Closing costs include the fees required for purchasing a home. In contrast, a down payment is the initial amount the borrower must pay to purchase a home. Closing costs are not the same as a down payment.
In real estate transactions, these two payments play an important role. As a real estate professional, I’ve noticed that students get confused with many real estate terms because of their minor differences. My job is to make these terms and definitions easier to learn.
In this post, I’ll differentiate closing costs and down payment with the help of examples. Let’s dive in to explore these real estate terms in detail.
What are Closing Costs vs Down Payment?
Closing costs are one-time administrative fees for finalizing the mortgage. In contrast, a down payment is the initial upfront payment for purchasing a home. The main difference between closing costs and down payment is the amount, where the down payment is the largest upfront expense in a mortgage.
Down payment and closing costs are paid during the escrow period. The escrow period is the period that starts when the lender and the borrower agree on a loan offer. On the closing day of the deal, the lender and the borrower meet to finalize everything. At this time, the escrow agent expects two fees; closing cost and down payment.
Closing costs are 2% to 5% of the home’s purchase price. The costs included in closing costs are all the fees required to close the loan, including the loan fees, origination fees, title fees, prepaid taxes, attorney fees, and others.
Down payment is the amount that the borrower pays to the lender as a percentage of the purchase price. Depending on the borrower and the lender, the down payment may be between 2% to 20% or more—the larger the down payment, the lower the interest rates. The percentage or amount of down payment also depends on the type of mortgage loan.
Is Closing Cost Included in Down Payment?
No, the closing cost is not included in the down payment. Both are different costs in real estate transactions but are paid at the same time. There is no fixed amount for both costs; it depends on the lender and the borrower to decide on the costs.
The buyer pays the closing costs and the down payment both. However, sometimes the buyer can request the seller to pay the closing costs, and the seller can use it as an incentive to sell their property. It is important to note that the closing costs do not count toward the mortgage payment or your down payment. The closing cost is separate from the down payment and must be paid to finalize the loan.
Calculating Closing Cost
Closing costs are all the expenses required to purchase the home and take out a mortgage. These costs are negotiable; the buyer can negotiate the costs with the seller and request them to pay some or all of the closing costs. But, the seller doesn’t need to always agree to this.
A mortgage company issues a closing disclosure 1 to 3 days before closing. If you want to calculate the closing costs of a mortgage yourself, you must know other costs that add up to make the closing cost. Generally, if the borrower sets aside 3% of the purchase price, it is good enough for the closing costs. Consider the following components of a closing cost:
Lenders may charge a loan application fee to process the loan application. Depending on the type of lender and the mortgage, the application fee may range from $0 to $500.
A real estate attorney charges attorney fees to prepare the home purchase documents and mortgage agreements.
An appraisal fee is a fee given to a certified appraiser who evaluates and determines the property’s market value. This fee is around $300 to $400.
Discount points are the prepaid interest that the borrower can pay to lower the interest rate on the mortgage. These are optional but are included in the closing costs of the loan.
Escrow fees are the fees that third-party charges for managing the closing costs. An escrow agent might charge fees anywhere between $300 and $1000.
Home inspection fees
Home inspection fees are the fees that a home inspector charges to evaluate the property. This fee can be between $300 and $500. A home inspector analyzes the property and indicates any problems.
Homeowners insurance is the fee that the homeowner will pay to keep their home safe from incidents. This fee may range between $400 and $1000.
The origination fee is the fee required for processing or underwriting the loan. This is the highest fee among the closing costs. The fee is around 0.5% to 1% of the loan amount.
Prepaid property taxes
Prepaid property taxes are the upfront costs that the homebuyer has to pay. These costs are for two months’ local property taxes in advance.
A professional surveyor charges a survey fee for evaluating the property lines. The fee is usually around $400.
Title fees are the costs related to the home’s title. The fees include title searches, recording fees, title insurance, and transfer taxes. The title fees can be around $200 to $2000.
