The Real Cost of Buying a Home
A home is the biggest purchase you will make in your life and it’s also the most important. You sign for a loan that is far bigger than any credit card limit, personal loan or car loan; you agree to a term that lasts several decades, and, in most cases, you make a substantial down payment.
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The average house price in the USA is around $230,000, which means you’ll pay $46,000 with a 20% down payment. But this isn’t the only price to pay. There are many hidden costs, some of which come as a complete surprise to first-time buyers and can seriously impact your finances and your chances of completing the sale.
Before you start looking for a new home, take a look at these additional costs and make sure you can afford to pay them.
Costs of Buying a Home Not Included in a Mortgage
Many first-time homebuyers make the mistake of looking only at the down payment and the mortgage costs. They review their finances, check mortgage calculators, and invariably, they set themselves a budget they can’t really afford. Only when they begin the mortgage application process does the truth sink in and they realize that they’ll also have to pay additional costs such as:
In addition to a down payment, the most cash you spend when finalizing a mortgage will go towards the closing costs. These vary greatly but are typically set at between 2% and 5% of the value of the home. These fees will be outlined in the loan documents and you’ll understand exactly what you need to pay long before you sign on the dotted line.
Like an origination fee, these costs are required for services rendered during the finalization of a mortgage loan and they will be paid by both the seller and the buyer, although the seller typically pays a lot less than the buyer.
The average buyer in the United States pays just under $4,900 for closing costs, but in some states the average skyrockets to over $12,000.
Private Mortgage Insurance Premiums
If you have a down payment of less than 20% you will be required to pay private mortgage insurance, or “PMI”. This is a type of insurance that protects the lender in the event you default on the loan.
The payments should stop when you reach 20% equity, but this isn’t always the case and you should review the mortgage documents closely to make sure you’re getting a good deal.
The lender needs to be sure that the house is worth what they’re lending you. They won’t simply take your word for it. An appraisal will be conducted, and this will set you back anywhere up to $500, on average. The appraisal will tell the lender what the house is worth and allow them to progress with the mortgage.
Real Estate Fees
The seller is often tasked with paying the real estate fees of both the buying and selling agent. However, these are often bundled in with the price of the property, which means you may pay more just to cover these costs.
Property taxes are paid annually and differ from state to state. They are typically fixed as a percentage of your home’s worth.
Property taxes are added to your monthly mortgage payment and are then held in an Escrow account, before being released to your lender at the end of the year.
As an example, the tax rate in California is between 1.1% and 1.6% of the value of the home.
Moving costs can vary depending on the size of your home, the amount of furniture and the distance between your current home and your new home. The average cost of a local move is between $1,000 and $1,500, but these costs are inflated significantly if you’re moving across state.
A move that requires transports of at least 1,000 miles costs an average of around $5,000, which can add a significant amount to your total spend.
A homeowner’s insurance policy will cover you for damaged items in your home, as well as fire and theft. It may also protect you in the event that someone is injured in your home or if you accidentally damage another person’s property.
Your insurance premiums can be added to escrow or paid separately.
Why Are There Hidden Costs?
There are no hidden costs as such. Most of the costs will be outlined on the mortgage documents, while moving costs can be paid after a detailed quote. No one is going to sting you with an unexpected bill if you’re paying attention during the process. Get your loan estimate, check local taxes, understand where you stand with regards to private mortgage insurance, and make sure you have all the money in advance.
How Much Money Should You Save Before Buying a House?
The more you save, the better. Any extra money will come in handy when you need to move cash to an Escrow account to cover fees and get the down payment out of the way. They’ll also help you finish the house, which can be costly if you’re buying your first home and have been living with relatives.
You also have to consider utility bills and, if required, mortgage protection insurance. This is a type of insurance that covers you in the event you can’t meet your monthly payment, such as if you lose your job. It’s not a prerequisite and won’t be added to your monthly mortgage payment automatically. But if you’re concerned about the future and want the peace of mind that this insurance can bring, it’s worth considering.
