How Much Do You Really Need to Buy a House?

 a couple discussing mortgage closing costs

Whether you are buying your first home or gearing up for a second purchase, you'll be responsible for paying a variety of closing costs and other fees related to obtaining a mortgage. Generally, closing costs are paid when you sign on the dotted line for your mortgage, often at a final meeting called the "closing," but it's important not to overlook other costs associated with your loan.

Understanding Mortgage Fees and Closing Costs

With upfront costs ranging anywhere from 2% to 5% of the sales price, closing can feel a little bit like sticker shock—but there are options to help you alleviate the sting. The key is understanding the purpose of closing costs and fees, where they come from, what role you play in the process and how much you are responsible for. Once you do, you'll have a much better understanding of where your money is going and when you need to have it ready.

Your Largest Cash Payments

For nearly any residential real estate transaction, the two largest individual sums you will need to pay at one time are your Down Payment on the property itself and the Earnest Money Deposit as a show of good faith the homeseller. Let's look at each item in turn and examine how to determine those amounts.

Earnest Money Deposit

If the seller accepts your purchase offer, you'll be required to provide them with earnest money deposit in order to create a binding contract. This money, typically about 2-3% of their asking price serves as a sign of "good faith" that you're committed to following through with the sales process.

The earnest money goes into an escrow account set up by a third-party (e.g. a real estate broker, attorney, title or escrow company) —and can't be withdrawn without written consent from both the buyer and seller. Once an offer is accepted, the earnest money is applied toward your down payment.

There are situations that can lead to you can losing your earnest money deposit, however:

  • If you waive financial or inspection contingencies. Buyers often risk their escrow money in high stakes markets. However, if they fail to secure financing or if an inspection isn't up to par and they change their mind, they'll lose their deposit.
  • If you can't get financing in time. When you put down an escrow money deposit, you also sign a contract with a listed deadline for financing and inspection. If you can't meet these dates you could lose your cash, although buyers and sellers are often able to work out extensions of these deadlines if the buyer is well-qualified.
  • If you get "cold feet." Even when some people are to arrange to finance and follow through with the home inspection, they walk away from the deal. In this case, they also walk away from their deposit money.

Most people keep their contingencies intact—which ensues the earnest money will be returned should they opt out of a property. To protect your earnest money deposit, be sure to get an official loan estimate, and thoroughly review your escrow agreement for any contingencies and deadlines.

Down Payment

Your earnest money deposit is only a portion of your total down payment. Once the real estate transaction is final, you'll be required to put down the full amount at closing. How much you put down depends on a variety of factors, including how your mortgage is financed. Traditionally, a 20% down payment is required, although the average down payment is between 3% and 10%. Keep in mind that your earnest money deposit will apply toward your overall down payment.

The size of your down payment is the single largest factor that determines your loan options, as well as your mortgage interest rate. While this cost is likely to be your biggest out-of-pocket expense, it isn't technically considered a closing cost. Understand that you will be required to make a down payment on top of any closing costs included in your mortgage.

What Are Closing Costs?

Closing costs are payments that cover the various expenses and fees involved in formalizing a mortgage and concluding a real estate transaction. Many of these fees stem from a variety of third-party entities such as real estate brokers, title companies, attorneys and home appraisers. Sellers and buyers are both responsible for closing costs, but on average borrowers tend to have higher closing costs stemming from their mortgage.

Breaking Down Closing Costs

While some sellers may foot a part of the bill, the reality is most borrowers will take on the bulk of the closing price tag. In 2016, the average homebuyer paid $3,815 in closing costs but these fees vary widely depending on your location, home type and loan program. For instance, In cities with super competitive housing markets, such as San Francisco, the average closing cost for borrowers is $10,798, while more affordable areas such as Milwaukee may see closing costs as low as $1,863 on a $200,000 mortgage.

These costs are typically required upfront, along with your down payment. For example, if you saved $10,000 to put toward a down payment on a $100,000 home, you'll actually need $15,000 to cover the cost of closing.

So, what exactly goes into mortgage closing costs? Let's take a closer look at the process and find out which fees and other payments make up your closing costs.

Loan Application, Processing and Underwriting

It takes a team of mortgage professionals to process your loan application. From securing credit checks to confirming employment, income stream and tax records, these fees help cover the wide variety of administrative and underwriting costs it takes to approve your loan. You can generally expect to pay about 1% of your total loan costs. For example, if your loan is $150,000, you'll need to shell out $1,500 to cover these fees.

Title Search and other Title-Related Fees

A title search ensures the seller is the true owner of the property and is legally entitled to sell. The seller typically picks a title company to conduct a thorough check into the property you're looking to buy. It also reviews whether there are any property liens, such as unpaid property taxes or any outstanding third party claims against the property.

