When most people imagine buying a house, they think about how many bedrooms they need or what kind of porch they want. When they think about homebuying costs, they decide how much to put down and what their maximum home price is.
But buying a house has many components, many of which get forgotten along the way. Closing costs are one of them. They can make up a huge portion of your homebuying budget and can surprise people who aren’t prepared.
Read more to learn about closing costs, how to minimize them and when you can avoid them.
What are Closing Costs?
Closing costs are expenses the lender and title company charge to finalize the mortgage and title transfer.
There are multiple items that are included as part of closing costs. Some of the most common include an application fee for the mortgage company, an appraisal fee to hire a professional appraiser to determine the home’s value and an extra deposit for homeowners insurance.
Because closing costs can be made up of a dozen expenses or more, it’s easy to get overwhelmed and overlook the cost. Buying a house is complicated enough, especially if you’re moving out-of-state.
But before you dismiss the document, look over closing costs carefully. Ask your real estate agent to take a look as well. You may be able to negotiate some of the fees.
Closing Costs for Sellers
Most often, the buyer is expected to pay all closing costs, but if you’re in a competitive market, they may ask you to share the burden. This is something you or your real estate agent can negotiate when the time comes. If you’re in an exceptionally tough market, you should be prepared for this possibility.
If you do agree to pay for closing costs, make sure you’re not overpaying. You can ask the buyer to choose a lender with lower closing costs or agree to only pay a certain percentage, such as 3%.
How to Mitigate Closing Costs
How much you pay in closing costs matters, but many people focus too much on the mortgage interest rate and forget to compare closing costs.
If you’re a buyer in a buyer’s market, you can often ask the sellers to pay your share of the closing costs. You should include this when you make an offer. This is something you can also negotiate if you discover there are extensive repairs that need to be done or if the seller needs more time to stay in the house.
Borrowers should also be aware that not every lender charges the same for closing costs. Closing costs range between 2% and 5% so it’s important to shop around when you’re buying a home.
Let’s say you put an offer on a $200,000 house. Bank ABC charges 2% for closing costs, which is $4,000. Bank XYZ charges 5% or $10,000. That is a huge difference between the two. That $6,000 difference is enough to purchase a new couch, dining room, mattress and bed frame. It’s also enough to pay for a new water heater or furnace.
Before you finalize a lender, ask if any closing costs are optional. Get quotes from at least three lenders and compare both the interest rate and closing costs.
How to Roll Closing Costs into Mortgage
Buying a home is expensive and it’s common for borrowers to feel broke after paying a down payment, moving fees and other expenses. Many simply forget to budget for closing costs.
One option is to roll your closing costs into the mortgage. If you have $5,000 in closing costs, you can add that to your mortgage. The obvious downside is that this increases your total mortgage amount and you’ll pay interest on your closing costs.
If your interest rate is 5% on a $200,000 home and you owe $5,000 in closing costs, you’ll pay extra interest on that $5,000. It’s the same thing as if you bought a home for $5,000 more than you budgeted for. That’s why adding your closing costs to your mortgage should be a last resort.
If the down payment and closing costs will wipe out your entire liquid savings, it might be better to roll the closing costs into the mortgage. It’s not good to have no emergency fund or savings after you’ve just bought a house. This can lead to huge problems if you lose your job or have a major home repair.
It’s difficult to add the closing costs to your mortgage if you’re a first-time homebuyer. Still, it’s not a bad idea to ask the lender.
How to Save for Closing Costs
When my husband and I started saving for a house, we knew what our budget was and how much we needed to save for a down payment. I had a friend who was a real estate agent who told me to start saving for closing costs. I knew they would be between 2-5%, and I decided to estimate at the high end of that range.
If you’re interested in buying a house, don’t forget to budget and plan for closing costs. A good rule of thumb is to save 5%, even if your lender promises it should be closer to 2%. It never hurts to save more money.
The easiest way to save for all homebuying-related costs is to set up a separate savings account and create automatic transfers to that account. If you know you want to buy a house next year, divide how much you need by how many months you have left.
You can also use the home loan affordability calculator & Goals feature in the Mint app to track your progress in that account. If you get a major windfall like a bonus at work, stash the money in that account. When you’re ready to buy a home, your closing costs will be there for you. Any extra funds can be used to buy furniture, paint or decor.
It’s not fun or exciting to think about all the expensive parts of buying a home, but it’s always better to be prepared.