The real estate industry has done a bang-up job on letting consumers know they’ll need some cash when they purchase a home. Typically, it’s the down payment that’s mentioned. Seldom are closing costs brought up so they end up a major surprise for homebuyers.
Between the two of those huge chunks of money are other cash outlays you’ll need to consider.
Earnest Money Deposit
You found the home you want to buy and you and your agent structured the perfect purchase agreement. In it, you’ll find a section dealing with your earnest money deposit (EMD). Your agent will list the amount you are paying and where it will be held.
So, what is this? There are several functions of an earnest money deposit. First, it shows the seller that you are serious about pursuing the purchase. After all, he or she will be taking the home off the market. This “skin in the game” evens the playing field. The seller takes a gamble by removing the home from the market and you put your cash on the line with the possibility of losing it, under certain circumstances.
The amount of money used for your EMD varies according to several factors, including what type of market you’re in (in fast-moving markets, a larger-than-normal EMD may entice the seller to choose your offer).
Typically, it’s 1 to 2 percent of the offering price, yet I have seen $0 as well as $1,000. In May of this year the median home price in Canada was $345,800, which would mean an earnest money deposit of between $3,458 and $6,916.
When the seller accepts your offer, you are now conditional and your lender starts their work.
Down payments are expressed as a percentage of the purchase price of the home. For example, using our national average home price, you will need $69,160 for a 20 percent down payment, $34,580 for a 10 percent down payment and $17,290 if you are required to come up with a 5 percent down payment.
Down payment percentages depend upon the loan you’ll be obtaining. Conventional loans generally require 20 percent down and the best choice if you hope to avoid paying a monthly insurance premium.
Other loans, such as those through insured through CMHC or Genworth Financial, require significantly less for the down payment, while the Credit Union options could require no money down.
This is the part of the process that catches far too many homebuyers by surprise. Closing costs are all the fees required of everyone who helps you purchase the home. From your real estate agent’s commission and appraiser’s fee to the title company’s research and issuance of a policy and, of course, the lender’s fees. These fees add up – fast – so it’s important to compare closing cost estimates from several lenders. It’s also important to understand which costs are negotiable.
It’s not unusual for closing costs to amount to 2 to 5 percent of the loan amount. Using our average home price mentioned above, with a 5 percent down payment, the loan amount will be about $328,510. Closing costs would be anywhere from $6,674 to $16,685. As you can see, closing costs, if not prepared to pay, can come as quite a shock to homebuyers.
3 Ways to reduce closing costs
1. You can reduce a portion of your closing costs by closing as late in the month as possible. Lenders charge interest in arrears, meaning that when you make a house payment, you are actually paying for last month’s interest (and the coming month’s principal). On closing day, the lender will have calculated how much interest you owe from the date your loan was funded to the end of the current month.
For example, if you close on your new home on August 15, you’ll pre-pay the interest due from August 15 until August 31. September’s interest isn’t due until October 1, when you will make your first house payment.
Reduce the pre-paid interest charge by closing at the end of the month.
2. You can eliminate the need to pay all or part of your closing costs by requesting that the seller contribute. The seller gets to write that amount off as a tax deduction and you get to skip the closing costs, so it could be beneficial to all parties.
3. Ask your lender if you can include the closing costs in your loan. Yes, there will be a charge for this but it won’t be nearly as large as the immediate outlay of cash necessary to pay closing costs.
Despite what many first-time homebuyers think, the down payment isn’t the whole ball of wax when it comes to cash outlays when you purchase a home. It’s important to determine exactly how much cash you’ll need to purchase a home so that you can budget for these expenses.
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