When purchasing a home in the Birmingham metro area, typically, it’s the down payment that a soon-to-be purchaser thinks of first, but the down payment is only one piece of the whole enchilada. Closing costs, “prepaid” items and earnest money at times come as surprise to many buyers. That is why, in the state of Alabama, real estate agents are required to outline an estimate of the purchasers and sellers closing costs at the time of offer or at the time of signing the listing paperwork. Every buyer and seller should understand their cash outlays as each considers their home investment strategy. In Alabama, all of the funds needed to close is wired to the closing attorney’s escrow account typically the day before closing.
Earnest Money Deposit
You found the home you want to buy in the Birmingham Metro 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. In May of this year, the median home price in the U.S. was $345,800, which would mean an earnest money deposit of between $3,458 and $6,916. According to the Alabama Real Estate Institute, there is no set amount but can be negotiated between seller and buyer.
The down payment is the largest and most essential piece of the pie. The down payment must be paid by the borrower or gift funds from a family member can be used. It cannot be paid by the seller in concessions. When the seller accepts your offer, your lender wants to know you have available funds to close. The bank will ask for documentation for proof of funds and also a paper trail showing where the money was derived.
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, $17,290 if you are required to come up with a 5 percent down payment and $12,103 for a 3.5 percent down payment. Signature Homes, a popular builder in the Birmingham area, has a mortgage calculator to help you see how your down payment will change your mortgage payment. This is also something that you should investigate when you are looking for a lender from one of the many mortgage lenders in the Birmingham area, 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 private insurance premium. Other loans, such as those through FHA or Fannie Mae, require significantly less for the down payment, while the VA and USDA require no money down.
This is the part of the process that is sometimes confusing to home buyers. The seller has their closing costs, typically broker commissions, half of the title fee, half attorney fee, as well as prorated interest and taxes. These typically are just as much as what the buyer will have to pay in closing costs and pre-paids, if not more. It can be negotiated that the seller pays the “buyers” closing costs and pre-paids, but there is nothing written anywhere that states this is standard practice or that the seller will agree to it. As we mentioned the seller has their own closing costs to be concerned with and if the seller has to pay the buyers as well, he or she will look at this in relation to what they want to net. If Mr. and Mrs. seller are resolved that they will only come off of list price $5,000 and Mr. and Mrs. Buyer needs them to pay $5,000 in closing costs and/or pre-paids because they are tight on funds, then they will want full price for the home.
So what are closing costs? Closing costs are all the fees required of every process that is a part of the sales transaction. 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. This is even more important for home buyers in Birmingham. 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 3.5 percent down payment, the loan amount will be about $333,697.
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 home buyers. Investopedia points out that luckily Alabama has one of the lowest rates for closing costs, which is great news for Birmingham home buyers, but there are still ways you can bring the cost down.
Prepaid costs that are also sometimes called closing costs are escrowed items such as homeowners insurance, taxes, pre-paid interest and private mortgage insurance (PMI) if you cannot afford to put 20% down on the purchase. They are called prepaids because you are pre-paying them into an escrow account so your lender can pay them on your behalf when they come due. These cost typically amount to 15 months of homeowners insurance, 3-6 months of taxes and a percentage of P.M.I. After the initial deposit, they are annualized then divided by month and this month amount will be added to your monthly mortgage payment.
The prepaids are only applicable to buyers. I know that is a lot to take in and that is why it is a law in the state of Alabama that real estate agents are required to outline an estimate of the purchasers and sellers closing costs.
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). When you close escrow, 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 prepay 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’s beneficial to all parties.
3. Get quotes from various lenders. Each lender you speak to you will learn something new. Be sure to get a cost estimate and a calculation of your monthly note, interest, etc. Include your agent when comparing these cost sheets. Sometimes things may not be estimated high enough in order to make the bottom line look better, but the key is comparing apples to apples and not being surprised at the closing table.
Despite what many homebuyers in Birmingham 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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