Breaking Down the Cost of Buying Your First Home

Image via Home Bunch
Image via Home Bunch

What do you think are the two most important decisions you’ll ever face in life?  If you answered marriage and buying your first home, trust me when I say this: you are not alone.

And rightly so. These intimidating choices are a launching point for many, many things to come—especially as it relates to your finances. In no way am I confident enough in my relationship skills to give advice pertaining to your love life (my game isn’t just bad, it’s non-existent).  So, for the purposes of this article, we’re going to focus on the easier subject of the two: buying your first home.

Deciding to be a first-time homeowner is such a terrifying prospect that, according to the NAR Annual Survey, this year saw the fewest number of first-time buyers enter the housing market in over three decades.  The reasons for this are many, but the most prominent of these is simply due to being misinformed.  That’s a shame, because that means there are thousands of potential homeowners out there passing on this crucial investment opportunity.

Buying your first home might seem like a steep mountain to climb, but it’s more conquerable than most think. Like any explorer preparing to attempt K2, all you need are the right tools: knowledge, preparation, and communication. All three dictate whether you’re ready to be a homeowner and how the buying process will play out.

Many ‘should be’ first time homeowners are staying away from buying for one major reason; they don’t think they can afford to buy a home.  Honestly, it’s hard to blame them—especially young adults. With students loans, low savings, and other debts wearing heavy on their mind like a bad dream, the thought of embarking on what might be the most expensive purchase they ever make probably sounds unwise at best, and idiotic at worst.

Below, I’m going break down the cost of buying a first home so you can determine whether you are ready to pull the pull trigger, or continue renting.  I don’t want to be that guy that tells you what to do or how to live your life, but at least I can do my best to insure that, whatever you decide, your decision will be an informed one.  So let’s get started.

First Things First

To start, get pre-approved! You will never know what you can actually afford until a mortgage lender provides that important information. With a pre-approval letter you can refrain from wondering ‘what if’ and begin looking for homes in your price range.

Want to put an offer in on your dream home? Good luck without a pre-approval letter. Getting pre-approved indicates that you are capable of buying, and the letter allows you to put in an offer once you find a home that feels right.  Sellers can’t just take the first offer that comes through their door without having some sort of guarantee they’ll be paid in full.  It’s the same logic that prevents a teenager working part-time at the local Pizza Hut from driving off a car lot in a Ferrari.  Letting someone take such an expensive product even when their financial standing seems to obviously indicate their ability to afford it is slim-to-none—that’s not good business.  Remember, the sellers you’re dealing with are embarking on at least as big and risky of an undertaking as you.  So play by the rules and set their mind at ease.

As much as we’d all like it to be, the mortgage process is not clear cut. You can learn more about the entire mortgage process from start to closing here.

What You Need to Buy Your First Home

FHA Loan

The FHA Loan is usually the best option for those buying their first home.  Why?  In short, It’s one of the easiest types of home loans to qualify for by far and requires a low down payment to boot.  As a bonus, it’s also a little more lenient on your credit score and history. For those borrowers who can’t afford to put the usual 20% down, the FHA loan only requires 3.5%. Another perk of an FHA loan is that it is “assumable.”  This means that if you choose to sell your home, the buyer can take over the existing mortgage.  For the first time homeowner, that could be a huge selling point.

Think about it: if you’re just introducing yourself to the housing market, chances are you’re still trying to figure things out from a long-term financial standpoint.  While everyone wants to put money down on a dream home you could happily spend the rest of your life in, most people make compromises for their first home by buying low with the intention of upgrading down the road.  When that time comes, FHA loans will give you the flexibility to transition into that next phase of your life seamlessly.

Down Payment

Another factor that scares many away from purchasing their first home is the down payment. As we’ve already discussed, if you qualify for an FHA loan you will only need 3.5% for your down payment. In monetary terms, that means if you find a home worth $250,000, you will need $8,750 as a down payment with an FHA. While that is definitely a big chunk of change, a traditional down payment of 20% would $50,000. A little eye opening, right?

Your down payment is going to be one of your larger costs.  Yes, that’s a tough pill to swallow—but there is good news! You can receive a gift for your down payment. Many young adults get help from parents or other family members.  There’s nothing written that say you have to do it yourself.

