One of the most confusing parts of a real estate transaction are closing costs. What are closing costs, what do they include or encompass, who pays them, and how much are they? These questions seem very straightforward and simple, the answers are anything but. Asking these questions to a real estate or banking professional can lead to what may seem to be non-answers that could leave someone feeling skeptical of the whole real estate industry. So today I’m going to take you on a journey into the deep dark world of closing costs and shed some light on what is really lurking behind these questions, so you can be prepared as you enter into your next real estate transaction.
What are Closing Costs?
Closing costs are all the fees, charges, and payments that are paid at closing, excluding the purchase price of the real estate.
For every person you ask what closing costs are, you may get a different answer. Frustrating, right? The reason confusion can happen when asking this question is that some may answer with what typical closing costs are for your side of the transaction. Some may answer with what only the charges for fees and services related to the transaction, excluding items like prepaid items that are not necessarily charged or collected as a fee for transferring the real estate. Some real estate or banking professionals may only answer that question with what their specific charges are, leaving out all the other fees, charges and payments collected for other items.
For the sake of this article and to eliminate any confusion, we are going to include every dollar collected at closing, excluding the purchase price, as a closing cost. Closing costs are easiest to break down by where they are coming from. It is very common to have real estate transactions with more than 20 individual costs (fees for services, charges for products, collections for future obligations, etc.) being collected at the closing. Let’s take a look at where these fees are coming from.
Taxes and Government Fees
Who would have guessed that the government needs it’s cut? It really is not as bad as you might have guessed though, at least here in Indiana where there are no transfer taxes. Really the only cost associated with transferring ownership is for the useful service of recording the transaction at the recorder’s office. This cost is usually less than $100 and is dependent on if you are only recording a new deed or if a mortgage is also needing recorded.
Although the recording is usually the only government cost associated with the transfer of real estate, property taxes are also usually collected as a prepaid item at closing to facilitate a smooth transition from the seller to the buyer.
Property taxes can be the single most complex factor in calculating closing costs. How property taxes are handled can be agreed upon in many different ways. In Indiana the taxes are paid in arrears, meaning the property taxes are billed the following year. Those property tax bills you are paying this year are from your ownership of the property last year.
There are a few things to consider when calculating what property taxes are to be collected at closing. First, any currently billed property taxes that are not yet paid by the seller would be collected and paid to the courthouse to ensure there is no tax lien placed on the property.
Then comes the calculation regarding how any future property tax bills will be handled. What I would argue is that the fairest way to handle property taxes is that the seller pays for the property taxes that are assigned to the time they owned the property up to the day it was sold, and the buyer then takes over from there. It sounds simple, but since the property tax bills will not be issued until the following year, an exact cost can not be known, only an estimate based on the most recently issued tax bills can be used to prorate an approximate tax amount that will come due in the next year. Since the tax bill will not be issued until next year, in this scenario the prorated calculation would be charged the seller and credited to the buyer at closing so that the buyer, who will need to pay for the taxes in the coming year, is compensated for the portion of the year that was owned by the seller.
Lastly, for buyers, how they will be paying for future tax bills will also come into account on how much cost is collected at closing. Again, property taxes are a prepaid item and not an actual cost associated with transferring property. If the buyer elects or is required to set up an escrow account to pay future property taxes from their mortgage loan, the closing is where that escrow account is initially funded. That way there are enough funds in the account to make the first property tax payment when it comes due.
Prorating property taxes is one popular option, but buyers and sellers can and do agree to handle the property taxes in many other ways. Depending on the time of the year and the type of agreement, you could theoretically have next to no property taxes or many thousands of dollars of property taxes collected at closing. Until you know the terms agreed upon, future tax estimates, unpaid current taxes, a closing date, and whether or not the buyer will be funding an escrow account through their mortgage to pay for future property taxes, the total amount of property taxes collected at closing will be hard to nail down.
If the property has homeowner association or other dues, these also need to be paid up to date.
There are usually numerous fees charged by the title company for the services they provide during the transaction. The main fees are:
Any title insurance policy being purchased for the buyer and/or lender
The cost of settling the transaction and facilitating the closing
Doing a title search to look into the public records to determine a property’s legal ownership and find any liens, judgments, etc.
Most transactions contain other small fees associated with the title work, but these are the main ones involved. For an average residential property being sold in southern Indiana, the total for all title fees is usually well under $2,000. Keep in mind, title insurance costs are linked with the amount of the transaction. If a transaction does not require title insurance, chances are that it will cost under $1,000.
Often the largest closing cost collected at closing is any real estate commission to be collected, if a property is being sold with the help of a realtor. Generally, realtors charge 6% of the purchase price for selling the property for the owner. Many property owners try to avoid this cost by selling their property on their own with no help. This can lead to tough situations and many headaches. Here at The Selling Table, the main goal is to help solve this problem. For property owners who want to avoid the high cost of sales commissions but need some help navigating their for sale by owner transaction, The Selling Table can help coordinate their transaction giving them piece of mind and a professional to lean on while eliminating sales commissions and replacing them with coordination fees that are a fraction of the cost.
If a transaction has a buyer who is getting financing for their purchase, you guessed it, the closing costs just went up. While many lenders only charge one or two fees for making the loan (average ballpark of $1K), there are some other services that they will require to be done in order to do the due diligence required by the institution or regulators. A typical mortgage loan will include these additional fees.
Credit report- $30-$100 depending on the amount of borrowers or reports needing to be run
Tax service fee- $80
Appraisal - $450
Lender’s title policy and initial escrow account funding (mentioned earlier)
While not technically a fee for the transaction, another prepaid closing cost will be any interest that will accrue on the mortgage loan up until the buyer’s first payment is due.
When work is done on a property the service provider will typically have the invoice paid at closing. Some examples of the most common services are home inspections, surveys, well water testing, home staging or other repair work. While many of these items are elective, in some instances they are a necessity to facilitate the transaction. For example, if the seller of a property is separating a parcel, a survey would be necessary to get the new legal description to create the new parcel to be sold.
When these other services are a part of the purchase agreement and paid at closing, they can definitely increase closing costs significantly. Most full surveys are in the ballpark of $1,500 and home inspections can easily get over $500. If you plan to have other services completed and paid at closing for your transaction, you’ll want to make sure your coordinator or other professional is aware of any work being done to include in their estimation of closing costs.
So Who Pays What?
Of course, there are many other fees and circumstances that can make these fees adjust up and down, and depending on how the purchase agreement is drawn up dictates who pays for a lot of these items. If you would like to learn more about purchase agreements, check out the latest blog post All About Real Estate Purchase Agreements. On top of figuring out who’s paying, certain regulations dictate how some deals are structured which can complicate matters even more.
As I mentioned earlier, my hope is that this article sheds some light on why asking a straightforward question about closing costs can often lead to confusing answers. It’s important, if you are unsure of what is included in a cost estimate or who is paying for a certain fee, ask questions. Remember, most folks only have a few real estate transactions in their lifetime and the age-old statement of “there are no stupid questions” was never so fitting than a time like buying or selling a property. If you are ready to sell, reach out to The Selling Table today to get a real estate transaction coordinator to help get you started!
***All costs in this post are ballpark estimates and are based on recent personal experiences.