Home buyers often focus only on the down payment when it comes to buying a house. Closing costs can increase the amount of cash you’ll need to close. What are those fees, and how much can you expect to pay?

One of the biggest shocks of buying a home is finding out that you need way more cash to close on a house than just a down payment. It’s hard enough to save for the down payment on your home, only to find out that you need more – often a lot more – in order to complete the transaction.

Let’s look at how much cash it takes to actually purchase a home. And where possible, I’ll suggest ways that can reduce or even eliminate the additional cash requirements.

The actual down payment

How Much Cash Do You Really Need To Buy A Home? - The actual downpayment

This is the only cash outlay in the home-buying process that’s obvious to most buyers. It is usually expressed as a percentage of the purchase price of the property. For example, if the purchase price is $200,000, and you’re required to make a 10% down payment, you’ll have to pay $20,000.

That’s the easy part.

How much do you need for a down payment on a house?

It varies. With most lenders, if you want to avoid paying additional private mortgage insurance (PMI), you’re looking at a 20% down payment. But coming up with 20% may be difficult for many first-time buyers, so mortgage lenders have options with down payments of 10%, 5%, or – if you qualify for special FHA loans or VA mortgage loans – as little as 3.5%.

This is another good reason to shop around for mortgage lenders.

Acceptable sources of funding for a down payment

Exactly where your down payment funds come from will depend on the type of mortgage you are applying for. In some cases, the down payment must come from your own funds, such as your bank account. But in other cases, it can come from a gift or even be borrowed from approved agencies.

Conventional and jumbo loans tend to have the strictest rules when it comes to the source of your down payment funds. If you are making a down payment of 5% or 3% of the purchase price, the lender will typically want to see that the funds come from your own financial resources. That can include money withdrawn from a bank account, funds withdrawn or borrowed from an employer-sponsored retirement plan, or even the sale of a personal asset. 

Typically, once you satisfy the “own funds rule”, the guidelines become more relaxed. For example, if you’re making a 10% down payment, the lender may require 5% coming from your own funds, and 5% from a gift from a relative. But if the gift is equal to at least 20% of the purchase price of the property, the lender won’t require you to show evidence of your own funds at all. 

FHA loans have a more relaxed view of down payments entirely. Not only can the down payment come from either your own funds or from a gift, but they also allow loan proceeds from approved down payment assistance programs. It can make it possible to get 100% financing on an FHA loan. 

With VA loans, the down payment isn’t typically an issue. VA loans normally provide 100% financing, which makes the down payment a moot point.

Where you can’t get down payment funds from

Two generally prohibited sources are cash and unsecured loans.

By cash, I mean currency you store at home or in a safe. Any money you invest into a home has to pass through a financial institution to be considered a legitimate source of funds. In addition, cash savings in the form of currency can’t be verified as being valid.

Unsecured loans are a no-go. If you have any ideas to provide a down payment from a credit card advance or the proceeds of a personal loan, this will be rejected by the lender. Not only does it indicate an inability to accumulate funds for the down payment, but it also creates an additional debt obligation.

Closing costs

How Much Cash Do You Really Need To Buy A Home? - Closing costs

This is where things start to get a little complicated. This is because the cash outlay to make the purchase becomes (often) much higher than the down payment alone.

Closing costs may run up to 2%-3% of your loan amount

On a $200,000 mortgage, you’ll need to come up with between $4,000 and $6,000 in addition to your down payment.

Closing costs vary from one state to another. This is due to differences in either the real estate transfer tax, or mortgage “stamps” (government taxes collected based on a percentage of your mortgage loan amount). They can also vary based on different rates charged for appraisals, attorneys, and even title insurance.

Closing costs can also vary from one lender to another, and even from one loan to another. For example, each lender charges a different application fee. In addition, lenders often charge “points” – so named because they represent a percentage point of the loan amount.

An origination fee is one kind of point. The charge will generally be between 0.5% and 1% of the new mortgage amount. It represents compensation to the lender for placing the loan. Discount points are another type. They represent points paid to lower the mortgage interest rate on a permanent basis.

