Buying a home is one of the biggest financial investments many people get to make in their lives. A big part of the home-buying process is figuring out how much cash you will need upfront and what expenses you must prepare for.
With the rise of low down payment options and other financing methods, it can be challenging to determine the exact amount of cash needed for a home purchase.
Whether you’re a first-time home buyer or looking to purchase your next home, this article will provide you with the information you need to make an informed decision.
In this article, we will explore the various factors that come into play when determining the amount of cash you will need to buy a home, including:
- Down Payment
- Closing Cost
- Extra Costs
- Mortgage Payment Vs. Cash Payment
The down payment is the initial amount of money you will need to put down on a home, and in most cases, it’s usually the total amount you can afford to contribute upfront. It typically ranges from 3% to 20% of the purchase price.
The larger the down payment, the less you will need to borrow, which means lower monthly mortgage payments and lower overall interest costs. Most new buyers often prefer to go for smaller down payments. The issue with this though is that the smaller your down payment, the lower your chances of securing a loan.
Technically, there are no rules on how much cash you should or should not put down. However, loan companies favor larger down payments when giving out loans. This is favorable to lenders, as a bigger down payment can demonstrate your financial stability and lower the risk of defaulting on the loan.
It is widely believed that you need to pay 20 percent of the purchase price as a down payment. However, this is not always the case.
There are options for obtaining a mortgage with a smaller down payment, such as government-backed loans, which may only require a minimum of 3.5 percent. Additionally, some lenders offer loan programs with no down payment at all.
The catch is to have a good-high credit score. Loan companies like FHA loans require as little as a 3.5 percent down payment but a credit score of at least 580. Once you do, it becomes easier to access such loans.
Other loans like USDA and VA loans don’t demand any down payment, except that you meet their eligibility criteria. If you decide to go these routes, remember you may need to spend more on interest and fees.
Most home buyers are usually tempted to spend all or very close to all they have on their down payment. This is a temptation you want to avoid. When deciding on a down payment, consider its impact on your overall budget.
Also, aim to keep some cash reserves. Lenders want to see some financial stability, plus an emergency fund can provide security in case of unexpected expenses.
So, just how do you go about building your down payment without putting yourself in a fix? Well, read on.
How to Build Funds for Your Down Payment
Building funds for a down payment on a home is a major financial goal for many people. While it may seem like a daunting task, there are several practical steps you can take to save for this important expense. Here are six strategies for building funds for your down payment:
- Create a Budget: The first step in saving for a down payment is to understand exactly how much money you have coming in and going out each month. This will help you identify areas where you can cut back on spending and redirect that money toward your down payment fund.
- Consider exploring additional income sources such as part-time jobs, freelancing, or starting a side hustle. This can provide you with extra funds to put towards your savings goals.
- Automate Your Savings: Set up automatic transfers from your checking account to a high-yield savings account each month. This will help you consistently save and make reaching your down payment goal easier.
- Cut Back on Non-Essential Spending: Look for ways to reduce your monthly expenses, such as cutting back on eating out, subscriptions, and entertainment. By reducing your spending, you can redirect that money toward your down payment fund.
- Consider a Down Payment Assistance Program: If you’re having trouble saving for a down payment, consider looking into down payment assistance programs. These programs offer financial support to help you cover down payment costs and are usually available based on your location, income, or other factors.
- Meet A Friend Or Family: If you have family and friends who have the cash to loan out, you may want to consider meeting them. In this case, you will need a letter from the giver as proof to the loaning company that the cash is a gift that you are not expected to pay back.
Closing costs are the fees you will need to pay at the end of the home-buying process. They are the fees that are associated with the sale and transfer of ownership of a property. They include but are not limited to credit check fees, attorney’s fees, title insurance, appraisal fees, etc.
Normally, your closing cost would be somewhere between 2% to 5% of the home’s purchase price. So, if the home price is $400,000 with a 2 percent for your closing cost, you would need at least $8,000 to close off the transaction. Add that to your down payment, and you will have most of the cash you need to buy yourself a home.
Closing cost is mostly different from loaner to loaner. But in all, closing costs are typically made up of the following;
- An appraisal fee
- Loan origination fee
- Attorney’s fee
- Application fee
- Credit report fee
- Title insurance
- Underwriting fee
- Deed Recording Fees etc
Closing costs are an inevitable part of the home-buying process, but that doesn’t mean you have to pay them all at once. If you’re short on cash, don’t worry! There’s a solution. Just ask your lender about no-closing-cost options.
