You have your down payment saved, so you think you are ready to buy a house. Before you start, you should know some things. You need more than just the money for the down payment to buy a house. Many fees go into the purchase, which is important for you to understand so that you can make the most of the situation.
THE COST OF BUYING A HOME
When you buy a home, you have to think of the following costs:
- Earnest money – The money you put down to show the seller that you do intend to buy the home
- Down payment – The actual amount of money you are going to put down on the home, but you can deduct the earnest money from the amount you must bring to the closing
- Closing costs – Your lender, appraiser, attorney, and title company will all charge fees that you’ll have to pay at the closing
- Prepaid expenses – You may have to cover interest, taxes, and insurance expenses at the closing
- Mortgage insurance or program fees – If you take out a government-backed loan, you may have to pay a funding fee or upfront mortgage insurance at the closing
Don’t forget, you’ll also incur fees outside of the closing. You may have to pay movers, furnish your home, pay for utilities to get turned on, and other miscellaneous fees. There is a lot to consider when you decide how much money you need to buy a home.
HOW MUCH OF A DOWN PAYMENT DO YOU NEED?
One of the largest components of your cash needed to close is the down payment. The exact amount you’ll need depends on the loan program. Are you going the conventional route? You’ll likely need at least a 5% down payment. If you are going the government-backed loan route, you may need less money down, but it depends on the program. VA and USDA loans don’t require a down payment. FHA loans do require one, but it’s only 3.5% of the loan amount.
You aren’t restricted to only putting that amount of money down, though. You are free to put down as much money as you want, as long as it’s verifiable. For example, on an FHA loan, you can put down 20% if you have it. You may not want to because you’ll be paying mortgage insurance for the life of the loan even when you have 20% equity in the home, but you get the picture.
WHAT ARE THE CLOSING COSTS?
We can’t give you a bottom line figure of how much your closing costs will be because it varies by lender and borrower. Lenders have some closing costs that are universal, such as underwriting and processing fees. Other fees are based on your qualifying factors though. They include origination points and discount points. Origination points are charged on loans that are ‘extra’ work or are risky. It’s like giving the lender prepaid interest. If you default, the lender at least has the interest they collected upfront when you closed on the loan.
Discount points are something you can choose to pay. They are points to lower your interest rate. If you don’t like the rate a lender offered, you could negotiate a lower rate by paying points. One point is usually equal to 0.5% of the rate. So for every point you pay, the rate may decrease by 0.5%.
You’ll also have third-party fees, such as appraisal fees, title search fees, title insurance fees, and attorney fees. You may be able to shop these costs between service providers to help you get the lowest costs possible. It’s important to talk to your lender to see if they allow you to shop around for things like the appraisal or title services.
DON’T FORGET THE PREPAID EXPENSES
Prepaid expenses aren’t something you can negotiate or ignore. They are a necessary part of every loan. They include things like:
- Interest – If you close before the last day of the month, you’ll have to cover the per diem interest on the days that remain in the month. It’s best to close at the end of the month so that you can avoid paying too much interest upfront.
- Real estate taxes – The timing of your closing and the due date for taxes will determine if you have to pay any taxes up front. Each lender has their own threshold regarding what portion of the taxes they want upfront when the taxes are due relatively soon.
- Homeowners insurance – Every borrower has to have homeowners insurance that at the very least, covers the loan amount. This helps the lender know that if the house were to be totally destroyed that you could afford to have it built up again otherwise the lender takes a large risk in insuring your home. You will likely have to pay for a full year of insurance premium up front.
DO YOU NEED CASH RESERVES?
You’ll have to check with your lender on this one. You may need to have money in a liquid account in case of an emergency. Some lenders and/or loan programs like to know that borrowers have money set aside should they be unable to pay their mortgage.
Lenders measure your cash reserves based on the number of months that it can cover the mortgage. For example, if your total mortgage payment is $1,000 and you have $5,000 in reserves, you have 5 months of reserves on hand. Lenders will tell you the number of months hat they require so that you can figure out if you have enough.
So how much money you need to close depends on your situation. The amount you plan to put down, the closing costs the lender and third parties change, the amount of reserves you need, and the cost of your prepaid items will tell you how much you need.
It’s a good idea to go over these numbers with your lender early on in the process. This way you know how much you need and if you need more time to save. There’s nothing worse than finding out at the last minute that you miscalculated and you need thousands of dollars more than what you have available. Get your costs in writing and know exactly what you have to pay upfront, what you can get credited by the seller, and what you can wrap into your loan amount.