Closing costs explained

In addition to the down payment, you'll also have to pay closing costs — miscellaneous fees charged by those involved with the home sale (such as your lender for processing the loan, the title company for handling the paperwork, a land surveyor, local government offices for recording the deed, etc.).  The average closing costs percentage is usually about 2-5% of the purchase price (e.g., ~$4500 on a $180,000 home), but 1-8% is not uncommon.  And to be clear, nobody chooses a specific percentage number—the closing costs will just happen to add up to some percentage.

Your lender will give you an estimate of closing costs on the purchase of a particular house you've selected. This is called a "Good Faith Estimate" ("GFE"). If they don't give it to you, ask for it.  Then, the day before the closing, ask your lender for the actual "Settlement Statement" (aka "the HUD" or "the HUD-1"), which is the final and complete form with all the numbers for the sale, including the actual closing costs.

Here are typical closing costs, along with a calculator to help estimate the cost for your own home.  Everyone's situation is different, and this calculator is not a substitute for getting the GFE and the Settlement Statement from your lender.  When you do get it, compare it to the calculator below to see if any figures appear to be higher than normal.

Tips about closing costs

Tip: Make sure to get the Good Faith Estimate (GFE) and Settlement Statement (HUD-1) from your Lender.  Review them and compare it to the typical closing costs above.  Direct any questions about it to your lender and your real estate agent.

Tip: Make sure there's no Yield Spread Premium on the GFE.  If you use a mortgage broker and get a bad deal with an interest rate that's too high, the bank will give a kickback to the broker called a Yield Spread Premium (YSP).  If you followed my advice on shopping for the best mortgage deal you're less likely to be in this position.  If there's a YSP on the GFE, then you're paying too high an interest rate and should try to negotiate a lower one.  Here's more on YSP's from ERate, Realty Times, and Wikipedia.

Tip: Roll in the closing costs into the mortgage. If you don't have enough cash to pay the closing costs, you can often get the closing costs added to the amount of the loan. For example, if the loan amount is for $150,000, and the closing costs are $4500, you'd add the closing costs to the loan amount so you'd actually be borrowing $154,500 total. This is handy if you're short on cash after making your down payment.

You need two things to be able to roll in your closing costs like this.  First, you have to qualify for the bigger loan.  The bank probably won't have a problem with loaning you a few thousand extra dollars extra, but they might.

The second thing is that the new loan amount can't exceed what's called the Loan-To-Value ratio (LTV), which is the amount of the loan compared to the to the value of the house, based on the appraisal. In simple terms, let's say the house is worth $100,000, and the bank will loan up to a 95% LTV, meaning they'll loan you up to $95,000. If your credit isn't so good then the bank might only loan up to an 80% LTV, meaning they'll loan you only $80,000.

Don't confuse the price of the house with the value of the house. The bank gets the value of the house (what they think the house is worth) from the appraisal, which is a report prepared by a professional which estimates the value of the house.  The selling price could be higher or lower than the appraised value.

Okay, so the point of all this is, if you roll the closing costs into the mortgage, the new loan amount can't exceed your LTV. If the LTV amount was $120,000, and the $4000 closing costs would push the loan amount from $118,000 to $122,000, then the bank won't let you roll in the closing costs. You could get around this by making a larger down payment, so you don't have to borrow as much money from the bank, but if you have the extra money for the bigger down payment then you also have the extra money to just pay that money towards the closing costs instead of rolling them into the mortgage in the first place.

One way of rolling the closing costs into the mortgage is to have a seller concession. It's a little complicated so I recommend you just ask the lender if you can roll the closing costs into the mortgage the easy way. The lender might require that you use the seller concession method, though. If you have to go that route, the way it works is that you and the seller say that the sale price will be about 6% more than the price you agreed on, and then the seller "gives" you that extra 6% that you paid. For example, let's say the price was $100,000 and you're putting 10% down, or $10,000, so you're getting a loan for $90,000. You and the seller decide to go the seller concession route, so you agree that the price should be 6% more, or $106,000. That means you'll now put $10,600 down and get a loan for $95,400. See what happened? You got a loan for $5,400 more than the original loan. That's what you use to pay the closing costs. The seller doesn't keep the extra money because part of the deal is that (s)he gives that extra money back to you at closing.

 

Tip: Ask the seller to pay some of the closing costs. If you're short on cash for the closing costs and can't roll the closing costs into the mortgage, ask the seller if they're willing to pay part of the closing costs. It's not unusual for buyers to ask for this.  Usually the worst that can happen is that they say no.

 

Tip: Get the lender to pay the closing costs.  If you're short on cash for the closing costs and can't roll the closing costs into the mortgage, some lenders will pay part or all of the closing costs, but in exchange you'll have to pay a higher interest rate on the loan, perhaps 0.25% or 0.50% higher.  Ask your lender if this is an option if you need it.

 

Tip: Borrow the money from another source. If all of the above fails, try to borrow the money for the closing costs from another source.

Why we don't count accrued property taxes in the list of closing costs

If you're wondering why we don't list accrued property taxes in the calculator, then here's the explanation.  (And if not, then feel free to skip to the next lesson.)

Since you're probably not buying your house in January, at closing you pay the taxes that have accrued since the beginning of the year.  For example, if you buy your house in May, you'll owe taxes from January through May.  You might think it's not fair that you owe taxes for a period when you didn't own the house, and you're right.  So at the closing, the seller will pay you those accrued taxes.  So it's a wash: you owe some accrued taxes, but the seller pays you those accrued taxes.

To be precise, you don't actually owe any taxes at the closing; taxes are generally paid in January for the previous year.  But most buyers take advantage of the bank's free escrow service, in which your monthly payment includes a little bit extra for taxes and insurance.  The bank collects that from you with each payment, and then once a year they pay your taxes and insurance for you.  So at closing, the accrued taxes you pay (that were paid to by the seller, remember) go to the bank, which holds them for you until your tax bill is actually due, at which point they pay it.

Accrued property taxes are shown on lines 210-213 and 510-513 of the Settlement Statement.

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Last update:  December 2012