Some lenders will let you roll the expenses into your loan, so you don’t have to pay them upfront. Just keep in mind that this will cost you more in the long run because you’ll be paying interest on the extra amount.
So, if you can, try to pay the closing costs in full to save money in the long run.
Aside from the down payments and closing costs, there are other expenses that are essential and are to be factored into your planning.
Prepaid costs are payments made to third parties for items that are yet to be due, thus the term ‘prepaid.’ While they are payments normally made at the closing, they are not to be mistaken or associated with closing costs.
They include homeowners’ insurance payments, mortgage interest, property tax, mortgage insurance payments etc.
Earnest money is the cash you deposit as a signal that you’re down for business. This payment is made into escrow, where it is kept till closing comes. When closing comes, the escrow company decides whether the money will be applied for the down payment or closing cost or if it is to be returned to you.
Good Faith Deposit is an alternative term for earnest money. This is because your seller can decide to keep the money if you do not fulfill your part of the contract or if you decide to back out of the deal.
Earnest money varies from house to house, depending on their price points. It ranges mostly from a few hundred dollars to a couple thousand of it. The costlier the house, the higher the required earnest money.
You can always consult your real estate agent or Realtor to determine the required amount of earnest money to demonstrate your commitment to purchasing the home. Your agent will assist in negotiating the specific deposit amount.
Underestimated but essential. It takes money to move between homes. When you buy a home, you’ll need to move all of your belongings from your old home to your new one– pretty obvious yea? But many home buyers forget to budget this in terms of its financial implication.
Moving costs can add up, so be sure to factor in the cost of hiring movers, rental trucks, and any other moving expenses.
If you are relocating a long distance, the service of professional movers is recommended. If that is what you are going with, go for days of the week that are least busy; that way, you can cut down on costs. Recommended days would be the beginning of the month, Tuesdays, and Wednesdays.
Every home needs maintenance. Depending on the condition of the property, you may need to make some repairs or renovations after closing. This could range from fixing a leaky roof to upgrading the kitchen. It’s a good idea to set aside some extra money for any unexpected expenses. Advisably, you should budget at least 1.5% of the home’s cost for annual maintenance.
This is why inspections are necessary before choosing and buying a house. This way, you can identify the parts of the house that need repairs and which is more urgent. Also, you get to decide whether or not you can handle the cost of the home’s repair.
Should I Go For a Mortgage Or Cash Payment?
If you have sufficient funds to pay for a house in full, you can eliminate some expenses and simplify the buying process. Understandably, if you have the funds to pay for a house outright, using cash as payment can seem like the best option. However, there may be cases where a mortgage is still preferred. Below are scenarios where cash payment is recommended and when a mortgage is a better option.
- To Beat Competition: As a seller faced with two potential buyers, one offering to pay in installments through a lender and the other offering full payment in cash, which would you choose? In these types of situations, the buyer offering full cash payment becomes a more attractive option compared to other competitors. Full cash payment puts you ahead of the competition and increases your chances of acquiring the property.
- Shortens Purchase Process: By eliminating the need for loan applications, underwriting, and other loan-related procedures, the process of buying a home becomes quicker and more streamlined.
- Cuts Down On Extra Expenses: If you have ample savings and a stable income, paying for a house with cash may allow you to save on interest and potentially reduce other costs associated with buying a home.
- Limited Funds: If you have limited savings or a fluctuating income, securing a mortgage may be a more practical option as it allows for a more manageable payment plan. You do not want to pay for a house and suddenly go bankrupt.
- Reduced Tax Bill: Mortgage interests are tax-deductible–a privilege you won’t have if you make full cash payment.
On the issue of reduced tax bills, contrary to popular belief, buying a home with cash is not a poor financial decision, despite missing out on the mortgage interest tax deduction. In fact, it may not make financial sense to rely on the deduction.
While it’s true that losing the tax deduction from paying in cash could be a drawback, it’s important to consider the bigger picture. In the long run, you may end up paying higher interest to your mortgage lender than you would in taxes to your IRS. The point is to always do the math first before jumping on a mortgage offer.
In conclusion, if you have the means to buy a home with 100% cash without affecting your emergency fund or other financial goals, it is definitely worth considering.
In conclusion, buying a house is a significant investment that requires careful planning and budgeting. Ultimately, the amount needed to buy a house will vary, but with proper planning and preparation, homeownership can be a fulfilling and long-term investment.
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