Closing Costs 101: What First-Time Homebuyers Need to Know

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You may be surprised to learn that your down payment isn't the only big cost due at closing. There is also a mysterious bucket of charges known as “closing costs” to account for. How much will they be? When should you plan to pay them? Why do you have to pay them?

While there's no need to have anxiety over closing costs, it's important to know that closing costs are currently on the rise. Closing costs generally rise in relation to rising home prices, and some buyers may find that inflationary conditions will also drive up the costs for vendor-related closing costs.

It just means that properly managing all aspects of financing a home purchase is even more important for buyers hoping to stick firmly to their budgets. This lesson on closing costs 101 can help!
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What are closing costs?

Closing costs are all of the fees associated with buying a home beyond the home's purchase price.

While buyer closing costs are pretty standard, you may pay a different amount for closing costs than your neighbor based on what you negotiate with the seller.

Common closing costs include lender fees, attorney and title fees, title insurance, taxes, prepaid insurance, prepaid property taxes, and HOA fees.
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Do you have to pay closing costs as a first-time homebuyer?

Consider this an unavoidable expense when buying a home. Generally, every buyer will pay closing fees. That includes first-time buyers.

While there are rare exceptions where sellers are motivated to cover closing costs, most buyers should be prepared to pay buyer closing costs in their entirety without expecting much generosity on the part of the seller.

It never hurts to ask a seller to cover a portion of your closing fees if you feel that you're buying in a "buyer's market." There's also sometimes wiggle room to ask for some closing fees to be covered if the home you're buying is in less than perfect shape.

While first-time buyers don't get any special treatment when it comes to closing fees, it's important to know that first-time homebuyers do have access to many assistance programs and loan options that can potentially reduce overall out-of-pocket expenses when making a home purchase.

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How much are closing costs? What should you budget?

The general rule for closing costs is that they usually equal between 2% and 4% of the purchase price you're paying for a home.

Closing costs on a $100,000 mortgage could be $4,000 (4%), but on a $500,000 mortgage they may be nearer to $10,000 (2%). For a median priced starter home of $300,000, budget for at least $6,000 in closing costs.

In real estate, everything is local. So, expect some variance based on where you are buying. For instance, someone in an area with a high cost of living may simply find that closing costs are higher due to everything from higher property tax rates to higher hourly rates for real estate lawyers.

In addition, the value of a property, the vendors you choose to assist with closing, the type of mortgage you're getting, and the complexity of a home's ownership history can all impact closing costs.

It's always wise to overestimate closing costs when browsing homes. Lenders are required by law to provide borrowers with a loan estimate that provides a detailed list of expected closing costs for a specific sale.
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Are closing costs the same as a down payment?

No, closing costs should never be confused with a down payment.

Closing costs represent a completely separate expense that should be seen as a one-time buying fee. The big difference between closing costs and your down payment is that your down payment is applied toward the purchase of the home. That means that your down payment adds equity to your home.

Unfortunately, closing costs don't actually go toward the cost of your home. However, the reason why many first-time homebuyers often confuse closing costs and down payments is that some people end up using part of their down payment to fund their closing costs.

There's also a fair amount of confusion over the differences between an earnest money deposit, a down payment, and closing costs.

An earnest money deposit is an amount of money that the buyer "puts up" into an escrow account to show the seller that they're serious. An earnest money deposit usually represents 1% to 5% of a home's purchase price.

If the deal goes through, the earnest money deposit can be transferred out from the escrow account it's being held in to apply toward your closing costs or down payment. If a buyer breaches a real estate contract for any reason, it's highly likely that the earnest money deposit will be considered forfeited.

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Do you pay closing costs all at the same time?

Not necessarily. In a typical transaction, closing costs are paid out in a breadcrumb fashion. You'll pay some of your closing costs on the journey to closing.

However, most closing costs are paid on your actual closing day. Here's a look at what's usually paid for at the closing table:

• Property Taxes: Buyers generally pay any city or county property taxes owed from the date of closing through the end of the quarter or year.
• Transfer Taxes: Most cities/counties charge a transfer tax to cover the cost of transferring the deed and updating their paperwork. This is not a negotiable fee.
• Title Insurance: Title insurance premiums are paid out for lender coverage (not optional) and buyer coverage (optional) at closing. This insurance protects you against title disputes for the duration of your ownership.
• HOA Annual Assessments: If you’re buying a property belonging to a homeowner association (HOA), the remaining balance for the year may be due at closing. Some HOAs also charge new account, and/or transfer fees.
• Prepaid Interest: This is the daily interest expected to accrue on your loan between the closing date and your first monthly mortgage payment.
• Loan Origination Fee: Many lenders charge a loan origination fee that's expressed as a percentage of your loan amount.
• Other Lender Fees: Some lenders charge application, underwriting, processing, and/or broker fees for processing, underwriting and closing your loan.
• Discount Points: If you're buying discount points in exchange for a lower interest rate, the amount is due at closing.
• Title Search Fee: Title search fees are often bundled into closing costs. However, this can vary by state.
• Survey Fees and Appraisals: In some areas, you’ll need to order a property survey for your loan. Most loans also require an appraisal - sometimes this amount is paid upfront (prior to closing), and sometimes it is paid at closing.
• Private Mortgage Insurance (PMI): If you're putting down less than 20% (hint: you should), your first private mortgage insurance payment may be due at closing.
• Homeowner's Insurance: Your first year of insurance premiums is usually paid at closing.