Your title company will also contract an underwriter to insure your title, both on behalf of you and your lender. This special insurance policy protects you from any legal liabilities should defects—such as fraud or forgery—be found following the title search, thus preventing you from landing in court.

Escrow Service Fees

When you put down your escrow deposit, it goes into a real estate escrow fund that is held by a third-party provider. This ensures that your funds are secure and will only be released once an agreement between the buyer and seller has been reached. While these services vary, they generally cost about $2 per each thousand of the purchase price, plus a base rate. Usually, buyers and sellers split this cost 50/50.

Home Appraisal

To ensure that the price of your new home justifies the loan amount, your lender will have your home appraised. This step confirms that your loan matches the market value of the home so you're not paying more than what is fair. To protect from bias, you cannot choose your home appraiser. Instead, your lender will contract a third-party licensed individual to conduct the home appraisal on your behalf.

Your home appraiser will calculate the value of your home by conducting an in-person walk-through of the home to record its square footage, the number of bedrooms and baths and condition—comparing it to county records and recent sales of similar properties in comparable neighborhoods. Lastly, the home appraiser will present a property analysis to you and your lender with the final report of value.

If your mortgage falls short of the appraised value, you may need to bring more cash to the table at closing.

Home Inspection

It's one of the most nerve-wracking parts of closing on a mortgage, but getting a home inspection is a critical step in the process and is ultimately there to protect the buyer. A home inspector thoroughly checks your property for any damages or repairs that need to be made before you close. If a problem is revealed, you may be able to negotiate with the homeseller to have the repairs done before proceeding with the deal, or you may choose to opt out of the deal altogether. Your home inspection does not need to be sent to your lender as it is not a required lender document.

Other Out-of-Pocket Costs to Keep in Mind

When you become a homeowner, you're going to have a few new bills in your mailbox. Some of these costs, such as hazard insurance or property taxes, may require you to make an up-front deposit order to close your loan.. Overall there are a variety of costs you should expect to pay in the course of purchasing your home.

Private Mortgage Insurance

Private Mortgage Insurance, also known as PMI, protects the lender on most non-government loan programs and, in most cases, a down payment of less than 20% requires PMI to be added to the monthly costs of the mortgage.

With so many special loan programs available, a large number of people pay a down payment that is less than 20%. That means that most people will also pay PMI. The monthly PMI payment can range from .25% to 2.0% annually, depending on the characteristics of your mortgage. Although the most common way to structure PMI is to pay a monthly fee, you can also structure the PMI into a one-time fee at closing to negate the monthly obligation. When you close on a mortgage, your lender may require you to pay the first monthly mortgage insurance payment upfront.

If you're an FHA homeowner, you'll also need to pay an Upfront Mortgage Insurance Premium (UFMIP), as well as a monthly mortgage insurance premium. UFMIP typically costs 1.75% of the total loan. Similarly, VA and USDA loan borrowers may also have to pay a UFMIP, though there may be options to roll these into the loan.

Homeowner's Insurance Premiums

Separate from mortgage insurance, new homeowners are also required to pay homeowner's insurance. This insurance protects you from incurring costs related to any damages to your home. While most homeowners pay between $300 and $1,500 a year for this insurance, your lender is likely to require you to pay the first year in full at closing.

Property Taxes

Similarly, you'll need to pay a portion of your annual property taxes at signing—typically two months' worth. The annual amount is generally determined by multiplying your tax rate by your home's appraised value. For example, if you own a $150,000 home, and your tax rate is 2%, you'll need to pay $3,000 annually, or $250 per month. In some instances, other factors specific to local laws and ordinances may affect your real estate tax rate.

If you have decided to escrow your hazard insurance and property taxes, your lender will collect both your monthly homeowner's insurance and property tax payments and place them into an escrow account, to be paid on your behalf upon each respective due date.

Stamp Taxes

Many states in the U.S. require a stamp tax, which is a fee charged to process the legal documents in the event of a land transfer (home sale). This fee is also known as a mortgage tax, a transfer fee, a recording fee, a deed recording tax or a documentary transfer fee.

Transfer fees vary because they are determined by your county and state. In Sacramento, California, for example, the stamp tax is $0.55 per $500 of the final sales price.

Typically, sellers pay this fee, but sometimes the buyer is responsible, too. Take a close look at your Loan Estimate form to see whether a stamp tax is included in your closing cost line items to determine if you'll need to pay these taxes.

The Additional Costs of Purchasing a Home

There are a few other costs that typically arise in the course of buying a home that is not necessarily out-of-pocket at the time of your closing.

Real Estate Broker Commissions

Ever wonder how your real estate agent gets paid? Real estate brokerages (the organizations that manage real estate agents) earn a commission for most properties their agents sell. The standard commission fee is between 5 and 6% of the final sales price, which is usually split between the listing agent, the buyer's agent, and each of their managing brokerages.

