Home Buyers Other Costs To Consider 5 of 9June 4, 2012 at 12:30 pm | Posted in Home Buyers Other Costs To Consider | 1 Comment
How much money will I have to come up with to buy a home?
Well, that depends on a number of factors, including the cost of the house and the type of mortgage you get. In general, you need to come up with enough money to cover three costs: earnest money – the deposit you make on the home when you submit your offer, to prove to the seller that you are serious about wanting to buy the house; the down payment, a percentage of the cost of the home that you must pay when you go to settlement; and closing costs, the costs associated with processing the paperwork to buy a house.
When you make an offer on a home, your real estate broker will put your earnest money into an escrow account. If the offer is accepted, your earnest money will be applied to the down payment or closing costs. If your offer is not accepted, your money will be returned to you. The amount of your earnest money varies. If you buy a HUD home, for example, your deposit generally will range from $500 – $2,000.
The more money you can put into your down payment, the lower your mortgage payments will be. Some types of loans require 10-20% of the purchase price. That’s why many first-time homebuyers turn to HUD’s FHA for help. FHA loans require only 3% down – and sometimes less.
Closing costs – which you will pay at settlement – average 3-4% of the price of your home. These costs cover various fees your lender charges and other processing expenses. When you apply for your loan, your lender will give you an estimate of the closing costs, so you won’t be caught by surprise. If you buy a HUD home, HUD may pay many of your closing costs.
The Down Payment
Not Everyone pays cash for a house.
Instead, you pay for most or all of it by getting a loan from a bank, called a mortgage. You will also probably make a down payment of 3 to 20% of the sale price, though sometimes it’s possible to pay nothing down. Since everybody wants to know how to get a house with zero down, we’ll cover that first.
You can probably get a Zero Down Payment loan if your credit score is excellent (~700+). If you qualify for a VA (veterans) loan, you might be able to get by with a slightly lower credit score.
No-money-down loans loans surged in popularity in the 2000’s, going from 4.5% of loans in California to 20% from 2000 to 2007. (HGTV) Among first-time homebuyers the figure was even higher, with a whopping 43% of them paying nothing down in 2006, up from 28% just two years prior to that. (Washington Post) But banks got burned on these loans because people who couldn’t scrounge up a down payment were more likely to default on their loans (duh), which is part of what caused the mortgage lending crisis. (See sidebar.) So today banks require a higher credit score than in the past for Zero-Down loans. If you’re a veteran, your chances of getting a no-money-down loan are greater since there are special VA loans.
But then you have to answer the question: Should you get a zero percent down loan just because you can? Not necessarily. Here are reasons to think twice about getting a 0% down loan:
- More likely to lose your home. If you can’t make a down payment it’s either because you didn’t have the financial discipline to save, or you’re not making enough money. Either of those things makes it more likely that you won’t be able to make the payments on your house, and that you’ll get foreclosed on and lose your house. A study in Denver showed that over half of foreclosures involved nothing-down loans (Denver Post 9/2006). Ouch.
- Higher monthly payments. The less money you put down, the more you’re borrowing. And the more you’re borrowing, the higher your monthly payments.
- Nothing down means a smaller home. The less you put down, the less the bank is willing to loan you. That means your options will be more limited as far as what homes you can buy. With a down payment — any down payment — you can get a bigger loan, and are more likely to be able to get the home you really want.
- Harder to find the loan. No-money-down loans are harder to find than something-down loans, which are ubiquitous.
- Harder to qualify. It’s harder to get a bank to give you a no-money-down loan than a loan where you put anything down.
- Private Mortgage Insurance. If you put nothing down on a conventional loan, you’ll have to pay for private mortgage insurance. Actually, you’ll pay this for any down payment less than 20%, but the less you put down, the more the PMI, and the longer you have to pay it.
So I encourage you to put down at least 5% if you can. I’m not saying that you should never pursue a zero-down loan, but if you get one just make damn sure you can afford it!
Often if you’re able to put 0% down, then it works just like you expect: You get a single loan for 100% of the purchase price. But sometimes your lender or broker will offer you an 80/20 deal, where you get one loan for 80% of the price, and another for 20% of the price. Why on earth would they do that, rather than keeping it simple? Because it’s typical for the 20% loan to carry a higher interest rate, which makes more money for the bank.
But there’s an advantage for you: With a 100% loan you usually have to pay for private mortgage insurance (PMI), while with an 80/20 loan you usually don’t.
So which is better? It’s different for each situation. For an apples to apples comparison, you need to find the total monthly payments, including PMI, for each loan deal you’re offered, over the life of the loans.
Don’t plan on borrowing the down payment from relatives
The down payment has to be your money. Why? Because when the bank gives you the main loan on your house, they’ve calculated that you won’t be able to pay back your loan if you take on additional debt, and borrowing the down payment is additional debt. Also, if you don’t make your payments and they have to repossess the house and sell it, they’ll often want to sell it for less than it’s worth so they can sell quickly, and your down payment prevents them from having a loss if they do that.
But what if someone gives you the money for a down payment (your parents, maybe)? That’s okay as long as you get an FHA loan, but not if you get a conventional loan. (Realize though that many sellers won’t agree to an FHA loan because it sometimes adds a little red tape and because the inspectors are more strict about the condition the house has to be in before it can be sold.)
Should you use your free cash to make a bigger down payment or to pay down debt?
A very common question among homebuyers is, “Should I use my extra cash to pay down my credit card debt, or should I save it all for the down payment?” That requires a detailed answer, that is for another time, but your lender can help by explaining then Debt Ratio to you.
How big a down payment should you make?
If you can afford to put 20% down, you should. You’ll get a better interest rate, won’t have to pay for private mortgage insurance, will qualify for a larger loan, and will save a bundle on interest.
In fact, if you can afford it, there’s nothing wrong with putting down more than 20%, as long as you still have enough free cash on hand for emergencies. Remember, once you put money into your house, it’s not easy to get it back out, so keep that in mind before you deplete your emergency savings.
Lawrence F. Sanek is a licensed real estate broker and owner of Castle Dream Real Estate, LLC Brooksville, Florida. He is also an engineer with experience in the structural and architectural disciplines. He has many years of experience in selling real estate and enjoys helping families relocate to Florida or to another area in Florida and to Capture The Dream. Visit the Castle Dream website at Castle Dream Real Estate, LLC or contact him direct at 1-888-51-DREAM (37326) or email him at Sanek