How Much Money Do You Actually Need to Buy a House?
It might be less than you’d think!
Most millennials view buying a home as a milestone they’ll never be able to cross off their life-long to-do list. And it’s no wonder! When was the last time you went a day without seeing a headline lamenting the state of the housing market, or blaming expensive avocado toast for the low rates of millennial homeownership?
Couple all the doom and gloom in the media with the common perception that you need to save at least 20 percent of a home’s purchase price for a down payment, and it’s easy to see why so many young people see homeownership as an impossible dream.
But here’s the thing: You don’t actually need to have $50,000 in the bank to buy a home. Yes, you need to have significantly more than the average American has saved up (which is less than $1,000), but especially if you’re a first-time homebuyer, your total out of pocket costs to close could easily be less than $10k, and that’s including your down payment.
Let’s break down the details, shall we?
Choosing your loan.
While you can buy a house out of pocket, you wouldn’t be reading this if you had that kind of cash saved up. But don’t worry, most people need to take out a loan in order to purchase a home, and there are several different kinds to choose from.
First, you need to look at the kind of loan term you want. There are two major options here:
- Fixed-Rate Mortgages: This kind of loan has a set interest rate for the entire term of the loan, be it 10 years, 15 years, 20 years, or 30 years. The amount of interest you pay every month won’t go up or down until you’ve paid off your loan.
- Adjustable-Rate Mortgages: Also known as ARMs, the interest rate on an adjustable rate mortgage can change with the market. This can be very good if interest rates are low—but if they go up, you could end up with a monthly payment that’s more than you can afford. Many ARMs start off with very low interest rates for a set period of time—typically five to 10 years. This is a good bet for borrowers who plan to sell or refinance their homes before that time is up or borrowers who plan to pay off their loans in full before the rate becomes adjustable.
Once you’ve decided what kind of loan term you want (the most popular is a fixed-rate 30-year mortgage), you can start shopping around to see what kinds of loans best fit your credit score, savings, and lifestyle.
- Conventional/Conforming Loans: These loans are offered by private lenders to borrowers who have good credit scores (at least 620). Most conventional mortgage loans require between five and 20 percent of the purchase price as a down payment, but “Conventional 97” loans only require three percent of the purchase price down. If you’re buying a $100,000 home, that means you only need a $3,000 down payment! The only downside to putting such a small amount down? Higher monthly payments, and a requirement to purchase mortgage insurance (another added monthly cost) until you’ve paid off at least 20 percent of the loan.
- FHA Loans: Federal Housing Administration Loans, created in 1934, are loans that are offered by private lenders but are insured by the government. These loans were created to help people who otherwise wouldn’t be able to buy a home—because of lack of credit or capital—become homeowners. Borrowers with credit scores of 500 to 579 can qualify for an FHA loan with just 10 percent down, and borrowers with credit scores above 580 can qualify for an FHA loan with just 3.5 percent down. The interest rates on these kinds of loans are typically higher than conventional loans, and your monthly payments will be higher because of this and the required mortgage insurance.
- FHA 203k Rehab Loans: These kinds of loans are designed for people buying “fixer-uppers” or investment property. They allow you to buy the home and make the renovations without having to take out multiple loans. FHA 203k loans typically have higher credit requirements than normal FHA loans.
- VA Loans: For veterans only, these government-backed loans often feature 100 percent financing, which means NO down payment is required. Additionally, mortgage insurance is also not a requirement, even for borrowers who put nothing down. See if you qualify here.
- Physician Mortgage Loans: Designed for early-career medical doctors who don’t yet have the cash to throw into a down payment, these loans have a slew of benefits. For one thing, they require zero percent down and have no mortgage insurance requirements. These loans are based solely on employment contracts, and lenders are much less critical of student loan debt. Interest rates are higher for mortgages with no down payments, but if you’re a doctor just starting your residency, this is a good option.
