Hidden Costs for First Time Home Buyers
November 12, 2020
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One of the biggest shocks of buying a home is finding out how much you actually need to tuck away for a down payment. Saving for a home can be overwhelming unless you break down your goal into smaller chunks and plan ahead.
Are you one of the millions of Americans dreaming of making homeownership a reality? It's the American dream, after all. Buy your own house, settle, make memories, work to make it your own. Yet, with the average age of first-time homebuyers increasing to 33 years old, it's obvious that dream is getting harder to make happen. Even more daunting is to realize the average income in 2018 of a first-time homebuyer was $93,200.
While a significant income might make it easier in saving for a house, many Americans find it hard to reach that threshold for several reasons. So, how much do you need to potentially save to buy a house? How do people come up with enough money to become homeowners? What are the hidden costs of buying a house?
Read on to learn about saving for a house and how much you really need to make homeownership a reality.
Before discussing saving, let's cover what is needed for different types of mortgages. The truth is that most people may not have enough to pay for a house with cash. They need to get a mortgage. The good news is that there are a variety of mortgage options with varying down payment requirements. Depending on what you qualify for, you can get into a house with way less down payment than the prescribed 20% down. The down payment is the upfront cash you pay to get a home loan, and it's expressed as a percentage of the home price. The required down payment depends on the type of mortgage and the lender.
With a conventional mortgage, it used to be you needed 20% down to get a loan. This would allow you to skip paying private mortgage insurance or PMI. This insurance protects the lender in the event you have a smaller down payment.
Of course, if you have PMI with your mortgage, it can cost you more. Ideally, you want enough of a down payment to avoid paying PMI. Yet, again, for many as first-time buyers that isn't realistic. For some conventional mortgages (with PMI), it’s possible to get a mortgage with as little as 5% down. This amount will vary depending on both where you live and the lender.
If you can qualify for an FHA loan, you can get a mortgage with as little as 3.5% down payment. This is a loan backed by the US Federal Housing Administration. So, you would go to a traditional lender who offers FHA loans.
If you are a veteran, you can actually get a VA mortgage with no down payment. The VA loans are guaranteed by the U.S. Department of Veterans Affairs for veterans and active service members. If you are low income and hope to buy in a rural area of the US, you might also qualify for a USDA loan. This might also allow you to get a mortgage with no down payment. These loans are backed by the U.S. Department of Agriculture's Rural Development Program.
Buying a House, How Much Cash Do You Really Need?
Focusing on a down payment is the most well-known first step to home buyers. It's obvious you need some cash before you go to a lender to get a mortgage. Again, ideally, you want 20% to avoid the PMI.
But with a variety of mortgage options that can be a much smaller percentage. This means if you are buying say a $200,000 house, you might need at least $40,000 in cash. It could also mean you need only $5,000. But is that all that you need cash for when you buy a house? Not exactly. There are a number of other expenses that people often overlook when they work towards that down payment.
Let's consider some expenses you might need beyond the actual down payment.
You’re going to be asked for money before you even sign the paperwork. So what is earnest money, and how much is it?
Earnest money is a sign that you’re serious about the offer you just made. It’s a little bit like a security deposit. You’re giving the seller some money to demonstrate that you aren’t going to make an offer and get the seller all excited, and then just go buy somebody else’s house.
The amount can vary. Some sellers might require a fixed amount such as $5,000 or $10,000 while others might charge a 1-2% fee based on the home's selling price. Generally, you’ll get the money back or it’ll go toward the purchase on the home. On the other hand, if the financing falls through due to a problem on your end, you may not see the money again, depending on how your contract is worded.
Closing costs can be a surprise expense for some first-time homebuyers. The closing costs can range from 2 to 5% of the cost of the house. This means on that same $200,000 house, you need an additional $4,000 to $10,000. Closing costs cover all of the expenses that happen on the closing day. This is for fees from the lender, title company, credit reports, etc.
Closing costs can be negotiable when you are working out the price of the house. Some sellers, for example, agree to pay the closing costs for the buyers.
In some cases, you can get the lender to include the closing costs in the loan terms. You might also agree to a slightly higher mortgage rate and then the lender covers the closing costs.
Whichever route you take, this is a significant expense for getting into a house beyond the initial down payment.
Most people have their mortgage company pay their insurance and taxes. As a matter of fact, this is often required by many lenders.
This means that you need to get money into an escrow account for anticipated tax and insurance payments that come due before you have time to build a balance with your payments.
This can often mean a few percentage points of the cost of the house needs to be put into escrow to cover those upcoming expenses.
You're thinking after all that cash, how will there be reserves? But many lenders as part of the terms of their agreement with you will require you to have some cash reserves in your account. This one takes many home buyers 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.
They want to make sure you are prepared with emergency funds. They don't want to set up a loan that makes your finances so tight that you couldn't suddenly pay your mortgage if you had an unexpected expense or an emergency. 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.
Other Home Buying Expenses
You should be prepared for some other expenses too. Often you need to pay for some adjustments in utility costs. This means the seller has already paid for some utilities on the house that is now yours and you need to reimburse them.
You will want to pay for a home inspection that provides you with valuable information about the home you are purchasing from an expert. While you might be sure you are buying the perfect house, often there are repairs or renovations you want to be done before moving into the house. You will also have moving expenses too.
Saving for a House in Your Future
As you can see, saving for a house is much more than only coming up with the down payment amount. It means you have to really carefully consider how much cash you will need to get into homeownership successfully. Saving for a house can be daunting. You might have a retirement account or a savings account where you are faithfully tucking money away. Looking for other avenues to invest while you’re saving for a home? Visit our site to learn more.
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