In this article, I wanted to give you a snapshot of all the costs involved when purchasing a property and to clear up some misconceptions.
When given a break down of all the costs involved in purchasing a home, I find that most of the buyers are unprepared for what to expect, and somewhat surprised, when they see how much they need to bring to closing.
This issue falls on our industry. Most of the agents, lenders and other industry experts are simply too busy or they make assumptions that people either already know or that their lender has had this conversation with them. Whatever their reason is, it doesn’t matter. My intention here is to educate you to ask the right questions when you sit down and talk with your mortgage broker and/or real estate agent.
Doing your homework prior to beginning your home search will save you a lot of time, money & unnecessary drama during the home buying process.
Buying a home is probably one of the biggest purchases that most people make in their lives. They don’t have a license to buy or finance real estate, so that’s why they hire the help of a professional.
Unfortunately, a lot of times if the professional doesn’t know what they are doing, it can get complicated for all parties in the transaction.
Before I outline some of the general costs that you must expect to acquire when you purchase a home, I also want to point out that this is very specific to your individual situation such as the type of loan, the amount of down payment you are putting in, your credit score, etc.
Your Monthly Payment, Closing Costs (and more) Break Down:
Principal: This is the amount that goes towards the value (not including interest) of the loan.
Interest: This is the interest you are paying on your loan.
- For Principal & Interest (P&I): ask your lender to show you the amortization schedule. It will break down your payments for the life of the loan.
- If your interest rate is fixed for the life of the loan, the Principal and Interest’s total is a fixed amount every month.
Taxes: These are the Real Estate Taxes you pay to the county that your home is located in. They are prorated and calculated based on the last Tax Bill.
- This is not a fixed amount. It can go up or down (most unlikely) based on your annual tax bill.
Insurance: This is your Homeowners’ Insurance Bill prorated (divided by 12 months). This also goes up and down based on your choice of insurance provider.
- The above is the PITI abbreviation your loan officer or agent might be using.
Mortgage Insurance: You have it on most loans. Depending on the loan type, it is calculated by a different formula and it has a different name (MIP, PMI).
- The only time you don’t is if you put a 20% down payment on a Conventional Loan.
Closing Costs: All junk fees associated with originating the loan such as lender fees, attorney fees, tax examination, title examination, appraisal fees, credit reports, application fees, transfer fees, loan origination fees, etc.
The lender is your best bet to give you the estimated amount. In my experience, 9 out of 10 buyers know what to expect at the time when we are putting an offer in. I usually calculate about 3% of the purchase price for closing costs if we are trying to negotiate some help from the seller.
Prepaid Items: This is the amount collected up-front to establish your Escrow account. When you have less than a 20% down payment, the lender requires you to have an Escrow Account. Every month the amount collected for Taxes and Insurance goes to the Escrow Account. This ensures that there is enough money to take care of the annual bills for the taxes and insurance when they come due.
- There is a formula that calculates the exact amount to be collected up-front based on what month you are closing on and what month of the year the taxes are paid.
- Again, your lender is the best resource to give you this information.
FHA and VA Loans have Mortgage Insurance or a Funding Fee associated with their loans that could be paid at closing or financed with the loan.
A note on prepaid items:
- Please ask your lender to estimate all the amounts for you based on your individual situation. Ask them to explain the APR vs Interest Rate to you. This is important. Some lenders charge points in order to reduce your interest rate but that increases your closing costs and your APR at the end.
It’s critical that you know all of your numbers in your particular situation prior to starting the search for a house.
Find a great agent who will refer you to a great lender that will educate you on your financial options. Then based on the facts, your agent will analyze your needs and help you find that dream home.
Please comment below and let me know what you think! I'm also always available to answer any questions.
Be sure to download my brochure for the 7 Buyer Traps and How To Avoid Them.