How to finance your Closing Costs when buying a home is a question I am constantly asked by Buyers who are seeking to minimize the amount of cash they "come to the table with" when determining their funds to close. The following information will hopefully help you understand the context of these terms (while perhaps learning how to implement some creative financing along the way).
The first step in determining how to finance your Closing Costs when buying a home is to understand some basic terminology. The total money you will "bring in" is referred to as your funds-to-close. For a detailed breakdown of where all the money goes when closing escrow, click here. In the spirit of keeping this article brief, I will summarize the formula for funds-to-close below:
- Funds-to-close = Down Payment + Non-Recurring Closing Costs (NRCC's) + Recurring Costs (RC's)
- NOTE: Your initial Earnest Money Deposit (EMD) is applied towards your remaining Funds-to-close at the conclusion of the escrow period
With this information in mind, the following underwriting guidelines will always prevail on any home purchase loan:
- The Loan-To-Value (LTV) requirements will always be based on the LESSER of the "purchase contract price" or the "appraised value."
- LTV is essentially a fraction that divides the base loan amount by the LESSER of the "purchase contract price" or the "appraised value"
- An example is that a Federal Housing Administration (FHA) loan requires a maximum LTV of 96.5% (requiring a Borrower to put down a minimum of a 3.5% down payment)
- Let's say you buy a house for $100,000, your down payment would be $3,500 and your base loan amount would be $96,500 (assuming the LESSER of the contract sales price or appraised value was $100.000)
- If the purchase contract price was $100,000 and the home only appraised for $95,000, your maximum base loan amount would be $91,675 (96.5% of $95,000)...this would require you to make up the difference in your out-of-pocket funds-to-close
With these basic concepts in mind, now I will show you how to finance your closing costs when buying a home:
- When it comes to your Non-Recurring Closing Costs (NRCC's) and your Recurring Costs (RC's), these cannot be financed into the loan amount. That said, there is oftentimes a work-around to accomplish this goal.
- Using the example from above, let's say the costs (NRCC's and RC's) you wanted to "finance into your loan amount" were $5,000
- Let's also assume that the Seller wishes to "net" a total of $100,000 for the sale of this home
- You could offer the Seller a $105,000 sales price with a $5,000 seller credit towards all NRCC's and RC's
- In this example, the Seller still "nets" $100,000 ($105,000 - $5,000 = $100,000)
- In this example, you get to avoid pulling the $5,000 out-of-pocket (because the Seller has credited this $5,000 towards your out-of-pocket expenses
- The only way this scenario works however, is for the home to appraise at $105,000 (since the Bank will base their LTV requirements on the LESSER of the contract sales price or appraised value)
The more Buyers there are versus Sellers in any given market, the more this strategy will work (as Buyer demand for the limited inventory of homes will undoubtedly cause bidding wars to increase the sales prices...and ultimately the values of these homes).
If you are in the market to buy a new home, you might find the following articles helpful in gaining the facts necessary to make the best choices for your family:
- The Truth Behind Mortgage Quotes
- How To Calculate FHA Mortgage Payments
- Why Do Loan Officers Ask For So Much Documentation?
- How To Choose A Loan Officer (Part 1 of 2)
- How To Choose A Loan Officer (Part 2 of 2)
For more information on any of these topics (and more), please feel free to contact me at 619-200-8031 or firstname.lastname@example.org
I hope you find this information useful and now have a better understanding of how to finance your closing costs when buying a home.