A Guide to Closing Costs: What Every First-Time Homebuyer Needs to Know

Closing Costs Explained: Buy Smarter as a First-Time Homebuyer

Buying your first home? Beyond all the home viewings, the offers, and running around a financial bill is lurking in the wings. Closing costs can add thousands of dollars to the basic carrying costs referenced by most “transactional” people during the whirlwind of the homebuying journey.  Unless you are aware, closing costs can be a shock, making the fun and excitement of buying your first home hit the skids and leave a hole in your stomach. 

A Guide to Closing Costs: What Every First-Time Homebuyer Needs to Know

Don’t worry, this guide will walk you through everything you need to know so you become a savvy first time home buyer before you start shopping for the house that will become your home.

What Are Closing Costs?

Closing costs are the fees and charges you’ll pay when finalizing your home purchase. Many of the professionals in the home buying process are not paid until the transaction is completed and the deed for the new property owner is recorded at the country recorder’s office.  If the transaction does not go through, there are no “closing costs”.  Closing costs can range from 2% - 5% of the home’s purchase price.  Many of the fees can be waived or lowered if you, technically, qualify as a first-time homebuyer.   

Typically, you’ll receive a detailed breakdown of these costs at least three days before your closing date, which is way too late in my opinion.  Additionally, when you initially talk with a lender about a mortgage, they will give you a Truth and Lending Disclosure and this disclosure will outline the basic fees of the loan. However, this is too early, in my opinion, because you do not have a specific property identified nor a specific loan type.  Details of the mortgage and the property can change while you are in the process of buying a home and those details can impact fees.  Nonetheless, these are the two disclosures used in the home buying process.  Let’s dive deep into each of these so you can customize your own working closing disclosure cheat sheet so, you won’t be surprised at closing.

Common Closing Costs You Should Know

 Loan Origination Fee: The loan origination fee is charged by the lender for processing your loan application. It’s typically a percentage of the loan amount however some lenders are moving to a flat fee. Some lenders allow you to pay a higher origination fee in exchange for a lower interest rate. Be sure to ask your lender about different fee and rate combinations to find the best fit for your situation. Should you use a mortgage broker, their fee may be wrapped into this fee.

Appraisal Fee: The lender may require an appraisal to ensure the property’s value aligns with the loan amount. An appraiser will complete an evaluation, and their report will be submitted to the lender and to you, as the buyer, for review.  Appraisers are third party consultants that work for the bank, yet you, as the first-time homebuyer, are responsible for the bill which ranges from a few hundred to a thousand dollars. Some loan programs offer appraisal waivers or credits, so inquire about potential savings when comparing lenders.

Credit Report Fee: Lenders will pull your credit report to assess your creditworthiness.  Before you apply for a loan and incur costs doing a personal self-study is prudent.

Title Search and Title Insurance: These fees are related to the transfer of the property unencumbered.  The title search verifies the people selling the property are legally allowed to do so. Yes, people do try to sell property they don’t own (usually in estate sales when someone has passed). The search verifies there are no ownership disputes or outstanding liens on the property.   Purchasing a title insurance policy protects both you and the lender against any mistakes with the title and you will avoid the hourly rate an attorney will charge to clean up the situation. With respect to title insurance, you will have two policies, one for the lender (this fee is non-negotiable) and an owner’s policy (optional but recommended) which covers you in the event of a dispute.

Recording Fees: Local governments charge these fees to record the deed (property ownership), the mortgage (lien on the property), and other official documents (such as a homestead). When you narrow down an area where you would like to live, research the recording fees at the governing county so you can see what will be required when purchasing a property.

Underwriting Fee: The underwriting fee covers the lender’s evaluation of your loan application and related financial documents. The bank will analyze your financial profile and determine whether or not you fit into a category to give you a mortgage to buy the house. Underwriters never speak to the consumer yet; they request verification of financial statements through paperwork.  Making sure your financial profile is in top shape before applying for a loan will aid in making the process smoother. Some lenders may offer discounts if you have a strong credit history or are a preferred customer.

Escrow Fees: If your lender requires an escrow account for property taxes and property insurance, you will have this fee delineated on the Closing Disclosure and it is technically part of the closing costs.  Should you purchase a condominium, typically 3 months of condo fees are required as part of the closing process.  (Example: condo fee $500 per month = $1500 due at closing).  You may also have options to pay these fees upfront or roll them into your monthly mortgage payments.

