Buying a home is probably the biggest purchase you'll ever make, and you need to be prepared for any hidden costs that you may encounter in the process.
If you're ready to buy a home, you've probably used an online calculator to figure out a monthly mortgage payment you can afford and you've likely got a down payment ready. Based on this, it might seem like you're informed and ready to make an offer on the home of your dreams, but there are actually a lot of hidden fees that are going to pop up during the process. And unless you're prepared, they can really hit you hard in the wallet.
Read on to learn what the home buying process looks like so you're fully prepared to cover all the costs involved.
What is Earnest Money?
The first cost you might not anticipate is something called earnest money. Earnest money is a small down payment—not your full down payment—to make it clear that you're serious about an offer you make on a home. You have to have this money ready when you sign the contract, whereas your down payment isn't actually due until closing.
The money is held in escrow until the deal closes and it's then subtracted from your total purchase price. But if the deal falls through because you can't deliver, you'll forfeit that payment. Plan on $500 to $1,000.
What are Standard Closing Costs?
Closing costs include a large group of expenses related to the approval of the mortgage and various steps to make sure the property meets all the requirements.
Scott Royal Smith of Royal Legal Solutions in Austin, Texas, says, "Typically, the closing cost of a property is around 3% for the real estate agent and then another two to three percentage points to close on the property. By the time you pay for all the associated fees, you are likely to pay around an additional 6% of the purchase price, in addition to the purchase price of the property."
Smith recommends that buyers "go through each of those line items and ask questions to see that they are absolutely required. Follow that with asking if necessary costs can be negotiated down. Even if it means doing that at the closing table and causing a delay. You could save as much as a couple thousand bucks by doing that."
What Fees are Included in Closing Costs?
Closing costs include a number of fees. These are considered routine costs, but you should be aware of them. Here's an overview:
- Notary fees: A notary verifies that the person signing a document is the person they say they are. Often your bank's representative is a notary and fees for this service will be added onto your closing.
- Mortgage origination fees: This is a fee the mortgage lender charges you for the processing of your loan application. It's usually billed as a percentage (between half a percent and one percent of your mortgage amount).
- Underwriting: The lender will charge you a fee for their work in researching whether you qualify for the loan.
- Credit report: The lender will run a credit report on you and you'll pay for it.
- Property surveys: A survey is done to provide an accurate drawing of the property boundaries. This can cost around $500, but might not be needed if there is a current survey available.
- Title search: County records are searched to make sure the seller owns the title to the property free and clear.
- Title insurance: The lender may require you to buy title insurance so that if there is a problem with the title, they are reimbursed.
- County recording fees: The sale must be recorded in the county office and there are filing fees to do so.
- Home inspection fees: Inspecting the home to make sure it is safe and in good condition is important so you don't walk into a money pit, but you'll need to pay the inspector to do it. Smith says "The bare minimum on home inspection fees is the inspection the bank is going to require. You'll want to find your own home inspection person that will be able to actually advise you more in-depth on things like structural integrity, the foundation, etc."
- Mortgage point purchases: As if buying a home weren't complicated enough, you can choose to buy points up front from your lender, which in turn gets you a lower interest rate. You need to do the math to see if the cost of the points will be offset by what you will save in interest over the life of the loan. Smith says, "I don't recommend buying points because it's uncommon for people to actually keep a mortgage and pay it all the way through (for 30 years)."
- Prepaid interest: Even though you'll be making mortgage payments, the bank might require you to pay the interest due for that month at closing.
What is Private Mortgage Insurance?
In addition to standard closing costs, there are more expenses you might encounter at or near closing. If you purchase a home with a down payment that is less than 20% of the purchase price, you may be able to get a mortgage, but a hidden cost is that the bank will then require you to obtain private mortgage insurance (PMI). It's an additional amount that gets tacked onto your monthly payment and can end up totaling thousands of dollars each year.
Eric N Klein of Klein Law Group in Boca Raton, Florida, explains, "PMI is available to people that have little to no money to put down towards the purchase of real estate. Many conventional lenders require a loan to value ratio of 80/20. The buyer will have to pay 20% of the purchase price and the lender will finance 80%. However, there are lenders that will lend up to 100% of the purchase price if the buyer were to purchase PMI, which would ensure the 20% down payment that the bank is looking for."
Smith warns, "Even though you have to pay it, it doesn't protect you at all. It protects the bank in case something goes wrong with the repayment of the loan." Once you have paid enough on the mortgage to own 20 percent of the home, the insurance will be dropped, but you'll spend a lot to get there and it's money that doesn't add to your equity.
How are Homeowner's Taxes Paid?
When you buy a home, there will be homeowner's taxes and insurance due on the property. The lender may require you to pay these amounts to them at a prorated amount each month, which they will place in escrow and pay the bills when they are due.
This will not only make your monthly mortgage payment higher than you planned, but the bank may require you to prepay the first year's fees up front into escrow at closing, so there are enough funds to cover the bills when they come due.
What is a Property Reassessment Tax?
While you will know the property tax currently assessed to your home at the time of purchase and can plan for property taxes based on that, what you might not expect is for this amount to go up and to receive a bill for the difference.
Your property may be reassessed once it's purchased (and this is common if the purchase price is higher than the assessed value). You could receive a bill from the taxing agency for the difference in taxes based on the newly assessed value before your yearly tax bill is even due.
What are Homeowner's Association Fees?
A homeowner's association creates rules and helps manage your community, whether it's a gated neighborhood or a condo building. They maintain common areas and create and enforce rules. All of that costs money of course, so the residents pay homeowner's association dues. Those prorated fees are due at closing, so it's another cost that could get tacked on that you're not expecting. Smith warns, "Prorated homeowner fees are something you always want to watch out for."
Planning ahead for closing costs and hidden fees will help your home purchase go smoothly and help you make sure you've got some money left to buy paint and a few pieces of new furniture.