A lot of time and energy goes into buying a home, and rightly so as it’s the largest financial decision most people will make. But imagine the frustration that would follow if you spent hours planning and narrowing in on a dream home in the perfect neighborhood that meets all your wants only to find out that you can’t afford it when push comes to shove. Starting with a price range can help you make the most of your search but you’ll need to account for closing costs to create a realistic budget.
A catch-all for the fees and services that result from the sale of a home, closing costs are generally about 2 to 5 percent of the home’s value when you’re making a purchase. In other words, you could pay about $4,000 to $10,000 on a $200,000 home. (If you refinance a mortgage later, you might pay about 1 to 2 percent of the loan’s value for refinancing closing costs.)
Sellers often pay more in closing costs than buyers due to the real estate agent’s fees, but buyers have a longer list of expenses. As a buyer, that could be a good thing because there are more items you can negotiate. You might even get the current owners to take on some of the costs for you if they’re eager to sell. However, even with haggling, you likely want to plan and budget for these significant expenses.
Estimating your closing costs. Your closing costs and fees vary depending on where you’re buying, how much you put down, who helps you with the home-buying process, the type of home you’re buying and the type of loan you’re taking out.
You can estimate the closing costs of homes you’re interested in by using one of the many closing cost calculators online. Also, ask your real estate agent to help you estimate the closing costs of homes in different neighborhoods.
A few of the fees you could encounter when closing on a home. While costs can vary and state laws dictate differences in the closing process, here are a few typical services or fees:
- Inspections. You likely want to hire an inspector to make sure the home doesn’t need any major repairs and there aren’t any wood-eating pest (such as termite) infestations. Many lenders require you get these inspections, but even when they don’t it’s usually a good idea.
- Attorney fees. You could have to pay attorneys to help prepare and review documents for the closing.
- Survey. Some states require you to hire a surveyor to verify the size of the lot.
- Homeowners insurance. You may need to pay several months’ worth of homeowners insurance premiums up front.
- Origination fee. Mortgage lenders, banks or brokers often charge about 1 percent of your loan’s value. It is an up-front fee charged for processing a new loan application or refinancing.
- Property taxes. Several months’ worth of property tax payments could be due at the closing.
- Up-front mortgage insurance payments. If you take out a conventional (non-government) mortgage and put less than 20 percent down, you’ll likely need to pay for private mortgage insurance (PMI) that protects the lender. You could choose to pay some of your premiums during the closing. With a low-down-payment Federal Housing Administration (FHA) or U.S. Department of Agriculture (USDA) loan, you’ll need to make an upfront mortgage insurance premium (UFMIP) payment, which is often 1.75 percent of the loan’s value.
- Veteran Affairs (VA) funding fees. VA mortgage loans don’t always require mortgage insurance or a down payment, but generally you’ll need to pay a funding fee equal to 1.25 to 3.30 percent of the loan’s value.
You might see some mortgage lenders advertising “no-closing-cost” mortgages or refinancing. While these offers can be enticing, you’ll generally pay a higher interest rate on the loan or the closing costs will be wrapped into the mortgage.
The no-closing-cost route might be a good option if you’re planning on moving within the next few years. However, if you stay in the home for a long time, you’ll likely wind up paying more in interest over the lifetime of the loan than you would have on the closing costs. You can do your own calculations based on your estimated closing costs, increase in monthly payments and how long you plan on staying in the home to determine your best option.
You’ll know approximately how much you have to pay before the closing. Mortgage lenders have three business days from when you submit a loan application to give you a loan estimate. The standardized document shows your estimated interest rate, monthly payments, taxes, insurance and closing costs.
The Consumer Financial Protection Bureau has an interactive example of a standard loan estimate form with explanations and definitions of terms. The second page of your loan estimate has a list of estimated closing costs, including a breakdown of which services you may be able to negotiate.
You can request a loan estimate from multiple lenders, and then continue the application process with the lender that gives you the best estimated terms. After deciding on a lender and loan estimate (if the lender gives you several options) you’ll need to contact the lender and tell them you want to proceed with that loan offer. You may need to pay an application or appraisal fee at this point, which could cost up to $1,500 (both could apply to refinancing as well).
Lenders must honor the terms on a loan estimate for 10 business days, although they can revise the loan estimates based on select changing circumstances. Three business days before your scheduled closing the lender must give you a five-page closing disclosure form with the finalized terms of your mortgage.
Carefully look over the closing disclosure and ask your real estate agent, loan officer or attorney questions. If you don’t agree with the new terms of the deal, it’s not too late to back out. If you’re happy with the terms and the closing goes smoothly, you’re just a few days away from getting the keys to your home.
Bottom line: Estimating how much you’ll need to spend on closing costs, and budgeting accordingly, can help ensure you’re looking for homes within your price range. That’s important because you want to be able to move quickly when you find a home you love. However, don’t move so fast that you miss out on savings opportunities. Shopping mortgage lenders and service providers could help you minimize your closing costs.
Nathaniel Sillin directs Visa’s financial education programs. To follow Practical Money Skills on Twitter: www.twitter.com/PracticalMoney
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.