You’ll Need to Set Aside More Than a Down Payment When Getting a Mortgage: Here’s Why
Buying a home — especially for the first time — is an exciting milestone. Whether you’re transitioning from a rental or moving out on your own for the first time, there’s something exciting and invigorating about becoming a first-time homeowner.
Of course, buying property isn’t all fun and games. In addition to the enjoyable parts of the process (house shopping and daydreaming about the future), buying a home brings on a new wave of responsibility. Not only do you become the sole caretaker of a house, you also need to have the financials to back up your purchase.
Generally speaking, you’ll need to have a down payment to purchase a property — but that’s not all. In addition to a down payment, you’ll need to pay for closing costs to take possession of your home. According to the Consumer Financial Protection Bureau (CFPB), “closing costs” is a term used to describe the transaction fees and prepaid costs you need to pay when you purchase a home.
And there’s more: Beyond closing costs, there are other potential fees and expenses to cover, says John Moran, mortgage loan originator and founder of TheHomeMortgagePro.com.
For example, buyers need to plan to pay for a home inspection. This expense typically costs $300-$400 for an average-sized home, Moran says, although it could cost more or less depending on the type of home you have and where you live.
People also need to account for moving costs, a home warranty if they want one, furnishing their home, curtains and décor, says Moran. “There’s always something to buy when you’re purchasing a home.”
Closing costs to plan for
While closing costs can vary depending on the details of the sale, here are the main costs to prepare for when you buy a home:
An appraisal fee is a fee charged to appraise the property or determine how much it is worth. “This fee varies widely based on where the home is located,” said Moran. An appraisal fee may cost $350 for a single family home, or surge up to $900 for a multi-unit investment property, he says. On average, however, you should expect to pay $300-$550.
Buyers need to display their creditworthiness in order to qualify for a mortgage, which is why they need to pay for a copy of their credit report. “The purpose of the credit report is to verify a buyer’s credit history, FICO score, and ability to repay their loan,” said Moran. Generally speaking, this shouldn’t cost more than $35. However, some lenders may not charge for this.
Discount points are fractions of your loan amount that you pay in exchange for a lower interest rate on your loan. Moran notes that if you paid one percent of your loan amount as a discount point, it would lower your interest rate by 0.25 percent most of the time. Discount points are optional, he says. “A typical rule of thumb for discount points is that it takes around five years to break even if you pay a point for a lower interest rate,” noted the mortgage pro. “If you plan to move within five years or less, you wouldn’t want to pay discount points because the interest savings wouldn’t be worth it.”
A flood certificate determines whether the property you’re buying is in a FEMA flood zone. If it is in a designated flood zone, then you must get flood insurance in addition to your homeowners insurance. This certificate tends to cost around $20, said Moran. If you need to purchase flood insurance, you will need to prepay for this coverage along with your homeowners insurance.
If the home you’re purchasing belongs in a homeowners association, you will likely need to prepay your HOA fees, and perhaps even a transfer fee. The average HOA fee was $331 per month in 2015, according to a 2017 analysis from Trulia, but these fees can vary dramatically, says Moran.
Loan application fees
While not all lenders charge an application fee, some may charge a small fee (in the $75 range, according to Moran) to process your loan application.
Origination fees are fees that can be charged by the lender for originating or “creating” your home loan. While this fee can reach up to 1 percent of the loan amount, Moran says that’s fairly high and some lenders may not charge an origination fee at all. “The market average for this fee is $895 to $1,595,” he said. Also keep in mind that many home loans don’t have an origination fee at all. “Some lenders will also let you waive your origination fee in exchange for a higher interest rate,” says Moran.
Prepaid homeowners insurance
When you purchase a home and choose to pay for homeowners insurance and taxes via an escrow account, you need to prepay your first year of homeowners insurance at closing. However, Moran notes that you should also expect to pay another two months of premiums to build a small buffer for insurance premiums into your escrow account in case your premiums go up the next year. “A lot of people always question why they need so much homeowners insurance,” says Moran. But, you have to keep in mind that your premium is prepaid for the year. Once your first year’s premium is covered, you’ll save up the next year’s premium each month in your mortgage payment – which may be more than you paid this year.
When you buy a home with a mortgage, you also need to pay for prepaid interest. This fee covers a prorated portion of a month’s interest on your home loan. How much you’ll pay depends on the size of your home loan, your interest rate and the day of the month your loan closes.
Prepaid property taxes
Moran notes that, when you purchase a home, you typically get a prorated credit to cover a portion of your property taxes from the seller. However, you may need to pay a few months of property taxes into your escrow account to build a small buffer in case your property taxes go up the following year, he says.
A recording fee is a fee that is charged to cover the act of taking your mortgage note and recording it with your county, which makes the purchase official, says Moran. This fee varies by location and may cost $25-$200 based on where you live.
Settlement or closing fee
A settlement or closing fee is a fee you pay to your title or escrow company to close your loan. This is a basic, general fee that covers the costs of administration and labor. Plan to pay around $300-$350, said Moran.
You may need to pay for the certification of the property taxes on your new property. In this case, a “tax service fee” of around $75 may show up in your closing costs.
There are two versions of title insurance, which insures the title of your home, notes Moran. One is lender’s coverage and the other is owner’s coverage. Both serve the same purpose but have different beneficiaries. “When you buy a home and you record it at the county, title insurance insures you from someone coming along and saying the property is theirs or pursuing a lien from the past,” said Moran. Title insurance can range from from $500-$1,500 for either type. While the buyer may pay for title insurance at closing, it is also fairly common for the seller to cover this insurance.
