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What Is the Formula for Calculating Closing Costs?

Understanding Closing Costs and Their Importance

Closing costs, those pesky fees tacked on at the end of a home purchase, can be a real budget buster if you’re not prepared. But knowing what they are and how to calculate them can help you plan ahead and avoid any nasty surprises.

In simple terms, closing costs are the expenses over and above the property’s price that buyers and sellers typically incur to complete a real estate transaction. For buyers, they can range from 2% to 5% of the loan amount according to this Investopedia article. Not exactly chump change, right?

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So what all goes into these closing costs? Well, a bunch of things like loan origination fees, appraisal fees, title insurance premiums, and more. The exact costs vary based on the property’s value, your loan program, and where you live. It’s kind of a headache to figure out, but knowing the formula can make it way easier.

The Basic Closing Cost Formula

At its core, the closing cost formula is pretty straightforward:

Closing Costs = Lender Fees + Third-Party Fees + Prepaid Items + Escrow Funds

Let’s break that down a bit:

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Lender Fees

These are the fees charged by your lender for originating and processing your loan. Some common lender fees include:

  • Origination fee (0-1% of loan amount)
  • Underwriting fee ($300-$900)
  • Application fee ($100-$300)
  • Rate lock fee (0-0.25% of loan amount)

According to this article from NerdWallet, lender fees can add up to 0.5% to 1% of the total loan amount.

Third-Party Fees

These are costs for services required by your lender that are provided by third-party companies, such as:

  • Appraisal fee ($300-$500)
  • Credit report fee ($25-$50)
  • Title search and insurance ($500-$1,000)
  • Survey fee ($150-$400)
  • Recording fees ($25-$250)

Third-party fees can vary a lot based on your location and property value, but typically range from 0.5% to 1.5% of the home price.

Prepaid Items

Some costs need to be paid upfront for the upcoming year, like:

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  • Homeowners insurance premium (varies)
  • Mortgage interest (depends on closing date)
  • Property taxes (pro-rated amount)

The amount you’ll need for prepaid items depends on the time of year you’re closing and your loan’s interest rate.

Escrow Funds

Lenders often require you to put some funds into an escrow account upfront to cover future property tax and insurance payments. This can add a few hundred to a couple thousand dollars to your closing costs.

Estimating Your Total Closing Costs

So how do you calculate your actual estimated closing costs? It’s really just plugging in the numbers for each fee category above based on your loan details, home price, and location.

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For example, let’s say you’re buying a $300,000 home with a $270,000 mortgage at 4.5% interest. Your estimated closing costs could look like:

Lender Fees:

  • Origination fee (1%): $2,700
  • Underwriting fee: $500
  • Application fee: $200

Third-Party Fees:

  • Appraisal: $400
  • Title insurance: $900
  • Survey: $300
  • Recording: $100

Prepaid Items:

  • Homeowners insurance (1 year): $1,200
  • Mortgage interest (2 months): $2,025
  • Property taxes (6 months): $1,800

Escrow Funds:

  • Homeowners insurance (2 months): $200
  • Property taxes (2 months): $600

Total Estimated Closing Costs: $2,700 + $500 + $200 + $400 + $900 + $300 + $100 + $1,200 + $2,025 + $1,800 + $200 + $600 = $10,925That’s over 4% of the purchase price just in closing costs! But at least you know what to budget for upfront.

The key thing is to ask your lender for a loan estimate that breaks down all the fees so you can get an accurate closing cost calculation. Don’t just go by general percentages or rules of thumb.

How to Reduce Closing Costs

Nobody likes paying thousands in closing costs, so it’s smart to look for ways to reduce them if possible:

  • Shop around and compare lender fees – they can vary significantly
  • Negotiate fees with the lender – some may be willing to waive or reduce certain charges
  • Consider a no-closing cost loan, but understand the tradeoffs
  • Avoid overpriced services like overpriced title insurance or surveys
  • Ask the seller to pay some costs – very common in a buyer’s market
  • Put down more than 20% to avoid mortgage insurance

Every situation is different, so look at all your options to minimize those closing costs as much as possible.

The Bottom Line

Closing costs are an unavoidable part of buying a home, but knowing how to calculate them takes away a lot of the sticker shock. Use the lender fees + third-party fees + prepaid items + escrow funds formula to estimate your total costs. And don’t be afraid to shop around and negotiate to get the best deal possible.

At the end of the day, a little preparation for closing costs goes a long way towards making that final step to homeownership a lot smoother. Trust me, you don’t want any nasty surprises at the closing table!

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