You've been renting for years and are "tired of throwing money away." Everyone has either heard that quote before or said it themselves. You may be deciding between purchasing a new construction or putting your own touches and upgrades on a previous family's creation.
Either way, let's go through all of the upfront costs to purchasing a home, as well as how much money you should have set aside AFTER the purchase is complete. Some of these numbers may surprise you.
Before we begin, I want to address the quote I mentioned above, "renting is like throwing money away." This is something I don't agree with for a few reasons:
1. Homeownership is expensive. You are responsible for all upkeep and maintenance on the home and property.
2. In New Jersey the average price of a home being purchased by my peers is in the $650,000 range. That is a downpayment at 20% of $130,000. What if you took that downpayment and invested it this year? The market has returned 28% year to date. Your $130,000 would have grew to $166,400.*
* This example is for illustrative purposes only and the return is not indicative of any actual investment. Actual investment results may differ substantially.
3. In order to make a profit on your home, you'd need to have the home appreciate more than you've spent on your mortgage interest, taxes, maintenance, and fees at time of sale. Certainly possible. Likely? I'm not so sure. My advice would be to not look at your primary home as an investment.
Now all that being said, there are equally as many reasons why homeownership makes sense. As I've said before, my family and I are very much looking forward to purchasing a home next year. This is simply meant to dispel the thought that renting is throwing your money away. You have to live somewhere don't you?
Now we'll get into the meat and potatoes of this post. Or as my Grandpa would say the spaghetti and meatballs.
Here are the main costs associated with purchasing a home.
This will be the biggest amount you'll need for your home purchase. To avoid PMI (Primary Mortgage Insurance) you'll have to put down at least 20% of the purchase price. There are many different variables that come into play here and even the possibility of putting as little as 3.5% down, but it's important to discuss your options with a mortgage lender.
In general, closing costs, such as attorney fees and loan origination payments, are estimated to cost around 3% of the loan amount. These vary from state to state and lender to lender, but it's important to note here that it's possible to negotiate these down in certain circumstances. I'll include the home appraisal and inspection in closing costs even though they are done separately.
Most homeowners roll their property taxes and homeowner's insurance into their mortgage payments. The lender will put these payments into escrow then release them to the appropriate party on your behalf when due. Therefore, it is required that you prepay some of these expenses at the time the mortgage is completed. Lenders vary in the amount you must prepay, but they range from 2-12 months of the monthly payment.
We are going to use an example of purchasing a $650,000 home using a 20% down payment:
Down Payment (20%) $ 130,000
Closing Costs (3% of mortgage balance) $ 15,600
Prepaid Expenses (2% of mortgage balance) $ 10,400
Total Cash Outlay $ 156,000*
* Not including home furnishings
The lender will want to make sure you have enough leftover cash to pay for your mortgage payments once the home purchase is complete. You will need a minimum of 2 months worth of mortgage payments available. In my opinion, this is not even close to a proper amount of cash needed after the home is purchased. You should have a stable emergency fund set aside with 6 months worth of total monthly expenses, not just mortgage payments. For example, if your total monthly expenses including your newly purchased home's mortgage payment is $8,000 per month. I would recommend having $48,000 in cash. You never know what type of unforeseen expenses might arise now that you're a homeowner.
As you can see, there is more than just a down payment that is needed when purchasing a home. With proper planning and saving, you can make this dream a reality for yourself and family.
Let me know how I can help!
Fun Fact: The streets in Monopoly are all named after real streets in Atlantic City, NJ.