Buyer concerns; cash to close.
When you are around people looking for mortgages as long as I have, commonalities become obvious. One concern I often talk to people about is the answer to the basic question of “How much money will I need to buy this house?” This piece is intended to give you both the information you need and some strategies you can use to ease your mind (and bank account).
Let’s begin with defining…How Much? and What For? Basically, you will need funds sufficient to cover four items- the Down Payment, Closing Costs, Pre-Paids, and Reserves:
• The Down Payment is defined as the difference between the Purchase Price and the Loan Amount. Do not confuse this amount with the amount you are depositing upon signing a contract. Those two amounts MAY be the same, but more often than not, they are different.
This is a good time to discuss how much financing is available to you. There is a popular misconception that you need to put down 20%...not true. While these loans will require an additional cost, there are options we use every day:
o Eligible Veterans can get 100% financing.
o The FHA allows as little as 3.5% down (and not just for first time buyers).
o Conventionally today, you can go with as little as 3% down (with some restrictions we can discuss) or 5% down with less restrictions.
• Closing Costs are monies you need to spend to buy a home. Some are tied strictly to the purchase (title insurance, recording the deed, your attorney, etc., and maybe an appraisal, home inspection, termite report, land survey, Peconic Bay and/or Mansion Tax- if the price is over a certain amount or location, and alike). And some additional charges occur when you add a mortgage to the equation (mortgage tax, more title insurance, recording the mortgage, lender fees, possibly discount points, and definitely an appraisal). Feel free to contact me to get a breakdown of specific expenses based on your sales price, loan choice, and so on. As a rough guideline, I tell people to estimate the total of Closing Costs AND Pre-Paids to be about 4.5% of the Purchase Price.
• Pre-Paids kick in when you take a mortgage and consist of two main items….short interest and escrows.
o Short interest is something you will pay at closing. Because lenders set up mortgage payments to be due on the first of the month and people close every day of the month (not just the first day), you have short interest. Understand that you lender cannot charge you interest until after you receive the money. As an example, your January mortgage payment pays the lender interest that covers December. To set everyone up for payments on the first, you will be asked to pay the daily interest from the day you close until the end of the month. In that way, your first regular monthly payment is due in the following month. Close November 17, pay 13 days short interest at closing and your first full mortgage payment is in January, ”skipping” a December payment.
o Escrows are collected by your lender for two things- insurance and real estate taxes- and they collect them in advance.
On the insurance front (homeowner’s insurance and possibly flood insurance), you will be required to pay the first year of premium at or before closing (hence a pre-paid item) and the lender will collect 2-3 month’s towards next year’s premium at closing because, in our prior example, a November closing means your first payment is in January and 12 months of payments will need to be paid in November of next year, and you will only make 10 mortgage payments by then.
Real Estate taxes do vary based on where you buy and when the taxes are due. But overall, taxes at closing can go to three different parties at the closing table- the seller (to reimburse them for taxes already paid), the title company (for taxes currently due) and/or the lender (for future tax bills). Many lenders under-represent how much you will need when they give you a Good Faith Estimate for closing costs. The truth is- if you are buying on Long Island count on needing eight months’ worth of the real estate taxes (and four months’ worth in the boroughs of NYC).
• Reserves are a calculation of monies left in your bank account AFTER closing. Not all, but some, loan programs require reserves of varying amounts, but having reserves (as a cushion) always makes an underwriter feel more comfortable. Reserves are usually calculated by looking at liquid cash accounts (like checking, savings, money market accounts and alike); however, often lenders will count IRA/Retirement accounts at 60% of their value, as they take into consideration the tax consequences of accessing those funds.
Now that, we have given you a feel for what your cash will be needed for, let’s venture into some of the tactics and strategies you can use to lessen your outlay of cash…(of course, the best strategy is to call me, so we can discuss YOUR individual options). Your choice of Mortgage Loan Program is where we begin because different programs have different guidelines for different strategies. We have already explained that different programs can impact your down payment requirement, but they can also help/hurt in other ways.
• Gift monies- Maybe you haven’t saved much (or anything), but your income and credit are solid. Maybe you have a parent (or other family member) who has some savings and they want to help you get into a home. That is great, but, depending on the amount of gift and the amount you are investing, you may have some program challenges. Now, allFHA and Conventional loans for a one-family home allow gift monies for down payment, closing costs, pre-paids and reserves (which are required when you buy a 3-4 family home). On conventional loans, for 2-4 family homes there is a minimum investment by the buyer of 5% of their own money.
(Before giving or receiving gift monies, you should understand that there may be income tax consequences and ways to minimize/avoid them. We can discuss them, and you should consult an accountant, as well.)
• Sellers’ Contributions- One of the best ways to pay for everything (other than the down payment) is to have the seller pick up the tab. Understand that most sellers are primarily concerned with the amount of dollars they leave the closing table with; and while the sales price is a major component of that, it is the “net” dollars, not the “gross” sales price that truly matters. In that spirit, many buyers today make their offer to sellers at a higher number with the contingency that the seller pays the closing costs and pre-paids. The trick is making the seller happy with their “net” number because the rest of it has no real effect on them. The only concern is that the house must appraise at that sales price, but usually your real estate agent can get you into the right deal.
FHA loans allow sellers to contribute up to 6% of the sales price in this manner. Conventional loans also allow 6% when you put down at least 10%, and a 3% concession for less than 10%. Often people who have planned for 5% down and 5% for closing costs are better served with 10% down and seller’s concession because of lower PMI rates, etc. We can examine your unique situation.
• Lender’s Contributions- Another possibility is having your lender pay some of your closings costs. This is done by closing with a higher interest rate. Simply, the higher rate you pay, the more the lender makes. We can take that additional income and choose to spend it on your behalf. As a rule of thumb today, bumping your interest rate .25% can give you 1% of the loan amount to use towards your closing costs. As an example, on a $300,000 loan at .25% higher rate will bump your payment about $45, and give you $3000 to spend at closing. For many people, it is easier to come up with $45 a month than save $3000.
There are other “tricks of the trade” and differing combinations we can discuss, when we sit down. Meanwhile, I hope this helps.
Written by
Lisa Zambelli
