Whether you're learning how to invest in real estate or taking the steps to buying a home for your family, it’s always a good idea to know what costs to expect. It’s a big financial investment; usually, the largest one most people make in their lives, so knowing exactly what you are going to pay is critical.
As you embark on your home buying or selling journey, you will start to hear about closing costs. There are a lot of factors that go into them, so understanding each one and how it relates to your taxes is essential.
Knowledge is power when it comes to real estate transactions. If you don’t know the numbers, you might pay too much when tax time comes around. Read on to learn about all the various closing costs you might encounter and which ones are tax-deductible.
Closing Costs Defined
When you buy or sell property, costs are associated with the transaction beyond the sales price. The amount you pay for the house (or receive if you are the seller) is usually the largest number, but it’s not the only one to be aware of. Fees, interest, taxes, and other variables all factor into the equation.These vary widely based on the home’s sales price, local regulations, lender choice, and other factors. It can also vary by state. According to Business Insider, these are the average closing costs by state:
Average closing costs with taxes
Average closing costs without taxes
As you can see, geography is a driving factor when it comes to closing costs. In general, buyers should budget between 2 and 5 percent of the amount of their loan for closing costs. That means if you purchase a home using a $300,000 mortgage, you can expect to pay between $6,000 and $15,000 in closing costs. Talk to your lender about the exact closing costs you can expect on each specific property you make an offer on before submitting the offer.
Closing costs apply to both buyers and sellers in a real estate transaction. In general, the buyer pays more than the seller. This can be negotiated, though. When buyers submit an offer on a home, they can request that the seller pays all or part of their closing costs. These are called seller concessions.
Seller concessions can cover mortgage points, lawyer fees, appraisal costs, recording fees, inspection costs, loan origination fees, title insurance, and property taxes. There are limits to the amount of closing costs the seller can contribute. This depends on the type of loan you are using. For all types of loans, the seller can never pay more than the total closing cost.
The seller concession limit is a percentage of the down payment amount for conventional loans. It also depends on the percentage of the downpayment in relation to the sales price or appraised value if that is lower.
The seller concession limits on a conventional loan for primary residences are:
The seller concession limits on a conventional loan for a second residence are:
For loans backed by the Federal Housing Administration (FHA) the equation for seller concession limits is much simpler. Sellers can contribute up to 6 percent of the sales price (or appraisal if that is lower) regardless of the down payment amount.
For loans backed by the Veterans Administration (VA), seller concession limits are a bit more complicated. 4 percent of the sales price or appraised value can be paid for by the seller for specific closing costs. These costs include the VA funding fee, prepaid taxes, and homeowners insurance.
There is no limit to what the seller can contribute to credit report fees, appraisal fees, survey fees, loan origination fees, and loan discount points for VA loans.
Read on to learn about all of the closing costs that apply to buyers and all of the closing costs that apply to sellers.
Buyer Closing Costs
Buyer closing costs are dependent on a litany of factors, including location, home sale price, loan type, lender, and government regulations. Your lender should be able to tell you what your specific closing costs will be.
A few days before your scheduled closing, you will receive a closing disclosure form from your lender. This form lists every cost associated with your home purchase and the exact amount you need to bring to the closing table to seal the deal. Again, specific fees will vary, but here are some of the typical costs buyers can expect to see.
When a lender loans your money to buy real estate, they want to make sure the property is worth the amount they are lending you. That makes sense, right? After all, if you default on the loan, your lender needs to make sure they can recoup their money by selling the property.
Lenders hire a professional appraisal to determine the value of the property. The appraiser reviews similar sales in the area, the real estate market as a whole, and the specific details of the home you are purchasing. They send a report to the lender that includes the appraised value. This service involves a fee that the lender passes on to you, the borrower.
In some cases, your lender will charge a loan application fee (usually anywhere between $100 to $500). Sometimes, this upfront fee can be applied to closing costs later, but it is rarely refundable even if your loan is denied.
One way you can reduce the interest rate on your loan is to buy discount points. Mortgage interest rates have been historically low for the last few years, but they are starting to creep up in 2022. This means understanding how to reduce your rates is even more critical than in the past.
One discount point is equal to 1 percent of the total amount of your loan. That means if you are approved for a $300,000 loan, one discount point would cost you $3,000 and reduce your mortgage interest by 1 percent. Unlike unavoidable fees, discount points are optional.
