What are closing costs?

If you’re budgeting to buy a home, it’s important to factor in closing costs. The closing process can take 30 to 45 days once your offer is accepted — and it’s likely you’ll need that time to review cost estimates and prepare for a substantial cash payment at closing.

How closing costs work

Closing usually refers to the final meeting between the buyer, the seller and their representatives. Both the buyer and the seller sign legal documents at this time in order to transfer ownership of the property. As the buyer, you’ll also sign paperwork to enter into a contractual agreement with your mortgage lender.

Closing costs are mostly made up of lender processing fees and property fees, though they include some other fees too. They cover services like title searches and home appraisals and can also include property taxes and escrow payments for homeowners insurance premiums.

The buyer typically pays for most of the closing costs, which can account for 2% to 5% of the home’s sale price (on a $200,000 home, that’s approximately $4,000 to $10,000). Your lender will generally require payment for these expenses at closing if you’re purchasing a home; if you’re refinancing, some lenders will let you roll those costs into the loan, which means you'll have less cash due at closing.

Types of closing costs

All closing costs are listed individually on both the Loan Estimate and the Closing Disclosure documents, both of which you’ll receive at different points in the closing process. The closing costs listed usually fall into one of three categories: mortgage fees, property fees and other fees.

The lender may require fees for required services (like appraisals or pulling credit reports). Other services, like a pest inspection, may be performed by any company you choose.

Mortgage fees

• Origination fee: The loan origination fee is usually a set percentage of the loan amount, like 0.5%. So, if you have a loan for $200,000, the bank may charge an origination fee of $1,000. If you pay discount points toward closing costs, they’ll be listed here as well. These fees also include application and underwriting charges. The application fee can run as high as $500, and the underwriting fee can cost as much as the loan origination and application fees combined.
• Credit report fee: This covers the cost of obtaining your credit report and score.
• Tax monitoring and tax status research fee: This fee pays for services that verify the property tax amount is correct and monitor property tax payments.
• Title fees: These usually include the insurance binder fee, the lender’s title policy fee, the settlement agent fee and the title search fee. These charges go toward determining whether the home’s title can be successfully transferred from the seller to the buyer.
• Prepaid interest: This figure represents the amount of interest accrued from the closing date to when the first mortgage payment is due. The buyer is expected to pay this amount at closing.

Property fees

• Appraisal: These fees pay for an official determination of the home’s value by a home appraisal company.
• Flood determination and monitoring fee: This covers the costs of determining whether your home is located in a flood plain.
• Pest inspection: Pest inspection fees cover inspections for the presence of bugs that may cause damage to the home’s structure (like termites).
• Survey fee: This covers a survey of the home’s property lines. Some lenders don’t require a survey if one has been completed within the past 10 years.
• Property taxes: The buyer is responsible for prepaying the property tax from the date of closing until the end of the year. These funds are managed by your lender in an escrow account.
• Transfer taxes: This tax may be levied by the local government; it’s a tax on the transfer of the home’s title or deed to the buyer’s name.
• Homeowners association fees: If you purchase a home within a homeowners association, you’ll have to pay for any fees upfront at closing. The fees will be prorated for the remainder of the year from the closing date.

Other fees

• Homeowners insurance premium: Some lenders require that you prepay the homeowners insurance premium for the rest of the year. These funds are held in an escrow account with your lender.
• Mortgage insurance: PMI, or private mortgage insurance, is required for borrowers who put less than 20% down on a home on a conventional loan. You may be required to pay this premium upfront at closing. If you have an FHA loan, you will owe an upfront mortgage insurance premium at closing.

Estimating closing costs

After your loan has been approved, your lender will give you a Loan Estimate document, which outlines all costs associated with the mortgage. It details the loan amount, interest rate, monthly payment and closing costs. While these costs are still estimates and could change depending on actual expenses, it’s a good idea to review this document in preparation for closing.

At least three days before the closing date, you’ll receive the Closing Disclosure, which finalizes the loan terms. Its format is similar to the Loan Estimate’s, so you’ll want to compare the estimated costs with the finalized costs to look for discrepancies (e.g., any new fees listed). There are some costs that legally can’t change from the estimate, like transfer taxes, while other costs, like mortgage insurance premiums, could differ.

One important figure you’ll need to compare is the “Cash to Close” amount, which is how much you’ll have to pay at closing. Your lender will specify the methods you can use to pay (usually a cashier’s check or wire transfer). Some banks require a few days’ notice before completing a wire transfer, so you’ll want to ensure you’ve accounted for that time.

Who pays closing costs?

The buyer typically pays for the majority of the closing costs; however, there are some expenses the seller may cover (these are called seller concessions). Buyers can negotiate seller concessions when they make an offer on the property.

For instance, sellers typically pay for the real estate commissions paid to both the buyer’s and the seller’s agents. Commissions can account for 6% of the sale.

There are also limits to how much the seller can cover, but these depend on what type of loan you have. These limits are percentages of the home’s sale price.

Below are seller concession limits based on mortgage type:

For example, if you have a conventional loan on a $200,000 home and you plan to offer a 5% down payment, the seller can’t pay more than 3% of the home’s sale price in closing costs, which is a $6,000 limit. If it were a USDA loan, the limit would increase to $12,000.

How to lower closing costs

If you want the seller to pay for some of the closing costs, you’ll have to negotiate those terms when you present an offer. Your real estate agent can advise you on typical seller concessions and help you hammer out which ones are most likely to be accepted in your situation.

Talk to your real estate agent about whether asking for seller concessions in your offer is realistic.

Your agent can also make recommendations based on housing market conditions. For example, in a seller’s market, where the inventory of homes is low and prices are rising, buyers don’t have much negotiating power. Sellers usually have multiple offers on the table, and adding numerous concessions to your offer could shut down the deal.

You can also ask for reduced closing costs from your lender, but you’ll have to make those requests before you find a home and submit an offer — ideally just after you’ve received approval from multiple lenders.

You can use the quotes you get as bargaining tools in negotiations: One lender might waive the application fee while others charge $300, so you can ask competing lenders if they’ll waive the fee as well.

If you have excellent credit, you’re in a much better position to bargain with lenders on closing costs.

Bottom line

Closing costs cover lender and property fees when you purchase real estate. The amount you’ll have to pay in closing costs depends on your lender, location and the type of mortgage. You can expect to receive a Loan Estimate and Closing Disclosure that spell out each of the costs you’re expected to pay with a new mortgage.

Usually, closing costs amount to about 2% to 5% of the home’s sale price. Buyers can negotiate with sellers to help pay for some of these costs, but there are limits to how much the seller can cover. Also, the seller could have the upper hand at the negotiation table if it’s a seller’s market. Ultimately, you’ll want to draw on the expertise of your real estate agent to decide the best plan of action for you.