But still, if you’re thinking about beginning the home buying process, you should start budgeting for the down payment as soon as you can.  If you start saving early with the explicit intention of using it on a down payment (and nothing else), when you finally get to set at the closing table signing the check won’t taste half as bitter.

Earnest Money

Of all the winding facets involved in homebuying, this might be the most confusing. Here’s the best way to describe earnest money: more or less, it’s a security deposit.

A third party will hold your earnest money in an escrow account until all agreements of the sale and purchase are met. The payments are required from the buyer, and they are required upfront. Think about it: you wouldn’t want to give the payments directly to the seller, would you?  With your money firmly in their possession, they’d have no obligation to hold up their end of the bargain.  Having earnest money grants you the ability back out of the contract If something goes wrong with the inspection or appraisal process. The escrow company will handle all of the money exchanged between buyer and seller, file any documentation that is required, and make sure if the worst comes to pass that you’ll get your money back.

The amount of earnest money required by the buyer should be outlined in your contract, and unfortunately you’ll have to make these payments before closing. I know the thought of putting down even more money can’t feel good, but just remember that this system is in place for your protection. When dealing with a life event as important as buying a home, too much protection is always better than too little.

The good news?  Each payment counts towards your closing amount. So if you pay $1,000 in earnest money, you can subtract that from the total needed for closing.  You can’t beat that!

Home Inspection

This is one of the most important steps in the process, if not the most important. You might think that you’ve hit the jackpot, that you against all odds have somehow managed to find the perfect home at a price you can afford…until home inspector come knocking and finds mold, termites, and rotting wood that’ll cost you thousands in home repairs.

Expect a home inspection to set you back about $300-$400.  Whatever your kneejerk reaction may be to that added cost, don’t cut corner with this. It’s worth every penny. My advice: make sure that you do your homework when hiring a home inspector. Most real estate agents or mortgage companies will provide their recommendations, but make sure you do your own research to find a reliable inspector.

A lackluster inspection could miss some major damage that could cost you big, BIG time in the long run.  Finding best inspector possible and having them go through the entire inspection process with you is absolutely crucial. Even if you have to spend a little more, you’ll be glad that you did.  Sometimes, especially when so much money is on the table, you just can’t put a price on peace of mind.

Appraisal

It’s make or break time. What will determine whether the home is worth what you are paying for it? The appraisal.

There’s no getting around it. This is something that must be done. It’s not that expensive (usually costing you around $350 or so), but you’re going to be in for a rough ride if the appraisal comes back lower than the purchase price.  John F. Kennedy’s negotiations with Russia during the Cuban Missile Crisis don’t hold a candle to the intensity of dealing with the ramifications of an unexpectedly low appraisal.

But let’s take a step back.

A professional appraiser examines the home to determine its value. They check every component of the house and provide their unbiased opinion on what a buyer should be paying. If they think it’s worth more than what you have agreed to pay the seller, you’re good to go because that means you’re getting a bargain. If it comes back lower however, you could run into some serious issues. In some scenarios it could even cause the deal to fall through entirely. You can learn about your options if the appraisal comes back lower here.

The appraisal usually happens a few weeks out. Once you receive the good news from an appraiser, it’s all smooth sailing from there.

Closing Costs

Now it’s on to the finale! At this point, you’re going to be extremely excited but ready for the process to be over.  Hang in there, you’re almost home. Literally.

The only thing standing between you and the keys?  The due date for all your remaining fees and payments, including your closing costs.  Woo hoo…

Usually buyers pay between 2 to 5 percent in closing costs.  This means that for the $250,000 home we mentioned earlier, you could pay anywhere between $5,000 and $12,500 in closing. But don’t let that scare you off.  Remember, you’ve already payed for some of that cost along the way. Your appraisal fee, escrow deposit, inspections fee, and many others will all be subtracted from your total closing costs.

Depending on your contract and situation with the seller, you might be able to negotiate that they pay a certain percentage of your closing costs. Even if not, it never hurts to inquire.  Don’t forget you’re not the only person at the closing table ready to move on with their life. You’d be surprised what a seller might be willing to do to sweeten the deal and get the paperwork done.  It may end up being only a small percentage, but every little bit helps when buying a home.

Author Bio: Caleb McElveen is a content specialist for Savings Thousands Radio hosted by Robert Palmer, a radio show providing consumer financial advice.