FHA Mortgage Insurance
FHA loans require you to buy mortgage insurance. Mortgage insurance protects your lender from losing the money they loan you if you stop paying your mortgage. Buying mortgage insurance includes paying a mortgage insurance premium. Part of this premium needs to be paid at closing, which is 1.75 percent of your loan.
For example, if you take out a $300,000 mortgage, the amount you will need to pay at closing for your mortgage insurance premium is $5,250. Some lenders will also allow you to roll this cost into your loan so you can pay it over time.
Homeowner's insurance, mortgage insurance, property taxes, and other specific types of fees need to be paid out over time instead of in one lump sum. However, you often need to pay these fees in advance at the closing.
Your lender sets up an account to hold these funds and then disperses them to the necessary places when they are due. This is called an escrow fund. The amount varies, but in many cases, your lender will require you to put a few months' worth of these fees into the escrow account at the closing.
Your lender will disperse the funds from the escrow account when insurance payments are due or if it’s time to pay taxes. This includes local taxes, state taxes, federal taxes, homeowner’s insurance, and mortgage insurance.
Before a lender can approve your loan, they need to check your credit score. This predicts the likelihood that you will be able to afford your mortgage. Your credit score is determined using several factors, including your debt to income ratio, credit history, the age of your credit accounts, and other factors.To determine your score, your lender must pull a credit report. They charge a fee for this, usually about $25 that you need to pay at the closing. You may be wondering what credit score is needed to buy a house. It varies greatly depending on your loan type and lender, so check with your specific mortgage company to get the details. Also, keep in mind that the better your credit score, the better your mortgage interest rate.
Depending on where your home is located, you may be required to get flood certification. This is only applicable to properties deemed to be in a flood zone. This designation is determined by the Federal Emergency Management Agency (FEMA). You can check on specific locations to see if they are in a flood zone on the FEMA website.
Flood certification involves FEMA experts reviewing your home and suggesting any necessary adjustments. This evaluation will cost you about $20 when you close on your new property.
A title company, attorney, or escrow company will coordinate your property purchase's closing date, location, and logistics. They charge a fee for this, which varies significantly on the location and company. In some states, an attorney is required to be present at all closings, which may increase the cost.
If the property you are purchasing is located in an area with a homeowners association (HOA), there will be a fee related to this at the closing. HOA fees depend on the home's specific association, and there is usually a transfer fee when the property changes owners.
Established business practice dictates that HOA fees are paid to the homeowners association by the seller. However, you may need to pay these as a buyer if the real estate market favors sellers (like the 2022 market).
Your lender has several processes that are required to approve your loan. One of the critical processes is underwriting. Underwriting involves lending professionals and computer algorithms verifying and calculating the information you provide to get a loan pre-approval.
Confirming your credit score, income, and debt are just a few tasks involved with underwriting and other loan processes. Your lender charges a fee for this at closing called an origination fee. Loan origination fees usually amount to about 1 percent of the total value of your loan.
If your home suffers damage or destruction, your homeowner's insurance covers all or part of the damage if the event is covered by your policy. The majority of lenders require homeowners insurance before they approve your loan. Your home serves as collateral for the loan if you default, so they want to make sure it’s protected.
Homeowners insurance varies in price depending on the home, location, and insurance company. Most homeowners insurance costs around $35 per month per $100,000 in home value. For example, if you purchase a home for $300,000, your monthly homeowners insurance will cost about $105 per month.
Title Insurance (Owner and Lender)
Owner’s title insurance, which is optional, insures the title of your property. Before closing, a title company reviews the title to make sure there are no liens or other legal entanglements that can prevent the sale of the property. However, sometimes they miss a thing or two during this process and liens can appear after the sale.
For example, if you find that someone has a lien on the property 5 years after you purchase it, your owner’s title insurance will help cover all or some of the cost of the lein. Expect to pay about .5 to 1 percent of your home’s purchase price for owner’s title insurance.
Lender’s title insurance protects your lender instead of you. Suppose a lien is found on the home after you purchase it and you lose the house, lender’s title insurance kicks in to cover the lender’s loss. This can cost up to $900 and is a one-time payment at closing.
