Cash Requirements to Buy a Home (and how to find enough)!

Getting enough cash together for a home purchase has been a major stumbling block for many would-be home buyers. But it’s less a problem today than it used to be, thanks to new loan programs and changes in the law.
You certainly will need some cash to make a down payment and cover settlement costs — how much will depend on the loan/lender you choose and the terms of your contract with the seller. You’ll also need to budget cash for moving expenses, new appliances and furniture, decorating costs, perhaps even immediate repairs or remodeling.

Down Payment

Although a 20% down payment is still considered “standard” in the lending industry, home buyers frequently purchase with much less. Most lenders will accept lower down payments, say 10%, if buyers purchase private mortgage insurance (PMI) to shield the lender from the higher risk associated with the loan. Often, an initial premium is paid at the settlement table, with additional premiums paid monthly. Other payment arrangements are available, however. (If you buy PMI, you can have it canceled when your equity in the home reaches 20% or more, either through payment on principal or market appreciation.)

The Federal Housing Administration (FHA) offers loans to qualified buyers with as little as 3.5% down. Veterans can take advantage of no-down-payment loans from the Department of Veterans Affairs (VA). And zero-down loans are now being offered by conventional lenders for home buyers with excellent credit, though the interest rate on these loans may be somewhat higher.

Whether you decide to make a large or small down payment will depend on the amount of cash you have available and your financial goals. Some buyers prefer to make larger down payments to minimize their monthly payments and interest expense. Other buyers make small down payments because they lack cash or they want to “leverage” their investment (watching their homes appreciate on OPM, other people’s money). The low-down-payment strategy also yields a higher mortgage-interest tax deduction.

Settlement Costs

Settlement costs (also called closing costs) cover a variety of expenses including:

  • Loan or discount points
  • Loan origination or service fee
  • Loan application fee
  • Credits report
  • Appraisal
  • Home inspection
  • Title insurance (lender’s and buyer’s)
  • Attorney or settlement agent
  • Recording fees and transfer taxes
  • Prepaid interest
  • Prepayments for taxes and insurance

You may also pay other costs, not listed above, depending on the particular transaction. Some of these costs are typically thought of as sellers’ costs, while others are often paid by buyers, with different traditions about who pays which in different areas of the country. Regardless of local tradition, however, you may be able to negotiate to have the seller pay some or all of your settlement costs. You may also be able to reduce your cash outlay by rolling your settlement costs into your mortgage loan.

Of the settlement costs listed, loan or discount points (paid to reduce your interest rate on the loan) may be the largest expense. If, for example, you pay 2 points (a point equals 1% of the loan amount) to reduce your interest rate by 1/4% on a $100,000 loan, you’ll pay $2,000 for points at closing. If you pay all of the other closing costs in cash as well, you could need an additional $3,000 or more.

Your lender will give you a Good Faith Estimate of closing costs within three days of your loan application. It is, however, an estimate — the actual numbers will differ somewhat by the time you get to settlement.

Collecting Cash

If you negotiate to minimize your cash requirements but you still don’t have enough to purchase a home, there are a number of creative options available. Of course, a disciplined savings plan is the first strategy you should consider. Here are a few other ways you can assemble the cash you’ll need:

  • First-time buyers (defined as those who haven’t purchased a home in the past two years) are allowed to borrow up to $10,000 from their individual retirement account (IRA), penalty free, if the money is used to purchase a home. The $10,000 can also come from parents’ or grandparents’ IRA accounts.
  • Borrow from a company pension plan or against a life insurance policy.
  • Get an advance on a future inheritance.
  • Ask parents or other benevolent individuals for a tax-free gift, accompanied by a “gift letter” indicating you will not be required to repay the gift.
  • Partner with others (friends, relatives, investors), to exchange their cash for equity in your home (which you can buy out later, if you wish).
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Find Out How Much Home You Can Afford! (courtesy of The Gooder Group)

Before you even begin to think about what type of home you want or what neighborhood you would like to live in, you’ll need to determine what you can afford. The answer will depend, partly, on the amount of cash you can bring to the purchase. But even more important, is how large a monthly payment you can afford based on your income and other debt obligations

Lender Standards
Lenders use a set of ratios to determine the maximum loan payment they think borrowers can handle without getting financially overextended. Most (though not all) lenders use 28% and 36% limits.