- USDA Loans: These loans, from the U.S. Department of Agriculture, are designed to get people to buy homes in rural areas. They offer no-down-payment options and low mortgage insurance fees but require a credit score of 640 or more in order to qualify.
There are a few other kinds of loans, called “jumbo loans,” which are loans for high-priced properties. But for the frugal first-time homebuyer, those are likely not that relevant.
How much home can you actually afford?
One thing you need to know before purchasing a home: If your credit is decent, you’ll likely get approved for a loan that’s significantly more than you can actually afford. Just because you’re approved for a $300,000 loan, doesn’t mean that buying a $300,000 home is a good idea, especially if you’re planning on paying less than 20 percent down.
Before you make an offer, you’ll want to sit down and calculate exactly what your monthly payments will be. This is more than just your mortgage and interest payment, it also could include:
- Mortgage insurance: if you pay less than 20 percent down, you’ll have to get this. The cost will be based on the price of your house, but it’s typically between 0.5 and one percent of the total amount of your loan annually. If your loan is for $200,000, you could be paying anywhere from $83 to $166 a month on mortgage insurance.
- Homeowners insurance: The monthly cost of this depends on the size and price of your home, as well as on the amount of coverage you choose. Could be $30/month, could be $300/month. But you’ll need to factor that in as well.
- HOA fees: If you buy a condo or a home in a neighborhood that has a Homeowners Association, you’ll probably need to pay HOA dues. These fees are gathered from every member of the community, are typically used to pay for things like trash, water, snow removal, gym/pool upkeep, and exterior insurance. They can range from very small (a few bucks a month) to very large (a few thousand dollars) depending on the amenities covered by the HOA.
- Taxes: You’ll need to pay property taxes on your home every month, the cost of which depends on the value of your home and other homes in your area.
Altogether, this could end up being a lot more than you were expecting to pay, especially if you buy a home at the top of your budget.
When you find a place you want to make an offer on, you’ll need to immediately write an earnest money check. Earnest money is basically a deposit—typically around 1 percent of the purchase price—which signals to the seller that you do indeed intend to buy their property. Usually, your earnest money is put towards your down payment at closing or used cover a portion of your closing costs.
In addition to your down payment, you’re going to have to have a chunk of money put aside to cover the costs of finalizing the purchase of your new home. According to Zillow, buyers can expect to spend between two to five percent of the purchase price of their home on closing costs, which need to be made via certified check—so you can’t just throw it on a credit card and hope for the best.
What are closing costs, exactly They’re a combination of a bunch of different things. From inspections to lawyers to the fee for changing over taxes, there are tons of tiny costs that add up to one big bill. From Zillow:
Application Fee: This fee covers the cost for the lender to process your application. Before submitting an application, ask your lender what this fee covers. It can often include things like a credit check for your credit score or appraisal as well. Not all lenders charge an application fee, and it can often be negotiated.
Appraisal: This is paid to the appraisal company to confirm the fair market value of the home.
Attorney Fee: This pays for an attorney to review the closing documents on behalf of the buyer or the lender. This is not required in all states.
Closing Fee or Escrow Fee: This is paid to the title company, escrow company or attorney for conducting the closing. The title company or escrow oversees the closing as an independent party in your home purchase. Some states require a real estate attorney be present at every closing.
Courier Fee: This covers the cost of transporting documents to complete the loan transaction as quickly as possible.
Credit Report: A Tri-merge credit report is pulled to get your credit history and score. Your credit score plays a big role in determining the interest rate you’ll get on your loan.
Escrow Deposit for Property Taxes & Mortgage Insurance: Often you are asked to put down two months of property tax and mortgage insurance payments at closing.
FHA Up-Front Mortgage Insurance Premium (UPMIP): If you have an FHA loan, you’ll be required to pay the UPMIP of 1.75% of the base loan amount. You are also able to roll this into the cost of the loan if you prefer.
Flood Determination or Life of Loan Coverage: This is paid to a third party to determine if the property is located in a flood zone. If the property is found to be located within a flood zone, you will need to buy flood insurance. The insurance, of course, is paid separately.
