Let’s Talk Money
In this post, we’ll talk through three important financial aspects of a real estate transaction: mortgage pre-approval; mortgage loan types; and other costs associated with a home purchase.
One of the first - and most significant - determinations you will make when searching for a new home involves finances. How much house you can afford is largely dependent on how large of a mortgage you can handle.
After consulting simple mortgage calculators (like the one on this website) to gauge the affordability of the homes you’re envisioning, it’s also wise to obtain mortgage pre-approval with a lender before you begin your home search. Having a pre-approval letter in-hand when making a home offer can give you a step up on other potential buyers!
One important caution to keep in mind: mortgage pre-approval is different from mortgage pre-qualification, with pre-approval being the over-and-above preferred method. While pre-qualification tells you as a buyer how much you can afford to pay for a home, pre-approval involves actually applying for a mortgage and receiving a commitment in writing from a lender. By obtaining pre-approval, you’re placing yourself at an advantage; assuming the home you're interested in is at or under the amount you are pre-qualified for, the seller knows immediately that you are a serious buyer for that property. Costs for pre-approval are generally nominal, and lenders will usually permit you to pay them when you close your loan.
Mortgage Loan Types and Terms
There are a variety of mortgage types available today, each with advantages and disadvantages depending on how long you plan to live in the home, the financial marketplace, and your income potential, among other things. Typical mortgage terms range from 15 to 30 years.
Fixed-Rate Mortgage. A fixed-rate mortgage is the most common. In a fixed-rate mortgage, your interest rate and payment stay the same for the life of the loan.
Adjustable Rate Mortgage. An adjustable-rate mortgage usually starts out at lower interest rates and lower monthly payments than fixed-rate mortgages, but your rate and monthly payments may rise and fall based on a financial index.
FHA Mortgage. There are also several government mortgage programs available, including FHA mortgages, which are designed to help people who might not otherwise qualify for a loan.
Other Costs Associated with a Home Purchase
After determining the kind of home that you can afford, it’s important to realize that owning a home involves more than a monthly mortgage. You’ll also have to consider money you’ll need to have at hand when you make an offer, when you close on a home, and on a monthly basis after the home is yours.
Payments you may have to make when you submit an offer and at closing include:
Earnest Money. Usually 1% to 5% of the cost of the house, which you pay as a deposit on the house when you submit your offer. It is your proof that you are a serious buyer.
Down Payment. Usually 10% to 20% of the cost of the house, which you must pay at closing.
Mortgage Insurance. Paid by borrowers making a down payment of less than 20%.
Closing Costs. Usually 3% to 4% of the cost of the house, which pays for processing all the paperwork.
As a buyer attending the closing for your new home, you will present a sizable check for the down payment and various closing costs. While buyers can and do often present an offer that negotiates for sellers to pay these fees at closing, as a responsible buyer, you should be familiar with these costs that are both mortgage-related and government-imposed, regardless of whether you’ve negotiated them to be paid by the seller.
Although many of the fees may vary by locality, here are some common fees:
Appraisal Fee. This fee pays for the appraisal of the property. You may already have paid this fee at the beginning of your loan application process.
Credit Report Fee. This fee covers the cost of the credit report requested by the lender. This too may already have been paid when you applied for your loan.
Homeowner’s Insurance. A paid homeowners insurance policy is required at closing.
Loan Origination Fee. This fee covers the lender's loan-processing costs. The fee is typically one percent of the total mortgage.
Loan Discount. You will pay this one-time charge if you have chosen to pay points to lower your interest rate. Each point you purchase equals one percent of the total loan.
Title Insurance Fees. These fees generally include costs for the title search, title examination, title insurance, document preparation, and other miscellaneous title fees.
PMI Premium. If you buy a home with a low down payment, a lender usually requires that you pay a fee for mortgage insurance. This fee protects the lender against loss due to foreclosure. Once a new owner has 20 percent equity in their home, however, he or she can normally apply to eliminate this insurance.
Prepaid Interest Fee. This fee covers the interest payment from the date you purchase the home to the date of your first mortgage payment. Generally, if you buy a home early in the month, the prepaid interest fee will be substantially higher than if you buy it towards the end of the month.
Escrow Accounts. In locations where escrow accounts are common, a mortgage lender will usually start an account that holds funds for future annual property taxes and home insurance. At least one year’s advance, plus two months worth of homeowner's insurance premium will be collected. In addition, taxes equal approximately to two months in excess of the number of months that have elapsed in the year are paid at closing. (If six months have passed, eight months of taxes will be collected.)
Recording Fees and Transfer Taxes. This expense is charged by most states for recording the purchase documents and transferring ownership of the property.