Down Payment and Closing Costs Explained
What a down payment does to a loan, what closing costs cover and how they are calculated, and why they change the number before the first month.
Two sums of money leave your account before the mortgage does. The down payment buys the house; closing costs buy the loan. Both change the arithmetic from day one, and both are routinely estimated with a rule of thumb rather than a figure.
The down payment
A down payment is the part of the purchase price you pay yourself. The rest is borrowed.
Its arithmetic effect is straightforward and its financial effect is not. A larger down payment means a smaller loan, which means less interest charged over the life of the loan. It also means less cash left in savings, which is an effect the mortgage calculation does not capture.
The requirements come from the loan type rather than from arithmetic. Conventional loans can be made with as little as 3 percent down, FHA loans start at 3.5 percent, and VA loans can be made with no down payment at all. Below 20 percent on a conventional loan, private mortgage insurance is usually required, and it is a cost that sits outside the payment.
The HUD housing resources and the CFPB’s mortgage tools both set out the current programme requirements.
What closing costs cover
Closing costs fall into a few groups:
Third-party fees. The title search, the title insurance, the appraisal, the survey, the recording fees.
Lender fees. The origination charge for making the loan, and any application or underwriting fee.
Government charges. Transfer taxes and recording fees, which are set by state and county and can be a meaningful share of the total.
Prepaid escrow. Property tax and insurance for the period after closing, collected up front because the bills have already been paid.
The last group is the one that surprises people most, because it is money that looks like a cost but is really a prepayment of a later bill. If the seller asks for six months of property tax at closing, you are not paying six months of tax; you are paying for the months that have already been billed.
How they are calculated
Most closing costs are one of two things: a percentage of the purchase price, or a flat fee. The origination charge is normally a percentage of the loan amount.
That gives a useful approximation: on a $450,000 house with a $360,000 loan, costs of roughly 2 to 3 percent of the price and roughly 1 percent of the loan are a reasonable place to start estimating. The spread is wide because the components vary by state, by county and by the complexity of the title.
The CFPB publishes a tool that works out the closing costs in a particular county, and it is the most accurate way to get a local figure.
The Loan Estimate
Three business days after you apply for a loan, the lender has to give you a Loan Estimate. It is standardised, which means the format cannot vary, and it is the document that makes the numbers comparable between lenders.
Two features of it matter for a comparison. It shows the cash to close at the top of the first page, which is the sum of the down payment, the closing costs and any prepaid items. And it shows, line by line, which fees can be financed and which cannot.
A third business day before closing, you get a Closing Disclosure. It is based on the actual figures rather than the estimates, and it has to be compared with the Loan Estimate. Some figures are allowed to change by a limited amount and others cannot change at all, and the document states which is which.
How this interacts with the calculators
The mortgage calculator on this site takes the amount borrowed rather than the purchase price, which keeps the arithmetic simple and keeps the comparison honest. To model a purchase, work out the loan amount first:
loan amount = purchase price − down payment + financed closing costs
Then run the calculator with that figure. The financed closing costs matter here, because they raise the amount borrowed and therefore raise both the payment and the total interest.
The rent versus buy calculator does the same thing, and it treats closing costs as a percentage of the price by default, so that they appear in the upfront outlay rather than disappearing.
The number that is easy to forget
In a rent versus buy comparison, the down payment and the closing costs are the two largest cash outflows on the buying side, and they arrive before the first monthly payment does. A comparison that starts from the monthly figures has already skipped them.
Sources
These are the primary sources behind the figures and the method in this guide.
Calculators behind this guide
Common questions
How much down payment do I need?
It depends on the loan type and the lender, and the requirements are published. Conventional loans can go as low as 3 percent, FHA loans start at 3.5 percent, and VA loans can be made with no down payment. The arithmetic consequence is that a smaller down payment means a larger loan and more total interest.
What do closing costs cover?
They cover the work of originating the loan and transferring the property: third-party fees, lender fees, government recording and transfer taxes, and prepaid escrow items such as property tax and insurance for the first period.
How are closing costs calculated?
Most of them are either a percentage of the purchase price or a flat fee, and the standard origination charge is a percentage of the loan. A cash-out refinance has its own rules about how much can be rolled into the loan.
Can closing costs be rolled into the mortgage?
Sometimes. Lender and third-party fees can generally be financed, and some government recording charges can be, but prepaid escrow and some taxes cannot. The limits are published in the Loan Estimate, which shows the cash to close and the financed amounts separately.
What is a Loan Estimate?
It is the standardised disclosure a lender must provide within three business days of an application. It shows the loan terms, the estimated closing costs, and the cash to close at the top of the first page.
Do closing costs affect the monthly payment?
They do if they are financed, because the amount borrowed rises. The calculator takes the loan amount directly, so the effect of a larger financed amount shows up in the payment and in the total interest.