The 28% limit is the maximum amount of your gross monthly income that can be used to pay principal, interest, taxes and insurance (PITI). For example, if you have gross earnings of $5,000 per month, the 28% standard would limit your PITI payment to no more than $1,400 per month. With a 7% interest rate on a 30-year mortgage, that $1,400 payment would qualify you to borrow about $208,000 (depending on the cost of insurance and taxes).

But wait! You still have a 36% limit to worry about. This second ratio holds your PITI payment plus all your other payments for long-term debt (e.g., credit cards, car loans, etc.) to no more than 36% of your gross monthly income. Say you earn $5,000 per month and have monthly installment payments totaling $600 per month. The 36% test would limit your PITI payment to just $1,200 (.36 x $5,000 = $1,800; $1,800 – $600 = $1,200). At that payment level, you could borrow about $180,000.

Add your down payment to the lower of the two amounts the ratios qualify you to borrow and you’ll know the top price you can pay for a home. (Of course, your actual numbers will vary from those above; give us a call to find out how much you could borrow based on your particular income/debt situation.)

Beyond Ratios
Bear in mind, just because a lender is willing to loan you a certain amount of money for a home purchase doesn’t mean you should borrow that much. The ratios yield a maximum amount, which may be too much for some borrowers to handle realistically.

Say you live in an area with a high cost of living, or you have an expensive hobby, or there are additional debt obligations on the horizon — college tuition, elder care, child care. The 64% of income you have left over (after 36% goes to your PITI and debt) may not be enough to cover all your other expenses comfortably. You could end up living “house rich and cash poor,” perhaps even defaulting on your home loan.

On the other hand, borrowers who know their income will increase steadily in subsequent years, or who are close to retiring some long-term debt, may want to take the full amount offered by a lender. You may even want to increase the amount of money you qualify for by retiring some of your long-term debt before applying for a loan. Another way to maximize your loan amount is to shop for a lower interest rate — the lower the interest rate, the more principal you can afford to borrow.

Tax Benefits of Purchasing a Home (courtesy of The Gooder Group)

When you purchase a home, you can take advantage of a number of lucrative tax benefits, thereby cutting the real cost of homeownership. Getting to know your tax advantages, and keeping track of home improvements, will pay off handsomely in the long run.

Mortgage Interest

For home mortgages totaling up to $1 million, taxpayers are allowed to deduct their annual mortgage interest payments from their income. Homeowners are allowed to deduct mortgage interest for primary residences, vacation homes and rental properties, one way or another.

For your primary residence, of course, interest payments are fully deductible under the $1 million mortgage limit. Your mortgage company will send you a statement at the first of the year showing the total interest paid during the previous year. If you’re in the 15% tax bracket, a mortgage interest payment of $8,000 for the year would reduce your taxes by $1,200. The savings would be $2,200 if you fall into the new 27.5% bracket.

For rental properties, interest payments are counted as part of deductible rent expenses. If an overall loss results because total rent expenses (including interest expense) exceed rent income, the loss is deductible against other income such as wages, but only up to $25,000 in losses. The property owner must be an active participant to qualify and the $25,000 amount is reduced when total income goes over $100,000.

For vacation homes, overall losses are not deductible, but all mortgage interest and property taxes are deductible, either as rent expenses or as additional itemized deductions. A residence is a vacation home if it was used personally more than 14 days or 10% of the days it was rented (if rented more than 140 days).

