How Much Money Do You Need Upfront to Buy a House?
According to a study published on January 22, 2020, rent in Orlando increased 39% from 2010 to 2019. Year-over-year rent prices are also exploding in other Florida cities. If you’re ready to break the cycle of paying more and more every year to an unresponsive landlord, you need to own your own home. Here’s a look at how much money you may need upfront to buy a house, including the down payment on a home you may need.
How Much Money Do You Need Upfront to Buy a House?
How much money you need upfront to buy a house depends on many factors, including the price of the home you’re buying, the location of the home you’re buying, and the type of mortgage you’re taking out if you’re not paying cash.
As a general rule of thumb, you will need to save up a down payment on a home plus roughly 2% to 5% of the purchase price. Also, depending on your lender, there may be other cash requirements. In other words, you should have the cash to cover 2% to 25% of the home’s purchase price. Let’s take a closer look at the factors affecting how much money you need upfront to buy a house.
Down Payment on a Home
Depending on the type of mortgage you’re getting, your down payment may be up to 20% of the purchase price of the home. It is often recommended that homebuyers put a 20% down payment on a home because private mortgage insurance (PMI) must be paid if they don’t. The cost of this insurance depends on the base loan amount, the mortgage term, and how much of a down payment was put down.
It typically ranges from $30 to $70 monthly for every $100,000 borrowed. The duration of PMI also varies. Sometimes, PMI must be paid for 11 years. In other cases, PMI must be paid for the entire mortgage term. Some lenders may automatically drop your PMI charges when you have paid off 78% of the loan. Other lenders require a formal letter when your LTV drops to 80%. Make sure you understand completely how your lender handles PMI.
FHA loans are incredibly popular because they only require a down payment of 3.5%. To qualify for an FHA loan with a 3.5% down payment, you need to have a FICO score of at least 580. You must put down a 10% down payment if your credit score is lower than 580. However, recently, more lenders are requiring a minimum credit score of 620 to 640. Here are some other FHA loan requirements:
- You are purchasing a primary residence
- You have documented, steady employment and income history
- Your home has not been foreclosed on in the last 36 months
- You have a debt-to-income ratio no greater than 50%
If you want to take out an FHA loan and don’t want to pay PMI, you only need to put down 10% of the home’s purchase price. If you don’t put down at least 10% of the home value, and you want to stop paying PMI, you can refinance your home. Your lender will charge you fees to originate the loan, but this may make the most financial sense if you have a much higher credit score or your LTV decreases significantly.
VA loans are also incredibly popular because you can get a VA loan without putting any money down if you present a Certificate of Eligibility (COE) to your lender. This COE shows your lender that your service history and duty status qualify you for a VA direct or VA-backed home loan.
However, you may have a debt-to-income ratio no greater than 41% to qualify for this type of loan. Also, while the VA does not require a minimum credit score, your lender might.
If you don’t qualify for a VA loan, you may benefit from taking out a USDA loan. This loan program allows zero-down financing and locks you into a fixed interest rate. People often make the mistake of taking out a variable-rate loan and end up with an interest rate so high they can’t afford the monthly payments. The USDA also does not require a balloon principal payment, and there are no prepayment penalties for rural USDA loans.
What many people don’t know about USDA loans is suburban home purchases can also be made with a USDA loan. You may think the area you want to purchase your home in won’t qualify, but 97% of the country qualifies as rural or suburban. Check the USDA’s eligibility map, and you may be surprised that the area you’re thinking about qualifies. Besides location, here are some other loan requirements:
- Salary no greater than 115% of the median local salary
- Minimum credit score of 640
- Upfront mortgage insurance of 1%
- Annual 0.35% fee paid monthly
- Escrow including annual homeowners insurance
- Escrow including annual real property taxes
- Closing costs (may be gifted by friends or family members)
- Primary residence purchase
Typically, closing costs range from 2% to 5% of the purchase price of the home. Among the closing costs you may have to pay are an origination fee, application fee, underwriting fee, and processing fee. These are all costs that may be paid to the mortgage lender. However, third-party fees may also be necessary. For instance, you may be required to pay for:
- The county recording fee
- An appraisal
- Escrow fees
- Title fees
- Title insurance
- A credit report
You may also choose to have a lawyer present when you close on your home, and the municipality of the residence may charge a fee. If you’re worried about out-of-pocket costs, ask the seller if he or she will pay for the appraisal. You can also speak to your lender about alternative loan options or a lender credit to reduce your out-of-pocket costs.
You should be prepared for your lender to collect between four and six months of property taxes upfront. In some cases, a full year of real property tax and homeowner’s insurance is required. On average, counties in Florida have a 0.98% real property tax rate. If you’re purchasing a $300,000 property, and you need to pay half of the annual property tax upfront, you should have $1,470 set aside assuming a 0.98% real property tax rate.
Be advised, you can view the property tax bill for the home you would like to purchase by searching by address on the county’s Treasury website. When you’re shopping around for lenders, make sure you ask how much of the real property tax must be paid upfront.
You also need earnest money to purchase a home. Earnest money is proof that you are truly interested in purchasing the home. If the seller accepts your offer and you sign the contract, the earnest money will be sent from the escrow account to the seller. A certified real estate agent can advise you on how much earnest money you need based on the current market.
In some cases, only a couple hundred dollars will be required. However, in hot markets, you may need earnest money that is closer to 1.5% of the home’s purchase price. In other words, if you are purchasing a $300,000 home, you may need around $4,500 sitting in an escrow account that will be applied to your down payment if the sale goes through. Also, your real estate agent can help you negotiate a lower earnest money deposit.
To qualify for a mortgage, you need to have cash reserves in investment or savings accounts. This money must be separate from the other costs of home buying, such as closing costs and a down payment. Lender requirements vary, but you should expect to need up to six months’ worth of mortgage payments. If your mortgage will be backed by Fannie Mae or Freddie Mac, you will need at least two months of cash reserves.
For instance, if you must pay $1,800 per month for your property taxes, PMI, HOA dues, homeowners insurance, loan principal, and loan interest, you should have $3,600 to $10,800 in cash reserves. Note, neither the FHA nor the VA require cash reserves, and the cash reserve requirement may be waived if your FICO credit score is at least 740.
Before you make an offer on a home, you should get an independent home inspection. An appraisal only determines the value of a home. It does not guarantee there are no structural or safety issues that the current homeowner must resolve before you make an offer.
Homeownership is not impossible. If you have a credit score of at least 580, you may qualify for an FHA loan. You can get the keys to your home with only 5.5% to 8.5% of the home price saved up. If you’re ready to start looking for your first home, contact David Dorman, a real estate agent certified to sell homes in over three dozen Florida cities.