Even if you’re a first-time or novice homebuyer you probably know that in order to avoid paying Private Mortgage Insurance (PMI) you’ll need to put down 20% of the purchase price of a home. What you may not know is that homebuyers are also typically required to pay closing costs that can range from 2-5% of the value of the loan. In fact, according to a 2020 survey by the National Association of Realtors, 25% of buyers are not prepared for average closing costs. If you haven’t saved average closing costs in addition to the 20% down payment, you could find yourself facing PMI if you’re able to qualify for a loan or being able to afford less home if you have to lower your loan amount.
In years past, asking sellers to concede a percentage of the sales price was a viable strategy for reducing costs to the buyers. But in today’s real estate market, with many offers coming in over ask, or in all cash, asking for seller concessions can take your home offer out of consideration. (One exception to this seems to be HOA transfer fees which are commonly low, but also often split by the buyer and seller.)
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What Services do Average Closing Costs Cover?
Closing costs vary from state to state due to different property tax rates, requirements for attorney presence and costs related to insurance, however, the responsibilities of the buyer are very similar across the country. As a buyer you’re typically expected to cover the cost of:
Appraisal Fees – Appraisal fees are typically several hundred dollars but are required if you’re working with a lender and recommended even if you’re prepared to pay all cash and waive the appraisal contingencies.
Home Inspection and Title Search Fees – These are different fees that both serve to protect you as a buyer. A home inspection ensures that you’re not caught off-guard by unexpected property defects and a title search (and title insurance) serve to protect your interest in the title and uncover prior claims that may “cloud” the title.
Loan Origination Fees and Prepayments – Both of these are part of your average closing costs and include things like mortgage origination fees, application fees, fees for the mortgage brokers, and any lending agencies involved. You’ll also be required to prepay some HOA fees, property or mortgage insurance, and prepaid interest and property taxes.
How Can You Reduce Your Average Closing Costs?
The best place to start is by working with your lender. Many lenders will offer or be willing to negotiate on a portion of your closing costs. If you’re building a new home, your builder likely has a preferred lender which frequently offer incentives that can save you thousands on average closing costs.
If you don’t have a preferred lender, shop around and see what different lenders in your area are offering for incentives. Because the mortgage application process requires both an initial hard credit pull as well as a subsequent pull at closing, you should avoid applying for mortgages with too many lenders as the frequent pulls can ding your credit.
If you’re in the process of shopping for homes and these average closing costs came as a surprise to you, there are still steps you can take to get into the home of your dreams. A gift from a family member (supported with a gift letter) can be a life saver. As can early retirement withdrawals, which can avoid tax penalties if you’re a first-time buyer that meets certain requirements.
You can also attempt to renegotiate with your lender or simply lower your price range. It can be understandably disappointing to have to start looking at smaller houses, but you’re better off avoiding the costs of PMI than throwing away hundreds of dollars each month with the hope of refinancing in the future (at an even greater cost to you).
As a last resort you can ask the seller to assist in covering a portion of the average closing costs through concessions. As mentioned above, in today’s market this can take your offer out of consideration, but it doesn’t have to entirely. If you’re willing to be flexible with inspection report items and closing, you may find a seller whose personal situation is better served by conceding a few percentage points from the price of the home.