How to Budget for Closing Costs When Buying a Home

Defining Closing Costs: The Hidden Expenses of Homeownership

When purchasing a home, many first-time buyers focus solely on the down payment and the mortgage amount, overlooking a critical category of expenses known as closing costs. These are various fees and charges incurred to finalize the real estate transaction and transfer the property title from the seller to the buyer. Closing costs typically represent a significant amount—often ranging from 1.5% to 4% of the purchase price, depending on the province and the complexity of the deal. Failing to budget for these non-negotiable, out-of-pocket expenses can lead to serious financial stress or, in extreme cases, jeopardize the entire closing process.

Legal Fees and Disbursements: The Cost of Title Transfer

A major component of the closing budget is dedicated to legal and administrative fees. You must budget for your real estate lawyer or notary's fees, which cover the work of drafting documents, reviewing the purchase agreement, and ensuring a clear transfer of title. Beyond the lawyer's fee are the disbursements—out-of-pocket expenses paid by the lawyer on your behalf. These include costs for conducting title searches, ordering necessary property certificates, preparing mortgage documents, and covering land title registration fees. As these costs are essential for a legally sound transfer, they must be estimated accurately early in the home-buying process.

The Principal Tax: Land Transfer Tax (LTT)

In many major Canadian markets, the single largest closing cost is the Land Transfer Tax (LTT), which is a provincial tax levied on the buyer for transferring property ownership. In cities like Toronto, buyers face both a provincial and a municipal LTT, effectively doubling the tax burden. This tax is calculated on a tiered basis, similar to income tax brackets, but based on the purchase price. For example, a $1,000,000 home could trigger an LTT of $16,475 in Ontario. New buyers should immediately research their province and municipality's LTT rates and seek any available first-time buyer rebates to mitigate this substantial expense.

Mortgage-Related Costs: Insurance and Appraisal

Several mandatory costs are tied directly to securing the financing. If your down payment is less than 20%, you are required to pay for Mortgage Default Insurance (e.g., CMHC insurance). While this fee can be amortized (added to your mortgage principal), the associated provincial sales tax (PST) on the premium must often be paid upfront at closing. Additionally, lenders require a professional appraisal fee to confirm the property’s value supports the loan amount, and a survey fee (or title insurance) to verify the property boundaries. These costs are non-negotiable steps in the lender's risk assessment.

Adjustments and Utilities: Pro-rated Fees

An easily overlooked expense category involves the Adjustments. On closing day, the buyer must reimburse the seller for prepaid costs that cover the period after the closing date. The most common adjustments are for property taxes, utility bills (like water or hydro), and pre-paid condo or strata fees. For instance, if the seller paid the annual property tax bill in July and you close in September, you must reimburse them for the remaining ten months. Though often minor, these pro-rated costs can add several thousand dollars to your final bill, so they must be factored into the budget.

Budgeting Strategy: The 1.5% to 4% Rule and Contingency

To budget effectively, new buyers should work with their mortgage broker and lawyer to obtain a comprehensive written estimate of all closing costs immediately after their offer is accepted. As a reliable rule of thumb, always reserve a minimum of 1.5% to 4% of the home's purchase price in liquid funds separate from your down payment. Finally, include a small contingency fund within this budget. Unexpected issues, such as minor property line disputes or last-minute legal filings, can arise, and having a buffer ensures you can address them without derailing your closing day.