Buying a home can be a long, tedious process, and the upfront cost of homeownership is more than just the down payment. For many potential homeowners, it takes several months to find the house they want to make a home. For first-time homebuyers or even those who have purchased a home before, it’s important to know what your financial situation needs to look like and how much money you will need to complete the process. A lot of potential home buyers put their focus on saving for the down payment, and while this is a key financial component when buying a home, it is not the only thing a potential buyer needs to budget for. Closing costs are a key component to closing the deal, for example. In some cases, the closing cost can be around 2% to 5% of the purchase price.1 In this blog post, we discuss the different fees that make up the closing costs.
What is a Closing Disclosure?
A lender will provide a Closing Disclosure at least three business days before closing on the mortgage loan. A Closing Disclosure is a five-page form that provides final details about the mortgage loan including the loan terms, projected monthly payments, and how much is paid in fees and other costs to get a mortgage (closing costs). Use this 3-day window to compare the final loan terms and costs to the estimated costs in the Loan Estimate the lender provided at loan application and ask the lender any questions before closing.2
What Do Closing Costs for Buying a Home Include?
One of the loan costs is the origination fee3. The origination charge is a fee charged by lenders for processing the application, underwriting and funding the loan, and other administrative services.4 Loan origination fees typically range from about 0.5% to 1% of the borrower’s mortgage, but can be higher for smaller loans because the fixed costs are a higher percentage of a smaller balance.5
Loan cost for services pertains to fees for services such as for appraisal, a credit report fee, flood determination and certificate, tax status, pest inspection, title search and insurance and survey fee.
Most homes will need an appraisal, and a potential buyer will need to either find someone who will do the appraisal or have the lender find one. They tend to cost between $300 to $500. An appraisal is important for several reasons. The main reason is to determine the value of the home. A bank will extend a loan based on the value at which the home appraised. If a bid on a home is $300,000, but the appraised value is $280,000, then the price will need to be negotiated down or the buyer will need to come up with the difference of $20,000. It is always up to the seller on how to proceed, including lowering the selling price to the appraised value.
Most lenders will require pest inspections as well as a survey fee. Surveys are helpful for the new homeowners to know the full layout of their land and or property. They can range from about $300-$500. A pest inspection will determine the presence of termites or other vermin that could undermine the value of the structure.
Title services can be shopped for so buyers should do their research because they can add up to about $2,000.
Taxes and Government Fees
Next are the transfer taxes and recording fees. Transfer taxes are charged when the title of the property changes hands. Transfer taxes vary by state and can be as high as 2.7% in parts of New York, for example.6 It does not matter if the buyer or the seller pays, as long as the transfer tax is paid to the government, so transfer taxes can be negotiated between the buyer and seller. Some states like Maryland can waive the state transfer tax. Recording fees are fees charged by the government for recording a real estate purchase or sale in the public land records.
Prepaids and Escrow payments
Buyers then have escrow items: homeowners’ insurance, property taxes, and primary mortgage insurance (PMI), which are prepaid and escrowed. If a buyer moves into a condo or townhouse there may be an HOA or homeowners association that collects monthly dues for the upkeep of the community. HOA dues vary by community and state, and some fees can range from $50-$800.
Prepaid items are one-time charges, paid at the time a real estate transaction is closed, or finalized. Escrow accounts are a continuing expense, typically billed monthly by the lender.7 Prepaids are a big upfront expense item because a potential buyer pays upfront for the upcoming months of interest expense, mortgage insurance, and property taxes.
Cash to Close
The total cash to close will be less than the total cost of fees associated with closing a home because the earnest money deposit (EMD) will be deducted from the estimated fees. The EMD is the amount held by the lender as proof the buyer is serious about making the purchase.
So now that all of these different fees and services are added up, take this figure and subtract the EMD and the balance left over will be the cash to close. This will be the amount needed to bring to settlement to close on the home.
How Much Do You Need for Upfront Costs When Buying a House?
As an example, let’s assume a buyer is purchasing a home for $275,100, (U.S. median sales price) with a 5% down payment, so the loan amount will be $261,345. Assuming closing fees are 2.5% of the loan value, the fees amount to $6,533. Assuming the buyer made a $2,000 EMD, they would need to bring $4,533 in cash at the time of closing.
Altogether, this means that the potential homeowner will need to have access to approximately $18,300 in cash to pay for the down payment and closing cost net of the earnest money deposit.
How Do You Pay for Costs Associated with Buying a Home?
Potential home buyers have used savings, family loans, 401k loans and some use stocks to come up with the funds for their home purchase. NAR’s annual Profile of Home Buyers and Sellers includes a chart depicting sources of down payments for first-time homebuyers and repeat buyers.
Most settlement companies prefer the closing money to be wired; this seems to be one of the safest ways to finalize the financial transaction.
4 What are mortgage origination services?, Consumer Financial Protection Bureau
5 What is an origination fee?, Millionacres