A HUGE mistake many home buyers make is not allocating enough funds for closings costs and being financially rattled by how much extra they end up paying than they had initially expected.
PS: Think your downpayment was enough? Think again.
Downpayment and Homeownership Costs
The more obvious costs of homeownership are the downpayment you would have saved up (and perhaps the entire cost of the home if you were making an all-cash offer) and taxes. We wrote in detail about this here.
But this is just one facet of how much you’ll end up spending when buying a home.
Closing Costs – Process
We briefly touched on closing costs in the previous article, but never have we detailed all the categories you’d have to pay attention to.
Earnest Money/Option Money
Earnest money refers to a payment that you will make to the seller (usually held in escrow) to prove your seriousness about buying their property. Depending on the practices in different markets, this money will be applied to the remaining closing costs if the transaction goes through, or might be absolved if the transaction falls apart.
There is usually an option period, during which a buyer can back out of the transaction due to various reasons (an inspection report coming back negative being one of the most common ones) without having to forfeit their earnest money (ie. they’ll get it back if they notify the escrow office in time).
This is usually about 1% of the price of the home.
Closing Costs – Third Parties
Title Search/Owner’s and Lender’s Policy
In our article laying out the steps to buy a home in Texas, we covered the basics of what title is. Essentially, since inscribing the owner’s name onto a property isn’t the smartest way to keep track of ownership, a title deed is a legal document describing ownership of that property. When you are purchasing a property, you will want to make sure that the title deed is clean (ie. there are no disputes over ownership, and there are no outstanding payments that you might end up having to bear the costs of if you were to transfer the deed to your name before the previous owner clear the debt). In fact, your lender will insist that you carry out a title search.
Alongside the search, your lender will also insist that you get a lender’s insurance policy from the title company, which insurances the lender against any future disputes over ownership.
You also have the option to obtain an owner’s insurance policy that insures you against such legal ownership disputes.
All of these expenses are going to add up to quite a bit – expect to spend around $5,000 on title-related fees. However, keep in mind that you CAN shop around for better rates. You don’t have to stick to the one that was recommended to you by your agent!
You’ll have to usually pay for the inspector to come and check the property. Sometimes, the seller will pay for the inspector, depending on the status of the market. This could also be negotiated directly when putting in an offer. You would want to check with your agent for standard practice in the market at that time.
Prices are usually based on the size of the property, and the layout (ie. if there are any ADUs, any special basements/attics, etc), and will usually cost between a couple hundred and a couple of thousand dollars.
In some markets, like NYC and Chicago, which are attorney-driven markets, you will have to fork out extra $ to pay the attornies that handle the closing process. While attorneys are not always involved in transactions, if you find yourself purchasing property in markets like NYC or Chicago, or even special properties and very high-end ones, you’ll find that an attorney is involved to ensure everything proceeds smoothly.
Expect to pay a couple of thousand dollars in fees here.
Closing Costs – Mortgage
Feel free to skip this section if you are financing your home through a mortgage.
Loan Origination Fee
Your loan origination officer will charge you a fee to begin the process. This is a service that can be shopped for, though you probably will end up going with one that your agent recommends to you (or one that you previously have a relationship with).
This could run you a couple hundred to a couple thousand dollars.
A lender will require you pay for an appraiser to appraise the value of the property. It is in their best interest to get a more accurate value of the property in the case of a default (ie. you default on your mortgage payments and they end up seizing your property) because they bare a financial incentive in the property.
This usually runs you a couple of hundred dollars.
Private Mortgage Insurance (PMI)
Your lender will probably require you to pay mortgage insurance if you are putting forth less than 20% in downpayment. This is a way for them to insure against your default in return for giving you a larger loan.
PMI usually costs around 0.5-1% of the sum of the loan and is amortized over the life of the loan (ie. broken down and combined with your monthly mortgage payments).
While this IS a steep sum, you can probably avoid it by putting forth a larger downpayment. Regardless, it should not hit you as hard as the others since it gets amortized over your loan period.
Closing Costs – Miscellaneous
Depending on your geography, you might be required to purchase natural disaster insurance for your property. For example, in Houston, you can expect to pay for Flood insurance, and in California, you can expect to pay for Earthquake insurance.
You can definitely shop around for these rates, but you would have to remember to pay attention to them during the home buying process.
Homeowners Associate (HOA) Fees
Depending on the type of property that you are buying, if it is part of an HOA, you will be required to pay a fee for the maintenance of property that is shared by all the residents of that HOA. This can include a pool, a garden, a parking lot, or even just walking pathways.
The rule of thumb here is that the HOA charges you these fees to take care of anything that occurs outside your walls, but within the boundaries of the HOA.
The converse is for anything that would occur within the walls of your property. For this, you would want homeowners insurance. You can also shop for these rates – perhaps a good place to begin is this review guide put together by our friends at LendEDU.
In some markets, upon closing, you will have to pay different taxes. For example, in NYC, you can expect to pay around 1-1.5% in transfer tax (depending on the price of your property), and an additional 1-4.5% in mansion tax if the purchase price is more than $1M (a common reason why you will come across MANY properties in NYC listed and sold at just below $1M).
If we got paid a dollar for every time we mentioned “a couple hundred to a couple of thousand dollars” in this article, we probably would never have to write articles anymore.
There are MANY different closing costs that you would want to keep in mind and budget for before beginning the home buying process. Though not exhaustive, this list is pretty elaborate. We hope that this acts as a good means for you to understand what you will be getting yourself into before you end up being unpleasantly shocked by the costs that will come your way during the home buying process.
PS: Many of these costs can be included in your loan sum if you’re approved by your lender, so you might not need to pay them upfront, but keep in mind that if you don’t, you’ll end up paying interest on them.