How Much Money Do I Need To Buy?
The desire to purchase a home is fueled by the “American Dream”. With any dream or goal, items need to be prepared in order to accomplish the dream or goal. One of the necessary preparations in buying a house is having a professional explain the process: real estate agents. The second preparation necessary for buying a house is to be in the correct financial standing. Financial standing, in regard to purchasing a house, is a combination of the credit score, debt-to-income ratio, and money saved up. In this article, I will discuss the different types of loans and the down payments for them, define what the debt-to-income ratio is and how it affects the buyer, explaining closing costs, and credit score.
Disclaimer: I am not a licensed mortgage lender or a credit repair specialist. For specific information about mortgage types and credit scores, talk with a licensed mortgage lender. The money down and loan types are for owner-occupied housing, not investment opportunities. Not all loan types mentioned below nor the minimum down payments apply to second homes (beach house or cabin) or investment opportunities.
Before purchasing a home, a mortgage lender will need to verify if it will be your first time purchasing a home or not. The reason is, not all loan types are available to second-time home buyers. There are 3 types of loans that both first-time or second-time home buyers loans can use if they fit the criteria: Federal Housing Administration (FHA), Conventional, and Veteran Affairs (VA).
The FHA loan is a government loan that used to apply only to first-time home buyers but now is acceptable for other home buyers. The minimum down payment required for an FHA loan is a 3.5% down payment. The loan’s minimum credit score can change as time goes on. For example, due to COVID-19, the minimum requirements for all loan types went up. Normally, the minimum requirement for FHA is now a 580 credit score. There are exceptions where you could have a lower credit score and be required to have a higher down payment or pay a certain percentage of mortgage points. Mortgage points, also known as discount points, are fees paid directly to the lender in exchange for a reduced interest rate.
The second common loan type for any buyer is the conventional loan type. A conventional loan is a private loan that is not backed by a government-sponsored entity, such as Fannie Mae or Freddie Mac. Private loans do not have the same requirements as government-backed loans, which is why sellers are more accepting of conventional loans. The requirements relate to the property’s condition. Although conventional has loose requirements for property’s overall condition, they have strict credit score requirements. Conventional loans require a minimum of 620 credit scores. For first-time home buyers, you can receive a down payment as low as 3%. The down payment requirement increases if it is not the first time purchasing a house.
The third common loan type is the Veterans Affairs (VA). The loan is common in the sense that it is acceptable for first or second-time home buyers. However, it is not common to everyone because it is only acceptable for men and women who have served in the military and their families. There is a previous article where I talk specifically about VA loans. If one meets the requirements, a home purchaser can buy a house with a 0% down payment and no Private Mortgage Insurance (PMI). PMI is insurance for the lender when the down payment of the loan is under 20%.
Not all loans apply to every situation, there are loans out there that apply to a specific buyer. The primary loan type specific to first-time home buyers is called the United States Department of Agricultural loan (USDA). The USDA loan is a governmental loan used to benefit the suburbs. Those who apply for a USDA loan have to verify the loan is acceptable based on the location of the house they are trying to purchase. The remarkable attribute the USDA has is first-time home buyers can buy a house with 0% for a down payment! There is also a maximum income for USDA, if you make too much income for that year, you cannot use this loan type. Unlike other governmental loan types, the USDA requires a minimum of a 640 credit score.
Debt-to-income ratio is the standard calculation financial institutions use to calculate what a person can afford, in order to purchase a home. The debts are necessary payments that occur each month divided by the income per month. The standard maximum debt-to-income for Conventional loans is 47%, FHA is 52%, and 41% for USDA loans. If the buyer gets an increase in pay, promotion, or other long-term pay increases, that will decrease the ratio. Likewise, if there is a new or increase in debt, purchasing a car using a loan, will increase the ratio. That is why it is not advisable to make any large purchases while searching for a home and being under contract, for it can alter the ratio or the credit score. Professionals in the field highly recommend speaking with a credit repair specialist or financial planner to see how one can decrease the debt-to-income ratio by decreasing the total debts per month.
The down payment for a loan is only a portion of the money needed for settlement. The remaining costs are referred to as closing costs. Closing costs are a compilation of different fees and taxes. With every transaction of real estate ownership, there is a transfer tax charged to both the seller and buyer evenly. The transfer tax is usually 2% of the purchase price. However, the transfer tax can increase depending on the location. There are also lender fees, insurance coverage fees, and property taxes. Property taxes are taxes an owner has to pay each year. The taxes are a compilation of school tax, state tax, and city tax. Property taxes vary per house and are an important factor in finding the right house. The property taxes will only increase over time.
In the instance where a homebuyer’s down payment amount is less than 20% or a refinance of the homeowner’s equity is less than 20%, a lender will mandate the buyer to escrow funds that the lender will have in their jurisdiction. The lender-controlled escrow is used to pay homeowner’s insurance premiums and real estate taxes. The escrow is created at the settlement table and the amount of money is calculated, in advance, by the lender and title company. Money needed in the escrow shall be more than enough to cover the real estate taxes on the home. The escrow account will also include your first month’s principal and interest payments. After purchasing the home, the buyer will have one month where they are not required to pay the lender, due to the escrow fund. The reason behind having an escrow account that is controlled by the lender is that home insurance premiums and real estate taxes have to be paid or else a tax lien is created. Liens are another form of debt. Liens have different hierarchies and a tax lien is above a mortgage lien. In matters of foreclosures, lenders want to recoup as much money as possible and be the first ones to collect. If there is a tax lien, they will not collect their funds first. Lenders want to eliminate that risk, which is why escrow is a necessity.
Two types of insurance are another larger portion of closing costs when purchasing a home: title insurance and home insurance. Both insurances are required from the lender before settling on a new home. Title insurance will search for any claims that could hinder the transfer of ownership from the sellers to the buyer. The title company will search for any possible liens, ownership issues, etc. This applies to both the property and the owners and buyers. Home insurance protects the home from different events that can cause damage or destruction of the home.
The total of the down payment of the loan plus closing costs equals the amount needed to buy a home. To gauge the amount of money needed for purchasing, estimate between 8-11% of the purchase price. The 8-11% of the purchase property is a combination of a 3% down payment and a standard 5-8% closing cost. If someone was purchasing a $200,000 home, estimate between $16,000-$22,000. Remember to consult with a mortgage lender, in order to determine the maximum budget required for purchasing a home.
Disclaimer: The percentages and estimates for purchasing a house are slightly above experts because I personally believe that it is better to be over-prepared than under-prepared. Estimates have to be used to determine the cash needed due to the number of variables each house possesses. These variables include the down payment being more or less than 3%, higher or lower than normal property taxes, and increased transfer taxes due to the location of the home. A buyer could also ask for sellers’ assistance, decreasing the cash needed to purchase a home.
Additional Expense: One thing that has not been discussed so far, speaking on needed finances for purchasing, is inspection costs. Inspections are not a requirement for buyers to choose and or pay. However, some loan types may require the buyer to schedule and pay for a certain inspection. Buyers have the responsibility to choose which inspections to perform before going under contract for a home. The number of inspections and the type of inspections vary, impacting the total estimate of the cost. It’s recommended to save anywhere from $500 to $5,000 for inspection costs.