When first starting out as a real estate investor, you’re hit over the head again and again about how important it is to factor in all of your costs when running your numbers. As you gain experience, you’ll get better at remembering even the sneakiest of costs, one of them being closing costs. Understanding how these costs work, and knowing average closing costs at any given time, will help you improve at estimating the true cost of closing on a deal. Let us first define what closing costs are before getting into the mechanics of what they include, how they work, and how you might potentially be able to avoid them overall.
Understanding Closing Costs
Closing costs are the fees directly associated with the transaction of real estate between a buyer and a seller. The term is self-explanatory, as it indicates the fees due at the time of closing, which is the time when the ownership of a property is transferred from the seller to the buyer.
What Are Typical Closing Costs?
According to Zillow, typical closing costs are between 2.0% and 5.0% of the purchase price of a property. That means for a median-price home in the U.S., which is roughly $315,000 according to Realtor.com, closing costs can range anywhere between $6,300 to $15,750 on average. That is not a cheap price tag, and you’re most likely wondering what type of fees can rack up such a large amount. The next section provides a list of typical closing costs.
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What Fees Will This Include?
Now, you may be wondering what could possibly contribute to racking up a price tag upwards of $16,000 from one part of the home buying process. Just take a glance at the length of the list below, and you’ll start to understand why. Furthermore, note that the below definitions are meant to introduce you to some of the most common fees, and that the list is not exhaustive.
Application Fee: When you apply for a mortgage loan, the lender will often charge you an application fee to process the loan. Be sure to ask exactly what goes into the fee, as it can sometimes include the credit check or appraisal fees as well. Not all lenders charge an application fee, so know that it’s negotiable.
Appraisal: This fee goes to the appraisal firm that is responsible for appraising the current market value of the property.
Attorney Fee: In some states, it’s required to appoint an independent attorney to review all of the closing documents on behalf of all parties involved.
Escrow Fee: The escrow or closing fee is paid to the independent agency that oversees and facilitates the closing on the property.
Courier Fee: This fee covers the cost of transporting all legal documents.
Credit Report: If not already included in the mortgage application fee, your lender will most likely charge a fee to run your credit report.
Home Inspection: It is highly recommended that you conduct a final home inspection to double-check the condition of the property before officially claiming it as yours.
Insurance: Title and homeowner’s insurance are also often paid at closing. Homeowner’s insurance protects against possible damage to the property, while title insurance assures your lender that you actually own the home and that the mortgage is not up against any liens.
Loan Discount Points: You can opt to prepay a certain number of “points” against your mortgage loan, which helps you to lower your monthly payments over the life of your loan.
Prepaid Interest: A majority of lenders will require you to prepay any interest that is scheduled to accrue between the time of closing and your very first mortgage payment.
Title Search Fee: The title company will perform a search through records to locate the title to the property. The fees associated with this function must be paid.
Transfer Taxes: Of course, there are taxes on everything. This specific tax is on the transaction of the title transferring over from the seller to the buyer.
Underwriting Fee: This fee is assessed by the lender, and is also often called the administrative or processing fee. This fee covers the cost of verifying the mortgage.
How Can You Avoid Closing Costs?
Although the sheer number of fees, insurances and taxes that make up closing costs can be daunting, many experienced real estate investors and buyers know how to negotiate these costs down significantly—and in some cases, avoid them entirely. The fees are paid either by the buyer or the seller, so in many cases, you can negotiate in a way such that many of the fees are taken on by the other party, especially if you have some type of leverage (such as if it’s a buyer’s market or if the property needs significant renovations.) In addition, you may also sometimes find deals where there are no closing fees associated with the mortgage. However, be cautious when taking on this type of deal, because costs can sprout up in other ways over the long-run. When working with your lender, don’t be afraid to ask if any fees can be waived. Any cost that you can save on is worth it the effort of negotiation. For more tips, you won’t want to miss our guide on six ways you can avoid closing costs.
When you’re running your next deal analysis, just remember that average closing costs will be between 2.0% and 5.0% of the property’s purchase price. You can play it safe and give yourself an estimate of 5.0%, but have the optimism that you could possibly negotiate your way down to the ballpark of 2.0%. This will give you some room to practice your negotiation skills, and to ensure that you don’t have any surprises for your delicate budget at the time of closing.
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