On home equity loans (loans secured by a primary or second home), interest is fully deductible for loans up to $100,000, regardless of how the proceeds are used. When added to other debt secured by the residence, the total cannot exceed the fair market value of the property. (In other words, you can’t deduct all the interest on a 125% loan-to-value mortgage.)

Property Taxes

In addition to mortgage interest, homeowners also get to deduct property taxes from their income on annual federal returns. You’ll receive a statement of property taxes paid from your lender early in the year. If you purchase a home this year, check your settlement papers when completing your return next year to see if you paid prorated taxes, which would be a deductible item.

Loan Points

Don’t forget to deduct any loan discount points that may have been paid at settlement — by you or the seller. You can deduct loan discount fees in the year you paid for financing to purchase a home, as long as you intend to occupy the residence.

A point equals 1% of the amount of the loan, i.e., one point would equal $1,000 on a $100,000 loan. (Be careful not to confuse loan discount points with mortgage service fees that are sometimes expressed as points — mortgage service fees are not deductible.)

Even if the seller pays the points, you can still claim the deduction. If you choose this alternative, however, you must reduce the cost basis of the property (discussed later) by the deducted amount when you sell the home. However, with current capital gain exclusion levels — $250,000 (single filers), $500,000 (married, filing jointly) — the basis reduction will usually have no tax effect.

Points Paid At Refinancing

Should you ever refinance your home, the rules for deducting discount points are different. In this case, you may not deduct the points in full the year you refinance your home. Instead, you must amortize them over the life of the loan. For instance, if you refinanced to a 20-year loan and paid $1,000 in points, you would deduct 1/20 of the points ($50) for each year of the term of the loan. (Note: If the home is refinanced again or sold, the remaining balance of points from the earlier refinancing is fully deductible.)

If any of the funds from the refinanced loan are used for home improvement, the percentage of the points paid for the part of the funds used for improvements may be deducted in full in the refinance year.

Track Home Improvements

It may be difficult to focus on selling a home when you’re just purchasing one, but you should be vigilant about keeping financial records related to your home from the outset. Bear in mind that when you sell your home, you could have a capital gains tax liability on your home-sale profits. Keeping track of your purchase and improvement costs will help reduce (or eliminate) your tax bill at sale time.

Capital gains. The profit you make when selling a home qualifies as a “capital gain.” Uncle Sam may be able to get a some of those gains if they exceed exclusion limits or you don’t meet the “time and use” tests.

Currently, you can exclude from taxable income home-sale profits up to $500,000 (for married taxpayers) or $250,000 (for singles). There are, however, a few rules:

  1. You must have owned the home for at least two of the five years prior to the sale.
  2. You must have used the home as your principal residence for a total of two of the previous five years. Any two years qualify, including intermittent, non-consecutive periods of time.
  3. You must wait two years between home sales that claim the exclusion.

If you must sell a principal residence before the two-year qualification is met due to a change in place of employment, health, or unforeseen circumstances, you may take a prorated portion of the exclusion. (Consult with a tax professional if this applies to you.)

To compute your capital gain, you must first know your home’s “basis value” — your costs to acquire the home plus or minus any “adjustments.”

Acquisition Costs. The starting point of your home’s basis value is the price you paid for it. But purchasing costs also include most settlement or closing costs you paid, such as fees for title insurance, legal service, recording fees, surveys, transfer taxes, abstract of title, and more. You cannot, however, include fire insurance premiums, rent to occupy the home prior to settlement, mortgage insurance premiums or loan-acquisition costs (such as discount points or credit reports). Nor can you include escrowed amounts for future payment of taxes or insurance.

Adjustments To Basis. You may add certain items to your home’s cost basis and you must subtract certain other items from it. The higher the basis value, the lower your capital gains tax liability will be.

Increases to basis include: the cost of “capital” improvements to your home (e.g., putting on an addition, replacing the entire roof, paving the driveway, installing air conditioning, etc., but not home maintenance or repair expenses); assessments for local improvements; amounts spent to restore damaged property.

