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When you buy a home, you typically need to bring two sums of cash to the table: your down payment and the closing costs. As lenders have become more comfortable accepting lower down payments, closing costs have been rising, and are sometimes the bigger challenge for would-be home buyers.
Typically, closing costs amount to between 2 and 5% of the home purchase price, but some home buyers have paid as much as 8% in these kinds of fees. The numbers vary widely based on location, mostly because some cities, counties or states levy high fees or taxes on real estate transactions, and these are often part of the costs you pay when you close.
Here’s what the sums might look like for an inexpensive home, a median-priced home, and a high-priced home.
Closing Costs as % of Home Price
At these rates, you can see why it would be better to pay less in closing costs. There are a few ways to do that.
Compare Good Faith Estimates
From big banks, to small ones, local credit unions and online-only operations, you have a lot of choices for a mortgage lender. Since a home purchase is such a major transaction, it makes sense to shop around. Get some recommendations from neighbors or friends, and then contact them to start comparing rates.
Once you’ve narrowed down to about three options, go forward with the pre-approval process with each lender all on the same day. Within three business days, each should provide you with a Good Faith Estimate, which itemizes all fees and costs associated with the loan. This estimate is required by federal law.You can use these documents to compare the costs you can expect to pay with each lender.
Some portion of these costs are actually prepayments for things like property taxes, accrued interest and homeowners insurance. Others are fixed costs, such as transfer taxes, which won’t change from lender to lender. But other portions, like loan origination fees and charges for appraisals, are at the discretion of the lender and thus could vary widely.
It’s important to try to get a good deal on those variable closing costs (though not if it means accepting other poor loan terms, like a higher interest rate). Unlike the down payment, which becomes part of the equity in your home, these kinds of fees are spent and gone once you buy the house. They are the main reason you don’t want to buy and sell homes too often—not more than every five years as a general rule.
How to Lower Closing Costs
You might be able to negotiate down some of the closing costs. It never hurts to ask. Once you have a few different GFEs in hand, see if you can pit one lender against another, without getting too specific. You could say something like, "Lender B’s cost estimate is coming in much lower than yours, can you do any better?" Or, you can have the lenders talk you through the fees and ask, "Are all of these absolutely necessary?"
The lender might be willing, and certainly has more power, to lower the fees they are charging themselves. These might include the loan origination fee and underwriting fees. The lender might also be willing to eat some of the smaller costs such as the credit check fee (hey, every little bit helps!). You can also try to get a good deal from any service providers you hire yourself, like your lawyer.
Have the Seller (or Lender) Pay Closing Costs
If the housing market is tough for sellers, yours might be willing to lend a hand with closing costs. Alternatively, your lender may be able to pay the fees for you in exchange for a higher interest rate on your mortgage.
Make sure you do the math to see what these different financial configurations will end up costing you over the long run. For example, on a $100,000 loan, if you plan to put down $5,000 and pay the $3,000 in closing costs in cash, you might get an interest rate of 4% on your $95,000 loan. But if you roll the closing costs into the loan, you’re now financing $98,000 and you might get a higher interest rate of 4.5%. In the second scenario, you’d end up paying $12,483 more over the 30-year life of the mortgage.
Pay Closing Costs in Cash
Ideally, you should save up the cash to pay for your closing costs outright. If you don’t have enough saved, consider using gifts from family members or your own retirement savings, which you may be able to pull out for a home purchase without penalty (there are limitations, and you’ll still pay any taxes owed).
Just don’t get too creative here. If, for example, you take a cash advance on your credit card, it will show up on the credit report the lender will pull just before you close, and could threaten the deal.
A certain level of closing costs are unavoidable, so you will end up paying for them one way or another. The trick is to minimize the damage, and to stay in the house long enough to make them worth it.