefully ask them to knock off their credit report fees. Cost: $20 to $60, depending on report counts and sources.
Flood Certification and Monitoring. Flood certification fees cover the cost of pulling up and reviewing your area’s flood hazard maps to determine whether your home lies within a flood-prone area. Lenders sometimes charge an additional flood monitoring fee that covers the cost of maintaining an accurate measure of flood risk over time, as flood hazard maps can change frequently. Flood certification is critical if you require flood insurance, so this fee is well worth paying. Cost: Approximately $20 for flood certification; up to $50 for flood monitoring.
Lender Appraisal. Lenders always order appraisals at some point during the underwriting process, usually early on. Appraisals are typically conducted by outside appraisers, not bank employees. The primary purpose is to ensure that homes’ values meet or exceed buyers’ offer prices. As lenders are not willing to lend more than the value of the home, and are sometimes reluctant to lend at higher than expected loan-to-value ratios, a low appraisal can be a serious roadblock to a deal. For the buyer, the upside to a low appraisal is that it can compel the seller to agree to a lower price. However, the seller may also take issue with a low appraisal and threaten to walk away from the deal. It’s not uncommon to order a second opinion (from a different appraiser) following a low appraisal. Cost: $250 to $500; roughly double if a second appraisal is required.
Broker Fee. Buyers’ agent commissions come from seller proceeds, so you don’t have to worry about paying your the lion’s share of your agent’s compensation directly. However, agents employed by brokerages or realty groups are usually required to collect a service or referral fee on their employer’s behalf. While you can’t shop around to reduce your broker fee after choosing a lender, you cancontrol or eliminate it by working with an agency that charges lower broker fees, or none at all. Cost: Widely variable – from token sums less than $100, to more than $500.
Recording Fee. City or county governments typically charge to record real estate transfers in the public record, an essential step in any real estate transaction.Cost: Widely variable, depending on local customs, property values, and other factors; $100 is a typical average, but can be much higher.
Transfer Taxes. City, county, and possibly state governments charge transfer taxes on real estate transactions that occur within their jurisdictions, usually as a function of local property values and local zoning. In some cases, buyers are required to purchase tax stamps in a separate line item on their settlement statements. Like property taxes, transfer taxes are highly variable. Cost: Widely variable, depending on local customs and property values, ranging anywhere from several hundred to several thousand dollars.
You need to pay these costs in advance at closing. Note that you may also be required to deposit an upfront escrow buffer to cover unexpected upward adjustments in tax, insurance, and HOA expenses. The buffer can either be built into your total prepaids or broken out as a separate line item.
First Month’s Interest. Lenders usually require advance payment of mortgage interest scheduled to accrue between closing and the first full mortgage payment (principal and interest) due date. Cost: Up to one month’s mortgage interest, depending on the closing date (less when closing is later in the month).
Homeowners Insurance Premium. Lenders virtually always require proof of homeowners insurance prior to closing. Once you choose a policy, you can reduce cost by choosing a higher deductible. If you already have an insurance policy, such as auto insurance, consider bundling your new home insurance policy with the same insurer – a move that can knock hundreds of dollars off your combined annual premium, relative to what you’d pay on two separate policies. Generally, you need to pay your first year’s premium at, or prior to, closing. If your home requires flood, earthquake, or other special hazard insurance, you likely need to pay your first year’s premiums for those policies up front as well. Cost: Widely variable, depending on factors such as geography, home construction and age, deductible, and property value. According to the Insurance Information Institute, the average annual U.S. homeowners insurance premium in 2013 was $1,096, ranging from a low of $561 in Idaho to $2,115 in Florida.