Every loan is processed and underwritten, but some lenders tack on an underwriting fee to cover the labor and administrative costs of underwriting your loan, says Moran. If you pay this fee, the average is around $500.
This fee is charged when a buyer wires their down payment for the home to their title company. This fee varies depending on your bank.
How to estimate closing costs
If you’re feeling overwhelmed by these costs or the thought of trying to estimate them, you’ll be happy to know that the grunt work is taken care of by your lender. Plan on receiving an upfront estimate called a Loan Estimate at the beginning of the loan application process. Once the home purchase moves forward and better estimates are prepared, you will receive a Closing Disclosure form at least three days prior to the consummation of the loan.
A loan estimate is the lender’s initial guess on what your loan will cost and what the terms will be, says Moran. Your estimate will list a good guess of your closing costs and a guess of your new monthly payment, although some of the details may change before you get to closing. “Consider this the first draft of your closing costs,” said Moran. As we mentioned already, this form is created at the beginning of the loan application process.
The Closing Disclosure is a five-page document you’re given at least three business days before your loan closes. This packet of paperwork offers the final figures included in your home purchase, including a final list of your closing costs and your final projected monthly mortgage payment.
What options are available for homeowners to cover closing costs?
If you’re looking for ways to minimize the burden of closing costs, there are different strategies and loan programs that can help. Your best options include:
No cost mortgage offers
According to Moran, some lenders let you avoid paying closing costs in exchange for a higher interest rate. “These concessions work inverse of how discount points work,” says Moran. “You can pay a higher interest rate in exchange for lender concessions or lender credits.”
Seller and lender concessions can’t equal more than the closing costs and prepaid items, however.
Negotiating closing costs with your lender
Moran states that many of the closing costs you’ll see are entirely negotiable – as long as they are charged on the lender side. There is no way to negotiate prepaid items like property taxes, homeowners insurance and prepaid interest, or third-party fees like fees for an appraisal or title work, he says. However, lender fees like origination fees, flood certification, underwriting fees, application fees, credit report fees and tax certification may be negotiated down or waived completely, Moran said.
If you’re curious whether your lender will budge on these fees, all you have to do is ask.
Asking the seller to cover closing costs
You can also ask the seller of the home to cover some of your closing costs in the form of “seller concessions,” said Moran. “Most loan programs let sellers offer 3 percent or more of the purchase price in seller concessions.”
Keep in mind, however, that seller concessions are essentially adding onto your purchase price. If you ask for $3,000 in seller concessions, the offer you make on the home may need to be $3,000 higher, for example. In that respect, you can reduce the amount of your mortgage by paying your own closing costs and negotiating the price of the home down to reflect that.
“Most sellers don’t care either way,” said Moran, adding that, “they only care about their bottom line and how much they walk away with after the sale.”
FHA loans are federally backed mortgages you can get with a low down payment, low closing costs, and less-than-perfect credit. No matter where in the country you live, you may be able to qualify for a FHA loan with a down payment as low as 3.5 percent, provided your credit score is at or above 580. With a lower score, you will likely need to put down at least 10 percent of the home’s purchase price.
While you may save on closing costs with an FHA loan, it’s important to note that these loans come with mortgage insurance. Not only will you pay an upfront fee of 1.75 percent of your home purchase, but you’ll pay an ongoing mortgage insurance premium in your monthly payment.
VA loans are offered to qualified veterans through the U.S. Department of Veterans Affairs. To become eligible for this benefit, you typically need to have served at least two years in active duty military with an honorable discharge. VA loans can help you purchase a home at a competitive interest rate, often without a down payment or private mortgage insurance (PMI).
However, even though VA loans don’t charge private mortgage insurance, they do charge an upfront funding fee. This fee varies depending on your down payment, but can range from 1.25 percent to 2.15 percent for regular military or 1.5 percent to 2.4 percent for reserves or national guard.
USDA loans are mortgages offered on rural dwellings through the U.S. Department of Agriculture. Both USDA Direct Rural Home Loans and USDA Guaranteed Loans come with maximum income requirements and must be used in a certified “rural area.”
These loans can come with no down payment, competitive interest rates, and low closing costs, making them an affordable option for those who qualify and want to keep their upfront costs low.
Good Neighbor Next Door
The Good Neighbor Next Door program is a housing program created specifically for law enforcement officers, firefighters, emergency medical technicians, and teachers. This program doesn’t help you save on closing costs per se, but it does help you purchase homes in a U.S. Department of Housing and Urban Development (HUD) revitalization area for up to 50 percent off the list price.
To qualify for this program, you must work time in an approved occupation mentioned above. To see where revitalization areas are located near you, you can search this page.
In addition to federal programs offered to help with closing costs, some states offer their own forms of assistance for residents who qualify. Check out HUD’s state resource page for information on state assistance programs in your area.
One of the best ways to prepare for the costs of homeownership is to educate yourself as much as you can. Also, start saving and don’t stop until you save up enough cash to cover your down payment plus the added costs for closing, moving, and decorating your home.
Keep in mind that can you save a bundle on your home purchase by comparing mortgage rates to get your best deal. Ideally, you’ll want to find a mortgage with the lowest APR you can qualify for, low closing costs, and a manageable monthly payment.