Items that decrease your basis include: insurance reimbursement for casualty losses; deductible casualty loss not covered by insurance; payment received for granting an easement or right-of-way; depreciation deduction for use of your home for business or as a rental property; value of energy conservation subsidy; points paid by the seller; gains deferred on sale of a home before May 7, 1997.

For detailed information on these basis issues, consult a tax professional or refer to IRS Publication 523, Chapter 2.

Home-Sale Proceeds. Next, you’ll need to compute the proceeds from your home sale, which equal the sales price minus your selling expenses. Note that selling expenses include broker’s commissions and legal fees. They also include expenses that would otherwise be considered repairs providing they were incurred to make the home more saleable and were completed within 90 days of the sale.

The Calculation. Now you can do the math. Subtract your home’s adjusted basis value from your home-sale proceeds. The answer is your capital gain amount. If it’s over the $250,000 or $500,000 limits, you’ll have some taxes to pay.

If you never sell your home for more than $250,000 or $500,000, you might never have to compute your home’s cost basis. Still, there’s no telling how much your home might be worth in the future, or whether you’ll need to know its cost basis for other reasons (such as depreciating the home as a rental for a period of time). Keeping good records of your home improvements could save you thousands of dollars in taxes later on.

7 Steps to House-selling Success! Part 7 of 7 (courtesy of Realtor.com)

Step 7: Moving!

Even the smallest home contains a lot of furniture, clothes, kitchen equipment, pictures and other items. For a short move, it may be worthwhile to transport small goods by yourself, but larger items will likely require a professional mover.
Realtor.com’s moving center provides calculators as well as information on moving options, storage, truck rentals and related topics. This information, plus assistance and advice from your REALTOR®, can ease the moving process.

How do you plan a move?
The time to plan your move begins once you’ve decided to sell your home. Some of the activities required to sell the home can actually help with the moving process. For example, cleaning out closets, basements and attics means there will be less to do once the home is under contract.
Your planning will be guided by a number of things:
Are you moving a long distance? If yes, you’ll likely require an interstate mover and the use of a large van.
Moving internationally. Contact the embassy in Washington, D.C., for information. Be aware that items which may be entirely common in the United States can be prohibited in foreign countries. Ask about customs protocols, duties and taxes.
Moving locally? If yes, will you move yourself? You’ll need to consider packing boxes, peanuts, blankets or padding and a van rental.
Planning is key. Stock up on boxes, packing materials, tape and markers. Always mark boxes so that movers will know where goods should be placed.
Who should you use?
The decision of who to use can begin with a visit to REALTOR.com’s® moving center and discussions with the REALTOR® who is marketing your home.
There are a number of factors to consider. Money is one issue: You’ll want to spend as little as possible, but choosing only on the basis of cost can be a mistake. Movers must have the right equipment, training and experience to do a good job. A mover, no matter how large or small, should be able to provide recent references for homesellers with a similar volume of goods to transport.
Get mover estimates in writing. Be aware that it’s possible to get discounts through membership organizations and, sometimes, on the basis of your profession: Clergy, for example, sometimes qualify for a discount.
Always confirm mover credentials. Movers should be licensed and bonded as required in your state, and employees should have workman’s comp insurance.
Get a checklist.
Moving is a big job and checklists can make it more organized and easier. Here are some of the major items to consider:
Money. If you’re moving more than a few miles then you should have enough cash or credit to cover travel, food, transportation and lodging.
Medicine. Keep medicines and related prescriptions in a place where they will be available during the move.
Number boxes so that all items can be counted on arrival. Make a list of boxes by number and indicate their contents.
If moving with children, make sure that each has a favorite toy or toys, blankets, games, music and other goods.
Moving historic, breakable or valued items? Such goods routinely require special handling and packaging.
Have address books readily available in case you need help.
If you have a laptop computer with a modem, make it accessible during your trip to pick up business and personal e-mail.