Step 2: Determining Your Home Buying Budget

Closing Costs and the Full Price of Home Buying

As a renter, you know that your monthly rent payment is just part of your expenses. Along with rent, you might pay for utilities, parking, valet trash, etc., each month while renting. Buying a home is similar: the sale price of a home is only part of the buying cost. Along with a down payment, there are always closing costs in a home sale.

Closing costs is an umbrella term for a wide variety of fees and payments paid out to every professional involved in the sale. The different fees involved in a home sale can vary widely from state to state. Below is a list of the most common closing costs:

Fees to the Lender

  • Application Fee: The cost for the lender to process your application, including a credit check for your credit score or appraisal.
  • Escrow Deposit: A deposit for your escrow account.
  • Homeowners’ Insurance: Covers possible damages to your home and varies by property type and location. The first year of insurance is often paid at closing.
  • Lender’s Policy Title Insurance: This assures the lender that you own the home and the lender’s mortgage is valid. It also protects the lender from potential problems with the title.
  • Mortgage Discount Points: This prepaid interest payment goes directly to the lender in exchange for a reduced interest rate. One point equals one percent of your loan amount.
  • Origination Fee: Covers the lender’s administrative costs and is often 1% of the total loan.
  • Prepaid Interest: Many lenders will ask you to prepay any interest that will accrue between closing and the date of your first mortgage payment.
  • Private Mortgage Insurance (PMI): If your down payment is less than 20% of the home’s purchase price, you will likely be required to pay PMI.
  • Property Tax: Lenders will want any taxes within 60 days of the purchase.
  • Underwriting Fee: This covers overhead and administrative costs for the lender.

Fees to other professionals

  • Appraisal: Covers the cost of the appraisal company to confirm the fair market value of the home.
  • Closing Fee: This is compensation for the title or escrow company overseeing the closing as an independent party in your home purchase.
  • Home Inspection: The home inspection will verify the condition of a property and recommend any necessary home repairs.
  • Recording Fees: A fee charged by your city or county recording office to keep the public land records up to date.
  • Title Company Search Fee: This fee is paid to the title company for doing a search of the property’s records and ensures that no one else has a claim to the property.
  • Transfer Taxes: This tax is paid when the title passes from seller to buyer.

Assess Your Financial Resources

Now that you have a general knowledge of common closing costs, you can determine how much home you can purchase by reviewing your finances. Assessing your finances includes:

  • Calculating monthly housing expenses

Consider how much you spend each month on housing and think about how much room you have to pay more. Keep in mind there will be continual expenses, like maintenance repairs, ranging up to $3,000 or more per year. You might have to pay a homeowners association fee as well.

  • Determining gross annual income and monthly debt

Your gross annual income is the amount of money you earn each year before taxes. Gross annual income can include wages, salary, commission, overtime pay, retirement funds, pensions, welfare benefits, child support payments, and investments. When estimating the cost of homeownership, the recommendation is not to exceed 30% of your monthly income.

You should also determine your debt-to-income (DTI) ratio. DTI is the percentage of your income that goes toward your monthly debts. Car payments, student loans, and credit cards are a few examples of common monthly debt. Lenders will use your gross annual income and your DTI to determine your interest rate and how much you can borrow.

  • Having enough money for a down payment and closing costs

Do you have enough money saved to put down on a house, along with closing costs? Although it is possible to have a smaller down payment, home buyers traditionally pay 20% of the home price for a down payment. If you don’t have as much saved as you would like, that doesn’t mean you can’t purchase a home. There are options available for home buyers to use a down payment ranging from 3% to 0% down.

For example, FHA, USDA, and VA loans are government-insured loans that allow home buyers to purchase with no down payment. These loans require a set of criteria to qualify, but they can help people who don’t have as much money saved or a lower credit score. It’s ideal to have more than enough money for the down payment and closing costs, so many home buyers wait until they have enough saved. However, you might have other options that can work for you.

  • Checking your credit score

Knowing your credit score is important so you can assess how large your mortgage can be. A mortgage is a secured loan that you will have to be pay back. The lender, typically a bank, technically owns your home until your mortgage is paid off. If a homeowner defaults on too many mortgage payments, they could go into foreclosure and lose their home. Knowing your credit score will also help you figure out what your interest rate might look like. You can review your credit history for free at annualcreditreport.com.

  • Estimating your interest rate

Your mortgage must be paid back, which is why knowing about interest rates is paramount. An increase in interest rates can increase the payment on your mortgage. The more you plan to borrow, the more a change in interest rates will affect your loan, payment, and overall purchasing power.

Eight factors that impact your interest rate: home location, credit score, home price, loan amount, down payment, loan term, loan type, and interest rate type. Even a fraction of a percent on your interest rate can save you thousands of dollars over the lifetime of your mortgage. Ideally, you want to get the lowest interest rate possible, so take your time once you begin interacting with lenders and compare offers.

Interest rates can also affect the overall mood of the market. Changes in either direction can cause a sense of urgency in buyers and sellers alike.

There are online tools to help estimate your mortgage interest rate, as well. By using your credit score and the state in which you are planning on buying your home, you can get a good idea of a potential interest rate.

  • Estimating your annual property taxes

Property taxes vary from city to city, but the most important thing is to get a general idea. You can find municipal property tax rates online via a quick search. The national average is just over $2,000 per year.

  • Using a mortgage calculator to estimate your mortgage

Once you have all of the information above, you can use a mortgage calculator to estimate how much your monthly payment will be.

Tip: Try to get prequalified for a home loan before you start seriously looking for homes. Prequalification for a home loan doesn’t guarantee you will be approved for a mortgage, but it is a good place to start.

When you prequalify for a home loan, you’re basically getting an estimate of what you might be able to borrow based on the information you provide about your finances, including a credit check. Prequalification also help you learn about different mortgage options.

Getting prequalified will give you an idea of how much home you can afford because it will provide you with the information you need early on in the process. Since your credit score, debt-to-income ratio, and down payment amount impact your interest rate, you can improve your chances of getting your loan approved at the best rate possible with prequalification.