Today, we are going to learn about the differences between a down payment and closing costs. Some of you are probably familiar with what that is, but we are also going to learn about their differences.
To refresh a short definition of these two elements, we can say a down payment is just simply a large initial payment that you make when you buy a home. On the other hand, the closing costs are processing fees you pay to your lender when you’re closing on your house.
To understand this lesson, we need to highlight the relation they have with the fees, the mortgages and other elements involved in this part of real estate business. The bank will ask you to provide truthful information so they can know if you are managing your funds well or if you represent a risky client.
Down Payment and Closing Costs: Highlights
1.- The first thing that we should highlight is that the down payment contributes towards the equity of your property. Whatever you use as a down payment, it’s part of the pricing that you’re going to pay for the property itself.
Meanwhile, the closing costs are just simply fees that you have to pay for someone else’s service. It could be the title search, the real estate attorney that’s helping you with the closing depending on the state that you are in, and some of the inspections that you have to pay for. These are actually fees and they don’t go towards the equity of your property.
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2.- The second thing that I want to highlight in terms of down payment is that it’s highly dependent on the type of mortgage that you have. There are various mortgages in the market, they are the FHA loans, which require somewhat between 2% to 3%.
You can have the regular mortgages that most of you have heard about, which requires the 20%, or you can also request for commercial loans which will typically require 25% of down payment. It’s highly dependent on the type of mortgage. Meanwhile, in the closing costs, it doesn’t matter what type of mortgage you have, because these are set fees that you’re going to have to pay anyway. These fees are not impacted by the type of mortgage that you have.
Down Payment Vs. Closing Costs: Differences and Similarities
Then the next thing you should take into consideration is the differences and similarities and one of them is that you have to show funds seasonality. You have to show that you actually have the funds in your bank account because based on that, they’re going to ask you to wire that money to the closing agency, to the buyer, whether it’s 2% to 3% or five sometimes, or 20% or 25%.
Meanwhile, with closing costs, you don’t necessarily have to use those funds and your bank account, you can actually pay for those fees using a credit card, or you can use the money in your bank account and just simply wire them. You don’t need to evidence where exactly, or how exactly you’re paying. They will want to see that because they need to know where that money is coming from. That’s going to help you contribute this 20%, 25% all the time, way up to the equity of your property.
Down Payment Vs. Closing Costs: Credit Score
Depending on your FICO score, depending on the loan that you ask, they might require a higher percentage. Maybe you didn’t qualify for an FHA, but maybe the bank decided not to give you the 2%. Maybe they decided to ask you for a 5% or the same thing with the regular mortgage. Maybe the minimum is usually 20%, but depending on your risk factor, depending on how risky you are.
For example, down payments and closing costs are usually issued at closing. You give them a lump sum. You give them the overall amount that you need to contribute towards down payment. Then whatever were fees that you pay separately, you don’t have to pay upfront, you wind up paying those closing costs for you at the end and the closing. If you are a little bit more creative you might leverage credit cards for the issuance of that down payment, as long as you have that money season in your bank account.
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