In the U.S., affordable prices, low mortgage rates and an abundance of first-time homebuyer programs make it relatively easy to go from a renter to a homeowner. However, homeownership isn’t only about down payments and mortgages; it’s an ongoing commitment you should enter into with both eyes open.
Here’s what you need to know:
Costs to Expect When Buying
Many newbies focus on saving a down payment and fail to consider other costs. Down payments, typically 0 to 3 percent for first-time buyers, are just the beginning. There are mortgage origination charges, fees for appraisals, government paperwork, title and escrow services, credit reports and more.
According to The Wall Street Journal, closing costs for a $200,000 mortgage run between $2,400 and $3,000, depending on the state in which you buy and assuming you have excellent credit and put 20 percent down. Expect these costs to be higher with smaller down payments or less-than-great credit.
In addition, all government-backed mortgages require up-front funding fees or mortgage insurance premiums, ranging from .5 to 3.3 percent of your loan amount. Fortunately, these fees can be wrapped into your mortgage, so you needn’t pay them upfront.
Along with mortgage expenses and transfer fees, you’ll pay property taxes and homeowners insurance premiums. These charges are called prepays, impounds or escrows. They’re all costs homeowners pay, but when you have a mortgage, you often pay them in advance into an impound account. Then, your lender distributes payments to your insurer and your county treasurer, because lenders want to protect their interest in the property, keeping its insurance premiums and property taxes current.
How to Save on Closing Costs
You may be able to reduce buying costs by qualifying for down payment assistance programs (look for assistance in your state on the Housing and Urban Development website), applying for MyCommunityMortgage or Home Possible 97 percent home loans, or qualifying for 100 percent Veterans Affairs (VA) home loans or Rural Development mortgages.
Many mortgage lenders will pay your lender fees and other charges if you’re willing to accept a higher mortgage rate, and sellers are allowed to pay between 2 and 6 percent of the loan amount toward your closing costs.
As a renter, you pay a monthly lease and utilities, but as an owner, you’ll be responsible for repairs, maintenance, homeowner association (HOA) dues, property taxes, insurance, trash collection, yard work, snow removal and more. When you shop for a home, consider the following costs of owning a property, and don’t leave anything out of your decision-making process.
- Utilities. The VA has a formula for estimating monthly maintenance and utilities: simply multiply the square footage of your home by 14 cents. This should only be utilized as a basic estimation tool; actual costs depend on local utility rates, the home’s construction and regional temperatures. For a better idea, ask the seller for copies of energy bills as part of your negotiation, or pay for a Home Energy Rating System (HERS) audit (costs around $100 at the low end and $373 on average, according to HomeAdvisor) before completing your purchase.
- Homeowners association dues. If you buy a condo, whether it’s a co-op or a planned development, you’ll pay HOA dues. These dues may cover all your home maintenance and insurance requirements, or very limited services, such as the maintenance of a common road. Find out what’s covered before you buy, and adjust your budget accordingly.
- Property taxes. These will likely be included in your monthly mortgage payment if you put less than 20 percent down on your purchase. The annual amount will be divided by 12.
- Homeowners insurance. Insurance may be included in your HOA dues if you buy a condo or co-op unit. In this case, you may want to insure your personal property within the home, because it won’t be covered by your HOA.
- Maintenance. This category includes yard maintenance, snow removal, driveway paving, septic inspection, gutter cleaning, pool maintenance and other outdoor tasks. Again, these tasks may be taken care of by your HOA if you buy a condo or co-op. Otherwise, add them to your budget.
- Upgrades and improvements. Don’t forget, most appliances and systems in your home will eventually wear out, break down or become obsolete. Personal finance experts recommend setting aside 1 to 4 percent of your home’s value for annual repairs and maintenance, depending on your property value, condition and location.
You can insure against some home repair nightmares by purchasing a home warranty from a reputable company. It costs several hundred dollars per year, but if an expensive appliance or system breaks, the insurer picks up most of the cost, and your fee is usually around $50 per repair. It makes budgeting easier.
Practicing for Homeownership
Not sure if you’re ready to become a homeowner? Here’s a good way to find out: Work through the list of costs for an entry-level home in your area, including mortgage principal, interest, taxes, mortgage insurance, homeowners insurance, HOA dues and estimated utilities, maintenance, and repairs. Next, subtract your current rent, utilities and renters insurance from this calculated amount. The difference is the added costs of owning a home. For a little added help managing income and expenses, consider using a money management or budgeting app.
Depositing this amount into a savings account every month accomplishes several things. First, you’ll learn if the added expense is something you can handle. Second, you’ll have more money for your down payment. Third, you’ll prove to mortgage lenders you’re responsible with money.
Homeownership is too important to go in blindly. By giving it a practice run, you’ll increase your chance of success and learn a lot about yourself at the same time.