Home Inspection: You will likely get your own home inspection to verify the condition of a property and to check for home repairs that may be needed before closing.
Homeowners Association Transfer Fees: The Seller will pay for this transfer which will show that the dues are paid current, what the dues are, a copy of the association financial statements, minutes and notices. The buyer should review these documents to determine if the Association has enough reserves in place to avert future special assessments, check to see if there are special assessments, legal action, or any other items that might be of concern. Also included will be Association by-laws, rules and regulations and CC & Rs.
Homeowners’ Insurance: This covers possible damages to your home. Your first year’s insurance is often paid at closing.
Lender’s Policy Title Insurance: This is insurance to assure the lender that you own the home and the lender’s mortgage is a valid lien, and it protects the lender if there is a problem with the title. Similar to the title search, but always a separate line item.
Lead-Based Paint Inspection: Covers the cost of evaluating lead-based paint risk.
Loan Discount Points: “Points” are prepaid interest. One point is one percent of your loan amount. This is a lump sum payment that lowers your monthly payment for the life of your loan.
Owner’s Policy Title Insurance: This is an insurance policy that protects you in the event someone challenges your ownership of the home. It is usually optional.
Origination Fee: This covers the lender’s administrative costs. It’s usually about 1 percent of the total loan but you can sometimes find mortgages with no origination fee.
Pest Inspection: This fee covers the cost to inspect for termites or dry rot, which is required in some states and required for government loans. Repairs can get expensive if evidence of termites, dry rot or other wood damage is found.
Prepaid Interest: Most lenders will ask you to prepay any interest that will accrue between closing and the date of your first mortgage payment.
Private Mortgage Insurance (PMI): If you’re making a down payment that’s less than 20% of the home’s purchase price, chances are you’ll be required to pay PMI. If so, you may need to pay the first month’s PMI payment at closing.
Property Tax: Typically, lenders will want any taxes due within 60 days of purchase by the loan servicer to be paid at closing.
Recording Fees: A fee charged by your local recording office, usually city or county, for the recording of public land records.
Survey Fee: This fee goes to a survey company to verify all property lines and things like shared fences on the property. This is not required in all states.
Title Company Title Search or Exam Fee: This fee is paid to the title company for doing a thorough search of the property’s records. The title company researches the deed to your new home, ensuring that no one else has a claim to the property.
Transfer Taxes: This is the tax paid when the title passes from seller to buyer.
Underwriting Fee: This also goes to your lender, covering the cost of researching whether or not to approve you for the loan.
VA Funding Fee: If you have a VA loan, you may be required to pay a VA funding fee at closing (or you can roll this fee into the cost of the loan if you prefer). This is a percentage of the loan amount that the VA assesses to fund the VA home loan program, however some borrowers are exempt from this fee. The percentage depends on your type of service and the amount of your down payment. Here is a breakdown of the cost of the VA funding fee and a complete list of allowed fees for VA loans.
If you’re buying a home for $100,000 and putting down 3.5 percent ($3,500), you should plan to have at least $8,500 to bring in at closing, plus a little more left over for any major repairs you need to make after you move in. If you’re buying a place for $250,000, you should aim to have between $5,000 and $12,500 on hand to cover closing costs, plus however much you’re putting down.
Your lender will let you know exactly how much you’ll need before you close, and if you don’t have the money to cover closing costs, you should probably think twice about signing any more legal documents.
That being said, because of all the low down payment options currently available to buyers, purchasing a home doesn’t require you to have a trust fund. Depending on where you live, it’s more than possible for you to save up for a home. Don’t believe the (sad!) media hype. You too can become a homeowner, and knowing all your options is the first step!
To learn more about dealing with large expenses, check out these related posts and articles from OppLoans:
- How to Finance a Medical Emergency: An OppLoans eBook
- Christmas Loans: The Holiday Borrowing Risk List
- Want to Avoid No Credit Check Loans? Build an Emergency Fund
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