Does Cash to Close Include Down Payment?
Gain clarity on the full financial commitment for homeownership. Distinguish your down payment from the various closing costs required at settlement.
When purchasing a home, buyers encounter various financial terms, including “cash to close” and “down payment.” While both involve funds a buyer must provide, their specific roles and components differ. This article clarifies their relationship.
Understanding Cash to Close
“Cash to close,” also known as “funds to close,” is the total sum a homebuyer must provide on closing day to finalize a real estate purchase. This amount is outlined in the Closing Disclosure, which buyers receive from their lender at least three business days before closing. It represents all funds required to transfer ownership, not just the purchase price.
Cash to close includes the down payment, various closing costs, and certain prepaid expenses, with any credits or earnest money deposits deducted. The down payment often constitutes the largest portion, directly reducing the mortgage loan amount. Understanding the full scope of cash to close is crucial for financial planning.
Key Components of Cash to Close
The down payment is the initial equity contribution, typically a percentage of the home’s purchase price, reducing the mortgage loan amount. For example, a 20% down payment on a $300,000 home is $60,000. Some loan programs, like VA or USDA loans, require no down payment, while others, like FHA or conventional loans, may require as little as 3% to 3.5% down.
Beyond the down payment, closing costs are transactional fees paid to various parties, typically 2% to 5% of the loan amount. These include lender charges like loan origination fees, which cover processing costs. Underwriting fees and discount points, which reduce the interest rate over the loan’s life, are also common.
Third-party fees cover services from external professionals. These often include appraisal fees ($300-$600) for market valuation, and home inspection fees ($300-$500). Other costs include title insurance, escrow fees, recording fees, and attorney fees where required.
Prepaid expenses are funds collected at closing to cover future homeownership costs. These commonly include the first year’s homeowner’s insurance premium and a portion of property taxes, often covering several months, placed into an escrow account. Per diem mortgage interest, calculated from the closing date to the end of the month, is also prepaid.
Down Payment Versus Closing Costs
Both the down payment and closing costs are components of cash to close, serving distinct financial purposes. The down payment directly contributes to the buyer’s equity, reducing the mortgage loan’s principal. A larger down payment can also lead to more favorable loan terms, such as a lower interest rate or avoiding private mortgage insurance (PMI).
Closing costs, conversely, are fees for services required to process and finalize the real estate transaction. These administrative charges are paid to entities like lenders, title companies, and appraisers. Unlike the down payment, closing costs do not build equity in the home but are necessary expenses to complete the purchase.
Managing Your Cash to Close
Homebuyers can explore strategies to manage cash required at closing. One common approach involves seller concessions, where the seller pays a portion of the buyer’s closing costs, such as appraisal or loan origination fees. This can reduce the buyer’s upfront burden. The amount a seller can contribute is often limited by loan type, such as up to 3% to 9% for conventional loans or 6% for FHA loans.
Another option is utilizing lender credits, where the mortgage lender covers some or all closing costs. In exchange, the buyer typically accepts a slightly higher interest rate on their mortgage loan. While this reduces immediate cash outlay, it can result in higher interest payments over the loan’s life.
Buyers can also negotiate certain fees with service providers listed on their Loan Estimate, such as for title services, surveys, or pest inspections. Shopping around for these services can sometimes yield lower costs. Strategically scheduling the closing date towards the end of the month can also reduce prepaid per diem interest due at closing.
Saving and budgeting for both the down payment and closing costs is fundamental. Buyers should aim to save beyond the down payment percentage for additional expenses. Various first-time homebuyer programs are available through federal, state, and local agencies, as well as some lenders, offering grants or low-interest loans to assist with these costs. Eligibility often depends on factors like income limits or homebuyer education requirements.