Home buyers are often taken back when they find out they may need additional cash to cover their closing costs after they’ve already put up a significant amount of money for their down payment on a home. Your down payment and closing costs are completely different. Being aware of how much money you’ll need to cover both is critical for qualifying for specific loan programs and closing the deal on your home purchase.
In this blog, we’ll break down:
- Down payment basics.
- How much money you’ll need for a down payment (and where to find help).
- Closing costs and cash-to-close basics.
- Examples of closing costs.
- Who has to pay for closing costs.
What’s a home down payment and how much money do I need?
The down payment is a portion of the home price you pay upfront. The remainder of the home payment is funded by your mortgage/home loan.
Your down payment is the initial investment on your home. The more you invest early, the lower your interest rate will be, which lowers your monthly mortgage payment. If you make a lower down payment, you pay a higher interest rate. If you put less than 20% down of the home’s value, you’ll also need to purchase private mortgage insurance. Both these factors increase your monthly mortgage payment. Keep in mind, you can get rid of mortgage insurance down the road. The down payment is the borrower’s skin in the game. This is your portion of the risk on the loan.
Depending on what loan program you qualify for, the required down payment will vary. Some loans can require 0% (USDA and VA), while others might require 3%, 3.5%, 5%, and 10% (FHA and Conventional). A 20% down payment is not a requirement. However, most loans will require at least a 3.5% down payment.
If you need help with the down payment, some loan programs offer the option of using a gift from a relative. In addition, there are state-wide and city-specific down payment assistance programs you may qualify for - such as Chicago’s Home Buyer Assistance Program.
What’s included in closing costs?
Closing costs are the payments needed for services that are required for processing your home loan. The money brought to the closing table to pay for these services is often referred to as “cash-to-close.” These include prepaid and non-prepaid charges and are not part of the down payment. Closing costs are completely separate, regardless of your down payment amount.
The list of possible closing costs will vary depending on your mortgage lender. Some of the services you can shop for yourself, which includes attorney fees, pest inspections, and architectural/engineering fees. Other common fees that are required to be paid include title insurance fees and wire transfer fee. You can view a full list of possible closing cost service here.
In addition, the chart below breaks down the possible closing costs on a loan. This sample shows cash-to-close for a USDA Loan purchase. The “Description” column represent the itemized closing costs. These are general descriptions and should help provide a sense of the types of items included in closing costs, both prepaid and non-prepaid charges.
Lines B through E are the non-prepaid expenses. These include true costs that a borrower is paying to get the loan - credit report, appraisal, etc.
Lines F through G are prepaids. These represent the homeowner’s insurance, property taxes, and reserves being established by the lender for future insurance and tax payments that will be held in escrow to pay those bills when they are due.
In this example, the loan is a no down payment mortgage, but the borrower needs $3,917.98 to close.
Who pays the closing costs?
Closing costs are the responsibility of the home buyer. However, there are occasions where the seller may pay for a portion or all of the closing costs. This would be part of the original purchase agreement negotiations. If you would like to explore this route, ask your mortgage lender for the estimated closing costs so you know what to ask the seller to pay if that is going to be part of your buying strategy. The seller of the home could provide you with a seller credit to minimize the closing costs. The maximum seller credit is 6% of the purchase price of the home.
In addition, you could use a lender credit to offset some of the closing costs. In return, this will leave you with a slightly higher interest rate.
Remember -being aware of the amount of money you need early in the process is very important.
You never want big surprises as you go through the home buying process. One of the easiest ways you can prepare yourself for the possible costs is by using our free mortgage calculator. By searching live rates and fees, you can run different examples of down payment amounts and home prices to see how much money you’ll need on hand and what kind of home you can afford.
If you’re still early in your home buying journey, make sure to download our free First-time Home Buyer’s Guide. You’ll learn insider advice and how to walk-through the purchase of a home step-by-step.