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Buying a house without a lot of cash

Dan Rafter
The Mortgage Reports contributor

In this article:

  1. Cash to close usually equals your down payment plus 2-5% of the purchase price
  2. You might also need “reserves” — funds available after you pay the down payment and closing costs
  3. You can reduce your out-of-pocket requirement by selecting a low down payment loan, receiving a down payment gift, or getting a seller credit for closing costs

Take steps to reduce your upfront cash requirement

You’ve found the perfect home, and you want to know if you can get pre-approved for the mortgage.

You make enough monthly income, but what about upfront costs?

Even with a no-down-payment option like a VA home loan or USDA mortgage, you may still need money in the bank for closing costs.

Plus, some loan types require you to have additional cash reserves after you come up with upfront costs.

Fortunately, there are ways around the situation in which you come up short.

You can often receive a gift from a family member or request a lender credit to pay your closing costs. Sellers are often willing to contribute to your closing costs as well. You can also choose a loan option that requires little or no downpayment.

Sometimes, you can buy a home with absolutely nothing out of your own pocket.

But it is still important to prepare for upfront costs, whether you pay them or get someone else to pay them for you.

Verify your new rate (Dec 3rd, 2020)

How much “cash to close” will I need?

The costs of buying a home will vary depending on things like the price of the home, type of mortgage, and property taxes.

For instance, the lender will typically collect four to six months of property taxes upfront. There is a big cost difference when comparing a house with a $100-per-month tax bill and one for which taxes run $500 per month.

But you can arrive at a broad estimate by considering average costs.

According to a recent closing cost survey, average lender fees in the U.S. were about 1.1% of the loan amount. Then you add 1% to 4% for third-party fees like the appraisal and title report. Also included in this amount are items that you pay ahead of time, like property taxes and homeowner’s insurance.

Cash to close is equal to the down payment plus around 2% to 5% of the purchase price

Cash to close is equal to the down payment plus around 2% to 5% of the purchase price: higher percentages for lower-priced homes, and on the lower end for higher-priced homes.

For instance, a home costing $150,000 might require $4,000 in closing costs and a $450,000 home might require $6,000.

The best way to find out your closing costs is to get a personalized estimate from a lender. They will provide a written estimate of your “cash to close,” which is the total amount you need to complete your mortgage. Then they will verify that you have, or will have, enough in your accounts to close the loan, via two months of bank statements.

Verify your new rate (Dec 3rd, 2020)

Calculating your cash reserve requirement

To qualify for a mortgage loan, you’ll usually need a certain amount of reserve funds saved in your bank accounts. These are dollars that you won’t be using to cover your down payment or other closing costs but that you can use to pay for your estimated new mortgage payment each month.

Lenders will vary on how many months of reserve funds that they want to see in your savings account. Most lenders to require at least two months of reserves if you are applying for a conforming mortgage loan underwritten to Freddie Mac or Fannie Mae guidelines.

For example, your total future housing payment is $2,000 including principal, interest, taxes, insurance, and HOA dues. You would need at least $4,000 saved to meet a requirement of two months’ worth of reserves.

But this isn’t a rigid rule. If your credit score is high — say 740 or higher on the FICO scale — and you are putting down a larger down payment, your lender might require no reserve funds at all. These borrowers have already show an ability to pay their bills on time, so lenders don’t need to see as large an amount of reserve funds.

Also typically exempt from reserve requirements are FHA loans and VA loans.

Expect to show more reserves if you are buying an investment property in which you are not going to live. Your lender will usually require a greater amount of reserve income, as much as six months’ worth. More cash reserves helps landlords weather a period of property vacancy or other unexpected financial events.

When is earnest money required?

You’ll also need cash in the bank to pay for an earnest money deposit. This is the money you pay right away after the seller accepts your offer and the contract is signed. The earnest money shows that you are serious about purchasing the home. This money is applied to your down payment and closing costs if the home sale goes through.

The money does not go directly to the seller. Instead, it is held at the escrow company, and the seller receives confirmation of receipt.

The amount of funds you include as earnest money will vary based on the home price and competition.

Sometimes, you’ll need just a couple hundred dollars. Other times, you might need an earnest money deposit of as much as 1.5 percent of the home’s sale price or more. If you are buying a $200,000 home, that much earnest money would come out to $3,000.

Ask your real estate agent an amount that is competitive in your market.

The amount of earnest money you put down will depend on how badly you want the home, what the sellers are requesting and what your real estate agent is able to negotiate.

Reduce your down payment when short on funds

The down payment is usually the biggest cost that any buyer faces. Again, the down payment you need will vary, often on how strong your credit is and what type of mortgage you apply for.

For a conventional loan guaranteed by Fannie Mae and Freddie Mac, you’ll usually need a down payment of at least 5 percent, although downpayments of 3% are available with programs like HomeReadyTM and Conventional 97.

Five percent down would require $10,000 for a $200,000 home. If your credit score is low or if you have too much debt or other financial issues, you might have to come up with a higher down payment, maybe as much as 20 percent.

This downpayment level assumes a conventional loan, which is not your only choice.

An FHA loan requires a down payment of just 3.5 percent of a home’s purchase price if your FICO credit score is at least 580. Some lenders may require a higher score of 620 to 640.

Other loan types eliminate the downpayment requirement altogether. Home buyers with military experience should check their eligibility for a zero-down VA loan. The USDA home loan, likewise, requires nothing down and is available to home buyers in rural and suburban areas.

Verify your new rate (Dec 3rd, 2020)

Lender and third-party closing costs

A mortgage loan costs money to open. Those costs are passed on to the home buyer. The following are some of the lender fees you might see on your cost estimate.

  • Origination fee
  • Processing fee
  • Underwriting fee

But the lender is not the only entity to which you will pay fees. There are also third parties who charge for services required for loan approval.

  • Title fees
  • Escrow fees
  • Appraisal
  • Credit report
  • County recording fee

Closing costs will vary depending on the size of your loan, whether a lawyer is present at the closing table and the fees that your municipality or state charges. In total, you can expect to pay about 2 to 5 percent of your home’s purchase price in upfront costs.

This is a wide range, so check with your lender about the exact amount needed in your situation. Ask for a lender credit or alternative loan options to reduce your total out-of-pocket expense.

Check your home buying eligibility

Mortgage rates are low, making it easier for first-time and repeat buyers to qualify for a mortgage. Low rates also keep upfront costs low: you can accept a slightly higher-than-market rate in exchange for a lender credit.

Check today’s rates with just a few pieces of information to start. All rate quotes come with an estimate of upfront costs so you know how to plan for your upcoming home purchase.

Verify your new rate (Dec 3rd, 2020)

Step by Step Guide

Buying a Home