What’s the REAL Cost of Buying a Home?
If you are thinking about buying your own home, you are probably trying to work out exactly how much it will cost and how much you can realistically afford. What is the ideal downpayment to have set aside? What about all the other costs involved in purchasing a home? Understanding the lending process and interest rates is undoubtedly important, but it is also crucial that you are aware of hidden costs which can surprise you further down the line.
In this article, we help you work out how much money you really need to buy a home. We’ll discuss down payments, bad credit, tax write-offs, and the ongoing expenses you should account for when owning a property so you can be confident you’re on the right track.
Do You Really Need 20% For a Downpayment on a Property?
Many people will tell you that you need 20% of a property’s value as a downpayment, but while this is definitely an advantage, it isn’t strictly true. Home buyers can actually put down as little as 3.5% with a U.S Federal Housing Administration (FHA) loan for a fixed rate mortgage over a 30 year period. Generally, these 3.5% down payments tend to be capped to an upper loan limit of $417,000, but this can vary depending on your location. For example, more expensive areas such as New York and Los Angeles will allow you to borrow more than that amount as part of a FHA loan thanks to the higher average price of property in the city.
That said, you don’t need to go with the FHA for your mortgage if you have less than a 20% downpayment reserved. Standard bank loans of up to $417,000 can also be approved with as little as a 5% downpayment. If you need to borrow more, though, you should expect to be asked to pay an additional 5% of the total loan amount upfront.
What Are The Benefits of Having a 20% Downpayment?
While it may be a relief to learn that it isn’t necessary to have a 20% downpayment, there are still many benefits to be enjoyed if you are able to meet that amount. First of all, you will end up paying less for your home over time if you can put down 20% upfront. If you pay off more of the property value at the beginning, your loan amount will be lower, which means you’ll pay less in interest over the mortgage term.
You are also likely to get a better mortgage interest rate. Lenders will see a 20% down payment as a sign of greater financial stability when compared to someone who only has 5% to put down on their loan. Therefore, those who put down less than 20% are often viewed as a higher credit risk and usually have a higher interest rate on their mortgage.
The same is somewhat true when you place an offer for a property. The unfortunate truth is that sellers usually prefer to deal with buyers who are able to offer a 20% down payment or higher. This may seem strange, but from a sellers perspective, buyers who have a higher down payment are more likely to have a mortgage application approved and thus lead to a sale. Lastly, if you’re able to put down 20% or more, you will not need to pay private mortgage insurance or PMI. This insurance will increase your monthly mortgage payments and can contribute to higher costs over the length of your mortgage term.
This might sound depressing, but don’t lose heart. Most people in the U.S are not in a position to put down 20% when they buy a home. In fact, in 2018, over a quarter of buyers under the age of 37 put down only a 5% down payment when purchasing a property.
What If You Have Poor Credit?
Not all lenders will have the same definition of “bad credit.” Some will consider a bad credit score to be anything that is lower than 650, while others are more forgiving and define bad credit as a score below 630.
Just like down payments, the FHA has a more lenient approach to an applicant’s credit score. From their perspective, as long as your credit score is higher than 580, you can put down as little as 3.5% for a down payment. If your credit score is less than this, the FHA will require you to put down a 10% down payment.
If your credit score is towards the lower end of the scale, there are things you can do to raise your score. But, you should definitely be shopping around for the best rates. You may be pleasantly surprised at the variety of rates you are offered across different lenders. After all, even a small reduction in your interest rate will make a big difference to the amount you wind up paying over the course of a standard 30 year mortgage.
Another thing to consider is the rate at which you submit your financing applications. You should be aware that mortgage applications count as a “hard inquiry” on your overall report, which negatively affects your credit score. The best way to minimize this effect is to submit all of your applications in a short time frame. This is because some credit score models will consider all inquiries sent within 45 days to have the same impact as a single inquiry.
Having a larger down payment can also help if you have a bad credit score. As mentioned above, a bigger down payment is viewed by lenders as an indicator of financial stability, so this may work in your favor.
Lastly, another potential solution is to apply for a mortgage with a co-signer. The co-signer can be a family member or a friend with a good credit score to vouch for you and help get your application approved. Once your credit has improved, you will be able to refinance the entire mortgage loan into your name. The downside to this strategy is that you’ll take on a great responsibility for your co-signer’s credit score. Should you miss a payment, your co-signer’s credit score will also be hit. Therefore, you should think very carefully about your financial circumstances before pursuing this route.
What Write-Offs Come With Buying a Home?
One of the benefits of owning your own home is the tax deductions that become available to you. These write-offs can help you to save a lot of money on your yearly tax bill and thus reduce your financial strain. Let’s take a look at the most important write-offs you can take advantage of as a new homeowner:
It should come as no surprise that every mortgage borrower has to pay interest to the lender over the period of the loan. The interest appears as a percentage that is applied to each of your monthly payments. The accumulation of mortgage interest can reach many thousands of dollars over the years, but it is also tax-deductible. Because interest on mortgage repayments reduces your household income, you’ll benefit from a reduction in your tax bill.
