You’ve been saving up for this moment for a long time. You’re about to spend those savings on a down payment for your first home. If you’re like many first-time home buyers in the United States, then you may not realize that you’ll probably want to hold some of that money back. The cost of buying a home is not equal to the cost of your down payment and subsequent mortgage payments. There are some fees that may surprise you after your offer is accepted.
Understanding Closing Costs
You may or may not have heard the term closing costs during your house hunt or when applying for a loan. But do you really understand how substantial these costs can be? Zillow, the popular real estate site, estimates that the average American spends about $9k on closing costs. That’s no small chunk of change.
To clarify, closing costs typically add up to around 2-5% of the total cost of the home. In other words, if you purchase a home for $300k, then your closing costs could range from 6k to 15k. Of course, the higher of those two numbers is not the norm. But it certainly could be, and that’s something you’ll want to be prepared for.
Closing costs could include any of the following:
- Homeowner Association fees
- Lender fees (e.g. the cost of pulling your credit report or conducting an appraisal).
- Title fees (e.g. fees associated with filing or the creation of an escrow account).
We’ve broken down some of the more common fees associated with closing and why they are necessary.
After your offer is accepted, it’s time for your home inspection. The inspector will walk through your property and look for issues. The issues could be small (some peeling paint) or large (a crack in the foundation). However, even if your inspector turns up nothing, you still need to pay the roughly $200-$400 fee.
If you’re feeling brave, you could forgo the inspection. However, it’s not recommended. If you find these issues now, you can negotiate to have them addressed by the seller, saving you a lot of money and hassle. However, if you wait and discover these issues down the road, you’ll have to pony up to get them fixed, and it’ll likely be more than a few hundred dollars.
Next, you have to get the property appraised. Really, your lender will do this on your behalf. After all, they want to know whether the property is actually worth what you and they are paying for it. However, the lender won’t be covering the cost. They’ll bill you around $300-$600 for the appraisal.
To add insult to injury, if the appraisal comes back under your asking price, you’ll be asked to either cover the difference or cut a new deal with the seller. For example, if you offer to buy a home for $385k and the appraiser thinks the home is only worth $370k, then you need to either find $15k lying around or convince the seller to lower the price.
There are monthly home expenses unrelated to your mortgage to consider. And no, we’re not talking about home utility bills. If you use a home expense calculator to estimate the cost of your mortgage, you might notice it adding property tax and homeowner’s insurance to the number. If you put down less than 20%, you should add mortgage insurance as well.
Not so bad, right? You were prepared for this and know that your monthly income can accommodate these monthly home expenses. However, your lender might have other ideas.
Some lenders require you to set up an Escrow account where you deposit money for your property taxes and mortgage insurance in advance. That means you need to pay that cash now so that the lender can use it to pay those expenses. Bet you didn’t see that coming.
Ask the Seller for Help
There is a light at the end of this deep dark tunnel. If you want to buy a home and avoid a financial crisis at the same time, consider asking the seller to cover some of the closing costs. This is not unheard of and can be a great way to bring your excess costs down to a manageable size. However, don’t assume they’ll agree. If you’re in a seller’s market, you might not have much leverage.
At the end of the day, buy a home that you can comfortably afford (fees and all), even if it’s not your dream digs. Then work on cutting your costs at home so you can save up and go bigger the next time around.