For example, by paying a discount fee of 1% of the loan amount you have, you can reduce your mortgage interest rate by approximately 1/8 of 1% (0.125%). However, if cash to close is an issue, paying discount points to lower the interest rate isn’t generally recommended. The small decrease in the monthly payment doesn’t usually justify the cost of the discount points paid upfront.

Typical closing costs (other than origination fees and discount points)

Below is a list of common closing costs, including their purpose and a general cost range. Not all will be charged in every case, and there may be additional fees specific to your geographic location. 

  • Application fee – Not all lenders charge this fee, but when they do it usually includes funds for both the appraisal fee and the credit report. It will generally be between $300 and $500 if it is charged.
  • Appraisal fee – This is the fee the lender will pay to an independent appraiser to establish the market value of the property you are purchasing or refinancing. It will generally be between $300 and $500 depending on the property and appraisal fees in your market area.
  • Title search – This is a search done by a title company to determine the existence of any liens against the property. It’s to ensure the property will transfer with a clear title. The cost of the search is typically between $200 and $300.
  • Title insurance – This insurance is purchased to cover any liens that may not have come out during the title search. You’ll be required to have lender’s title insurance to protect the lender against any undiscovered liens. But it’s strongly recommended that you also get owner’s title insurance as well, which will protect you if such liens are discovered. With owner’s title, you’ll be able to refinance your home or sell the property even if a prior lien is discovered. The cost of lender’s title insurance is usually several hundred dollars, and is based on the value of the home. Owner’s title is usually around $200.
  • Attorney fees – In many states, real estate closings are handled by title companies. But in others, they’re customarily handled by attorneys. Expect to pay between $400 and $1,000 or more depending on the complexity of your transaction and your geographic location.
  • Home inspection – While an appraisal will be performed to establish the market value of the home, it does not address deficiencies with the property unless they are obvious. A home inspection is recommended – but not required – whenever you purchase a home. The cost will generally be between $200 and $400. But it can be money well-spent if it identifies costly problems that you can have repaired by the seller prior to closing.
  • Real estate transfer and mortgage taxes – Many states impose taxes based on the value of the property being transferred or the amount of the mortgage, and sometimes both. It will typically be a small percentage of the property value or the mortgage amount, and will vary by state and county, and sometimes even by municipality.

There are actually two alternatives that can either reduce or completely eliminate closing costs:

  1. Negotiate for the seller to pay your closing costs – This will only be permissible in areas where this is common practice.
  2. Negotiate premium pricing with your lender – This is where you pay a higher interest rate on your mortgage in exchange for the lender paying the closing costs.

Either may be a good option, particularly if you are making a minimum down payment, like 5%, and adding closing costs on top would make your cash outlay significantly higher.

Prepaid expenses

How Much Cash Do You Really Need To Buy A Home? - Prepaid expenses

These are probably the most confusing charges for home buyers, but they are completely necessary. With most mortgages, the lender will put real estate taxes and homeowner’s insurance in escrow. This means that those charges will be included in your monthly payment, and paid by the lender when due.

In order for that to happen, the lender needs to collect certain amounts upfront, to ensure that the funds are available to make the payments when they are due. The escrow accounts are set up to pay the charges on the next due date, while a portion of your monthly payment replenishes the escrow account for the due date after that.

Depending on where you live, and the frequency of real estate tax collections, the lender may have to put anywhere between two and 12 months of real estate taxes in escrow. If the taxes on the house are $250 per month, and a six-month escrow is required, that will translate to a prepaid expense of $1,500 at closing.

The same applies to insurance.

For homeowners insurance policies, you’re typically required to prepay a one-year homeowners insurance policy on the house, plus an extra two months of premium charges to the lender’s escrow account. The lender may also escrow one or two months of premiums for PMI as well, if required. You can find the best insurance rates by going through Policygenius – they can show you a number of rates and you can easily compare and choose the best one for you.

Depending on where you live, prepaid expenses may come to as much as 2% of the loan amount.

