Buying a home is an expensive proposition. In the Greater Princeton area one can get a condo for $200,000 or a huge colonial for $1,000,000 or something higher or in-between. Whether the purchase is for cash or a mortgaged loan, that cost is high, but it’s not the only expense when purchasing a home. Both the buyers and sellers will pay closing costs to finalize their transaction.
You may have heard of “closing costs,” but if you’re a first-time buyer you probably have no clue what they are and, more importantly, how much they may be. What are they for? Are they different for buyers and sellers? Is that an additional amount I need in addition to a down payment if I’m getting a mortgage?
Buyers’ closing costs
Let’s look at an actual transaction in 2021 from the buyers’ side, the purchase of a townhome in West Windsor. At the closing all parties to the transaction received an ALTA Combined Settlement Statement which outlines who paid what to whom. Extracting the amount paid for the townhome itself, the buyers saw that their closing costs for the purchase were $16,200.
“Sixteen thousand dollars? For closing costs?” I can imagine you clutching your chest as you read that. Yes, that sounds like a lot of money, and it is. But what it isn’t is a true reflection of what the buyers’ actual closing expenses were. Let’s break down that amount.
Expenses vs. pre-pays
Closing costs are categorized as one of two types of expenses: transaction fees and pre-pays. Fees are the amounts the buyers pay to make the transaction happen; if there were no transaction, these expenses would not be incurred. Pre-pays are expenses the buyers would incur whether or not they are purchasing a home—“living expenses” if you will.
At the closing the buyers paid the next quarter’s property tax and home insurance, amounts to be held in escrow by their lender. They also paid the currently due bills for those accounts as well as HOA fees that their new homeowners’ association requested up front. The total of these pre-pays was $8,700, about half of the total closing costs.
The lion’s share of the transaction fees went to the title company which researched the ownership and liabilities history of the townhome, issued an insurance policy protecting the buyers against past claims and administered the entire pre-closing and closing process. The buyers also paid their lender points to reduce their mortgage payments, paid their attorney and covered the expense of county recording fees. The total of these fees was $7,500.
But the points paid by the buyers were an optional expense; it was not required by the lender to secure their loan. Because this discretionary expense can range from zero to thousands of dollars, it’s not considered a true closing cost. Removing it from the transaction fees equation along with the pre-pays results in a net true closing expense of $4,900.
Now, $4,900 is not a small amount, but it’s a far cry from the $16,200 that appeared on the ALTA. That should be a relief to buyers who are trying to calculate the true cost of purchasing a home.
“How about the sellers?” you may ask. “Do they have closing costs as well?” They do, but the amounts are much smaller than those for buyers. Or are they?
Sellers’ closing costs
The same ALTA for the above transaction lists sellers’ closing costs of $5,200. Two fees make up virtually all of that amount: the state transfer tax and the sellers’ attorney’s fee. You may ask, “Isn’t there a fee for sellers to list their home with a real estate agent?” There is, but that reduces the amount owners will receive from the sale rather than being an out-of-pocket expense.
So in effect, the buyers and sellers paid almost the same amount for closing costs, $4,900 and $5,200. There is one major difference between those two sets of expenses, however. Closing costs for buyers cannot be borrowed or rolled into their loan, with a few exceptions. Their lender will want proof that the buyers have enough money in their bank account to cover those costs on top of funds to cover the down payment.
Sellers on the other hand have a big advantage: they will typically be getting a substantial amount of money from the buyers at closing and those funds can be used to pay every penny of closing costs and other obligations right at the closing table.
You are never alone in your journey
For more information regarding real estate transaction costs you should seek the advice of a professional who is licensed to understand and manage them—your lender or mortgage broker. Think of home buying as a positive experience in a real estate restaurant: I can show you a menu and offer my recommendations along with excellent service, but it’s the chefs in the kitchen—your attorney, lender and home inspector—who will prepare your delicious closing meal.
