Buying a home is part of the American dream and a rite of passage for any young adult. It’s a satisfying feeling knowing that your domicile is yours, and you don’t have to worry about ever paying rent again.
However, buying a home costs money, and aside from the sticker price, many hidden costs go into finalizing the deal. The chances are that you already know about the down payment you need to finance your new place. However, did you realize that you’ll require some cash to handle other expenses related to the closing costs and utilities?
Preparing for all of the unseen financial hurdles when buying a home will ensure that you don’t make the mistake of over-extending your finances. By understanding how much cash you need on hand to settle the deal, you won’t have to worry about losing your offer on your new residence.
We put together this guide to give you a clear idea of the out-of-pocket cash expenses involved with purchasing a home. Read through our tips to ensure you get the best deal for you and your family.
Speak to a Financial Advisor
Your first step in buying a home should be figuring out exactly how much house you can afford with your income. Financial advisors recommend that you keep the monthly cost of running your home, (mortgage payments, maintenance, and property taxes,) to less than 30-percent of your net monthly income.
Working with a financial advisor will give you valuable insight into how much spending power your salary offers you every month. A talented financial advisor will help you arrange your monthly budget to include your mortgage and property expenses, while still giving you enough room in your budget to save for retirement.
The Pros and Cons of Buying Your Home with Cash
Most Americans dream of paying for their home with cash. Imagine if you have a debt-free residence, and what it means for your monthly cash flow. Housing is the most significant monthly expense for all Americans.
When you take care of your payment up front with cash, you don’t have to worry about negotiating interest rates, or paying almost double the value of your home in interest payments over the duration of the loan contract.
Paying with cash gives you more buying power with the seller, and you could even negotiate a lower selling price if you’re willing to part with money up front.
The possibility of foreclosure is a thought of the past, and you don’t have to worry about someone repossessing your home because you miss a mortgage payment or two. The equity in your home also makes it possible to apply for other forms of finance in your personal and business life, because it acts as collateral on loans to cover the lender’s risk.
However, paying cash for your home might be the preferred option if you can afford it, but there are some drawbacks to this strategy as well.
By paying cash, you lose your mortgage interest deduction. This tax break lets you deduct the interest you pay on a home loan from your taxes, with a value of up to $750,000. Paying cash up front may also extend your finances, reducing your liquidity, leaving you with less money available to cover a financial emergency.
Paying with cash also prevents you from investing that money in other financial vehicles, which may offer a monthly return that could pay your mortgage.
The Down Payment
The down payment on your home will be the most significant out-of-pocket expense in closing on your property. The amount of money required for a down payment on a home has changed dramatically over the course of the last two decades. Before the 2008 financial crisis, lenders were willing to sell homes to anyone with a paycheck – with no down payment.
While this may sound like the opportunity of a lifetime, the practice of easy lending to unqualified candidates meant that many people bought homes that they couldn’t afford. As a result, when the bubble burst, many Americans lost their homes to the bank as they defaulted on their mortgage payments.
After the 2008 disaster, regulators and lenders tightened their belts, and would only issue home loans to customers that could afford to put up a 20-percent down payment. This strategy also hurts the housing market. As a result of the lack of home loans, the American economy started to suffer, and the government decided to relax lending regulations to spur new growth in the market.
As a result, most Americans can purchase a home with a down payment of between 3.5-percent and 10-percent of the asking price. The amount required for your down payment depends on a few factors. Your credit score, previous lending history, and income all play a significant role in the size of the down payment required by lending authorities.
Please speak with your financial advisor. They should be able to give you advice on what you can expect to pay for a down payment on your home. Their insight gives you an idea of what kind of deal you can expect from lenders.
FHA loans only require a 3.5-percent down payment in most cases, making them remarkably affordable for first-time homeowners. It’s important to note that you can’t roll the costs of the down payment into the loan, and you can’t use cash for the down payment either. Your bank or lender will require that the funds for the down payment come from a verifiable source to prevent money laundering.
There are a few lenders that will allow you to make the down payment with a cash gift from a friend or family member.
How Much Cash Do You Need for a Down Payment on Your Home?
Let’s break down the costs involved with the buying process for your home. You’ll need to ensure that you have these costs covered before making your offer. Remember, even a verbal offer on the home is considered a binding legal agreement, so never extend your finances if you know you can’t afford the house.
Let’s take an example of a home that costs $400,000 using an FHA loan. To meet the affordability requirements involved with purchasing this house, you’ll need the following cash amounts available for each step of the process.
