What are Mortgage Closing Costs?

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Point of Interest

Closing costs are a costly but important part of the closing process on a home. These fees pay for the lender costs and third-party fees associated with closing on a loan. 

 

As you save up to purchase a home, don’t forget to set aside cash for the closing costs, as these costs — which range, on average, from between 2% to 5% of the loan principal — need to be paid before a home can be called yours.

 

Paying this amount on top of an expensive home purchase may seem daunting, but closing costs are a necessary part of your home purchase. These expenses are associated with the originating, processing and servicing that occurs during the purchase of a home.

 

What are closing costs?

Closing costs refer to the total expenses associated with finalizing the purchase of a home. Generally, closing costs can include appraisal and inspection fees, title search fees, loan application processing fees, attorney’s fees, transfer taxes, homeowners insurance and a number of other charges. The exact fees will vary by lender and the kind of property you are purchasing. If that sounds dizzying, don’t worry. Lenders are required to spell out all closing costs on both the initial loan estimate and on the closing documents.

The three largest fees are loan origination, property tax reserves and homeowner’s insurance.  The loan origination fee amount varies depending on the lender. Some lenders may not charge an origination fee with a low interest rate but could charge higher processing and underwriting fees instead. Others may charge an origination fee with a higher interest rate but lower administrative fees like underwriting and processing.

Property tax reserves can also vary widely and will depend on the property’s location and the property tax collection schedule. The lender needs to keep enough in reserve to pay the home’s property taxes, typically three to eight months, depending on when you buy the home relative to tax collection day.

Mortgage companies require borrowers to have homeowners insurance that covers the full or fair value of a property before they approve a loan. Lenders will collect one year’s premium upon closing to pay the insurance company. The amount depends on the value of the home and the amount of insurance.

How much are closing costs?

Closing costs fall into six categories: lender, lender-ordered, upfront, third party, government and prepaid. It’s important to note that not all of these fees apply to every loan, and you will likely be charged a combination of these fees. Every lender is different, though, so there isn’t a set menu for closing costs.

Lender fees compensate the mortgage company or bank for handling your mortgage loan. These entities have overhead — branches, employee salaries, etc. — that are covered by lender fees. Lender fees can include the loan origination fee, mortgage broker fees, discount fee, processing, underwriting, application fees and lock-in fees.

Lender-ordered fees pay for the variety of services needed to process your loan. Lender-ordered fees can include credit report fees, flood certification, tax service fees, wire transfer fees and courier/postage fees.

Third-party fees cover services provided by the outside parties associated with your loan other than your lender. Third-party fees can include the appraisal, pest inspection, title report, escrow fee, notary fee, closing protection letter, the survey fee and attorney fees.

Government processing fees compensate the government entity that records the transfer of ownership following the sale of the home. These fees can include a recording fee as well as transfer taxes. The recording fee details the transaction, including the new owner’s information. It is proof you own the home.

Prepaid items are the costs of owning the home that many lenders require you to pay in advance. These fees can include your homeowners insurance, flood insurance, tax reserves, mortgage insurance and prepaid daily interest charges.