Inspections (Lead-Based Paint And Pest)
Before you finalize the sale of a home, you need to have it inspected. This ensures that there aren’t any significant problems with the home that you aren’t aware of. You don’t want to move into your home and find out it needs a costly roof replacement, for example. Finding this out before you close the deal allows you to reduce the price or walk away.
A general inspection includes a complete overview of the home by a professional with an eye toward potential problems. They will review everything from top to bottom and point out defects you might not otherwise be aware of. Sometimes they will recommend you have an expert on a specific part of the house (like a chimney or roof) inspect those areas to determine if there is an issue.
Lead-based paint inspections are almost always waived during the inspection process. However, some sellers hire a professional to determine if there is lead-based paint in the home because it can be a health hazard.
Pest inspections are often required when home buyers are using a VA loan to purchase a home. They also need to be paid for by the seller. This involves a review of the attic, basement, and other areas of the home that might have a pest infestation.
Inspections vary in price depending on the location and size of the home They also vary based on the inspection company you select. A general inspection costs around $600, a pest inspection costs around $100, and a lead-based paint inspection costs around $300.
Some states require an attorney to be involved in all home sales. Even in states where this is not a requirement, many homebuyers choose to have a lawyer review all of the documents before signing them. You are probably aware that lawyers charge fees, so calculate this into your closing costs. Fees vary widely depending on the lawyer and how much you use them. Most will charge you an hourly fee.
Each month you pay interest on the principal of your loan to your lender. When you close on a home, your first mortgage payment usually isn't due until the beginning of the following month. That means interest accrues on your mortgage between your closing date and your first mortgage payment. Most lenders ask you to pay this interest upfront at the closing. This is called prepaid interest and the amount depends on the terms of your loan.
Private Mortgage Insurance (PMI) is required by lenders if your down payment is less than 20 percent of your total conventional loan amount. For example, if you purchase a home for $300,000, your down payment needs to be at least $60,000 if you don’t want to pay for private mortgage insurance.
Lenders will often allow you to make PMI a part of your mortgage so you can pay it over time. However, sometimes they require this to be a cost you pay at closing. The amount depends on the terms of your loan.
Local governments charge taxes on properties in the community to pay for roads, schools, and other public services. The amount you need to pay in property taxes depends on the local government regulations where you live and the value of your home. The more your home is worth, the more you will pay in property taxes. When you close on your new home, your lender often requires that you pay the first year of property taxes.
Many buyers and sellers elect to have a survey done to determine the property lines before closing on a real estate transaction. A professional survey company completes this process and charges a fee. The cost depends on the location and size of the property. You can expect to pay between $250 and $1,000 for a survey to determine the boundary of the real estate you are purchasing or selling.
When a lender pre-approves you for a mortgage loan they quote you an interest rate for the loan. This rate can change over time before the final loan approval is done. This means your rate could be higher when you finally close on your home. To keep the rate you are quoted during pre-approval throughout the loan process, you can pay to lock it in. This usually costs between a quarter and a half percent of your loan, though sometimes lenders will allow you to do it for no charge.
When property changes owners, the transaction needs to be recorded by your local municipality. This will cost you about $125 at closing.
Your lender will outsource the task of verifying the amount of property taxes you owe. This company will let your lender know if it's time to pay taxes and you don’t have the necessary funds in your escrow account. The cost of these services varies greatly depending on location and who your lender is.
Updating the title of a recently sold home and transferring ownership from the seller to the buyer is done by your local government. They charge a tax for this called a transfer tax. This amount depends on where you live.
Title companies research the title of a property to ensure there are no liens, unpaid taxes, or legal proceedings that could prevent the property from being sold. This is called a title search. Sometimes an attorney needs to do this instead of a title company, depending on what state you live in. The fee for this work is usually between $200 and $400.
If you are using a VA loan to purchase property you usually need to pay a VA funding fee. The fee goes directly to the VA to help them continue making these loans available to active-duty military, veterans, and their spouses.
The amount you pay for a VA funding fee depends on the terms of your loan, specifically the amount you put down. This fee can be waived if you receive disability through the VA or if you are the surviving spouse of someone who received disability through the VA.
Mortgage documents need to be transported to a number of different places safely and securely. This is often done by a professional courier or someone from the lending institution. A courier fee is usually about $30.
Seller Closing Costs
Buyers aren't the only ones who need to account for closing costs when a home is sold. Sellers will have closing costs they need to pay as well. Here are some of the most common closing costs people will face when they sell a property.