With a 580 credit score or more, you qualify for a down payment of 3.5-percent. This rate means you’ll need $14,000 available for the down payment. You’ll need a cash reserve of two mortgage payments, which totals to $5,600, and you’ll require closing costs totaling $32,500. Let’s not forget about the money you need available for the appraisal as well.
Appraising The Home
When purchasing your home, lenders require that you have the property valued by a qualified estate agent. This strategy ensures that the banks aren’t lending you more money than it costs to purchase your home, minimizing their risk in the deal.
If the loan-to-value of the property exceeds the maximum percentage allowed for the loan, then the lender may refuse the deal, leaving you to bargain with the seller for a better price. Depending on the agency you use for the appraisal, the cost for the service could be anywhere between $200 and $800 on average, and you’ll need to pay these costs out-of-pocket as well.
The Costs Associated with Closing
Closing costs will vary from state to state and from lender to lender depending on the transfer tax, government stamps, and other application fees involved with finalizing the deal. Closing is the final stage of the process, and it’s vital that you have enough cash on hand to cover all of the costs involved.
Closing costs can far exceed what you paid on your down payment, and it’s not unusual for the cost to be anywhere between two to three percent of the value of the deal. Attorneys may also charge varying amounts for preparing the title agreements and transfer of the property into your name.
You’ll also need cash on hand to cover the costs of the bond origination fees, as well as two months’ worth of property taxes that you’ll need to pay upfront.
Other miscellaneous expenses include the credit report fees when the lender checks your score. There is also an underwriting fee attached to the mortgage for insurance purposes, and you can expect to pay up front for a home inspection and any courier fees related to the transfer of documents between lawyers.
Lawyers set up escrow accounts to ensure that the money is available for the deal, without laying legal claim to the funds. Escrow accounts are a vital part of buying a home, but they are a confusing service to deal with for homeowners.
Of all the charges involved with buying a home, escrow fees are probably the most confusing for new homeowners to grasp. You require an escrow account to accept the lender’s homeowner’s insurance premium and real estate taxes. These charges are included in your monthly installment and paid by your lender when they are due.
Depending on which state you reside, and the frequency of property transactions in your area, your lender may have to issue anywhere up to 12-months of real estate taxes in the escrow account. Should the charges on the home be $250 per month, requiring a 6-month escrow, then that translates to an expense of $1,500 due on closing.
Home Owners Insurance
Lenders require you to buy homeowners insurance with your mortgage. If your house burns down or a tornado destroys it during a storm, the bank needs to recoup their money. If you don’t pay your homeowners insurance, you lose your home and any payments you’ve made on the mortgage if something goes wrong.
For the most part, homeowners are required to pay 1-year of homeowner’s insurance premiums in escrow before closing on the deal. Your lender may also require the escrow of one or two months of insurance premiums for PMI as well.
Fortunately, it’s possible for you to recover some of the prepaid expenses from the seller, such as courier fees. In other circumstances, you may be able to wrangle the costs by agreeing to pay premium pricing to your lender.
You have the right to decline the escrow arrangement. However, should you choose this option, the lender will most likely require you to make a 20-percent down payment on the home.
Adjustments to utilities can incur a significant amount of charges when purchasing your home. Fortunately, these charges rarely amount to more than a few hundred bucks. This payment represents an advance on the utility costs made by the seller. For example, if the seller recently filled their oil heater, then you’ll be liable to reimburse them.
These types of negotiations happen in the closing stages of the deal, and the seller has the right to ask you for payment of any prepaid utilities, such as sewage, water, electricity or trash removal.
Homeowners association fees are another closing cost that you’ll need to account for when you sit around the closing table to finalize the transaction, and most HOA’s require fees payable a year in advance.
The Bottom Line
As young people turn into adults and venture out into the world to start a family and their career, buying a home is the most significant expense they will encounter in their young adult lives. Purchasing a home means that you own property – and it’s a substantial escalation in your responsibilities as an adult.
Unfortunately, many young adults are woefully unprepared to deal with the cash requirements for buying their house, and as a result, they end up purchasing a home they cannot afford. As a result, bankruptcy looms around the corner at any moment.
The red tape and expenses involved with making the purchase may leave your head spinning at some times. Eventually, the deal closes, and you are now a homeowner, congratulations! We hope this guide gives you some insight into the out-of-pocket cash expenses required to close on your home.