On a monthly basis, the difference between the cost of rent and the cost of a mortgage payment could be negligible. Instead, the biggest concern among first time buyers is the initial chunk of money they will have to cough up for a down payment- and the closing costs associated with the sale.
The money due at closing is definitely one of the biggest hurdles most buyers will have to face, but there are some common misconceptions surrounding them, and they might not really be as bad as you think.
Aside From The Down Payment- Which is Cheaper?
I think what might come as a surprise to a lot of people is that the monthly payments for rent and mortgages are actually extremely comparable. Most sources* say the average mortgage payment in NC is $1,100-1,400, while the average rent in NC is $1,100-1,300.
So both of them will be taking roughly the same amount out of your pocket every month, but the real thing to consider is where that money is going. Rent is paid to a Landlord, while mortgage payments go a few different places. Some of it goes to the banks as interest, some goes into your escrow to pay for things such as insurance, and some of it is directly paying down your balance on the home- which means that money is not completely gone, it’s just waiting for you to reclaim it when you decide to sell.
Real estate is also an appreciating asset, which will mean one of two things for you: If you are renting, you will likely face rent increases as the value of the unit goes up. If you are owning, your asset is going up in value, but your payment is locked and not going anywhere.
These reasons are why, even with a downpayment included, owning a home is commonly understood to be the more cost-effective approach if you plan on living in the property for a few years.
Is a Down Payment Necessary?
Most types of loans do require a downpayment, but not all. The Veterans Affairs (VA) loan and the United Stated Department of Agriculture (USDA) loan are the two types that need no downpayment whatsoever.
As you might guess, you must be a Veteran to qualify for the VA loan, but you can use it multiple times. The main criteria with that loan is that the property must be your primary residence, and you can only use it on one property at a time.
With a name like “Department of Agriculture” most people would assume the USDA loan is not for them, unless they are planning on buying a property with lots of acres for some sort of agricultural purpose. Actually, USDA loans can be used on many different properties, as long as they are in a rural area. Your house might even be able to qualify for a USDA loan, you can check here.
The downsides of USDA loans are that they are a little more strict than some other options we are going to discuss, and they cannot be used on pre-existing manufactured homes, which are always a popular choice on the market.
In addition, most lenders have a first time buyer program, which might just include 100% financing and possibly an allowance for some closing costs too! Be sure to check with your lender if you think this could apply to you.
How Much Down Payment Can I Get Away With?
Like our last question, the answer to this one depends on what kind of loan you are using. For a FHA loan, you can get away with 3.5% down, but Conventional loans surprisingly only require a 3% initial payment.
One more thing to mention is that in many situations, if you are doing less than 20% down, the lender might require something called Private Mortgage Insurance. PMI is a monthly expense paid by the borrower to protect the lender in the event the borrower doesn’t make their monthly payments. Technically the conventional loan is the only loan that has PMI, but most other types have something very similar, just under a different name.
What About Closing Costs?
Unfortunately, the down payment is not the only expense a buyer is faced with on closing day. While the seller does handle the bulk of the closing fees, the buyer is still responsible for some- such as the title fee, title transfer fee, homeowners insurance fee, escrow fee, and possibly the appraisal and inspection fees if those hadn’t been paid prior.
All in all, closing costs in NC can typically run 1.1-2% of the purchase price. They can vary and it’s better to have more than you need set aside instead of less. If you plan on using a conventional loan with a 3% down payment, plan to have at least 5.5% of the purchase price set aside for closing day. Your lender can also give you a more accurate idea of the closing costs you will be faced with on closing day.
How Can I Pay Less Closing Costs and Down Payment?
If you are working with a good REALTOR, they will be able to negotiate with the seller for them to pay some of your closing costs for you. I have even had buyers walk away from the closing table with a check, which can be a huge help when you are about to buy furniture for your new home. There are different limits tied to how much they can pay however, so check with your lender to see the maximum amount they will be able to contribute towards your closing costs.
Should I Pay As Little Up Front As Possible?
This question ultimately depends on your preferences as well as your position in life. While we did discuss how you can get a the smallest payments up front, keep in mind that you will still be paying that money over the life of the mortgage.
In addition to just repaying that money, there will also be interest charged on it- and more of it too. Typically, the higher the down payment, the lower the interest rate, since the bank is less worried about the buyers ability to repay when there is less to repay.
Another thing to consider is the PMI that you might be faced with. You might determine that it makes more sense to pay more up front if it means getting rid of the monthly PMI you’d be charged if you didn’t.
The best option for anyone using a mortgage- low down payment or not- is to speak with a lender and ask as many questions as they can. A good lender will be able to run all the numbers with you and determine how X amount of down payment will effect your interest rate and monthly payments compared to if Y was your down payment. If your goal is to come out of pocket as little as possible, I would be happy to put you in touch with a lender who knows exactly how to help you!
Thank you very much for reading this weeks blog post, have a blessed week!
*Sources used: businessinsider.com, rentdata.org, apartment list.com, money geek.com