Buying a home is an exciting milestone in one’s life, but it’s also a significant financial undertaking. While you might have budgeted for the down payment and your monthly mortgage payments, there’s another crucial financial aspect to consider: closing costs. Understanding these costs is essential to avoid any surprises when you’re finalizing the purchase of your new home. In this comprehensive guide, we’ll discuss the world of closing costs, explaining what they are, what they cover, and how you can prepare for them.

What Are Closing Costs

Closing costs are the various fees and expenses associated with completing a real estate transaction. These costs are typically incurred at the “closing” or “settlement” of the deal, which is when ownership of the property officially transfers from the seller to the buyer. The specific expenses involved can vary depending on several factors, including the location of the property, the type of mortgage you’re using, and the terms negotiated between the buyer and seller.

Closing costs differ from prepaid items which are costs of owning the home that are prepaid upfront to cover costs in the future. Buyers often pay upfront for property taxes, homeowners insurance, and mortgage interest.

Closing Costs vs Prepaid Items vs Down Payment

It’s important to distinguish between closing costs, prepaid items and your down payment. While all involve upfront expenses when buying a home, they serve different purposes:

1. Closing Costs: These are the fees associated with the actual process of transferring ownership of the property and obtaining a mortgage. They do not contribute to the equity in your home and are sunk costs.
2. Prepaid Items: These are a prepayment of costs associated with home ownership such as property taxes, homeowners insurance and interest. These funds are placed in an escrow account to cover future payments. Although they do not contribute to equity, these are not sunk costs and are often refunded when you sell the home (Get more information on Escrows).
3. Down Payment: This is a percentage of the purchase price that you pay upfront and goes directly towards reducing the amount you need to borrow for your mortgage. It represents your initial equity in the home.

Common Components of Closing Costs

1. Loan Origination Fees: This is the fee charged by your lender for processing and underwriting your mortgage application. It typically ranges from 0.5% to 1% of the loan amount. For most loan products, Lakeside Bank charges a flat loan origination fee instead of a percentage of the loan amount (Get more information on Origination Fees).
2. Appraisal Fees: Before a lender approves a mortgage, they want to ensure that the property’s value aligns with the loan amount. An appraiser assesses the property’s value, and the cost of this appraisal falls on the buyer. The appraisal fee will vary with the type of loan and type of property (Get more information on your Appraisal).
3. Credit Report Fees: Lenders will pull your credit report as part of the underwriting process. This fee covers the cost of obtaining your credit report and credit score. Lakeside Bank caps its credit report fees (Get more information on Credit Scores).
4. Condo Questionnaire: If you are buying a condo, the homeowners association may charge the lender to obtain a condo questionnaire and other condo documents. This cost is passed through to the borrower.
5. Transfer Taxes: If you buy a property, there is often a one-time tax paid to the state, county and town/city. In the State of Illinois, the seller pays the state and county tax. Most towns and cities charge the seller for the local transfer tax except for the City of Chicago which charges a hefty transfer tax to both the borrower and seller. Outside of Illinois, the amount of transfer taxes and who pays them will vary significantly.
6. Title Fees: In the State of Illinois, the seller’s attorney typically picks the title company and does the title work. Most of the title fees are a pass-through charge of what the seller’s attorney charges the title company for the title work. The borrower can pick their own title company, but overall cost is higher than if the borrower used the seller’s title company (Get more information on Title).
   1. Title Insurance: Both the buyer and the lender usually purchase title insurance. This protects against any title defects or disputes that may arise after the sale. In the State of Illinois, the buyer pays for the lender’s title insurance and the seller pays for the borrower’s title insurance policy. In some states, the buyer will pay for their own title insurance.
   2. Title Search and Title Examination Fees: These fees cover the cost of researching the property’s title history to ensure there are no outstanding liens or issues that could affect ownership.
   3. Courier and Delivery Fees: These are minor expenses associated with delivering documents and payments throughout the closing process.
   4. Other Title Fees: There are numerous other title fees that you can be charged as part of your home purchase and closing. You will get a list of these before you close.
7. Attorney Fees: In some regions, it’s customary to have an attorney present at the closing to ensure all legal documents are in order. Attorney fees can vary widely. In the State of Illinois, it is customary for the borrower to hire an attorney for a modest fee.
8. Home Inspection Fees: While this is typically paid for by the buyer before closing, it’s still considered part of the closing costs if it’s not already settled.
9. Recording Fees: When the property deed is transferred from the seller to the buyer, it needs to be recorded with the appropriate government agency. This incurs a fee.
10. Survey Fees: In some cases, a property survey may be required to confirm property boundaries and any encroachments. The cost of the survey is typically borne by the buyer.

Estimating Closing Costs

The total closing costs can vary significantly, ranging from 2% to 5% of the purchase price or even more in some cases. It’s essential to get an estimate from your lender early in the home buying process. A closing cost estimate outlines the expected closing costs based on your specific mortgage and property.

Keep in mind that closing costs can be influenced by factors like the type of mortgage you choose. Some government-backed loans, like FHA and VA loans, have specific rules about which closing costs can be paid by the buyer or seller, which can affect your total expenses.

Negotiating Closing Costs

In some cases, buyers may be able to negotiate with the seller to cover a portion of the closing costs. This negotiation can be part of the initial purchase agreement and is typically in the form of a credit from the seller to cover closing costs and prepaid items. However, the extent to which sellers are willing to contribute to closing costs varies and often depends on the local real estate market conditions and the overall condition of the property. Please consult your lender and realtor.

Preparing for Closing Costs

As you embark on your home buying journey, it’s crucial to factor closing costs into your budget. Here are some tips to help you prepare:

1. Save in Advance: Start saving for closing costs as soon as you decide to buy a home. Having a dedicated fund for these expenses will help ensure you’re financially prepared. It is not enough to just save for your down payment.
   
2. Review Your Loan Estimate: Your lender is required to provide you with a Loan Estimate within three days of receiving your mortgage application. Review it carefully to understand your estimated closing costs.
   
3. Ask Questions: Don’t hesitate to ask your lender and real estate agent for clarification on any fees or expenses you don’t understand. It’s essential to be well-informed. Try to understand which costs are negotiable and which are standard.
   
4. Consider Seller Contributions: If it’s a buyer’s market or there is not much demand for a particular property, you may have more leverage to negotiate with the seller for a contribution towards your closing costs.

Closing costs are a necessary part of the home buying process, and understanding them is crucial for budgeting and financial preparedness. While they may seem daunting, with careful planning and negotiation, you can manage these expenses effectively. Remember to work closely with your real estate agent and lender to ensure that you have a clear understanding of your closing costs and can transition smoothly into homeownership. Ultimately, being informed and well-prepared will help you achieve your dream of owning a home without any unexpected financial surprises.