Understanding closing costs: What to expect and how to prepare

When buying a home, it’s essential to budget for closing costs. These are the expenses that cover the cost of processing your mortgage and go beyond any money you might set aside for a down payment.

Let Homes.com guide you through everything you need to know about closing costs, including ways to reduce them.

Closing costs are the final fees and expenses required to transfer ownership of a home. These fees are necessary to seal the deal and are paid by either the buyer or seller at settlement. By law, lenders must provide an estimate of these expenses after your mortgage application is approved and before you move forward with the purchase. It’s essential to note that these fees are not always final and may change prior to closing.

“Closing costs help to cover the necessary work and protections that make a home purchase legal, safe and official,” said Matt Vernon, head of consumer lending at Bank of America. They pay for services that verify the property’s value, check for legal claims on the deed and ensure the transfer of ownership is properly recorded with the local government.

Some fees, such as the appraisal, origination and credit check, may be paid upfront, either at the time of application or after the contract is signed. Most closing costs, including the down payment, title insurance, attorney fees, government taxes and other lender or third-party fees, are paid on the day of closing when you sign the final paperwork and take ownership. Payment is typically made by cashier’s check, though some costs can be financed through assistance programs.

Closing costs typically range from 2% to 5% of the home's price or the loan amount. For example, on a $400,000 home, closing costs could be $8,000 to $20,000. These amounts can vary based on location, lender and negotiation.

Some lenders will negotiate origination fees and discount points (which let you lower your interest rate by paying more upfront). Others may offer “premium pricing,” where you accept a higher interest rate in exchange for the lender covering some or all of your closing costs, said Christopher Davis, assistant vice president of residential lending at Navy Federal Credit Union.

Other closing fees, such as title charges, can be negotiated with the seller. Title fees include the title search, settlement, lender’s and owner’s title insurance, attorney fees and abstract fees. Transfer charges are also important, as they ensure the legal transfer of ownership.

Points, also known as discount points, are optional fees you pay upfront to lower your mortgage interest rate. One point typically equals 1% of your loan amount. For example, on a $300,000 loan, one point would cost $3,000.

When you buy points, you're essentially prepaying interest to get a lower rate over the life of the loan.

Pros of buying points:

• Lower monthly mortgage payments: A reduced interest rate means you'll pay less each month.
• Long-term savings: If you plan to stay in the home for at least five to seven years, the upfront cost of buying points may be offset by the interest savings over time. The break-even period depends on your loan amount, the cost of the points and the extent to which they reduce your rate.

Cons of buying points:

• Higher upfront costs: You'll need more cash at closing, which can be a barrier for some buyers.
• Break-even period: You may not see actual savings unless you stay in the home for at least five to seven years. If you sell or refinance too soon, you might lose money.

Pro tip: Run the break-even analysis with your lender to see how long it will take for the monthly savings to outweigh the upfront costs.

Think of recurring costs as the charges you’ll continue to pay after you purchase your home. They’re ongoing expenses.

They include:

• Homeowners insurance: Most lenders will ask you to pay the first year of your homeowners insurance premium on or before closing day. Data from NerdWallet shows that average homeowner insurance premiums are about $1,784 per year. Keep in mind your home’s value, location and coverage amount could impact your costs.  
• Property taxes: These are annual taxes paid to your local government. You may need to prepay a portion at closing depending on the time of year and local requirements.
• Mortgage interest: Interest accrued between your closing date and the end of the month may be collected upfront.  
• Homeowners association fees: If your property is part of an HOA, you may need to pay dues upon closing for the current or upcoming period.  

