Photo Credit: 401(K) 2012/Flickr.
One of the first things people think about when planning to purchase a home is how much money they will need for the down payment. But often times, they forget about the other expenses associated with buying a home.
In this article, I will address the most common and largest cash needs, such as the down payment and closing costs, but I’ll also address some of the other common costs / cash needs that you should be prepared to pay.
Some of the most common low down payment loans are FHA, USDA, VA, and Conventional Loans with a 3% down payment.
In general, these programs allow for down payments ranging from 0% for USDA and VA up to 3.5% for FHA. FNMA has also recently announced a 3% down payment program for first-time home buyers, and Freddie Mac is expected to offer a similar program in the near future. Each of these has advantages and disadvantages, as well as qualifying features, and should be evaluated based on the individual borrower’s circumstances. Generally, the borrower’s first consideration should be to save for a down payment of 3% to 3.5%.
Closing Costs and Prepaid Expenses
Many borrowers contact me for a pre-qualification once they have saved 3% to 3.5% for the down payment, but haven’t given consideration to how much additional cash they will need for closing costs and “prepaid items”. While there are ways to get help from sellers, and even from the lender through an “interest rate credit”, that can cover all or most of the closing costs, it is still a good idea to prepare for the payment of some closing costs. You may find a home where the seller is not willing or able to provide any assistance with closing costs. And a lender credit may not be sufficient to cover all costs.
Most closing costs are paid at closing, however, there are some that are paid upfront.
While this fee is disclosed by the lender as part of closing costs, it is typically required to be paid upfront at the time the appraisal is ordered and is not part of the final fees paid at closing. In the last few years, appraisal fees have increased considerably and can range from $350 – $500. If an appraiser has to go back to the property after the initial inspection because there were items needing to be repaired, it can add an additional $100 – $200 for the re-inspection.
In addition to the home inspection and appraisal, a boundary survey may be required. This is typically in order if there are no defined property lines or the seller is not aware the property lines.
We have seen instances in which owners of large or unique properties have been asked to pay for the fee. For properties with acreage this cost can be as high as $1,000, but on average you should expect to pay $400 – $500 for a simple boundary survey if you are questioning the borders.
Insurance Premiums and Escrows
In addition to the traditional closing costs of lender fees, title fees, government transfer taxes, etc. there are also “prepaid” items such as insurance premiums and escrows.
Many buyers do not realize that the lender will require the full annual premium for their homeowners insurance to be paid in advance. While this can usually be paid at closing, it can still be a large amount that many borrowers had not planned on saving for. If flood insurance is required, many lenders require it to be paid upfront of closing. So it is always wise to check with your Realtor before making an offer on a property to determine whether it’s in a flood zone.
We have unfortunately seen some deals fall apart after it was discovered that the property was in a flood zone or high fire zone and the cost of insurance was something the borrower had not considered.
The lender will also require that 2 – 3 additional months of taxes and homeowners insurance be collected at closing to provide adequate funds for the payment of those items when they come due the following year. These are considered escrows.
Pro-rations of HOA fees and other property assessments are also often collected at closing but usually paid for by the seller.
In addition to these items, there are additional smaller items that are often forgotten that can add up quickly.
Most lenders do not require you to have a home inspection but it is strongly suggested that you obtain one. Many buyers like to have this done before they order the home appraisal to make sure there are no major issues with the home, such as leaking roofs, non-functioning heat and AC units, plumbing issues, etc. A good home inspector will provide a report of all items in the house that require any type of repair. This fee is also required to be paid upfront directly to the home inspector and can vary greatly, depending upon the location and size of the home. On average, home inspections range from $300 – $500.
Again, most lenders do not require pest inspections. VA loans do require it. Most home inspections described above do not include the pest inspection, so this must be done separately. Typically, these inspections are not expensive and range from $75 – $150 and can be paid for by the seller in most cases.
Depending upon the age of the home, insurance companies may require certain additional inspections, such as the 3 point inspection and wind mitigation inspection. Wind mitigation inspections are on average $100 – $125 and can save on homeowner’s insurance premiums, so they are generally worth the expense.
When buying a home, many people leave the task of obtaining the homeowners insurance until late in the process. But, we recommend that it be done early on, in order to determine what type of inspections may be required and to allow enough time to insure that any issues with the home are addressed early. We have seen instances in which deficiencies noted in the home inspection that were thought to be minor precluded the home buyer from obtaining homeowner’s insurance.
Many loans do not require the borrower to maintain additional funds as “reserves”, however there are some that do. One particular situation in which reserves are required is when the buyer is purchasing a new home, but retaining the existing home either until it can be sold at a later date or for rental purposes. Reserves are required on each additional property owned. On a conventional loan, typically they will require that six months of PITI (principal, interest taxes and insurance) be available in additional cash funds.
Earnest Money Deposit
Even if you are getting a 0% down payment loan, such as a VA or USDA home loan, the seller of the property will require some type of earnest money deposit. This depends on the value of the home, but typically a minimum of $1000 or 1% of the purchase price is required to be placed in escrow upon making an offer on a property. This money is often refundable if financing cannot be obtained or other circumstances develop which preclude the purchase, but buyers should be aware of the need to have these funds available at the beginning of the home buying process.
Acceptable Sources of Funds for Cash Needs
An entirely different topic, but also important one is: “What are acceptable sources of funds for these cash needs?” This is a topic for another discussion in a later blog since it can be complicated.
Additional Costs of Home Ownership
In addition to the “required” cash needs, don’t forget to take into consideration the additional costs associated with home ownership that you may not have taken into consideration, such as electricity, water, pool maintenance, general repairs, or unexpected emergency repairs. So, make sure you have prepared yourself for the responsibility of home ownership, by saving as much as you can before shopping for your dream home.
Take Away: Your Savings Plan
When creating a savings plan to buy a home, it’s helpful to set a goal for the minimum amount of money you need to save.
The savings you need is determined by a number of factors, including the types of home loans for which you could qualify. It’s helpful, therefore, to begin saving for a home by discussing your specific situation with a mortgage loan originator.