While most sellers are responsible for paying these costs, there are occasional instances where the fees are shared by the seller and buyer, or the buyer agrees to pay all broker costs. Most of the time, however, sellers simply incorporate the estimated broker fee into the home sale price. Check with your real estate broker to see who is responsible for the commission.

Obtaining a Home Warranty

People often confuse a home warranty with homeowner's insurance but the two are not the same. While a homeowner's insurance policy protects you from incurring costs related to property damage (caused by weather events, accidents, vandalism, etc.), a home warranty helps to cover costs of systems maintenance or malfunctions. This can include:

  • Plumbing
  • Electrical systems
  • Central heat and air
  • Kitchen appliances
  • Washer and dryer units

A home warranty plan ensures you won't have to pay to repair or replace these items completely out of your own pocket. While you'll still be responsible for paying portions of the service costs, it offers many homeowners peace of mind. The home warranty cost typically ranges from $350 to $600 per year for a basic home warranty plan and is usually initiated at closing.

In addition to the above-mentioned costs, you may additionally be responsible for paying other fees and debts, commonly:

  • Prepaid mortgage interest
  • Land survey fees
  • Courier and notary costs
  • Attorney compensation
  • Homeowner's association fees

Note: If you have a mortgage backed by the Federal Housing Association (FHA) or U.S. Department of Veteran Affairs (VA), you may need to pay fees required for those types of loans.

Talk to your real estate agent or an attorney and review any and all closing costs associated with your specific loan.

Loan Estimate and Closing Disclosure Forms

Before you sit down at closing, your lender is federally mandated to provide you with two legal forms: a Loan Estimate and Closing Disclosure form.

The Loan Estimate Form

The first document you will receive is the Loan Estimate. Most borrowers receive this three-page form shortly after they apply for a mortgage. The Loan Estimate outlines all of the terms and costs of your home loan. On a purchase transaction, these are typically an estimate since the closing agent has not been identified. Some of this information includes:

  • The loan amount
  • Your interest rate
  • Projected monthly payment
  • Whether you have a fixed- or adjustable-rate loan
  • Origination and loan processing fees
  • Closing costs

The Closing Disclosure Form

At least three days before you reach the settlement, you will also receive the Closing Disclosure form. This document breaks down all of your closing costs and fees, and sets the total closing costs you can expect to pay. Once you receive your copy, this document and the stated costs should not change before your scheduled closing date.

The Closing Disclosure form includes the final terms of the loan you selected, the details of each closing cost, and the details of who pays and receives the outlined costs at the time of closing. In addition to reviewing your loan amount, rates and terms, and monthly payment, a few items you should look for include:

  • Whether you have a prepayment penalty
  • What your estimated taxes, insurance and assessments will be
  • Whether you have an Escrow account, and its estimated costs
  • Your Seller Credit, which is the amount the seller agrees to contribute to closing
  • How much late fees will cost if you do not make an on-time payment
  • What your closing costs are, and what they are applied toward
  • What your Cash-to-Close amount will be, or the total you will need to bring to closing

It's important that you closely compare the Loan Estimate and the Closing Disclosure forms to ensure that your lender is fulfilling their end of the deal as promised when you first applied for the mortgage. If you don't like what you see, you still have time to reject the offer or to shop for a different lender. You will need to electronically sign the closing disclosure in order for the federally mandated three-day "waiting period" to begin.

Mortgage Rebate Points

One way to trim your closing costs is to take advantage of mortgage rebate points, also known as negative points. This allows you to lower your closing costs in exchange for a higher interest rate. This may work well if you can't afford your closing costs, or don't plan to stay in your home for very long. Your lender can help you decide how big of a rebate you should take and help you weigh the costs.

Strategically Structuring Closing Costs

If you can't afford your closing costs, there are generally two avenues you can take advantage of:

  1. Persuade the seller into absorbing some or all of the closing costs.
  2. Negotiate with the lender to pay the costs of closing into your loan.

This second option comes with a price. If your lender agrees to include closing costs in your mortgage, you'll have to make up for the shortfall by paying a higher interest rate and thus will have a higher monthly payment. However, if you're planning on refinancing in a few years or can afford to pay the closing costs upfront, you may actually enjoy greater savings in the long-term.

Following the Path to Homeownership

Getting to the mortgage closing can often feel like a long, winding road. Researching your closing costs and fees and knowing your loan options, before you get to the settlement table can ease the process and help you make the most out of your purchasing power.

If you still have questions about the closing process, pick up the phone and talk to one of our loan specialists, today. We work hard to ensure all of your questions are answered and that you have a smooth and easy closing.