Property Insurance

Homeowner’s Insurance: Insurance costs are paid as part of the closing costs. Should you purchase a single-family home or even a duplex with no condo fee, you’ll need to pay for your first year of homeowner’s insurance upfront. Costs vary based on the property’s location and coverage levels. The home insurance is delineated on the Closing Disclosure; however, for a single-family home, you pay the insurance carrier directly before closing. 

Should you purchase a condo, home insurance is part of your condo fee.  Please note: the condo policy only covers the exterior and common-owned land, therefore, should you want the contents of your home insured you will need to purchase a separate policy.  A “contents” policy is like renters’ insurance and does not need to be purchased by closing.   Many lenders require three months of condo fees to be escrowed as part of the purchase (See Escrow Fees).

Flood Insurance: Should the property be in an area where you need flood insurance as part of the purchase, you will need to purchase a flood insurance policy as part of the closing costs.  Flood insurance costs have been rising and recognizing this cost before you start your home search is well worth your time.  You do not want to be looking at properties where a flood insurance expense will keep you from your homeownership dream.

Property Taxes: Property owners are responsible for property taxes up until the day the property transfers to the new owner.  Local governments bill property owners for single family homes in different revenue collection cycles, therefore, if the property owner paid their bill to the local jurisdiction, you may be required to reimburse the seller for pre-paid property tax.  The adjustment to the property tax is delineated on the Closing Disclosure and is a part of the closing costs.  Condominiums collect the property tax as part of the condo fee, and a similar adjustment is made on the Closing Disclosure.

Attorney Fees: In some states, it’s common to have an attorney handle closings and charge fees for their services. Verify whether this applies in your area.

Discount Points (A buy down): Paying points upfront can lower your interest rate. Each point typically costs 1% of the loan amount. Should you choose this option when formulating your loan, this fee will appear as part of the closing costs.

Prepaid Interest: You may need to pay interest for the period between your closing date and the end of the month. Unlike rent, which is paid upfront, mortgages are paid in arrears. This means your first full mortgage payment will be due the month after closing. Should you purchase a home on January 15 your next full mortgage payment is due March 1, as an example.

Mortgage Survey Fee: The bank employs a third-party consultant to verify the boundaries of the property and ensure there are no structures that encroach on the lot lines. The mortgage survey fee covers this verification.

Real Estate Agent Fees: Recent legal rulings may require first time homebuyers to pay their buyer agent’s commission. While this cost was traditionally covered by the seller, first-time homebuyers should be prepared for this possible expense. A recent Missouri lawsuit has effectively changed the way the real estate agents are paid. However, many sellers still see the value in covering these costs to attract buyers.  As of this writing, the real estate industry is still evaluating a path forward and if the property you are interested in purchasing does not offer compensation for the buyer agent, you may be asked to cover that fee. Before you start your home shopping, look at your finances and see if you will be able to or willing to cover that expense. As a side note, traditionally lenders would not roll a real estate agent’s fee into the mortgage so, be aware of that banking stipulation.

5 Ways To Save on Closing Costs

1. Compare Lenders: Request loan estimates from multiple lenders to identify the best terms and lowest fees.
2. Negotiate Fees: Many closing costs, such as origination and underwriting fees, are negotiable. Don’t hesitate to ask for discounts or waivers.
3. Explore First-Time Homebuyer Programs: Some government-backed home loan programs offer assistance with closing costs.
4. Ask About Seller Contributions: In some markets, sellers may agree to cover part of your closing costs as part of the home purchase negotiation.
5. Review Your Closing Disclosure: Ensure all fees are accurate and accounted for before signing.

Final Thoughts: Closing costs are an inevitable part of buying your first home but understanding them can help you make smart decisions. Remember, not all fees apply to every transaction, and many are negotiable. Use this guide as a reference and a starting point for discussions with your lender and other professionals that you will hire during this process.

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Disclaimer: This blog post is intended to educate first time homebuyers and let you know there are options. Discussing the issues with the professionals you hire during your home buying journey is prudent. We are not recommending or advising you on your financial or legal situation.