At the beginning of every year, usually in January, your mortgage lender will send you a 1098 tax form which details the amount of mortgage interest you have paid over the previous year. You can then claim this amount as a deduction in the section of your tax return marked ‘Schedule A’. Mortgage interest deductions are capped at $750,000 for married couples filing jointly or $375,000 if you are married but submitting your tax returns separately.
Sometimes called “loan origination points” or “discount points,” mortgage points are paid to your lender to reduce the overall interest rate on your mortgage loan. Each point accounts for 1% of your mortgage amount.
If you were to buy a $300,000 home, the mortgage lender could charge mortgage points of $3000. Thankfully, these mortgage points are also tax-deductible, but some rules do apply. For example, the mortgage must have been finalized and secured, the amount of points paid cannot be higher than the average for your locality, and your down payment must be more than the value of the points paid.
What Are The Hidden Costs of Buying a Home?
Aside from the obvious fees involved with buying a home, there are some additional, hidden costs of home ownership to take into consideration. You should factor these into your overall budget when deciding what you are able to afford.
Closing costs are an additional expense involved in finalizing your home purchase and can include: appraisal fees, title searches, loan origination fees, insurance, taxes, credit report searches, discount points, surveys and deed-recording fees. Both buyers and sellers will incur closing fees as a part of the title transfer process.
Often overlooked, closing costs can add up to an additional 2-5% of the overall cost of your home. Therefore, if you purchase a home which is worth $150,000, you could end up paying as much as $7,500 in closing costs.Your mortgage lender can offer you an overall estimated cost for your loan including the closing costs within a few days of receiving your application. It is important that you recognize that this is just an estimate which is subject to change, although, your lender will inform you in writing should the estimated amount be revised.
If you are on a tighter budget, you may be able to negotiate on some of the fees that are included in the closing costs. If you are left feeling like you are being overcharged, you can always get in touch with competing lenders to see if they can offer you a better deal.
Once you have settled into your new home, you should expect to invest a percentage of your homes’ value back into the property every year in maintenance. Generally, homeowners will spend around 1.5% of the value of their home on upkeep annually. The sad truth is that property deteriorates over time. Keeping on top of the maintenance will ensure your home holds value and helps you to avoid a much bigger repair bill later.
Every year, you’ll likely need to apply weedkiller, pest-control treatments and give the exterior of your property a good powerwash. Carpets will need to be deep-cleaned and your ventilation systems will require servicing. Every few months you’ll need to change HVAC filters, maintain your yard, and give the guttering a good clean out. This all requires the use of tools which you must either purchase or hire out at a daily rate. You’ll also have seasonal expenses such as insulation fixes and heating system maintenance to consider.
Individually, these upkeep jobs may not be very expensive, but over the course of 12 months they can add up to a noticeable amount. If you are unsure how much you should factor into your budget for maintenance, you can ask your local real estate agent for their advice.
No matter what, if you are buying a home, you must get home insurance. The cost of home insurance will vary by state, but the national average is $1,244 per year when based on a $200,000 home ($1,000 deductible and $300,000 liability). Of course, there is always the chance you could make savings by getting quotes from many different providers.
Furthermore, you can discuss what discounts are on offer based on particular criteria. For example, if you work from home or have a good security system installed, your provider may reduce your premium. It is important to be aware that homeowners insurance has its limitations. If you live in a flood-prone area, for example, you’ll probably need to get separate flood insurance coverage. Also, condominiums may require you to have an additional liability rider to cover any damage or accidents that occur on the property.
Once you have purchased your home, you’ll need to pay property taxes to your local government. The money generated by these taxes is used to support local services, including infrastructure, public schools, and local police and fire department. The amount you need to pay varies depending on your locality and the value of your property. You can find information regarding your local property tax rates here.
Property taxes are paid to the local government either as part of your mortgage payments or on an annual, quarterly or monthly basis. Sometimes, homeowners challenge their property tax burden, believing that it is higher than it should be for their area. If you think your property tax is too high, you can recruit a lawyer to help you or grieve your taxes yourself.
Buying a property in the city will be more expensive, but you may also find that the money you save by purchasing a home in the suburbs is offset by the amount of time and money you then spend commuting. If you are likely to be traveling back and forth every day for work and leisure, you should calculate how much this is going to cost you every year. If not, your commuting costs may come as a nasty surprise once you’ve moved into your new home.
Purchasing your own home is widely believed to be a much better financial decision than renting because you are instead investing into your own property. As we have seen, though, buying a home is an expensive business. Beyond the down payment, there are many additional costs which will creep up on you if you haven’t done your research first. Closing costs, property maintenance, insurance, taxes and commuting costs can all potential add up to a much larger figure than you were initially expecting.
That said, even with all those extra fees, buying is still a much better option in the long run. Owning your own home enables you to make savings on your tax bill and can help you feel more stable and secure about your future. So long as you do your research and factor in these additional expenses, you should be well prepared to purchase your own home while avoiding any costly surprises.