Closing Costs: What Are They and How Much Will You Pay?

Whether you’re buying a house or refinancing an existing mortgage, acquiring a primary residence or an investment property, or purchasing a residential building or a commercial space — all real estate transactions include closing costs. For those that have purchased property before, and for those that are considering buying real estate, chances are that these costs near the end of the process have taken you by surprise and were not factored into your original calculations.

However, closing costs are common fees that everyone pays. Although they might seem like additional late-stage charges, they are very much a part of the mortgage process. We want to break down these costs so that you’re prepared and ready to cover them when they arise, whether you’re buying a new property or refinancing a mortgage.

Depending on the exact circumstances of your loan, such as the property type, the location, and actions needed to complete the process, closing costs can vary. However, they generally fall between 3-6% of your loan amount. Although every lender has slight variations on closing cost fees and their classifications, they can generally be segmented into five main categories: origination charges, appraisal fees, title fees, prepaid expenses, and initial escrow payments.

Let’s dive a little deeper into each category and provide working explanations of the main fees that combine to create closing costs.

Origination Charges

Loan Origination charges cover the cost of creating the paperwork for your loan, processing your loan, and underwriting your loan. These fees usually apply when applying for a new loan or refinancing a previous loan, and can often have several subcategories grouped under them. These subcategories are not limited to, but can include:

1. underwriting fees
2. originating fees
3. administration fees
4. attorney fees, in some cases

The originating fee is an upfront cost charged by the lender to process a loan or mortgage refinance application. The underwriting fee is usually a small charge in exchange for the lender taking on the risk of the loan. In regards to the attorney fees, these don’t always apply — in some states, you might not be unable to close on a housing loan without an attorney. Attorney charges will usually depend on the state and the local fees.

Appraisal Fees

Getting an appraisal on your new property — and even on a current one — is a very important part of the mortgage and refinancing process. Appraisals are important because they determine the value of the home and also ensure you aren’t overpaying for a property. An appraisal might also help increase the amount of your loan, especially in the case of DSCR loans that are directly tied to the rental income a property might be able to generate. In the case of a cash-out refinance, an appraisal is helpful in determining by how much the value of a property has increased since its purchase price, and can be used to cash-out additional equity in a property that has accrued over time since being acquired.

Lenders will usually order an appraisal through a third-party appraisal management company, which will take a look at your home and determine the value of the home in accordance with the current real estate market in that neighborhood. They might also provide some basic safety checks to confirm that the property is up to standard and is move-in ready.

Title Fees

Another group of fees associated with closing costs are title fees. A title is important because it grants the owner of the title the right to own or use a property. Title-related fees usually go towards paying the title company that is used in the process, who’s job is to review, adjust, and insure the title of the property. There are often a few smaller subcategories of fees that fall underneath the broad umbrella of Title fees, fees that may include but aren’t limited to:

1. title search fees
2. title settlement fees
3. lender’s and owner’s title insurance fees
4. title recording fees

A title search is the process of examining public records to determine the property’s owner and if there are any claims or liens on the property — in most cases, this cost falls under the responsibility of the seller. The title settlement fee refers to the administrative costs that the title company incurs during closing. Title insurance fees are usually separated into two separate costs, lender’s and owner’s title insurance fees. Lender’s title insurance protects the lender from any claims or liens on the property that might’ve been missed in the process while owner’s title insurance protects the buyer from any claims or liens on the property. Title recording fees are the costs related to filing deeds and other documentation with the local county’s public records.

Prepaid Expenses

The prepaid expenses category and the escrow funds category can seem very similar — as we’ll get into escrow funds, below. However, even though there is some overlap, there are enough differences to separate the two sections to have better clarity. Usually what is included in prepaid expenses are the homeowner’s insurance premium, prepaid mortgage interest, and property taxes. If the property taxes are due within 60 days of the closing, the full annual tax amount is collected at closing. These costs are paid at closing and sent from the escrow company to the Homeowners Insurance company and County for property taxes.

In general, most lenders require borrowers to obtain homeowner’s insurance in order to take out a mortgage. Prepaid expenses generally include 6-12 months of homeowner’s insurance premium’s upfront, which the lender will use to pay the insurance company during that same period. Prepaid mortgage interest refers to the interest a borrower pays from the day they sign the loan agreement through the last day of the month.

Initial Escrow Payments

In addition to the prepaid fees, there are supplemental fees that a lender might require to be placed into an escrow account at the time of closing. The initial escrow payments usually consist of two months of homeowners insurance, in addition to whatever premiums you might also pay at closing. This extra cash ensures that there is enough money available to those bills when they are due. Usually, the 2-month property tax fee that was required in the prepaids category gets mixed into the initial escrow payments, as well.

Additionally, usually two months of property taxes are required as well for a cushion. So if your annual property tax bill is $12,000, you would have to prepay $2,000.

For those that are looking to buy a property, not all of these closing costs might apply. To clarify which fees might apply to you, and how much they will cost, connect with one of our loan officers.

The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.