This is a common question I get from many first time home buyers, and even from those that haven’t purchased a home in a while. There is no standard answer I can give that is correct for each and every scenario, but let’s look at a few financing options and other costs you’ll have in order to complete a home purchase.
What are closing costs?
Closing costs are just that, your total costs to close or complete the purchase. For our purposes let’s assume you are obtaining financing for all or most of the purchase price. Closing costs include the fees your lender charges to make the loan, appraisal fee, title and escrow charges, prorate of property taxes and the county recording fee. The total amount of these fees will vary based on the property, purchase price, lender and the borrower’s financial strength.
For borrowers obtaining USDA 100% financing a good rule of thumb is 3-3.5% of the purchase price. If you are purchasing a home for $150,000 your closing costs would be approximately $4500, plus the cost of any inspections you order (home or septic inspections are the most common).
For FHA borrowers you will have your down payment added to the total amount which must be at least 3.5% of the sales price.
If you have 20% in savings to put toward the purchase of a home then conventional financing is what you’ll be looking at. Closing costs are slightly less excluding your down payment, as low as 2%.
Using the example of $150,000 sales price:
- USDA financing: $4500 c.c. + inspections + earnest money deposit
- FHA financing: $4500 c.c. + $5250 down payment + inspections
- 80% LTV conventional: $3000 c.c. + $30,000 down payment + inspections
Can I finance all or part of my closing costs? Will the seller pay them?
Depending on the type of loan you are getting you might already be financing a portion of the loan costs. USDA and FHA loans charge a one time funding fee that is added to the final loan amount. Using the above example of a $150,000 purchase price your final loan amount might end up being $153,000. The additional $3000 is the upfront funding or guarantee fee that can be financed however other charges such as the appraisal and loan origination fees must be paid at closing. The $3000 is for example only, the fee could be more or less.
One of the ways a deal can be structured to reduce the total out of pocket expenses is negotiate a credit to cover the closing costs with the seller, as part of the terms of purchase. In general terms you are still paying those costs as the final sales price does include these fees, however the seller is receiving a lesser amount in their pocket and the difference is a credit on the final closing statement. Clear as mud? Here’s a example:
Let’s say you are buying a home for $150,000 and your total closing costs are $4500. As part of the $150,000 purchase price your agent (me!) negotiated a provision that the seller credit you $4500 to cover your closing costs. In the end you are still paying $150,000 and your lender receives $4500 out of the seller’s proceeds at closing.
It’s important to note that while the seller is giving you a credit in this example that the final loan amount really does include the amount of your closing costs. Why? Because the seller nets exactly the same amount by either giving you the credit of reducing the sales price by $4500. Essentially it’s a one way of including your closing costs in the loan amount.
If I get the seller to pay my closing costs, do I need to pay anything else?
Aside from the traditional closing costs you will need about $1500 to complete a home purchase even if you are getting 100% financing from a USDA or VA mortgage. The costs of any inspections and your earnest money deposit must be paid upfront, generally $1500 will cover these costs. This does not include any requirements by your lender that you have reserves in savings to cover 1-3 months of your mortgage payment or property taxes.
There’s several reasons it’s important to get pre-qualified by a lender before you get too far into the shopping process. Among them is knowing how much you can afford, and what your total costs to close will be. This will vary slightly based on the property but will give you an idea if you have enough cash to complete a purchase or need to save a little more.
Ready to take the next step? Get in touch and I can refer you to a reputable local mortgage lender.