How Does My Money Get Distributed in a Real Estate Transaction?
Buying a home will most likely be one of the largest purchases you’ll ever make. This is why it’s important to know exactly where your money goes and what your home-related finances will look like in the future.
The first step of the homebuying process is to meet with a lender. Once you’ve been approved for a home loan, you’ll have an idea of exactly how much house you can actually afford. After you’ve found a home, made an offer, and started the closing process, you’ll begin to see your money move.
What Will I Bring to the Table?
Before any funds can be transferred to the necessary parties, the buyer must bring the required amount of money in an official form, such as a wire transfer or cashiers check. This will ensure that the funds are good and can be distributed correctly.
Generally, the buyer brings funds to cover the:
- Down payment
- Closing costs
- Setup of an escrow account (for taxes and insurance)
Paying Off the “Bank”
Whether you obtain a home loan through a traditional bank or through a mortgage lender, whoever holds your mortgage will receive the first payment, in most cases. Once the bank receives their funds, the closing agent is free to disburse the remaining funds to the seller, real estate agent (or Realtor), and any additional third parties involved in your closing process.
Important note: In order for the buyer to receive a title that are free of any liens, with the exception of their own mortgage, the seller’s bank(s) must be paid off first.
Paying the Real Estate Agent
After the bank has received the appropriate funds, the lien can be removed from the property and the seller will then “pay” the real estate agent. (These funds usually come directly out of the proceeds from the sale.) On average, real estate commission is between 5-6% of the home’s sale price.
Paying Additional Third Parties
Aside from your real estate agent, there will typically be other third parties and services that will require payment, such as:
- Escrow fees
- Home warranty (if applicable)
- Title insurance
- Transfer tax
Paying the Seller
Last, but not least, is the seller. Once all of the other parties receive their required funds, the seller will receive their portion. The law requires both the buyer and the seller to receive a closing statement before attending the closing. This enables the seller to go over the statement and confirm that everything documented was agreed upon prior.
Time to Pay Off Your Home
Once you’ve made it through the closing process, you’re officially a homeowner! Now that the home is yours, you will make regular monthly payments toward your home loan until you pay it off. Typically, your first payment is due at the beginning of the first full month after closing, and the interest on the loan will accrue on your principal balance.
Because mortgage interest is paid after it’s accumulated, you would pay for the past month’s interest, not the current month. For example, a December 1st payment would include the interest for the entire month of November.
Principal is Paid in Advance
As we mentioned above, there are many costs that are usually lumped into your mortgage payment, but the main two are interest and principal.
The principal balance is the part of the loan’s balance still owed to the lender, or the loan amount borrowed from the lender, excluding interest. This portion of your mortgage is paid going forward, rather than for the previous month like the interest. Paying toward the principal reduces the balance you owe as of the date that it’s due and is paid.
TIP: Paying a little off of the principal balance each month has the potential to shave years off the life of your loan.
How the Process Works
In most cases, your closing agent will collect interest from you for up to 30 days before the first full month when you buy a home and obtain your mortgage. (This interest will be listed on your closing statement, and it’s charged as a closing cost.)
So, let’s look at an example. If you close on your home on March 15, you’ll be charged a prorated daily interest from March 15 to March 31. Now, remember the interest collected at closing? This will cover the interest due on your mortgage for the last 16 days of March. Then, your first mortgage payment will be on May 1 and will include the interest from April.
Take a Closer Look
The journey to homeownership looks different for each homebuyer. Although this is the standard process, your situation is unique, so you will probably have additional questions to ask. This is where we come in!
Let’s make homeownership a reality for you in 2020.