Fortunately, you can have some or all of the prepaid expenses paid for you by either the seller, or by premium pricing paid to the lender. A third option is to decline the escrow arrangement by the lender. This will require that you make a down payment of at least 20%.

Utility adjustments

Utility adjustments can include a large number of charges. Luckily, they seldom come to more than a few hundred dollars. They basically represent utility costs paid by the property seller in advance.

For example, if a seller fills the heating oil tank just before the closing, you’ll be required to reimburse the seller for the unused oil. This will happen at the closing table. Similar charges can be incurred if the seller has prepaid other utilities, such as water, sewer, or trash removal.

Still another expense that could require adjustment at closing are homeowners association fees. In many homeowners association neighborhoods, member fees are paid on an annual basis. If the seller has paid the fee for the full year, and you’re closing on the house on March 31 – three months into the year – you will be required to reimburse the seller for nine months’ worth of fees. There may also be a fee to the HOA to get started. They may call it a transfer fee or something similar. Basically, it’s a lump sum upfront from the new homeowner to get into the HOA.

Lender-required “cash reserves”

How Much Cash Do You Really Need To Buy A Home? - Lender-required “cash reserves”

This one takes many homebuyers by surprise. It isn’t a closing expense, but lenders require that you have so much cash left in savings after all closing costs are paid.

Lenders have a cash reserve requirement to avoid a buyer “closing broke”. They don’t want you to end up in an early-term default. This requirement ensures that the borrower will be able to make their payment during the first few months.

The most typical cash reserve requirement is two months. That means that you must have sufficient reserves to cover your first two months of mortgage payments. So if your principal, interest, taxes, and insurance (PITI) come to $1,500 per month, the reserve requirement will be $3,000.

These are not funds that must be deposited with the lender. But the lender must be able to verify that you will have the funds available in a liquid source. These include savings account, checking account, or money market fund – after closing on the property. Generally speaking, they frown on using retirement assets for this purpose, since those funds cannot be easily liquidated.

Where to get mortgage financing to buy your home 

Credible 

A great place to start your search is Credible. Before you even start shopping for a new home, you can find out how much of a mortgage you can afford and even get preapproved for that amount. Having a preapproval letter will help you gain the confidence of your real estate agent and any homebuyers since they’ll see that you can get a loan for the amount of the purchase.

What’s great about Credible is that with one quick preliminary application, you can get quotes from multiple lenders. That lets you compare rates to make sure you’re getting the best interest rates and terms for your mortgage. If you like one of the offers, you can proceed to a more extensive application.

Like Reali Loans, Credible doesn’t charge fees for its services. Any fees you’ll pay will be to the lender you choose based on the quotes Credible gives you.

Summary

If you are buying a home for $200,000 and need a 10% down payment, the total amount of cash that you may need to provide or at least show looks something like this:

Cost How much you need to saveAmount needed in cash
Down payment10% of $200,000$20,000
Closing costs2.5% of $180,000$4,500
Prepaid expenses2% of $180,000$3,600
Utility adjustmentsEstimated$500
Cash reserves$1,200 mortgage payment x 2$2,400
Total cash required$31,000

As you can see, you could need more than 1.5 times your down payment to successfully close on a house.

That’s why it’s important to include the additional cash requirements in your home buying plans.

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About the author

Total Articles: 155
Since 2009, Kevin Mercadante has been sharing his journey from a washed-up mortgage loan officer emerging from the Financial Meltdown as a contract/self-employed “slash worker” – accountant/blogger/freelance web content writer – on Out of Your Rut.com. He offers career strategies, from dealing with under-employment to transitioning into self-employment, and provides “Alt-retirement strategies” for the vast majority who won’t retire to the beach as millionaires. He also frequently discusses the big-picture trends that are putting the squeeze on the bottom 90%, offering work-arounds and expense cutting tips to help readers carve out more money to save in their budgets – a.k.a., breaking the “savings barrier” and transitioning from debtor to saver. He’s a regular contributor/staff writer for as many as a dozen financial blogs and websites, including Money Under 30, Investor Junkie and The Dough Roller.