If a seller chooses to have an attorney help them sell their home by reviewing closing documents, this is something they will have to pay for. Just like with buyers, the amount sellers pay in attorney fees is largely dependent on the number of billable hours they require.
Using an escrow account from a real estate broker, title company, or lawyer can benefit both buyers and sellers during a real estate transaction. When money is deposited in an escrow account, it can’t be released until both parties agree.
For example, if a buyer puts their earnest money deposit (EMD) into an escrow account, the seller knows they can’t just take it back anytime they want. The buyer also knows the seller can’t independently remove it either. The sale needs to be completed, or both parties need to agree to release the EMD funds.
Escrow accounts serve as a neutral bank account that is not controlled solely by the buyer or the seller in the real estate transaction. Escrow fees are usually split between the buyer and the seller.
Credits To The Buyer
Sellers who are having trouble finding a buyer for their home may consider offering some incentives. This can include contributing to the buyer’s closing costs. This is not common in a seller’s market when inventory is low and demand is high. It is more common in a buyer’s market when market inventory is high and buyer demand is low. As previously mentioned, 2022 has been a hot seller’s market so far. Sellers offering credits toward buyer closing costs has been very rare.
When a home is sold, real estate taxes need to be paid by both the buyer and the seller. This is prorated depending on what time of year the closing takes place. Once all the property taxes are up to date, the buyer pays them according to local tax schedules and regulations.
Real Estate Agent Commission
Real estate agents are paid for their work on a commission basis. That means they don’t get any money for the work they do until the deal closes. At the closing, the real estate agent fees will usually be taken out of the seller's proceeds from the sale.
Home sellers typically pay about 6 percent of the purchase price in real estate agent commissions when they sell their homes. 3 percent goes to the listing agent (the agent the seller hired to help them sell their home) and 3 percent goes to the buyer’s agent (the agent the buyer hired to help them buy a home). In some cases, the buyer will pay a portion of the real estate agent commissions but it’s rare.If you are buying a house without a realtor or selling one on your own, you don’t need to worry about real estate agent commissions. Think twice before doing this, though, as the experience and expertise of a real estate agent can be valuable during a home purchase or sale.
Closing Cost Tax Deductions
Now that you know all of the costs associated with closing on a home, let’s take a look at the buyer closing costs that can be deducted from your taxes. Be sure to check with a tax expert that understands the specific details of your real estate transaction and the tax regulations in your specific location before you pay taxes each year.
Local real estate taxes are always deductible when tax time comes around. As previously mentioned, your lender will keep a certain amount of prepaid money in an escrow account and add to it each month to cover local property taxes. At the end of the year, you can deduct all the property taxes that you prepaid into that escrow account. This is true for your yearly property taxes as long as you own your home.
Mortgage interest paid at the closing for the time between closing and the end of the month can be deducted from your property taxes. For example, if you close on a property on April 20, you will owe home mortgage interest for the period between April 20 and April 30. This is called prepaid interest and it is tax-deductible.
Insurance Premiums On Your Mortgage
FHA mortgage insurance premiums, VA funding fees, and private mortgage insurance (PMI) are all considered tax-deductible by the IRS. If you pay your mortgage insurance in one lump sum instead of monthly, the entire amount can be deducted when you pay taxes that year.
Loan origination fees, as described above, are tax-deductible. These are fees that can only be claimed as a property tax deduction the year you purchase your property
Points On Your Mortgage
Points you pay your lender to reduce your interest rate are tax-deductible. Like origination fees, lender points can only be claimed as a property tax deduction the year you purchase your property.
VA Funding Fees
On most mortgages like a conventional loan or FHA loan, the funding fee is not tax-deductible. However, if you used a VA loan to purchase your home, the funding fee can be deducted from your taxes.
Closing Costs That Aren’t Tax Deductions
Now that you know what costs are tax-deductible when you purchase a property, let's look at some of the closing costs that cannot be claimed as tax deductions.
Buying a property can be a huge financial investment. Beyond the sales price, there are a plethora of fees and other costs to consider. Understanding what those costs will look like before you begin the home buying journey will set you up for success.
No one wants to pay more than they have to when purchasing a property. Make sure you understand what closing costs are tax-deductible so you can save some cash when it comes time to pay taxes each year.