How to Prepare for Buying a Home
The road to buying a home is long, especially if it’s your first. But by preparing, putting the time in and doing your research, you can avoid potential pitfalls and ensure you’re ready.
Follow these steps to get on the right track and make sure you stay there.
The sooner you start looking for homes, the better. It’ll give you an idea of what’s on the market and what’s in your price range. The average homebuyer spends 6 months looking for a home, so don’t feel like you need to rush.
Take note of how long certain homes stay on the market, how much interest they generate (do they remain for months at a time, do their prices keep falling, etc.,) and how much they sell for. This is important, as it’s information that the seller will know and it will shape their expectations.
Most buyers have a rough idea of what sort of house they can afford, but in nearly all cases, it’s more than they actually can afford. They don’t think about the additional costs discussed on this page and they assume they’re going to be offered very favorable mortgage rates, terms, and totals, even though that isn’t always the case.
Base your affordability on a mortgage that is three times your salary, with a 20% down payment that you can afford. You may be offered more, and you can also pay a small down payment, but by focusing on the worst-case scenario there won’t be any nasty surprises and you’ll be well prepared.
You’re now ready to get preapproved for a mortgage. This isn’t a commitment and it doesn’t mean that you have a mortgage. However, it means that a lender has assessed your situation and determined how much you can afford. It will give you a better idea of what sort of variable or fixed-rate mortgage you can expect and how much it will cost you (when accounting for tax and insurance).
Start saving as soon as you can. This is true even if you have enough for the down payment—it always helps to have more. Not only are there many additional costs to cover, but if you have more cash then you’ll have more options when it comes to furnishing your home.
You can also increase your down payment, which will greatly improve your terms and reduce the interest you pay.
Find a Real Estate Agent
Real estate agents can help when you’re buying and selling. They provide an invaluable service, offering expertise, knowledge, and experience in a package that doesn’t cost you anything. A real estate agent will get a cut from the sale of the house and this is often covered by the seller.
Make an Offer
You’re now ready to make an offer on the home of your dreams. Once you find the right home, make sure you:
- Schedule as many visits as you need. The average is 3, but the only limit is the seller’s patience.
- Check the basics, such as plumbing and electrics.
- Check local crime rates.
- Look into local schools and transport links.
- See if there are any development plans that will impact the value of the home.
Arrange an Inspection
A detailed home inspection can be arranged after the offer has been accepted. The inspection will highlight any issues with the property, which can help you when negotiating a discount. Don’t be scared to reduce your offer based on potentially expensive renovations, that’s what this process is all about.
The Final Steps
The only thing left to do now is sign on the dotted line and start the process that will result in you owning your brand-new home. There will be lots of paperwork and checks and this process can take several months to complete, but the initial hard work is over and you’ll get the keys before long.
What Credit Score is Needed
Generally speaking, you need a minimum credit score of 500 to get a home and the higher it is, the better the interest rate will be. A credit score of 500 qualifies for an FHA loan with a down payment of 10% but this drops to a minimum of 3.5% with a credit score of 580.
VA loans typically require credit scores as low as 620 but may drop to 580 while conventional loans require scores no lower than 620.
These differences are relatively minor, but they mean a lot to the lender. It’s worth taking some time to improve your credit score. It only takes a few months to make some serious changes to your credit score and these could result in a mortgage that saves you tens of thousands of dollars over the term.
Your debt-to-income ratio will also be factored into the equation as lenders confirm that you have the money needed to cover your monthly mortgage payments.
Do your future self a favor, take a time out, and use it to rebuild your credit and improve your financial situation.
Summary: More Time
The most important thing you can do when buying a home is to take your time. Many buyers rush in. They want to stop renting, stop living with parents, and get their hands on their dream home, but this increases the risk of mistakes and oversights.Study the market, understand your personal and local tax situation, look into insurance for your mortgage, your home, and the lender, and save as much money as you can. Be a smart buyer, not an impulsive buyer, and remember that this is as much about a valuable, lifelong real estate investment as it is about buying your ideal home.