Homebuyers often focus only on the down payment when it comes to buying a house. But closing costs need to be factored in, too. On a $400,000 house with 10% down, you can expect to need around $70,000 upfront. Show One of the biggest shocks of buying a home is finding out you need way more cash to close on a house than just a down payment. While it’s hard enough to save for the down payment, you’ll need more — often a lot more — in order to complete the transaction. Exactly how much? Well, if you are buying a home for $400,000 and need a 10% down payment, the total amount of cash that you may need to provide (or at least show) could look something like this:
Let’s break down what these numbers mean. And where possible, I’ll suggest ways that can reduce or even eliminate the additional cash requirements.
The down paymentThis is the only cash outlay in the homebuying process that’s obvious to most buyers. It is usually expressed as a percentage of the purchase price of the property. For example, if the purchase price is $400,000, and you’re required to make a 10% down payment, you’ll have to pay $40,000. With most lenders, if you want to avoid paying additional private mortgage insurance (PMI), you’re actually looking at a 20% down payment. But since coming up with 20% may be difficult for many first-time buyers, mortgage lenders have options with down payments of 10%, 5%, or — if you qualify for special FHA loans or VA mortgage loans — as little as 3.5%. Read more: How to find the best online mortgage lenders Acceptable sources of funding for a down paymentExactly where your down payment comes from will depend on the type of mortgage you are applying for. In some cases, the down payment must come from your own funds, such as your bank account. But in other cases, it can come from a gift or even be borrowed from approved agencies. Conventional loansConventional loans (those that aren’t insured by the government like FHA or VA loans) tend to have the strictest rules when it comes to the source of your down payment funds. If you are making a down payment of 5% or 3% of the purchase price, the lender will typically want to see that the funds come from your own financial resources. That can include money withdrawn from a bank account, funds withdrawn or borrowed from an employer-sponsored retirement plan, or even the sale of a personal asset. Typically, once you satisfy the “own funds rule,” the guidelines become more relaxed. For example, if you’re making a 10% down payment, the lender may require 5% coming from your own funds, and 5% from a gift from a relative. But if the gift is equal to at least 20% of the purchase price of the property, the lender won’t require you to show evidence of your own funds at all. FHA loansFHA loans are insured by the Federal Housing Administration and have a more relaxed view of down payments entirely. Not only can the down payment come from either your own funds or from a gift, but they also allow loan proceeds from approved down payment assistance programs. It can make it possible to get 100% financing on an FHA loan. Read more: How to qualify for an FHA loan VA loansWith VA loans (government-backed loans for veterans, service members, and surviving spouses), the down payment isn’t typically an issue. VA loans normally provide 100% financing, which makes the down payment a moot point. Where you can’t get down payment funds fromTwo generally prohibited sources are:
By cash, I mean currency you store at home or in a safe. Any money you invest into a home has to pass through a financial institution to be considered a legitimate source of funds. In addition, cash savings in the form of currency can’t be verified as being valid. Unsecured loans are also a no-go. If you have any ideas to provide a down payment from a credit card advance or the proceeds of a personal loan, this will be rejected by the lender. Not only does it indicate an inability to accumulate funds for the down payment, but it also creates an additional debt obligation. Read more: A beginner’s guide to mortgage loans Closing costsThis is where things start to get a little complicated. This is because the cash outlay to make the purchase becomes (often) much higher than the down payment alone. Closing costs may range from 2% to 6% of your loan amount. So, on a $400,000 mortgage with 10% down, your loan amount is $360,000. That means you’ll need to come up with between $7,200 and $21,600, in addition to your down payment. However, there are two factors to keep in mind:
An origination fee is one kind of point. The charge will generally be between 0.5% and 1% of the new mortgage amount. It represents compensation to the lender for placing the loan. Discount points are another type. They represent points paid to lower the mortgage interest rate on a permanent basis. For example, by paying a discount fee of 1% of the loan amount you have, you can reduce your mortgage interest rate by approximately 1/8 of 1% (0.125%). However, if cash to close is an issue, paying discount points to lower the interest rate isn’t generally recommended. The small decrease in the monthly payment doesn’t usually justify the cost of the discount points paid upfront. Typical closing costsBelow is a list of common closing costs (other than origination fees and discount points), including their purpose and a general cost range. Not all will be charged in every case, and there may be additional fees specific to your geographic location.
There are actually two alternatives that can either reduce or completely eliminate closing costs:
Either may be a good option, particularly if you are making a minimum down payment, like 5%, and adding closing costs on top would make your cash outlay significantly higher. Prepaid expensesThese are probably the most confusing charges for homebuyers, but they are completely necessary. With most mortgages, the lender will put real estate taxes and homeowners insurance “in escrow.” This means that those charges will be included in your monthly payment, and paid by the lender when due. In order for that to happen, the lender needs to collect certain amounts upfront, to ensure that the funds are available. The escrow accounts are set up to pay the charges on the next due date, while a portion of your monthly payment replenishes the escrow account for the due date after that.
Read more: What does homeowners insurance actually cover? Depending on where you live, prepaid expenses may come to as much as 2% of the loan amount. Fortunately, you can have some or all of the prepaid expenses paid for you by either the seller, or by premium pricing paid to the lender. A third option is to decline the escrow arrangement by the lender. This will require that you make a down payment of at least 20%. Utility adjustmentsUtility adjustments can include a large number of charges. Luckily, they seldom come to more than a few hundred dollars. They basically represent utility costs paid by the property seller in advance. For example, if a seller fills the heating oil tank just before the closing, you’ll be required to reimburse the seller for the unused oil. This will happen at the closing table. Similar charges can be incurred if the seller has prepaid other utilities, such as water, sewer, or trash removal. Still another expense that could require adjustment at closing are homeowners association fees. In many homeowners association neighborhoods, member fees are paid on an annual basis. If the seller has paid the fee for the full year, and you’re closing on the house on March 31 — three months into the year — you will be required to reimburse the seller for nine months’ worth of fees. There may also be a fee to the HOA to get started. They may call it a transfer fee or something similar. Basically, it’s a lump sum upfront from the new homeowner to get into the HOA. Lender-required “cash reserves”This one takes many homebuyers by surprise. It isn’t a closing expense, but lenders require that you have so much cash left in savings after all closing costs are paid. Lenders have a cash reserve requirement to avoid a buyer “closing broke.” They don’t want you to end up in an early-term default. This requirement ensures that you will be able to make your payments during the first few months. The most typical cash reserve requirement is two months. That means that you must have sufficient reserves to cover your first two months of mortgage payments. So if your principal, interest, taxes, and insurance (PITI) come to $2,000 per month, the reserve requirement will be $4,000. These are not funds that must be deposited with the lender. But the lender must be able to verify that you will have the funds available in a liquid source. That could be a savings account, checking account, or money market fund. Generally speaking, they frown upon using retirement assets for this purpose, since those funds cannot be easily liquidated. The bottom lineMany first-time homebuyers are surprised to discover the down payment is just one cost they’ll have to pay. For example, if you are buying a home for $400,000 and need a 10% down, you’ll actually need roughly $70,000 in cash to close the sale. Remember to include these additional cash requirements in your homebuying plans, so you won’t be surprised down the line. Read more:
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