Total Amount of Cash You Need to Buy a Home
The amount of cash you need to comfortably buy a home is a challenging figure to estimate. On one hand you have a down payment amount, but you also have to consider closing costs (the fees and payments made to Title Companies, Mortgage lender, etc to actually complete the transaction), and also ensure you have enough cash left over in the bank for emergencies.
What does it take to estimate these figures?
Part One: The Down Payment
The down payment is the upfront money you spend to buy the home. This amount plus the mortgage amount equal the price of the home. Therefore, if you are putting “down” $50,000 and borrowing $250,000 your down payment is the $50,000 and you would finance the rest through a mortgage amount of $200,000. Your down payment percentage is simply the down payment amount divided by the home price:
$50,000 / $200,000 = 20%
The percentage of down payment can be different than 20%, but that figure is a good rule of thumb. The more money you are able to put down, the lower your monthly payment will be (because you’re borrowing less money from the bank in effect).
Monthly Payment for $200,000 Mortgage and Different Down Payment Amounts
Depending on the type of loan you choose, your down payment percent may be as little as 0–3.5% or may be 20% or higher! Keep in mind that for borrowers who put down less than 20%, mortgage lenders will often require the borrower to pay monthly mortgage insurance (PMI) until you have reached 20–22% equity in your home. This amount can be as much as several hundred dollars a month, so talk to your lender about these costs and the tradeoffs.
Part Two: Closing Costs
Closing costs are those fees and payments made in addition to the down payment. The below is not an exhaustive list, so be sure to review with your lender. Your lender should provide a very close approximation of the closing costs required to help you budget appropriately.
Keep in mind there is no free lunch with mortgage lenders, and for options that appear to be ‘no-cost loans’ or have significantly reduced closing costs, be sure to compare the interest rates and APR because often times if you are not paying closing costs out of pocket, they may be instead rolled into your mortgage in the form of a slightly higher mortgage amount (i.e. you’re ‘financing the costs’) or you will pay a higher interest rate.
One of the first things a lender will do when you’re getting pre-approved is to run a credit report. This is done to check your credit score, which is a proxy for your trustworthiness as a borrower, and calculate other outstanding debts (such as student or auto loans), all of which is considered in the decision to lend you money.
The cost of this report is generally paid for by the lender at the time and added to the closing costs. If you choose to shop lenders (as you should), it is okay to have other lenders run credit reports for you in succession, but try not to spread these out over more than a couple weeks as running multiple credit reports can ding your score, although when done by a lending institution it generally does not given it’s obvious the purpose.
Also commonly referred to as origination fees or lender costs, these fees represent the biggest cost outside of the down payment and represent the payment to the lender for processing your loan. These fees can be negotiable.
This is the fee of having the appraisal done on the property. Lenders generally require an appraisal on the property to ensure it’s worth at least what the bank is lending you. For example, a bank would not lend $250,000 to a borrow on a property where the appraised value is $200,000.
This is the fee paid to those outside the lender responsible for processing the transaction — the Title company, escrow company, and/or attorney. This depends on the purchase price but can be reasonably estimated by your lender.
Title Search and Insurance Fees
Before handing over the keys to you, the Title Company needs to search the historical records to ensure the owner is the actual owner and insures the lender is lending money against the property that is actually able to be transferred. The lender requires insurance against this event and the Title company charges you a fee for this service.
Simply put, you need insurance on your home in case of damage. Homeowner’s insurance depends on a number of variables, as does any insurance, and therefore can cost substantially different given the type, location, cost, and more of your home. This insurance is generally paid semi-annually or annually, but your mortgage lender can collect this from you monthly as part of your housing payment to help smooth your annual housing expense. Lenders will often recommend insurance providers but buyers should consider shopping around on their own for the best rates and coverage.
This is often the second largest component of your housing expense. Property taxes can be paid in a variety of ways (quarterly, semi-annually, or annually) depending on your county but thankfully during closing you can elect to simply pay them monthly as part of your payment to your lender. The lender will actually “store” these funds in your escrow account and pay them when they’re due. This way means less hassle for you as the borrower. You may, however, choose to pay them yourself in the lump sum when they are due.
Additionally, given the fickle timing of property tax payments, depending on when you buy a home, the owner may have ‘pre-paid’ a portion of the taxes, so you will need to reimburse them on a pro-rata basis, meaning if they prepaid six months forward and you’re buying two months into that period, you need to reimburse the seller for those four months they prepaid but will obviously not own the home.
Pre-Paid Interest and First Month’s Payment
Given you wont always close on the last day of the month, you may owe a small amount of interest that’s accrued between your closing date and the end of the month, so choosing a closing date on the last of the month (or as close to as possible) is a quick way to save some cash.
Similarly, a homeowner’s first mortgage payment is due the first day of the month following the 30-day period after the close. If you’re buying a home and you close at the end of the month, for example, your first payment would be due on the first of the following month. That means you basically get a month to live in the home mortgage-free. For example, closing on the 31st of May means you wont pay until the 1st of July.
Earnest Money Deposit
Earnest money is a cash deposit made by the borrower as a sign of good faith. Increasing your earnest money deposit is often a good strategy to making an attractive offer, and is made into escrow. This is normally defined in the purchase agreement and is often 1–3% of the home price. This proves to the seller that you have the cash and are serious in your intent to purchase.
This amount of money is not in addition to your down payment, but is considered a cost because it is an upfront payment made by the borrower.
Cash to Close
Once these items have been presented and discussed with your lender, you have a good approximation of your total cash required to close: the closing costs plus your down payment (which includes the aforementioned earnest money deposit.
Part Three: Emergency Fund
At Homebloq we care about a complete education for the home buyer, and stopping at down payments and closing costs when considering the cost of buying a home paints an incomplete picture. This is why our affordability calculator uses your pre-existing monthly debt and non-debt expenses alongside an estimated housing payment to calculate an emergency fund (or rainy day fund).
Buyers should always have a cash reserve for emergencies in the form of three to six months of living expenses. These expenses can cover anything from home repairs to keeping you afloat if someone, for example, loses a primary source of income. Lenders will also consider the total amount of cash available to you (in the form of bank statements and retirement account balances) in a similar way.
Using the estimated housing payment provided by your lender, add to that any other loan payments (such as student, auto, childcare, alimony, etc) and an estimated amount of expenses on top of that (general spending, utilities, etc.) for a total monthly expenditure and simply multiply that number by three.
Emergency Fund = 3 * (Total Housing Payment + Monthly Debts + Other Monthly Spending)
Combining this with your down payment and closing costs provides a reasonable estimate of the cash or funds required to buy a home.