CategoryExpenseWhat is itCost
LenderLoan origination feeMortgage broker feeCompensates lenders for originating loan0 – 1% of total loan amount
LenderDiscount feeFees you pay to lower your interest rate0 – 2%+ of total loan amount
LenderProcessing feeCompensates loan processors for gathering documentation$300 – $900
LenderUnderwriting feeCompensates underwriting team for analyzing loan documentation$300 – $900
LenderApplication feeNon-refundable deposit to take application. Avoid if possible$100 – $350
LenderRate lock-in feeFreezes interest rate while loan processes$100 – $300
Lender-orderedCredit report feePays credit reporting agency for generating credit report$20 – $40
Lender-orderedFlood certificationPays to check home’s flood zone status$20
Lender-orderedTax service feeCompensates company hired to check on status of any tax liens$50
Lender-orderedWire transfer feePays the bank wiring the loan funds$25
Lender-orderedCourier feeCompensates courier if documents must be hand-delivered or overnighted$20 – $30
Third-party feesAppraisalCompensates appraiser to estimate value of the home$350 – $500+
Third-party feesPest inspectionPay to verify pest status. Uncommon$100 – $500
Third-party feesTitle report/title insuranceBased on home’s value and location; checks to ensure no other person may claim the home$300 – $1,500+
Third-party feesEscrow feeCompensates third-party for housing funds while loan processes$300 – $700+
Third-party feesNotary feeLoans require a notarized signature. Uncommon unless signed for outside of the escrow office$100 – $150
Third-party feesClosing protection letterLetter stating the title company is responsible if the escrow company incorrectly distributes funds. Very uncommon.$50
Third-party feesSurvey feeCompensates title company if property lines must be determined. Uncommon$400+
Third-party feesAttorney feeSome states require an attorney to be involved during the closing. Mostly a formality and uncommon.$400+
Government-processing feesRecording feeSolidifies your legal ownership of the home and determines property tax information$20 – $250
Government-processing feesTransfer taxesSome states require compensation any time real estate changes hands. Uncommon but be aware as costs can be substantialVaries
Prepaid itemsHomeowner’s insuranceIndemnifies the home prior the loan issuance$400 – $1,000+
Prepaid itemsFlood insuranceIndemnifies the home from flooding$300 – $1,000+
Prepaid itemsTax reservesSatisfies property tax requirements for upcoming tax schedule$500 – $5,000+
Prepaid itemsMortgage insuranceIndemnifies the lender in the event you default on the loan$100 – $700+
Prepaid itemsPrepaid daily interest chargesYou prepay interest on your loan from the day your loan closes to the end of the month$100 – $2,000+

How to mitigate closing costs

There are a variety of fees that a lender may charge to originate, process and service your loan. You should consider asking the lender to work with you to reduce closing costs. There are nuisance fees — like notary or application fees — that can be waived or outright avoided by you in the process of obtaining the loan. Ask the lender for the good faith estimate to comparison shop other lenders.

There are a number of other ways to reduce closing costs, including:

  • Use your banking partner: Most of the major banks will offer a discount to you on closing fees if you’re an existing customer.
  • Close at the end of the month: The prepaid daily interest charges can get burdensome quickly. Close at the end of the month to minimize the number of days you could be charged interest.
  • Ask the seller to help: Most lenders will allow the seller to contribute up to 6% of the sale price to the buyer as a buyer cost credit (and it’s tax-deductible for the seller). It’s a nice kicker that can help cut down on costs, but be aware that it’s not very common in hot markets.
  • Structure the closing costs into the loan: No closing cost financing works by structuring the closing costs into the loan by either charging a higher interest rate for waiving closing costs or tacking them onto the loan principal. If you opt for this type of loan, you should carefully consider how much the closing costs are relative to what you pay in terms of higher payments or interest.

How do you pay for closing costs?

Most closing costs are due when you sign the final loan documents. You often pay for third-party services like home appraisal and inspection when services are rendered, but they can be part of your closing costs in some cases. Otherwise, most closing costs are bundled together and due at the end of the loan process. You can use a wire or a cashier’s check to cover closing costs. Ongoing expenses include homeowners’ insurance, flood insurance and PMI (if applicable), as well as your monthly mortgage payment.

The final word

Closing costs are generally related to the costs with obtaining, aligning and approving documentation that demonstrates that you are in good financial condition and that the home you wish to buy is in equally good condition, both physically and legally. 

When determining whether the closing costs on your loan are necessary, make sure to take your time. Don’t be afraid to ask questions and request clarification until you feel comfortable with what to expect. Loan origination takes a while and things can change during that time. And remember: you are not committed until you’ve signed the final closing documents.

Alexander Clark

Personal Finance Contributing Writer