You and your family are finally considering exploring the housing market and buying real estate. Congrats! This is a major life decision and it pays to be prepared.
The home-buying process can be intimidating, especially for first-time homebuyers. You already know that your down payment is a huge upfront cost, but there are also a bunch of other costs that are contingent on your home’s value, your credit history, and how much money you have saved up, among other things.
In this post, you will learn how much money you should expect to bring to the table when it’s time to buy your dream home.
Buying a House: What to Expect in Upfront Costs
The short answer is that how much money you need depends on the purchase price of your home. But the total costs of buying a home extend far beyond the initial purchase price.
Here are some of the top home-buying costs that you can expect to pay:
- Down payment
- Private mortgage insurance (PMI)
- Homeowner’s insurance
- Home inspections
- Emergency fund
- Moving costs
- HOA fees
The above list contains just a few of the costs that you may have to pay, which often surprises many people that have never gone through the process.
All those additional and unexpected costs can serve as a filter to remove homebuyers who may not be ready to tackle such a major investment. If you have trouble covering the costs of a home purchase, it could be a sign that you’re not yet up for the task of owning a home and dealing with the potential unexpected expenses that will undoubtedly arise.
The best thing that you can is to plan ahead of time and save as much money as possible. At a minimum, I recommend having at least six months of monthly mortgage payments saved up on top of the loan’s down payment requirements and other closing costs.
This way, you can move forward confidently, without having to worry about taking out more loans or charging emergency expenses to your credit cards.
Here is a closer look at the top home-buying costs that you can expect to pay.
In the United States, the average down payment on a house is 6% of the total loan value. However, to avoid PMI (more on that in a second), you’ll want to put down at least 20%.
Down payment amounts can vary depending on your financial situation and the type of loan you are applying for. If you only have a low down payment, you will likely be looking at higher mortgage insurance premiums.
You should also keep in mind that putting more down on the house can encourage the lender to give you a better interest rate. Generally speaking, the more you put down, the lower your risk is to the lender, and the more money you’ll save on interest fees over time.
So, if the home you’re buying is worth $300,000 and you only want to put 6% down, you’ll need to have $18,000 saved for a down payment. If you put 20% down, the amount jumps to $60,000.
Private Mortgage Insurance (PMI)
In addition to the down payment, you may also have to pay for insurance on both your loan and your home depending on the type of loan you have.
PMI is a type of insurance that lowers the risk to the lender. In most cases, if you put less than 20% down, you are going to need to pay PMI, which can easily add a few hundred dollars onto your mortgage premium each month.
It is possible to purchase a property with low or no money down, but remember that the mortgage lender is always trying to minimize their risk.
Homeowners insurance is separate from mortgage insurance. It covers the liability of your house — like if it burns down or a tree falls on it. The average cost of homeowners insurance in the U.S. is just under $1,500 annually and this amount usually gets tacked onto your monthly mortgage premium.
Most real estate transactions require an appraisal by a third party to assess the overall value of a house. Appraisals are usually necessary when buying, selling, or refinancing a property so that the lender knows the real value of the property that the loan covers.
Appraisals generally cost $300 to $500 and must be paid for in cash on top of your other closing costs and purchase fees.
A home inspection is a separate analysis conducted by a home inspector that looks at the overall quality of the house, including its foundation, roof, electrical wiring, heating system, and more.
Inspections benefit the homebuyer because they provide insight as to whether the home is a good investment and how much work is required after the sale. Inspections can also help during negotiations. For example, a savvy real estate agent can leverage the inspection results to lower the price of the house.
In addition, an inspection can provide a way out after putting an offer on a house. If the inspection reveals that the house needs major work, such as a new septic system, the borrower can usually back out and receive their initial deposit back.
Inspections usually cost between $500 and $600, depending on the size of the home.
Having an emergency fund is not a requirement when buying a home. However, it’s a very good idea to set aside at least six months’ worth of expenses to cover any unexpected costs or the loss of anticipated income that may arise after buying the home.
For example, suppose you lose your job or get injured immediately after signing a mortgage. You’ll want to have some reserve funds on hand to be able to make your mortgage payments without having to take out a loan.
Home Repair Funds
In addition to having an emergency fund, you may also want to set aside a cash reserve to cover unexpected repairs on your house.
For example, suppose a pipe bursts or your dishwasher breaks. These items need to be quickly replaced. Therefore, you should have at least $5,000 set aside to cover repairs. Contribute to this fund on a monthly basis so that you can handle any incident that happens.
Don’t forget about moving costs, which can be substantial. If you are moving within the same town or city, movers can run from $500 to $3,000. If you’re headed across the country and have a lot of items, you could be looking at much more than that.
