The latest numbers show interest rates for mortgages are nearly one percent higher than this time last year. While that may seem insignificant, for the average homebuyer, it can cost them an additional $60-75,000 over the life of the loan. But interest rates alone are not the only expenses in home buying.
While some of the costs are upfront and generally well-known, such as the earnest money deposit (EMD) or down payment, most additional costs are unknown to the masses. In the midst of the excitement over buying a home, it’s important to make sure you know the ins and outs of purchasing a home – especially the easy to overlook hidden costs.
Whether you are a first-time homebuyer or a repeat buyer, the main costs include down payment, closing costs, condo or HOA fees, and appraisal or inspection fees. So here's a deeper dive into just what those possible costs can be when buying a home.
Down Payment Requirements and Mortgage Insurance
Financial experts recommend putting down 20% of a home’s purchase price, giving a total loan-to-value (LTV) of 80%. Having an LTV of 80% for a conventional loan means mortgage insurance is not needed. Mortgage insurance (MI) is one of the hidden costs that fluctuate depending on loan factors, including credit score, loan amount, and debt-to-income (DTI) ratio. For FHA loans, mortgage insurance is included in the total loan amount and is required regardless of the LTV.
As part of the down payment, there is a portion called the earnest money deposit (EMD). This deposit is made to make the seller feel confident in pulling the home off the market. The EMD is usually 1% to 3% of the total down payment. If you have a $100,000 purchase price and want to put 20% down, the total down payment would be $20,000 with $200 to $600 acting as the EMD. The rest of the down payment would be due at closing in addition to the closing costs.
Breaking Down Closing Costs: Fees That Are Included
Closing costs are simply the costs charged for closing a loan. Experts say closing costs range from 3% to 5% of the purchase price but recommend having at least 5% to avoid being short of funds to close. Closing costs are made up of lender fees to originate and underwrite a mortgage, real estate agent commissions, appraisal fees, mortgage insurance, property taxes, homeowner’s insurance, title insurance, and fees for filing local and state records.
The lender should provide a fee sheet that will outline most of the expected fees. Depending on the lender, some of these fees come as a flat fee, like the underwriting fee, while others fluctuate depending on the choice of coverage. For example, homeowner’s insurance or HOI can be chosen based on buyer preference – do you need a lot of coverage, special coverage for flood or wind, or do you want simple coverage for a lower payment?
Escrows can be waived for conventional loans with 20% down, which means the buyer wants to pay property taxes and/or HOI out of pocket instead of escrowing it with the loan. By doing this, closing costs can be lowered. Waiving escrows does come with a pricing hit which your lender can explain more about.
Additional closing costs include the costs for any inspections on the home. A standard home inspection provides details on the home you want to buy, but it does not always include everything you need to know about the home. Standard home inspections are for easily inspectable things such as structural components, roof, plumbing, etc. Home inspections are recommended but not required. They also cost anywhere from $200 to $500. Additional home inspections such as radon or pest inspections will also come at a fee.
Appraisals are another cost to consider. In today’s market, houses are selling at or above the asking price because of demand. Due to the inflation of today’s economy, the homes are selling far above the appraised value.
The appraised value is derived from an inspection done on the interior and exterior of the property by an expert called an appraiser. They are hired through the lender and are required to evaluate the home. Appraisers use the current and comparable homes in the area to determine a value they believe the house is worth. If the appraised value comes in lower than the asking price, this typically means the buyer must bring more money to the closing table to cover the cost difference.
The last portion of closings fees includes condo or homeowner’s association (HOA) fees. These fees only come into play for either a condo or a planned urban development (PUD) that is part of a homeowner’s association. Condos tend to sell for a lower amount than a typical single-family home, making them more affordable for people starting out. However, there are different fees to consider when owning a condo or buying a home with an HOA. Both condo and HOA fees are added to the monthly payment and can increase this by a few hundred dollars, depending on the community.
How To Combat the High Costs
To help bring down the higher costs, there are a few ways to offset these costs. We already talked about putting more money down to avoid MI on a conventional loan and how you can waive property taxes and HOI to lower your monthly payment and the closing costs. In addition to these options, three different credit or assistance programs could help with total costs. Seller credits and lender credits can help manage the closing costs needed to buy a home.
Seller credits are essentially a deduction of costs from the seller to the buyer. These costs vary between 2% to 5% and help the buyer lower closing costs. It is not very common to see seller credits, though, as the sellers are already losing around 5% in real estate fees, commissions, etc.
Lender credits are an agreement between the lender and the buyer where the lender agrees to cover a portion of the closing costs. The buyer agrees to a higher interest rate in exchange for this kind of credit. Lender credits are a great opportunity to avoid paying closing costs essentially; however, there is always a catch. In this case, the buyer will pay more over time due to the higher interest rate.
Buying a home is exciting and a great investment for the future. Just make sure you are doing your part in protecting your investment.
Ask your lender for a fee sheet upfront so you can be better prepared for the hidden costs that like to show up at the closing table. During the loan process, loan estimates and closing disclosures give a more in-depth breakdown of the fees. Be sure to review these closely and seek help from your lender on any questions you might have.
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