Nonrecurring closing costs are one-time charges, such fees include:

• Application: This is charged by lenders for submitting a loan application. Not all lenders will charge you this fee, but it’s typically paid when you apply and most likely non-refundable.  
• Credit report: A fee to cover the cost of making copies of your credit report to assess your mortgage application. One of the most important factors determining the interest rate offered to you is your credit score, which is part of your credit report.  
• Loan origination: A loan processing fee charged by your lender. This could typically range between 0.5% and 1% of the total loan amount. Separately, there potentially could be an underwriting cost, which is the process of verifying your information about your employment, income, assets, debts and credit history to see if you could afford to pay back the mortgage loan you’re applying for.  
• Government recording costs: A charge that covers the registration of the property under your name on your deed, mortgage and other official documents related to your home loan. These costs are determined by state and local government agencies and can vary by agency.  
• Appraisal: A cost paid to a professional who assesses the value of your property. The cost can vary depending on the size or value of the home.  
• Home inspection: While this charge is not required, it's a charge paid to the inspector who examines the physical structure and condition of the property. It’s highly recommended because it can help you identify minor problems before they escalate into bigger ones.  
• Title insurance: This is paid to the title company, which searches county records to ensure the title to the property is clear from any pending debts or liens.  
  
  • Lender's title insurance is required.  
  • Owner’s title insurance may be recommended.  
• Attorney: In some states, an attorney is required to oversee the real estate transaction. These are services that may be included: reviewing and explaining the closing disclosure and other legal documents, ensuring the title transfer is legally sound, handling contract negotiations or resolving disputes, overseeing the signing process to ensure compliance with state laws. Fees vary by location and complexity.  
• Title Search and Settlement: Covers the cost of researching the property’s ownership history and facilitating the closing process.  
• Escrow or closing: Paid to the escrow company or closing agent for handling the transaction and funds.  
• Notary: Covers the cost of notarizing legal documents during closing.  
• Wire fees: Charged for sending funds electronically, such as your down payment or closing costs. 
• Courier and delivery: Covers the cost of sending physical documents between parties involved in the transaction.  
  

Some closing costs are negotiable, but the extent of negotiation depends on the type of fee and the party with whom you’re negotiating. According to Vernon, you generally cannot negotiate these fees with the lender. However, you can shop around for your loan terms, such as rate, structure, and lender fees. Negotiating with the seller for seller-paid costs is a separate process.

Pro tip: Some lenders may cover closing costs if you accept a higher interest rate, according to Davis.

A closing disclosure is the final statement of your loan terms and closing costs, sent by your lender at least three days before closing. It breaks down your loan terms, purchase price, principal, interest, payment amounts and all fees. Review this document carefully — go through the numbers yourself and review them with your lender and real estate agent. In states where you are required to be represented by legal counsel, your attorney will help but always double-check for mistakes.

Pro tip: “Compare the final disclosure to initial estimates to avoid surprises,” said Davis.

Closing costs directly impact a home purchase by increasing the upfront cash needed, affecting loan approval and determining whether you can actually close on the home.

Pro tip: Ask yourself, “Do I have enough money to close on the home today and can I get the monthly payment to where I want it to be?" said Davis.

What can go wrong: Closing costs are first estimated early in the process but can change before closing. Davis said that closing costs may shift, especially during contract negotiations or if there’s a misunderstanding between the buyer, lender and real estate agent.

“Make sure that your [real estate agent] understands what your expectations are so that when you do get into the contract negotiation, you stick with those expectations,” Davis said.

Always compare your initial loan estimate to the final closing disclosure and ask about any differences. Some fees paid upfront may be credited back or offset by assistance programs, which can affect the final numbers.

What can go wrong: Davis warned, “You don't want a surprise and find out that you thought you were going to need to bring your $28,000 to closing and it turned out to be $38,000,” emphasizing the importance of clear communication and preparation.

Some lenders, including Bank of America, offer assistance programs such as the “America’s Home Grant,” which provides up to $7,500 for closing costs and lender credits for one-time expenses. Eligible borrowers may also benefit from a down payment grant, offering up to 3% of the home’s purchase price, capped at $10,000 for upfront costs or to reduce the loan amount. Together, these programs can save buyers up to $17,500, depending on location. These grants do not require repayment.

Certain loan programs, such as Navy Federal Credit Union’s Homebuyers Choice and Military Choice loans, offer 100% financing and allow for seller concessions and gift funds to be used toward closing costs.

Additionally, many cities, counties and states offer grants or assistance programs that can be applied to closing costs. Eligibility often depends on income, location or being a first-time homebuyer.

Pro tip: “It's incredibly important…to do your research,” Vernon told Homes.com. Some lenders offer closing cost calculators. “Sit down with a trusted adviser, a real estate professional or a lending officer...to navigate that process.”