Calculating Down Payment
The percentage of down payment varies according to the type of mortgage. For conventional loans, the down payment is usually 10% to 20%. For the FHA loans, the down payment is 3.5%. The amount of down payment the buyer chooses also helps the lender determine how much and what type of mortgage to offer. A larger down payment makes the borrower competitive and the mortgage less risky for the lender. The following is the formula you can use to calculate a down payment:
Purchase price X % down = $ amount of down payment
In real estate exams, they may ask you to calculate the amount of the down payment or the home’s purchase price. To calculate the amount of the down payment, you can use the above formula. If you are asked to calculate the purchase price of the home, you can use this formula:
Purchase price = amount of down payment / % down
We’ll discuss the examples of a down payment for both formulae in the section below.
Closing Costs vs. Down Payment Examples
Example 1: Suppose John purchases a home that costs $350,000. The lender asks John to pay 20% down for this mortgage. John calculated his down payment in the following ways:
- Down payment = $350,000 X 20% = $70,000
- Mortgage balance = $350,000 – 70,000 = $280,000
In this example, John has paid 20% down, which means a down payment of $70,000. The lender will now give a mortgage of $280,000 to John. The 20% down is the percentage of the home’s purchase price. And we obtained the mortgage amount by subtracting the down payment amount from the home’s purchase price.
Example 2: Suppose Sally purchases a home, and she doesn’t tell the purchase price to her friend, Mary. However, Sally told Mary that she paid $60,000 as a down payment, which is 30% of the purchase price of her home. Mary can now calculate the home’s purchase price as follows:
- Purchase price = $60,000 / 30% = $200,000
- Purchase price of the home = $200,000
Example 3: David wants to know the closing costs on his mortgage. He bought a property for $300,000, and the loan officer told him the closing costs were 4% of the purchase price. The closing costs can be calculated as follows:
- Closing costs: 4% of $300,000 = $12,000
David wants to know other fees, which were added to the closing costs to make $12,000. The following is a breakdown of the closing costs for David:
- Loan application: $300
- Appraisal: $400
- Attorney: $300
- Escrow: $600
- Home inspection: $1000
- Origination fee: $3000
- Homeowners insurance: $1000
- Private Mortgage Insurance: $2000
- Prepaid property taxes: $1300
- Title fees: $2000
- Total closing costs: $12,000
Frequently Asked Questions
Is There Any Such Thing as Zero Down Payment?
Yes, some types of mortgages come with no down payment. For instance, the VA and USDA loans come with zero down payment. The federal government backs these loans, and there are certain qualifications for them.
How To Get a Lower Down Payment?
To get help with down payments, there are down payment assistance programs. These programs help first-time buyers cover the cost of the down payment. Besides that, the FHA programs allow you to pay only a 3% to 3.5% down payment. Fannie Mae and Freddie Mac are government-backed organizations that require only 3% down, but they have strict qualification criteria. Sometimes individual lenders may offer their own down payment assistance on conventional loans. Thus, it is always a good idea to shop for mortgages to get the best deal.
Is A Large Down Payment Better?
In most cases yes, a large down payment is better as it reduces the mortgage balance. This means that homebuyers will have to pay a lesser amount to the lender in the form of a mortgage. If the homebuyer can afford a large down payment, they must go ahead as it will help them pay off the mortgage quickly. However, if a large down payment will result in no money for meeting daily expenses, it is not wise to put a larger down payment.
What to Know for the Real Estate Exam
Closing costs and down payments both are initial upfront costs but are separate from each other. Closing costs include all the fees required to process or administer the loan, and a downpayment is a cost required to lower the mortgage. Both costs are expressed as a percentage of the purchase price. The closing costs can be in between 2% to 6% of the purchase price, and down payments can be zero or can go higher than 20%.
I hope you can now easily differentiate between the closing cost and the down payment. If you want to learn more such definitions, go through these easy-to-learn Real Estate Terms.