Financing Your Home Purchase
When it's all said and done, the two most important numbers when considering a home purchase are the cash you have available for a purchase, and the total ongoing monthly cost you'll incur.
Cash for Purchase & Loan Programs
The amount of cash you have is the single most important factor determining the loan programs that are available to you. You'll need cash to cover a loan downpayment and closing costs to purchase a home. The minimum loan downpayment is set by the loan program you choose. Closing Costs are typically somewhere between 2.5% and 3.0% of a home’s purchase price. The three biggest costs based on the purchase price are transfer taxes (~1.1%), funding your loan escrow account (~1%) and title insurance (~0.7%).
You should always consult with a loan officer on the specifics of loan programs. To get started, here are a few common strategies to finance a purchase based on your cash situation. Once you pick your loan program and mortgage provider, get the very best loan approval letter possible to help negotiate the best deal on a purchase.
You Have Access to Lots of Cash
Conventional Loan Financing 80%. Short of paying cash, this is normally the best option giving you the best rates and lowest monthly loan costs. For a $400,000 purchase as an example, you would need $90,000 at settlement to cover the downpayment and closing costs. Monthly payments would be based on a $320,000 mortgage. Advantages of this strategy compared to others:
- Readily available loan program available by most (all?) lenders giving you the best interest rate
- Lowest monthly mortgage payment with no mortgage insurance, best rate, and lower loan balance
- If in competition with another buyer who has a lower downpayment, your offer is stronger (with all other things being equal).
You Have Most Cash Now with More Coming Soon
You would like to put 20% down now to get the best loan terms, but you need additional cash that will be available soon (sale of another property, bonus, investment, etc.).
Conventional Loan + 2nd Trust. Get two loans: a primary mortgage financing 80% and a “second trust” at 10%. Once you receive additional cash after your purchase, payoff the 2nd trust. For a $400,000 purchase, you would need around $50,000 at settlement.
- Best rate on the 1st trust, but rate on the 2nd trust will be higher
- No mortgage insurance on the 1st trust, but you’ll pay interest on the 2nd trust increasing your monthly mortgage costs
- Additional loan process charges (a few hundred dollars)
There are other strategies to get additional cash for a purchase. Gift from Family. It’s not unusual to receive a cash gift from family. You’re on your own figuring out these details! Borrow from Retirement Account. This can be the easiest and lowest cost option to obtain cash for a short period of time. Home Equity Line for Current Home. Getting a Home Equity Loan on your current home (if you have a home to sell) or an investment property is a common way to get cash for a purchase.
You Have Limited Cash for Purchase
Consider other common loan programs if you don’t have access to much cash for a purchase.
Conventional Loan with 5 or 10% Down. These programs aren’t as common, so you’ll need to shop around. Expect rates to be higher and/or your monthly payment to include a mortgage insurance premium (MIP).
Credit Union. Local credit unions tend to hold loans they originate, so they are positioned to offer programs found nowhere else. We’ve seen loans with great rates that require 5% or even 0% downpayments.
FHA Loan. With a minimum down payment of 3.5%, this is the most common low-downpayment loan widely available. Rates can be competitive, but an upfront MIP and monthly MIP inflate monthly payments making this a very expensive loan. An FHA loan is also a good match for buyers who have lots of cash for a purchase, but whose low credit scores disqualifies them for a conventional loan.
VA Loan. These are federally backed loans for veterans and active service members. These can be fantastic loans with low costs, low downpayments and great rates. Always consider a VA loan if you qualify – even if you plan to make a big downpayment.
Seller Credit. Maybe you have enough cash for a downpayment, but cannot cover closing costs. You can negotiate a credit from the seller which pays for most of your closing costs. Note, however, this is not free money! A $10,000 seller credit on a $400,000 purchase is like a $390,000 offer to the Seller.
Monthly Costs
When budgeting monthly expenses for a home purchase, include the Mortgage, Taxes, Insurance, Home Owner’s Association or Condominium Fees (if any). Here are some strategies to estimate and reduce each of these factors.
Reduce Monthly Mortgage
Make a Larger Down Payment. Having a lower loan amount will result in lower monthly payments. This is obvious. What may not be obvious: making a larger downpayment may reduce or eliminate monthly mortgage insurance premium (MIP).
Improve Your Credit Scores. For all loan programs, having the highest credit score will allow you to get the lowest rates. Now’s the time to review your credit report. It’s not uncommon for a report to have one or two small items which, if removed or paid off, can dramatically improve one’s score. Your loan officer can obtain a report and advise on the items to address.
Consider an Adjustable Rate. Adjustable rates will be less than a fixed rate mortgage, but many buyers avoid adjustable rate mortgages thinking they are too risky. If you believe there's a high likelihood of selling in five to seven years, then a 5/1 ARM can be an ideal program. With a 5/1 ARM the rate is fixed for the first 5 years and then it can adjust every year after that. Other variations have fixed rates for the first seven years or longer. ARMs may not be right for you, but check them out before you rule it out.
Other Monthly Fees to Estimate
Property Taxes. Property taxes are based on a property’s tax value and local rate. Properties in municipalities like Gaithersburg and Rockville will be higher. For planning, estimate annual taxes at 1% to 1.3% of a home’s sales price. So a sale of $400,000 would likely have a monthly tax payment of $330 - $430. Once you find a specific home of interest, you can calculate the exact tax payment.
Insurance. Your mortgage provider will require home insurance. Costs vary based on coverage and the provider. We estimate 0.18% of the purchase price. So a sale of $400,000 would have an estimated monthly insurance cost of $60.
HOA and Condo Fees. These are impossible to estimate given the wide range of fees. You’ll see the exact fee for a property of interest. Note that condo fees can be very high even for very low-priced properties.