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First-time home sellers are often shocked by the extra expenses deducted when the transaction to sell the home is concluded, a point in time typically referred to as “closing.” Depending on the price of the house, deductions can be as high as 7%-10% of the sales price, and those costs are deducted before any repayment of an outstanding mortgage loan.
In 2019, the average closing costs for a single-family home were $5,749 and included both a lender’s and an owner’s title policy, an appraisal, recording and settlement fees, a survey cost, and transfer tax. If substantial repairs are required, the net amount received by the seller can be even lower.
What are closing costs?
Closing costs refer to the miscellaneous fees and expenses required to transfer the legal title of ownership from one entity to another. They exist to facilitate the sales transaction by reducing both parties’ risk — seller and buyer — by unknowingly assuming undisclosed existing and potential liabilities.
The composition and payment responsibility of closing costs varies from one state to another, either by law or custom. For example, according to Money Geek, sellers typically pay the bulk of closing costs in Florida, while they are generally shared equally in Alabama.
Generally, who pays what is negotiated, whether you are a seller or buyer. A sale contract for a house (or any other asset) typically includes various standard terms and legal boilerplate that can be amended and customized to fit specific transactions. The contract terms typically identify each party’s legal and financial obligation to the other party.
Sellers should remember that they have the option to ask the other party to pay all or a portion of their closing costs or, conversely, offer to pay the buyer’s closing costs to facilitate and expedite the sale.
Closing costs components
The law requires that both the buyer and seller receive closing documents that provide the transaction details at least three business days before closing. These documents include an itemized list of closing fees and expenses paid at closing:
These costs stem from the buyer’s efforts to secure a mortgage and fees required by the lender as a loan condition, including a loan application fee, credit checks, inspections, appraisals, prepaid homeowner insurance, and property taxes. Traditionally, buyers are responsible for the costs rolled into the loan or deducted from the buyer’s down payment.
Sellers are responsible for payment of outstanding judgment or liens on the property. Sellers may also incur a prepayment fee for the early payoff of any loans secured by the property.
Title and settlement fees
Sellers are typically responsible for the costs of an escrow or title company required to assure a clean title to the buyer and title insurance premiums. If a title dispute arises during or after a sale, the title insurance company may be responsible for paying specified legal damages, depending on the policy.
Prorated property taxes and transfer charges
The state, county, and city governments maintain homeownership records and typically charge fees or taxes when a property is transferred to a new owner.
Because property taxes are generally charged in arrears — paying the past year’s taxes in the current year — the seller of a home is responsible for his prorate ownership during the year. For example, if estimated full-year taxes are $12,000 and the house closes on July 1, $6,000 will be collected from the seller’s proceeds for payment.
Other costs or fees paid at closing
While not considered closing costs, there are other fees the seller will pay at closing.
Real estate transactions can be complicated, so an attorney’s use is often warranted to ensure the seller understands the contract terms with penalties and remedies for breaches by either party. For example, what happens if the seller refuses to pay closing costs as outlined in the purchase agreement?
If either party violates the terms of the purchase agreement — which would be the case if the seller refused to pay closing costs as contracted — the buyer can take legal action forcing the seller to pay damages, complete the transaction under court order, or both.
If a seller has any hesitancy or qualms about any detail of the contract, they should delay acceptance until the agreement’s terms are satisfactory. Whenever dealing with legal matters, it is better to be safe than sorry.
Commissions are not considered a closing cost, although they are paid at the time of closing. Real estate commissions are covered in an independent contract between an agent and the buyer or seller of a property with negotiated terms between the two parties (agent and seller; agent and buyer).
Typical commission costs across the country range from 5.06% to 5.85% of the house’s sales price. The listing agent (representing the seller) and the buyer’s agent split the commission, usually on a 50/50 basis. The split can vary among locations. While sellers typically pay the commission for both the seller’s and the buyer’s agents, the responsibility for payment can be negotiated.
Commission rates can also be negotiated. Many listing agents offer repeat clients lower rates. Others are willing to accept flat fees or a lower percentage of the sales price ($3,000 or 1% for homes sold for more than $350,000) for their work. Striving for a lower commission rate can add thousands of dollars to the seller’s proceeds.
Potential income tax liability
While income taxes on the sale of a home are not collected at closing, they may be due at the end of the tax year. Fortunately, the federal tax code provides several provisions to reduce or eliminate the taxes due:
- Unless you are engaged in the business of buying and selling houses, the difference between your home’s original purchase price and the sale proceeds is treated as a capital gain. The profit is taxed up to a maximum of 20%, depending on filing status and taxable income.
- Homeowners living in the same house at least two of the previous five years before the sale who file as individuals are eligible for an exclusion of $250,000 of the gain ($500,000 for those filing jointly with a spouse).
- Homeowners who receive Form 1099-S from a closing agent — title company, real estate broker, or mortgage company — should report the house sale on their tax return, even if no taxes are due.
Closing costs are inescapable and due when you close the sale of your home. The fees are collected when you and the buyer meet with the closing agent, title company, and attorney to disburse the funds and sign documents to complete the sale.
While negotiating fees is legal — and prudent — evading their payment exposes the buyer and seller to potential criminal and civil damages, a risk to be always avoided. The best approach is to negotiate to lower the fees as much as possible, then grin and bear the expense.