Closing costs are, on average, between 2% and 5% of the new home's purchase price. This means that a home with a national average price of around $370,000 would have closing costs between $7,400 and $18,500.
But what are closing costs? Are there any that new homeowners can control? This article aims to help homeowners understand closing costs when applying for a fixed-rate mortgage, including potential strategies to reduce them.
What are Closing Costs?
Closing costs are the costs that homebuyers must pay for a mortgage, other than the down payment. These include lender fees, taxes, prepaids and escrow, payoffs, and other third-party fees. These costs are a one-time payment due at closing, which differs from the down payment, which goes toward the loan's value. Despite this, many lenders will include both payments as one number in their estimates, called “Estimated Funds to Close” or something similar.
The specific price of these closing costs varies widely by state, time of year, market conditions, and lender policies. Each category of closing costs has a different potential for negotiation. While some fees are within the buyer’s power to shop around, others are required by state, local, or lender policies.
Types of Closing Costs
Closing costs are divided into four categories: lender fees, taxes, third-party fees, and prepaids. Homeowners must understand each category to gauge their potential for negotiation and accurately predict the total cost to close on their new home.
1. Lender Fee
Lender fees vary by lender and include points applied toward the loan amount, if applicable. These include certain non-negotiable costs grouped together into the origination fee, which includes application and underwriting fees. This usually comes out to 0.5% to 1% of the loan amount. On a $300,000 house, for example, that would be around $1,500-$3,000.
2. Taxes
Taxes, including other government fees, differ by state but include recording fees for both the deed and the mortgage, plus a fee for state tax and stamps.
3. Third-Party Fees
Third-party fees involve many fees that homeowners are likely unaware of before initiating their home purchase. Some of these services cannot be shopped for, which means they must be paid based on state, local, or lender regulations. These include:
- Appraisal fee
- Credit report fee
- Processing fee
- Tax service fee
- Flood certification fee
Each varies widely in amount depending on local requirements and is usually not negotiable. Specific fees, such as the processing fee, depend on the lender’s policies rather than local regulations. Therefore, different lenders will offer different processing fees, though each lender will not negotiate the amount of their fee once they are assigned to the mortgage.
Other third-party fees include costs that the buyer can shop for to get a better value. These include:
Home inspection fee- Lender endorsement fee
- Lender title insurance
- Owner title insurance
- Recording fee
- Settlement agent fee
- Closing fee
- Title examination and search
- Title endorsement
These fees can be significant, but a professional insurance broker can shop for the best value. Alternatively, an experienced financial institution can offer competitive rates on third-party fees.
4. Prepaids and Escrow
Prepaids and escrow are the fees required at closing to start insuring the home, paying prepaid interest, and taking care of initial property taxes. These vary widely based on state conditions for insurance and tax rates. However, this is a category where most homeowners, especially second or third-time buyers, will notice a significant increase compared to past markets in the years since the pandemic-era market hikes.
How to Negotiate Costs
Timing is essential for the costs that can be shopped or negotiated. Each fee is calculated based on market conditions at the time of calculation; some will change weekly, while others remain the same, provided certain conditions are met. Lenders must provide an estimate within three business days of the initial mortgage application, which helps homeowners budget for their purchase.
Fixed-rate loans provide buyers more monthly stability, while adjustable-rate mortgages offer lower initial costs.
For a fixed-rate mortgage, homeowners will be locked into their interest rate at the time of closing. However, there are other ways that homeowners can mitigate their costs to close:
1. Seller Negotiations
While this is easier in a buyer’s market, sellers may agree to cover some or all closing costs. This rarely happens in seller’s markets since buyer competition is much higher. However, in the right market conditions, it’s not uncommon for buyers to receive seller concessions to help with closing costs.
2. Shop Different Lenders
Different lenders offer different rates on some of these fees. Homebuyers should compare at least two loan estimates before committing to a lender. The two estimates should come from different institutions, such as a local broker and a financial institution, such as a bank or nationwide lender.
3. Ask for Lender Credits
Some lenders offer closing cost reductions in the form of credits. These credits cover some initial costs in exchange for a higher interest rate. Homebuyers should only consider this strategy if they cannot close without help.
4. Search for Local Programs
Local programs and grants may be available to help with closing costs, especially for first-time homebuyers. Eligibility varies by state and by the requirements of each grant, but this could be a viable strategy, especially for military service members.
Partner With an Experienced Lender to Understand Maryland Mortgage Rates
Closing can be daunting for many first-time homebuyers. Recognizing these costs, including which can and cannot be negotiated, is essential to choosing the right lender for your homebuying ambitions. At Woodsboro Bank, our experienced team works with homeowners of all experience levels to help them understand their closing costs and find competitive estimates.
Contact our team today to learn more about the costs you can expect to pay and how you can strategize your budget to close on your new home.