If you’re shopping for your first rental property, it’s easy to focus solely on the purchase price. However, it’s important to budget for closing costs so you aren’t surprised as the transaction moves towards closing.
There are a lot of moving parts when you take out a mortgage on a property. Your lender, mortgage broker, attorney, and other players will collect their cut at the closing.
So what exactly is included in closing costs and how much should you expect to pay relative to the purchase price of the property?
Let’s dive in and take a look at what you need to know.
When you are purchasing a rental property, there are a number of expenses that are due at the closing. The term closing costs refer to all of the additional costs above and beyond the purchase price of the property. Paying these costs is required in order to finalize the real estate transaction.
You will need to factor closing costs into the equation when selecting a rental property. You can expect to pay somewhere between 3% and 6% of the total purchase price in closing costs.
Depending on your lender, your loan, and the property you’re purchasing, the fees you are required to pay can vary. That being said, you can still get a sense of what might be owed at closing by looking at some common closing costs for investment properties.
Appraisal
There are two reasons why a lender will require an appraisal of your investment property. Firstly, they want to make sure that you are not borrowing more money than the property is worth. Secondly, they need to make sure that they will be able to recover the home’s value if you end up defaulting on the loan.
Appraisal fees for a single-family home typically cost between $300 and $500. However, multi-family homes and apartment buildings can cost from $500-$1000+ and $1500-$3000+, respectively.
Home Inspection
It is common for lenders to require a home inspection when you’re purchasing a property. The point of this process is to ensure that the home is structurally sound. It also gives the buyer an opportunity to renegotiate or walk away from the deal if undisclosed issues are uncovered, so long as there is an inspection clause in the contract.
The cost of a home inspection for a single-family home is usually between $300 and $500. The fees for this service will be higher for multi-family homes, apartment buildings, and commercial properties.
(Are you comparing different prospective rental properties? Check out this article to learn how a cap rate can help you choose a property that fits your risk tolerance and financial goals.)
Application Fee
When you request a loan, there are costs associated with processing the application. Depending on your lender and the real estate transaction, the application fee will vary.
Assumption Fee
This fee only applies if you take over the remaining balance of a loan when the seller has an assumable mortgage. In this instance, you’ll pay a variable fee that is based on the loan balance.
Attorney’s Fees
A real estate attorney might be required to be present at the closing depending on what state the transaction is taking place in. How many hours the attorney puts into your deal will determine how much this costs.
Prepaid Interest
It is common for lenders to charge you the accrued interest from the settlement date to the first mortgage payment. How much you owe at closing depends on how much money you’re borrowing.
Loan Origination Fee
This is one of the larger closing costs you will be faced with. Also known by the terms administrative fee, underwriting fee, or processing fee, the loan origination fee is usually about 0.5% of the amount of the loan. This means that for a $500,000 property, the fee will be around $2,500.
Discount Points
Whether or not you want to buy discount points will depend on how long you plan on keeping your rental property. Purchasing these points lowers the interest rate you pay over the entire life of the loan.
Mortgage Broker Fee
Are you planning on using a mortgage broker to help you find the right loan? If so, you can expect to pay somewhere between 0.5% and 2.75% of the purchase price of the home to the broker as commission.
Property Taxes
At closing, it’s common for buyers to pay for two months’ worth of property taxes. This includes both city and county property taxes.
Insurance Premiums
Insurance is typically required by lenders to make sure that your property is covered in the case of various unfortunate events. Depending on the value of the property and its location, the cost of insurance premiums can vary quite a bit.
Annual Assessments
If your investment property is a condo or in a homeowners association, you usually have to pay an annual fee. Depending on the circumstance, this might be required in a lump sum at closing.
Owner’s Title Insurance
Buying title insurance can help protect you if there are title claims or problems after the closing. As long as you or your heirs still own the property, this insurance covers you.
Lender’s Title Insurance
Loan policies are required by most lenders. This helps protect them from title claims or errors in the title search.
Title Search Fee
The cost of title searches can vary depending on the region, company, and property. These searches are conducted in order to make sure there aren’t outstanding liens or claims against the property as well as to make sure that the seller actually owns the property.
It’s possible to lower your closing costs if you are savvy when you are purchasing a rental property. Shopping around for your mortgage lender, checking the “services you can shop for” section of your loan estimates, and negotiating on lender-side fees can all help you reduce your closing costs.
If you’re exploring your options when it comes to buying rental properties, you’ll want to make sure all the numbers add up in your favor. Check out our rental property calculator to quantify the prospects of your potential investment.
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