How Much Money Do You Need to Purchase a Home?
As you get prepared to purchase your first or next home, I’m pretty sure this question lingers in the back of your mind: How much will I need to purchase the home? This is also assuming that you’re not looking to send yourself into financial hell by liquidating your entire life savings in order to purchase your new home. After all, I always tell my clients not to go into a transaction while sacrificing a comfortable lifestyle after. Your home will most likely be your biggest monthly expense so be sure to factor this purchase into your goals for a healthy financial position.
This is what makes the home buying process so emotional; money. Not to mention a home isn’t something you can return back to the store with a receipt if you’re not satisfied after 30 days of your purchase. The better you are prepared, the better you will set yourself up for a successful transaction and better quality of life after.
There are 3 major expenses that you will incur during the transaction. Always factor these expenses into your analysis. Your agent will also be able to help you calculate these expenses to make sure you are prepared. (Assuming that’s me!)
- Down Payment
This will be the biggest expense that will come from your pockets. There are various programs and grants that are available to assist with your down payment if you qualify. For example, a VA loan’s biggest incentive is that it offers 0% down payment – can’t beat that! For the purpose of this article, we’ll only focus on the most commonly used loans, conventional and FHA. Conventional will require a minimum of 5-20% down on your home so if you’re looking at a $300,000 home, you’re looking at anywhere between $15,000 – $60,000.
Obviously the more you put down the cheaper your monthly mortgage payments will be. Some mortgage companies even require as little as 3% down for condo financing. In the end, it will be your lender who will determine, based on your current financial situation, how much the minimum required down payment will be. Budget accordingly and shop around for lenders with the best rates and terms.
The infamous FHA loan with it’s 3.5% down payment is the common financing choice of first time home buyers allowing those who may not have a huge chunk of money sitting in the bank to still attempt to go after the same homes as a conventional buyer. As mentioned before, your down payment on your home will always be the biggest expense – budget for it!
- Closing Costs
This will be your second biggest expense that is often overlooked that will also require a decent amount of money to complete your transaction. When purchasing, some of the buyer’s closing costs will include prepaid taxes, prepaid homeowner’s insurance, attorney fees, recording fees, mortgage fees, etc. The bulk of your total closing costs will be in the form of your prepaid taxes and your prepaid homeowner’s insurance. The other miscellaneous expenses usually stay fixed from transaction to transaction. Since taxes and homeowner’s insurance vary from property to property, depending on where your looking will have a major impact on the closing costs that are involved. A general rule of thumb is that the closing costs will cost around 2-5% of the purchase price. Don’t forget to factor this expense into your overall estimate.
There is a double side to closing costs that many of you have heard of or are already familiar with; a seller’s concession. Many individuals believe a seller’s concession is an agreement that makes the seller pay for your closing costs. That couldn’t be further from the truth. A seller’s concession allows you to roll the amount of the closing costs on top of your mortgage which will allow you to finance your closing costs instead of coming out pocket liquid cash.
So should you use a seller’s concession or not?
My answer: it depends on your situation.
Ideally, if you can afford to pay your closing costs out of pocket that will always be the better option. However, if paying for closing costs makes you feel heat on your wallet then seek to go after a seller’s concession.
Here’s two things you’ll need to remember when going after a concession:
One is that you are financing your closing costs so therefore you are incurring interest on those closing costs. While interest incurred on the closing costs are peanuts compared to your entire mortgage, you are still financing which means you will be paying more in the end.
The second thing to keep in mind is that now you have to make sure the home appraises for the amount of your home plus your closing costs. For example, let’s say that you’re looking at the same $300,000 home and you’re estimating about $12,000 in closing costs. You notice that there are other individuals that are interested, so you decide to place an offer at full price. Since you are requesting a seller’s concession, the total “purchase” price will be $312,000. During your appraisal inspection, if other homes very similar to the one you are looking to buy are only selling for $300,000, it will be extremely tough to have the home appraise at the $312,000 that you need in order for you to keep your seller’s concession. Does that make sense?
An easy way to combat this is make your offer at a max of $300,000, however, you will technically only be offering $288,000. ($288,000 offer price + $12,000 concession = $300,000 total purchase price). You can see how your purchasing power will drop a bit.
Be sure to keep these two scenarios in mind when choosing to go after a seller’s concession. Nonetheless, I have helped many buyers get a seller’s concession and I have also used a seller’s concession on my own home.
It’s a great option, just be wary of the pitfalls.
- Inspection Costs
These costs will be the cheapest amongst the expenses needed to complete a transaction. The most common two inspection costs are your home inspection and your appraisal inspection expenses. Each expense should only run you about $450-$500 or so. It’s important to understand these are NOT part of your closing costs so therefore even if you get a concession, you will not be able to finance these costs.
Your home inspector is just that, a home inspector. While they may have experience, they may not be a licensed plumber, electrician, or contractor, therefore, your home inspector may advise that you bring out a certified professional if something needs to be examined further beyond their scope. This may be a plumber, electrician, structural engineer, roofing inspector, chimney inspector, etc. Although it may seem like inspection costs can go through the roof if you have to consult with everybody, usually that is not the case and inspection costs remain fairly cheap and easily manageable financially.
All that to say…
Your estimated down payment, closing, and inspection costs will give you an overall idea of how much you will need to fund your purchase. You can now take your analysis and line it up with your current situation to let you know how much you can actually afford. Notice that these three expenses are just to fund and close the transaction. Be sure to also notice where your monthly payments will be. My suggestion is first figure out how much you can afford as a monthly mortgage payment and work backwards from there especially considering that your monthly payment will be the only expense that will be reoccurring after you close. Be sure to communicate your plan with your agent and mortgage officer to put yourself in the best position to succeed when buying your home while continuing to enjoy your current lifestyle after!
What are some concerns you have financially when purchasing a home? Comment below!