Paying all cash for a home is one of the best ways to get a great deal on a property. With all cash, a buyer can make a no-financing contingency offer that is much more attractive to the seller. A financing contingency and an inspection contingency are the two main reasons why deals fall apart.
Although paying cash for a property saves you money in terms of closing costs because you cut out fees associated with the lender, you’ve still got to pay various fees to protect your purchase.
Closing costs for the seller and the buyer is the main reason why people should hold onto their properties for as long as possible. If you are thinking of selling your property within five years of purchase, buying is not recommended.
Selling costs can easily eat up about 6% of the returns from your home due to the 5% real estate selling commission plus transfer taxes and other settlement fees that can amount to 1%.
If you plan to buy a property with cash, you must bake in the closing costs when making your offer.
Below is an example of all the closing costs related to a cash purchase of a $1,750,000 home in California. Each state has slightly different fees, but the main costs are more or less the same.
The costs are listed under the Debit column.
After paying a 3% deposit for the home ($52,500 Credit) once the offer was accepted by the seller, it’s time for the buyer to pony up the following fees:
County Taxes: $322.46. This is the pro-rated amount of taxes the buyer must pay that the seller no longer has to pay.
Owner’s Title Insurance (optional): $3347. Although owner’s title insurance is optional, it is highly recommend all buyers get owner’s title insurance to protect their purchase from any title defects, such as liens on the property or wrong names. The older the property, the more potential defects to the title. We’ll go into detail on why owner’s title insurance is important below.
Escrow Fee: $1,570. This fee is paid to the escrow company handling the transaction. The escrow company is usually picked by the seller because the seller initially pays a fee to analyze the title of the property before selling. For the buyer to insist on a different escrow company would be a waste of money since analyzing the initial title costs money (~$500).
Title Notary: $15. The notary takes your signatures and thumbprints and makes sure all the documents are official.
Title Record Processing Fee: $25. Another fee the Escrow company charges to make sure the documents are filed and official.
Record Of Grant Deed To San Francisco County Assessor: $36. This is the cost to get the grant deed, the official document that says you are the owner of the property according to your city.
Total Cost To Buyer: $5,315.46. The buyer must send $5,315.56 plus the remaining purchase price balance after Credit of $1,697,500 = $1,702,815.46. The buyer closing cost of $5,315.56 equals 0.3% the cost of the home ($1,750,000), which is not bad.
If the buyer were to go with a lender, s/he would have to pay the lender title fee, mortgage origination fee, and more. The total buyer cost would be closer to $8,500 instead of $5,315.56.
Note: there is no inspection fee or real estate attorney fee because they are not mandatory in California or desired in this example. Further, these fees have nothing to do with what the buyer owes a seller, lender, or escrow company.
Out of the total buyer cost of $5,315.56, $3,347 is in the form of the Owner’s Title Insurance (63% of cost). It is very tempting to not get Owner’s Title Insurance for this purpose, especially since you are signing all these documents trusting the seller and the escrow company and the city did their jobs.
Unfortunately, Owner’s Title Insurance is a necessary expense.
Most lenders require a borrower to purchase a lender’s title insurance policy, which protects the amount they lend. But, a lender’s title insurance policy does not provide added protection to the borrower.
An owner’s title insurance policy will protect the home buyer’s financial investment in the home. In general, owner’s title insurance protects home owners from someone, at some point, contesting their ownership in the property.
An example of a very common title issue is one that occurs during a refinance. Often times during a refinance, the new lender pays off the current lender’s loan with the proceeds from the refinance. When this happens, a Discharge of the paid off loan is to be recorded at the Registry of Deeds either by the new lender, the closing attorney or the borrower.
But what happens if a Discharge is never recorded? And what happens if there is another refinance a few years down the road and yet another Discharge is not recorded? A problem will arise when the home owner attempts to sell the property and a title search of the property is conducted.
The title examination will reveal that there are several outstanding mortgage liens on the property and the property will not be able to be conveyed to a buyer until this title defect is cleared.
Owner’s title insurance will not only protect the seller from this kind of loss but the title insurance company will also defend the seller and pay for the cost in clearing the title. A costlier title issue to clear would be one involving a discrepancy with land ownership.
A seller has co-owned her property with her brother for 25 years. She and her brother have not spoken in the last ten years and she is unaware that she needs her brother’s signature on the deed to sell the property.
A buyer purchases the property and attempts to sell it someday. A title examination reveals that the buyer did not purchase the property with good, clear, marketable title as the brother still has an ownership in the property.
Again, owner’s title insurance will not only protect the seller from this kind of loss but the title insurance company with also pay for the financial cost of litigating the claim of ownership to the property. The financial cost to a seller without owner’s title insurance could be hundreds of thousands of dollars.
Although you may never need it, the peace of mind and financial savings are monumental if you need it someday.
In the above example, the buyer put down a $52,500 deposit, or 3% of the home’s purchase price in order for the seller to accept the offer.
Although there are closing costs, the 3% deposit is by far the highest cost IF the deal does not go through and the seller decides to contest. The 3% deposit is always deposited to an escrow account at a title company. The title company’s main responsibility is to ensure the transaction is completed properly and nobody gets screwed.
From the buyer’s perspective, the 3% earnest money deposit should be considered your “at risk money.” Your financing and inspection contingencies should give you an out without having to sacrifice a dollar of your earnest money deposit. However, if you decide to back out last minute for a different reason, there is a chance the seller gets to keep your deposit.
From the seller’s perspective, if you have a choice, you should absolutely only engage with borrowers who are at least preapproved if they do not have all cash. Going through the preapproval process can often take 2-4 weeks. Therefore, not only will the seller know that a preapproved borrower has the financial means, the seller will also know the buyer has the intent.
A savvy homebuyer or real estate investor will bake into their offer contract the closing costs. Do not be blindsided by closing costs when it finally comes time to sign the papers.
In the above $1,750,000 example, it would have been a mistake for the buyer to think that $1,750,000 was all s/he had to come up with. If that was the case, the buyer should have offered $1,744,684.54 if $1,750,000 was the maximum s/he wanted to pay.
Closing costs are somewhat negotiable if it is a buyer’s market. In other words, you may be able to get your seller to pitch in to cover some of the costs. But this negotiation might also backfire and cause you to lose the property.
As a result, it’s better to have a clean offer that bakes in closing costs in your transaction. That way, everybody feels better if the offer is accepted.
Instead of paying all cash, maybe you want to take advantage of record-low interest rates like I am doing. If so, check out Credible, one of the leading mortgage lending marketplaces where qualified lenders compete for your business. It’s free and takes less than three minutes to get real quotes.
If you’re looking to not spend as much cash investing in real estate and would like to diversify more in an uncertain environment, take a look at Fundrise for their private eREITs. You can invest in eREITs for as little as $500 and get diversified exposure to real estate.