It’s a tough and tight market out there for everyone looking to buy a home in this strong sellers’ market. Second and third time buyers have a few advantages because they have been through the process before and know there are buying expenses beyond the down payment. Additionally, now that most homes are no longer underwater, repeat buyers have equity in their existing home to help pay most or all of the closing and related costs when it comes to buying another home. These cost pop up everywhere. Don’t forget about the cost to move.
For many first time buyers, these additional expenses come as a surprise after they struggle to save the down payment only to find many other expenses needing to be paid before or at the closing table. Before closing, these include inspections and appraisals. First time buyers need to become educated and prepare for these additional costs…
Costs to Homeownership Vary
The difference between renting and owning a home can be substantial. On one hand, as a renter, you are almost certainly covering all of the landlord’s monthly costs plus a profit for the landlord’s investment and efforts to maintain the home. However, consider your rent is almost certainly based on costs to the landlord that were incurred years ago.
He or she probably have a much lower mortgage payment (if any at all) because they purchased the property years ago at a much lower price than you can buy at today. Their original closing costs on the purchase have either already been recovered from monthly rents or are gradually being recovered through your monthly rent. Same thing with major repairs. The landlord might have laid out $15,000 for a new roof a few years ago, that is now being gradually recaptured as a portion of your monthly rent. As a homeowner, you would need the funds up front to pay for that $15,000 roof replacement. Either all out of your pocket or as a second loan that can gradually be repaid over time.
And then there are the closing costs…
Buying Costs Much More Than Just the Down Payment
Twenty percent of the purchase price is the amount of down payment that you hear tossed around the most. Fortunately, there are plenty of loan programs available that lower that amount to 10, 5, 3, and even zero percent down. Of course, you’ll have to qualify for one of these programs but most first time buyers do.
Even if you qualify for the most generous down payment, don’t forget about other closing costs and higher costs of homeownership. Many but not all of these can be wrapped into the mortgage to be paid over the length of the loan.
Closing costs vary significantly by location. Generally, these range from 2 percent to 5 percent of the purchase price. The average sale price for a new home in May was $337,000 according to the U.S. Census Bureau. A 20% down payment on that sale price amounts to $67,400. On top of the down payment, you would need between $6,740 and $16,850 to cover other closing costs. The expenses include everything from a loan origination fee and attorney fees to prepaid homeowners association fees and taxes. You should receive an estimate of your total closing costs before you sit down at the closing table. Study it carefully.
Future monthly and quarterly costs add up quickly. These typically include property taxes, homeowners insurance, private mortgage insurance (almost always required when the down payment is less than 20 percent), and possibly HOA fees as well as other costs that might apply to your specific purchase.
Many buyers use online mortgage calculators to gain an insight into how much the monthly payment will be. While all of these calculators include the principal and the cost of interest on the loan, not all of them include the cost of other taxes and fees. You’ll need to ask your realtor or escrow officer for estimates of these costs. A $200,000 mortgage (after the down payment) with a 4 percent interest rate comes to about $955 per month before other costs are added in. Once the property taxes and homeowners insurance are added in, the monthly payment can rise to a little over $1,200 (depending on your specific situation).
A traditional mortgage typically rolls these ongoing costs into an escrow account that is funded with your monthly payment. As these bills come due, they are paid by the mortgage servicer from the escrow account.
With more and more people turning to private loans to finance a home purchase, it’s worth noting most private loans don’t include an escrow account. The homeowner will need to write separate checks for these expenses as they come due. These can amount to a couple of hundred dollars each month for insurance. Property taxes are often collected semiannually which can mean a $1,000 tax bill showing up every six months. HOA fees can vary greatly. At the upper end, these can be $400 or more per month.
Don’t forget about utilities that are more expensive. You’ll enjoy the extra elbowroom in a 1,500 square foot house compared to a 600 square foot apartment. But it’s going to cost more to heat and cool. Additionally, you become responsible for garbage collection, home maintenance, and yard maintenance along with other homeowner related costs.
These numbers can be scary for first time buyers. Keep in mind that if you are renting, most if not all of these costs are currently rolled into your rent (you’re already paying them indirectly). What’s important is you fully understand all of the costs you are likely to incur before you sign the closing papers. It’s always a good idea to have a reserve account for unexpected emergencies.
Please leave a comment if this article was helpful or if you have a question.
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 10 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.