For most people, a house will be the biggest purchase of their lifetime – one that will take years to pay off. Spending too much on a house could leave little money for other life goals, like a comfortable retirement, a child’s college education, or family vacations.
While a house is the biggest purchase most people likely make, the final choice will also be one of most emotional decisions they’ll ever make, too – one that might be full of doubt about making a colossal and costly mistake. For many, buying a home is the realization of the American Dream – a symbol of achieving a certain position in life.
One of the greatest services a Trembley Group Real Estate Sales Executive provides is being an attentive listener for their clients, giving objective professional advice, and helping to navigate the seemingly treacherous path between a sound, rational financial decision, and a highly-charged emotional choice.
To Rent or To Buy
Before the house hunt even starts, a homebuyer must first decide whether renting or buying makes the most sense.
A renter needs to remember that over time, rent will go up. Renters frequently rent because they like the idea of being able to move if and whenever they’d like. Also, renters usually do not have to pay for the maintenance, lawn care or home repairs. But that also means they’re not putting sweat equity and creating value in their home. Renting makes the most sense when planning to live somewhere for a relatively short period of time. The costs associated with buying a home – such as escrow fees, taxes, and closing costs – take some time to amortize.
Buying is a years-long commitment. It means years of fixing anything that breaks in the house, manicuring the lawn, and paying for any major repairs like roof repairs and replacements. But if plans are to stay in a place for a longer period of time, buying a home is usually the best way to go. Even though the market may fluctuate, over a long stretch you’re likely to make money. But as the 2007 and 2008 real estate market has shown, it can be a bumpy ride. Nevertheless, very few people have lost money owning a home over the past fifty years.
How Much House Is Really Affordable?
If home ownership seems like the right choice, the next step is to decide how much home is affordable. Typically, most lenders suggest that homebuyers spend no more than 28% of their monthly income on a mortgage. SmartMoney’s “How Much House Can I Afford” Calculator is a useful tool for determining home-affordability.
A homebuyer will need cash for a down payment…and then some. One of the biggest shocks of buying a home is finding out that a lot more cash is needed to close on a house than just a down payment. It’s hard enough to save for the down payment on a home, only to find out that more cash is needed – often a lot more – in order to complete the transaction.
This article takes a look at the actual amount of money that’s needed on hand at closing to purchase a new home. Keep in mind, in addition to the mortgage costs, there will also be closing costs and legal fees associated with the home purchase. And
don’t forget moving fees and labor, and any fixes that might have to be made to the house upon moving in, plus monthly maintenance fees if moving into a condominium or planned community.
So, How Much Cash Is Needed?
Let’s look at how much cash it takes to actually purchase a home. And where possible, suggest ways that can reduce or even eliminate the additional cash requirements.
The down payment can range from 3.5 percent to 20 percent of the total cost of the home, depending on a credit score, mortgage interest rate, and current financial situation. Most accountants recommend putting down closer to 20 percent because it gives a bigger stake – more equity – in the property from the start.
“With a higher down payment you’re going to be lowering your monthly payment in the future, and you also have a buffer if you need to sell in a soft market,” says Jeremy, a Trembley Group Sales Executive. “But for responsible homebuyers, there are a lot of options out there, even low down payment options. That’s why I always have the down payment discussion early in the home-buying process. The questions I can’t answer are easily handled by our strategic business partners at Anderson Brothers Bank or Movement Mortgage.”
Closing costs, including inspection fees, property taxes and prepaid interest, will typically tack two-to-five percent of the total cost of the home onto the final price. Closing costs can complicate the purchase process since the necessary cash outlay is often much higher than the down payment alone. On a $250,000 mortgage, a home purchaser will need to raise between $5,000 and $12,500 in addition to the down payment.
Closing costs vary from one area to another and vary based on different rates charged for appraisals, attorneys, and even title insurance.
Closing costs can also vary from one lender to another, and even from one loan to another. For example, each lender charges a different application fee. In addition, lenders often charge “points” – so named because they represent a percentage point of the loan amount.
An origination fee is one kind of point. It represents compensation to the lender for placing the loan. Discount points are another type. They represent prepaid interest paid to lower the mortgage interest rate on a permanent basis.
