Closing Costs vs Down Payment: Explained
Once a home buyer and seller have agreed on an offer, the real estate transaction enters the escrow period.
During this period, there are a few contingencies to clear before the parties close the sale.
On closing day the parties meet to sign formal documents to legally transfer the property.
The escrow agent expects the buyer to finance two fees at escrow. One fee is the closing cost and the other fee is the down payment.
Is a Down Payment and a Closing Cost the Same?
Closing costs and down payments are conflated in a real estate transaction. In reality, they are different costs in the mortgage lending process.
In other words, the down payment and the closing cost are not the same.
Prospective buyers are expected to have the funds for both when they close on a home. The buyer’s agent educates their client on what to expect in the home buying process.
Therefore, that includes what they can expect to pay for the closing cost and down payment on a home.
Let’s take a look at which fees are associated with closing costs and down payments.
How Much are Closing Costs on a House?
The closing costs for a sale are typically due once the seller accepts the buyer’s offer.
The buyer goes to the lender to complete the process or close the loan. At this point, the seller is required to pay closing costs. The closing costs of a home are various fees associated with the loan.
The closing costs usually amount to 2 – 5% of the purchase price. Setting aside 3% of the purchase price is a good amount to finance closing costs.
What are the Closing Costs on a House?
So, what are the closing costs when buying a home? Closing costs are the fees a party accrues throughout the transaction and must be paid on closing. Buyers can expect many of the following fees:
Most lenders will charge an origination fee, which covers the cost to open a loan.
Other associated loan fees include the document review and processing fees to cover the cost of assembling the documents for the mortgage application.
Lenders also charge underwriting fees to pay the underwriter for evaluating the mortgage loan application.
While companies charge different amounts for these fees, homebuyers can expect to pay around 1% of the home’s purchase price in loan fees.
The transfer of title is an important legal aspect of purchasing real estate.
Many lenders will require a title examination, or search of public records for any documents, liens, or judgments, to ensure that there are no impediments to the title transfer process.
Also, lenders will require that borrowers purchase a title insurance policy to protect the lender’s investment.
It is wise for homebuyers to obtain their own title insurance policy as well. During closing, the parties are expected to pay fees to the agent coordinating the closing process.
Mortgage lenders also expect buyers to pay some bills a couple of months ahead of the first payment.
On average, buyers are expected to pay the entire annual homeowner’s insurance premium at closing.
The average annual cost of homeowner’s insurance is $1000. But, buyers will also pay the interest that accrues between the loan closing and the first monthly mortgage payment.
This is why many closing days are scheduled for the end of the month – to cut down on the prepaid interest due at closing.
Real estate sales are subject to local and state taxes.
Many municipalities charge a real estate transfer tax when a property is transferred from one owner to another. Therefore, this tax is usually a percentage of the purchase price.
Similarly, recording fees are charged by the county clerk’s office to record the sale in the public record. But, property taxes are collected at closing as well.
Who Pays Closing Costs on a Home?
The party who pays the closings cost is typically the buyer. However, buyers can request the seller to finance the closing costs. By doing this, the seller will give the buyer an incentive to buy the house. This doesn't always happen, but it is possible.
Whoever pays the closing on a home is outlined in the initial purchase agreement so, when the time comes, it's clear who pays what.
How Much is a Down Payment on a Home?
Mortgage companies expect buyers to put their own money down toward the loan at closing.
The down payment is separate from closing costs, but this payment is also due on closing day.
The amount of the down payment depends on the type of loan that the buyer and lender decided to use. Many people believe that they must have 20% of the home price as a down payment for a home loan.
This is a good general rule of thumb. But, the average down payment for first-time homebuyers is 6% of the purchase price. Also, there are common down payment home loans that require smaller payments.
Down Payment Home Loan Types
Finding a down payment home loan is typical when buying a home. But, there are few types of home loan options that are available for home buyers.
The FHA Loan
The Federal Housing Administration (FHA) began backing home loans for U.S. citizens in 1934 as a response to the Great Depression.
The goal was to increase access to homeownership and create construction jobs.
Today, FHA loans are a perfect option for buyers who have smaller down payments or average to below average credit scores.
The minimum down payment required for people with credit scores above 580 is 3.5% and 10% for those with lower credit scores.
The VA Loan
VA (Veterans Affairs) loans are backed by the U.S. Department of Veterans Affairs. VA loans were designed to assist veterans to transition to civilian life after World War II.
The government guarantees loan repayment for part of the amount if the borrower cannot make mortgage payments.
With this insurance for lenders, VA loans allow borrowers to secure home loans with no money down.
Today, veterans, active duty service members, and qualifying surviving spouses are eligible for these loans.
The USDA Loan
USDA (U.S. Department of Agriculture) loans are another common loan option for homebuyers.
The aim of this loan program is to encourage rural development through home loans that support low and middle-income homebuyers in underdeveloped areas.
Down payments are not required with USDA home loans.
Final Thoughts Closing Costs vs Down Payment
Many first-time homebuyers may not have a clear sense of what is involved in the mortgage loan process. As a buyer’s agent, you’ll excel if you understand the process and can expertly navigate your clients through it.
Remember that both the closing costs and the down payment are expected when the buyer is ready to close the loan.
The amount expected for the closing costs is approximately 3% and the percentage of the down payment depends on the type of loan the buyer chooses.
As an agent, when would you discuss closing costs and down payments with your buyers?
TL;DR: The difference between closing costs and down payments is simple. Closing costs are the costs accrued at the end of the transaction while the down payment is the percentage of loan payed upfront at the start of the transaction.