Closing Costs Explained

Today I’m going to be talking about closing costs, all of the things that you have to pay to purchase a property. We will talk about what you will pay, what the seller will pay, and many other aspects of closing that can be negotiable.

One quick disclaimer on closing costs is that customs for closing costs vary state by state and even area of the state as well. For example, even within California, in Northern California, buyers usually pay the title insurance premium, while sellers usually pay the premium in Southern California.

Again, this is all customary, but everything is negotiable. That being said, almost every single offer that I write, and every offer that I see written for homes that I’m selling tends to be pretty consistent, so we are going to stick to the customary closing costs for this discussion.

I’m going to do this video first from the perspective of the buyer, and then go over a few items that are unique to sellers.

Ok let’s start with the very first one. Not really a closing cost per se, but it does roll into the final settlement statement, so I’ll include it here, and that is the earnest money deposit. I could do a whole video on the earnest money deposit, and maybe I should, but here are is the quick and dirty.

It’s 3% of the purchase price, it is wired to escrow within 3 business days of an accepted offer, it is fully refundable if you properly exercise any of your contingencies, but not refundable if you would like to pull out of the purchase after you’ve removed all contingencies.

It becomes a part of your down payment, so if you’re putting 20% down and 3% is in escrow from your earnest money deposit at the very beginning, your remainder of down payment will be 17% of the purchase price.

Ok, now for the list of what most people consider to be closing costs which are things above and beyond your down payment. First is property tax. Property taxes are due twice a year, on November 1st and February 1st. They are prepaid for the period, so it is highly likely that one of two scenarios will play out.

Either the seller has prepaid property tax and they sell the property tax to you, and thus it will be a credit to the seller for the property tax for that difference in time period. Or the seller will not yet have paid the property tax up to the sale date of the property and it will be a credit to the buyer from the seller for the difference.

Speaking of credits, they will also show up on your closing costs. Most often we see credits from the seller to the buyer for issues that came up during the inspection.

Because this is cash that the buyer would need to pay to close on the property, we typically refer to any credits to the buyer as “cash in hand”, ie cash that you have to spend immediately.

The next category is title costs, and the big one is title insurance. In Southern California, the seller typically pays title insurance as a way of stating that they are handing the property over with a free and clear title.

However, the buyer pays their portion of title insurance called lender’s title insurance, which is separate from the seller’s title insurance and specifically covers the lender. If you get a mortgage on the property, the only collateral that the bank has is the property itself, and thus, the bank wants to know that you have free and clear ownership if they have to foreclose.

This is usually cheaper than seller’s title insurance because it only covers the portion of the property the lender has lent.

Then you have all the little title fees, which include recording fees for the deed of trust, recording fees for the grant deed, wire transfer fees, and notary fees.

Most of these you can’t really shop around too much for, they’re kind of just built into the title company, so make sure you choose one that is reputable. It is worth noting that tile fees are heavily regulated, so you can pretty well know for sure that you’re not paying double what another title company would pay.

Next are your escrow costs. As a reminder, escrow is paid to be the neutral third party that gathers all of the documents and money related to the transaction and disperses them properly. They too have to be paid, and they have a settlement fee, a document preparation fee, and possibly some small loan tie in fees.

It is worth noting that both the main title insurance and escrow fees are typically tied to the purchase price of the property on a point system, i.e. a flat fee plus a percentage of the purchase price.

Finally you have lender charges. Most of the time you are not closing exactly on the 1st of the month when your mortgage payment becomes due, so you’ll prepay the interest on your loan up until your very first mortgage payment, and at that point it will be rolled into your first payment.

There are underwriting fees which is the cost for the lender to evaluate and create your loan. Then there are a lot of small fees such as credit report, flood certification, and tax service fees.

Also, any lender credits that you may have by either paying points or from taking a higher interest rate will show up in this section.

Finally, you have a few miscellaneous things that are handled at closing. You likely will pay your insurance for the entire year in one lump sum which is somewhere between $500 and $1200 .

Home warranty shows up here, however it is customary for the seller to pay for almost all if not the entire home warranty.

HOA dues and fees, if they are applicable, will show up here, but that will only apply to properties that have a Home Owners Association, like condos and townhomes.

Ok that generally covers the closing costs from the buyer’s perspective, let’s talk about a few items unique to the seller.

First you have the broker commission. Many people don’t understand exactly how commission works so here is a quick breakdown. The seller pays the commission for the sale of the home to the listing agent.

The listing agents signs an agreement that they will share a portion, usually 50%, of that commission to the buyer’s agent. The seller has this taken out of their proceeds on the sale of the property and each portion of the commission, the listing agent and the buyer’s agent, are paid out of escrow.

Next is the Documentary Transfer Tax. This is a governmental tax on the transfer of real property, over and above any lien, also called a real estate transfer tax in other states. This is California after all, we definitely have our taxes!

Finally, the seller has to pay their portion of the escrow fees. It is customary in southern California for each party, the seller and the buyer to pay their own escrow fees, which roughly works out to a 50/50 split.

That isn’t the way it is in all areas of California, but it is what usually happens in Southern California.

This covers all of the common closing costs you’ll see when purchasing a home. Remember that as a buyer, you have to pay these in cash on the purchase of the property.

The seller can simply have their closing costs taken out of the proceeds of the sale, but the buyer will need to have these funds liquid before closing day. I always tell people to estimate at least 1.5% of the purchase price, and 2% just to be safe.

That is a pretty important number, so I’ll just reiterate that: a minimum of 1.5% liquid in cash for closing costs. But luckily this is something a good lender will work with you on before you even go down the road of a preapproval.

One quick tip I have for buyers before I wrap up this video.

You should know that your monthly payment is estimated with PITI - Principle, Interest, Tax, and Insurance. But wait, as I talked about above, insurance is prepaid for the year and taxes are due twice a year as lump sums.

That’s because your actual mortgage payment itself only includes the principle and interest, but these other things are payable so you want to budget for them accordingly.

All lenders will offer the ability create what is called an impound account or an escrow account (not to be confused with the escrow for the purchase itself), and this will be used to collect an estimation for your property taxes so you don’t accidentally hit the due date without the thousands of dollars required to pay your taxes.

This is either to protect new homeowners that were previously renters and used to paying a flat monthly “housing payment” from not budgeting properly, or people who simply want that convenience.

However, my tip is actually to NOT do this. That’s right, I usually recommend my buyers not set up this impound account. Why?

First of all it is a lot of money that you are pre-loaning to the government. At closing they can impound multiple months worth of property taxes which can be a lot of cash to hand over.

Additionally, I’ve heard horror stories about lenders either taking far too much or not enough, leaving buyers still footing the bill, or taking a refund far after the fact.

Finally, for anyone that has any variability with their income, like a lot of the folks in the film industry here in Los Angeles, it's far easier to wait and pay then prepay property taxes if you’re in an income gap.

As I mentioned before, property taxes become due twice a year, on November 1st and February first. However they don’t become delinquent until December 10th and April 10th respectively. I always suggest people be diligent, put aside your property taxes and pay them before the delinquent date.

To me, it just makes far more financial sense.

So that wraps up this video on closing costs. I hope you found this video informative, and if you learned something, please don’t hesitate to share it with someone that may be interested in purchasing their first home, or even selling their current home.

This market has low interest rates for buyers, but has also been commanding top dollar for sellers with a lack of inventory. I’ve been highly successful on both sides of the transaction, so if there is anything that I can do to help, please reach out.

Thank you for reading!