By Arvin Sahakian
Finally! You believe you have saved enough money for a down payment. Your next steps should be to make sure you have actually saved enough, account for upfront costs and reoccurring monthly expenses after you’ve bought a home.
When it comes to owning a home, we cannot help to have an emotional attachment to the idea. We get excited imagining how the kitchen and bathrooms will look after remodeling. We might even begin picking out floors and deciding where your guests from out of town will sleep. I know I certainly did when I was able to finally purchase my first home many years ago. Although these things are important to consider, there are even more important things which should be on your mind.
Let’s take a look at how to:
- save an appropriate amount for a down payment
- have correctly calculated your upfront costs
- take into account the follow-up monthly reoccurring expenses
Saving Enough for a Down Payment
You have worked hard and believe you have enough savings for a down payment on a home, but have you really saved enough?
Ideally, you want to have a down payment that is equal to 20% of the price you’re willing to pay for the home. If this is a $200,000 home, then you should save at least $40,000 as a down payment. By doing so you will avoid the need to pay for mortgage insurance every month. In addition, you will be able to qualify for a better interest rate on your purchase loan.
Depending on your loan amount, mortgage insurance can start at about $40 a month for a $140,000 loan and increase from there.
Lenders require mortgage insurance to protect their interests, because when your down payment is less than 20% there isn’t enough equity in your home for the lender to recoup their losses in case you ever default on your payments.
If you plan on putting down less than 20%, then mortgage insurance is a monthly expense you should account for in addition to a higher interest rate and monthly payment on your purchase loan.
After saving enough for a down payment, there are some upfront costs you will have to pay out of pocket before the home buying process is complete.
Hiring inspectors to check for pests, structural, electrical and plumbing issues that are not easily visible to the naked eye is very important. Most, if not all, lenders will require these inspections before giving you a loan. This is where you will discover all the costs that will be required to make your home pest free and structurally perfect. Depending on the size and area of the home, you should expect to pay anywhere from $300 – $700 for a pest and home inspection.
You may have to pay for the inspection costs out of pocket, unless negotiated into the purchase contract for the seller to pay or negotiated with your lender to include into your loan amount.
Lenders will need to see an appraisal report before issuing a loan. This report can stretch dozens of pages, detailing every specification of the home and compares it to other similar homes within driving distance to determine a value. This is where you’ll see if you’re paying a price that is too high, too low or just right to buy the home. Depending on the size and location of the home, you should expect to pay anywhere from $400 – $1,000 for an appraisal report.
Lenders don’t like giving more money to buy the home than it is worth on the appraisal report, so it’s important to remember that if you’re paying a price that’s higher than the appraised value, your lender will require you to come in with a higher down payment to cover the difference.
You may have to pay for the appraisal cost out of pocket, unless negotiated into the purchase contract for the seller pay or negotiated with your lender to include into your loan amount.
Closing costs can be the most expensive part of your purchase transaction. Depending on where you get your loan, be it a bank or a broker, you are likely to pay an origination fee to process your loan. In addition, you will also need to pay fees for escrow services and for title insurance.
Although it’s variable, you should expect to pay approximately 1-2% of your loan amount in closing costs. For a $200,000 loan amount, this expense will be about $$2000- $6,000. Using this closing cost calculator, you will see an accurate breakdown of where all the costs to open and close your loan transaction will be allocated.
You may have to pay for all the closings costs out of pocket, unless negotiated into the purchase contract for the seller pay all or part of the closing costs or negotiated with your lender to include into your loan amount.
In my 12+ years of experience in the mortgage and real estate business, it never ceased to amaze me how many people don’t calculate all of their future monthly housing expenses before they apply for a loan or put in an offer to buy a property. This tells me that the loan officers and real estate agents people rely on to guide them don’t have the heart of a teacher.
Don’t set yourself up for disappointment, or worse, financial disaster. Do your research and make a budget. Here is a simple monthly income and expense budget spreadsheet to help you keep track.
Reoccurring Expenses After Purchasing A Home
Depending on where you are in the nation, your property taxes will vary. In Los Angeles County California, for example, property taxes amount to 1.1% of the value of your home. If your home is worth $400,000, then you can expect to pay $4,400 per year, or $367 per month. To find out what your property tax rate is, contact your local County Assessor’s Office.
For example, assuming you have a $200,000 loan amount, and a 5% interest rate on a 30 year fixed loan, your monthly mortgage payments (including principal and interest) will be $1,075 per month.
Your lender will send you loan disclosure documents approximately three days after you have applied for a loan. These documents will indicate your exact monthly payment, loan amount, interest rate and closing costs.
Putting less than 20% down on a purchase loan means you will have to calculate for mortgage insurance. This is variable based on each unique scenario, but assuming the mortgage insurance rate is within a range of 0.20% – 0.40% of your loan amount each year, then you should expect to pay anywhere from $400 – $800 per year ($33 – $67 per month) for a $200,000 loan amount.
Consider your monthly expenses for water, sewer, electricity, gas, and trash to mention a few. In Los Angeles California, a homeowner should expect to pay an estimated range of $70-$200 per month for these utilities, and in some cases much higher. Check with local utility companies to get an idea of what you should expect to pay for your specific area before you buy.
Home Owners Insurance
Home owners insurance can cost 0.50% – 1% of the replacement cost for your home every year. This replacement cost will be outlined in your appraisal report. Assuming a $200,000 replacement cost, you should expect to pay anywhere from $900 – $2,000 per year ($75 – $167 per month) for your home owners insurance policy.
Home Owners Association
If you’re purchasing a condo or townhome, chances are very good that you will have Home Owners Association (HOA) fees due every single month. Depending on the size of the development and the quantity and quality of your amenities and common areas, this can be anywhere from $150 – $700+ per month. It’s not uncommon for high end condo complexes to charge their residents over $700 per month for HOA.
When you buy a home, you are really taking on two major responsibilities at the same time. The first is your mortgage loan and all the expenses related to that loan. The second is the home itself and all the financial responsibilities that come with home ownership.
Through my experience working in the mortgage and real estate industry, I have spoken to thousands of clients, many with personal horror stories resulting from rush decisions, misinformation and bad planning. I learned something important by listening to my clients carefully, that given the right information at the right time, most people can avoid negative financial outcomes and setbacks.
Arvin Sahakian’s Bio:
Arvin is the Vice President at BeSmartee, a do-it-yourself mortgage marketplace where you can get a home loan as easy as booking a plane ticket online. He has spent over 12 years in the mortgage lending and real estate industry, having worked with thousands of small and large investors. In his personal life he enjoys listening to music, reading, hiking, and spending time with his family.