Homeowners Association (HOA)
Certain communities come with monthly homeowners association (HOA) fees, which can cover costs like maintenance, security, and landscaping. HOA fees can cost hundreds of dollars per month. In most cases, they are administered by the community and not the bank — meaning you have to factor in the additional cost into the total price of the loan.
For example, a mortgage plus PMI and property taxes may cost $2,200 per month. In addition, there may be a $300 HOA fee bringing the total monthly cost of ownership to $2,500.
Next, let’s take a look at how your mortgage factors into the equation.
What is a Mortgage?
A mortgage is a type of loan issued by a financial provider to cover the purchase costs of a house. If you qualify for a mortgage, you can own a house for a fraction of the cost of buying it outright. Generally speaking, a mortgage gives you the option to pay for the house over a period of many years (usually 15 or 30).
How Mortgage Rates Are Determined
Lenders issue loans based on how risky they consider borrowers to be. This risk is determined by your overall financial status — including your assets, credit history, and so on. The higher your risk, the larger your mortgage interest rate is going to be.
There are several different types of home loans, with varying levels of eligibility for borrowers.
Types of Loans for Homeowners
These are the most common types of mortgages for new homebuyers.
Conventional loans are issued by private mortgage lenders instead of a U.S. government agency. This type of mortgage is for people with strong credit scores and minimal debt.
A Federal Housing Administration (FHA) loan is a type of mortgage insured by the FHA and issued by an approved lender.
The interest rate you pay on an FHA loan is determined by your credit score. A FICO score of at least 580 or better can land you an interest rate of 3.5%. If you fall into the 579 to 500 range, you might be looking at an interest rate of up to 10%.
In any situation, improving your credit score will decrease your loan’s interest rate.
If you are an active member of the U.S. armed forces or a veteran, you may be eligible for a loan through the Department of Veterans Affairs (VA) program.
VA loans typically have no down payment, mortgage insurance, or prepayment penalties. In addition, VA loans typically have minimal closing costs.
Make sure to have a clear understanding of your credit report before you apply for an FHA loan.
A United States Department of Agriculture (USDA) loan is a type of low-interest mortgage that comes with a zero down payment benefit. USDA loans are for Americans who don’t have enough credit to obtain traditional types of mortgages.
USDA loans are for people who want to buy a home in a rural or suburban area.
Getting Pre-Approved for a Loan
Before you put an offer down on a house, you’ll need to go through a pre-qualification and pre-approval process.
Pre-qualification is an optional step for buyers that you can even get online from a lender. By providing some basic financial information, such as your estimated annual income, credit score, and expected home purchase price, you can often get a pre-qualification within a few minutes.
While pre-qualification is not mandatory, it can signify to the bank that you are serious about putting a formal offer on a house — increasing your chances of getting approved for a loan. Additionally, many realtors require a pre-qualification letter to ensure that the buyer is (most likely) qualified.
The pre-approval process comes next, which is a more thorough review of a borrower’s financial history and credit rating by the mortgage lender.
Frequently Asked Questions
Below are answers to some of the most common questions I receive about buying your first home.
What are Freddie Mac and Fannie Mae?
The Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) were created by Congress to provide liquidity, stability, and affordability in the housing market.
What if I stop paying my HOA fee?
If you stop paying your HOA fee, the bank cannot seize your house outright. However, you can expect the HOA to attempt to collect payment through a collection process. You are going to receive collection calls and letters, and they may attempt to initiate foreclosure if it goes far enough. In short, this is not a road you want to go down. Pay your HOA fees on time, just like a mortgage.
What is escrow?
Escrow refers to a legal agreement where a third-party organization holds money and makes payments until an agreement has been completed. For example, a lender may collect escrow and use it to pay your taxes and homeowners insurance.
Does equity increase a home’s value?
Equity does not increase the value of a home. A home’s value fluctuates over time, and it does so independently of how much of your mortgage you pay down.
As such, it’s generally better to pay off your mortgage over the course of many years. This approach can give you more freedom to invest and grow your money while paying your mortgage down.
So, How Much Money Do You Need to Buy a House?
The bottom line is that the amount of money you need to buy a new home mostly depends on your home’s purchase price and how much you want to put down.
If your home costs $300,000, I recommend having a 20% down payment ready to go, plus an extra 10% to cover closing costs and other fees. In this example, that’d be $90,000.
Beyond that, you also want to have six months of emergency expenses saved up. If you are hurting for money, you’re probably better off renting until you have more saved up.
If homeownership were easy, everyone would own a home. But despite the costs and challenges, homeownership can also be one of the most rewarding financial decisions you ever make. It breaks the renting cycle, saving you tons of money over the long term, and adds to your net worth.
Here’s to finding your dream home that makes financial sense. Happy house hunting!