Don't consider this an exhaustive list of all closing costs! Conversations with your agent, lawyer, seller, and lender will ultimately determine what's due at closing. Don't forget that some clever negotiations could get a few of these items knocked off of your plate if an eager seller is willing.
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Who tells you how much your closing costs will be?

Your lender is obligated to provide you with an estimate of your closing costs after you submit your application.

It's then your responsibility to make sure the cash will be ready to go on closing day. Be sure to check back in with your lender to confirm closing costs if your deal undergoes any major changes.

While the initial estimate for closing costs provided by your lender is your blueprint for putting money aside, you'll actually get a more concrete estimate in a document that's called your loan closing disclosure at least three days before your scheduled closing date. This estimate will more precisely tell you the expected dollar amount to bring to closing.
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Can closing costs change at the last minute?

While it's unlikely for drastic changes in closing cost estimates to occur, it's not impossible for your estimate to change.

Is your closing disclosure way different than what your lender initially quoted? Buyers should know that it's illegal for lenders to deliberately underestimate the costs on your loan estimate.

However, lenders can change certain costs under specific conditions.

For instance, your interest rate may change if it wasn't already locked in. Prepaid interest, property insurance premiums, and initial escrow account deposits can also change. Some fees can go up with a cap of 10%. This includes recording fees and required service fees from third-party providers.

Here's a look at closing costs that cannot go up:

• Fees paid to the lender, mortgage broker, or an affiliate of either the lender or mortgage broker for a required service.
• Fees for required services that the lender did not allow you to shop for on your own.
• Transfer taxes.

Buyers should receive a revised loan estimate if an application has had what is legally referred to as a "change in circumstance."

What happens if you're seeing an increase above the allowed limits without a change in circumstance? You may be entitled to a refund for the amount over the allowed limits.
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Does the seller ever pay the buyer’s closing costs?

This is possible even though you shouldn't bet on it. The buyer will need to initiate negotiations for the seller to pay some of the buyer's closing costs as part of the deal.

Buyers should be warned that having a seller pay your closing fees is very unlikely in a competitive market. However, it is always a possibility if a seller is motivated enough.

Just make sure that any promise to cover closing costs is written into the terms of the offer. Buyers should also know that closing costs covered by a seller won't necessarily be transferred to their bank accounts. At closing, a portion of the seller's proceeds totaling the amount promised is typically applied toward closing costs.
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Can you negotiate your closing costs?

While some closing costs are static, others do have room for negotiation. Generally, service-based closing fees can be negotiated. Fees associated with the property cannot be negotiated. Here's where there's some wiggle room:

• Homeowner’s Insurance: Shop around to get the best deal. Gravy can help!
• Origination Fee: Most lenders are open to negotiation with this fee.
• Underwriting Fee: The reason why you often hear an underwriting fee called a "junk fee" is because it's possible to negotiate it away!
• Title Insurance: Some states allow you to skip it. However, deciding if that's smart is a different matter.
• Closing Attorney: Ask different lawyers about fees.

What these fees have in common is that they all apply to vendors. That means that buyers can do some "comparison shopping" before committing. Any taxes, government-mandated fees, appraisal fees, and credit check fees don't have the same potential for negotiations.
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Can you get closing cost assistance?

Yes, many states have financing programs that help to cover down payment and closing costs for first-time buyers. A great place to start is your state's down payment assistance program, housing finance authority, or equivalent.

Programs are often available for buyers who don't have enough money to pay upfront costs of homeownership even though they have the monthly income needed to cover mortgage payments.
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Are closing costs the same as "cash to close?"

Not exactly. Your closing costs are a part of your total “cash to close.” Closing costs refer to the cumulative cost of all fees needed to close on your home loan. "Cash to close" refers specifically to the amount of cash you'll need to bring to closing day.
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Can you roll your closing costs into your mortgage loan?

Some buyers do choose to roll closing costs in their mortgage loans. It's necessary to confirm with your lender that this is allowed.

It's also important for buyers to understand that they'll pay interest on their closing costs if they do choose to "finance" closing costs instead of paying cash. This makes your closing costs more expensive by default.

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