Sometimes a seller will negotiate to pay the buyer’s discount points and sometimes a borrower will agree to a higher mortgage interest rate in exchange for the lender waiving the discount points. Either is an option when the borrower is making a minimal down payment and adding closing costs would make the cash outlay significantly higher.
These are some of the most confusing charges for home buyers.
Certain liens like tax liens take precedence over a mortgage lien. To assure that the funds are available to pay the taxes when they are due (to protect the lender’s investment), the lender puts one-twelfth of real estate taxes into an escrow account each month. When the tax bill comes due, the lender will pay the bill from the funds in the escrow account on behalf of the borrower. Homeowners in Myrtle Beach and along the Grand Strand enjoy some of the lowest property taxes on the east coast.
A fire or a flood could also destroy the mortgage loan collateral (the house) so the same escrow rules apply to insurance. A lender will typically require the borrower to prepay a one-year homeowner’s insurance policy on the house at closing. The lender will then escrow one-twelfth of the premium each month and pay the insurance bill on the borrower’s behalf when due to assure the policy never lapses.
Utility adjustments can include a large number of charges. They seldom total more than a few hundred dollars. They represent utilities paid by a property seller in advance. For example, if a seller fills the heating oil tank just before the closing, the buyer will be required to reimburse the seller for the unused oil. This typically occurs at closing. Similar charges may be incurred if the seller has prepaid other utilities, such as water, sewer or trash removal.
Another expense that could require a closing adjustment is homeowner’s association fees. Many homeowner’s association member fees are paid on an annual basis. If a seller has paid the fee for the full year, the buyer will be required to reimburse the seller for a portion of the year’s fees. There may also be a fee to the HOA to get started. It may be called a transfer fee or something similar. Regardless of what it’s called, it’s an upfront lump sum to establish a new HOA account.
Don’t overlook the money it will take to make a new house a home. In addition to physically getting stuff delivered, immediate expenses will crop up. Are a few pieces of furniture needed to fill a larger space? Will it be necessary to decorate a little and repaint the mustard yellow dining room before it’s used? And fencing the backyard for the dog might be a necessity.
“Unless your home is brand new, there could be things that you’ll need to upgrade or add,” Jeremy says. “It’s human nature to want to make the home feel, ‘homey’ and comfortable, so people often end up buying furniture after they move in, even if it’s just a piece or two.”
Lender-Required “Cash Reserves”
This closing cost frequently takes many homebuyers by surprise. It isn’t exactly a closing expense, but lenders require buyers to have cash left in savings after all closing costs are paid. Buying a home typically signifies that a buyer has reached a major savings goal, so it’s normal to see their accounts drain.
The lender’s cash reserve requirement prevents a buyer from being “closing broke”. The lender doesn’t want a buyer to be an early-term default. This lender requirement ensures that the borrower will have the necessary cash to make the first months’ payments when due. The most typical cash reserve requirement is two months. The lender must be able to verify that the funds available in a liquid source. These include savings account, checking account, or money market fund—after closing on the property. After all, it only makes good financial common sense to have a prudent financial reserve.
Let’s Put It All Together
Let’s say a homebuyer is buying a home for $250,000 and needs a 10 percent down payment. The total amount of cash that’s needed will look something like this:
Down payment @10 percent of $250,000 $25,000
Closing costs @2.5 percent of $225,000 $5,625
Prepaid expenses @2 percent of $225,000 $4,500
Utility adjustments Estimated $500
Cash reserves 1,500 mortgage payment x 2 $3,000
Total cash required $38,625
The homebuyer will need more than 1.5 times the down payment to successfully close the house. It’s critical that every potential homebuyer include the additional cash requirements in their home buying plans and a Trembley Group Real Estate Sales Executive has the patience and expertise to help simplify this complicated process and put an accurate estimate together.
At The Trembley Group, we pride ourselves on being the experts at more than just selling real estate. We are local residents, some of us have been here for a lifetime. The rest of us will be here until the end of time. We love living, working, and playing in the diverse backyard of Coastal Carolina, and look forward to helping you live and love your dreams soon too. Please reach out to us by phone or email for personalized service and one-on-one advice.