Real estate closing costs can quickly add up. And, if you don’t plan correctly, you may not have enough cash on hand when you need it. As such, real estate investors often ask: what happens if you don’t have all the money at closing?
Simply put, if you don’t have all the required money at closing, you won’t be allowed to close. This could lead to a seller lawsuit and/or forfeit of your earnest money deposit. As such, investors need to understand how to A) calculate closing costs; and B) secure additional financing, if necessary.
In this article, I’ll talk about closing requirements and how to figure out the money you need. Specifically, I’ll dive into each of the below closing-related topics:
- An Overview of the Money You Need at Closing
- What Happens When You Don’t Have All the Money at Closing?
- Calculating Closing Costs
- Financing Options to Cover Closing Costs
An Overview of the Money You Need at Closing
Real estate investors casually throw around the terms “closing costs” and “cash to close.” Both of these terms represent funds you’ll need when closing on a house purchase. However, they are not the same thing, and investors need to understand the differences:
- Closing costs: Broadly speaking, closing costs represent everything you need to pay a lender, not including your down payment. In other words, closing costs include the fees, taxes, and other payments your lender collects on your behalf outside of the loan itself. While not a comprehensive list, common closing costs include appraisal fees, loan origination fees, transfer taxes, attorney fees, title insurance, application fees, private mortgage insurance, and FHA or VA fees.
- Cash to close: On the other hand, cash to close represents the total amount you need to bring to the closing for your property purchase. The largest portion of this amount is typically your down payment. However, cash to close also includes: all of your closing costs not paid directly or rolled into the loan, a reduction for your earnest money deposit, and a reduction for any seller credits.
Let’s look at an example. Assume you’re purchasing a $200,000 property and putting 20% down. This means your loan totals $160,000 with a down payment of $40,000. On average, closing costs total between 2% to 5% of the purchase price, so let’s split the difference and call it 3.5%, or $7,000. In this scenario, none of these closing costs will be rolled into the loan itself. Here’s how the numbers work:
- Closing costs: $7,000
- Down payment: $40,000
- Earnest money deposit: $1,000
- Cash to close: $46,000
I used round numbers for example’s sake, but real-world numbers won’t be so neat. However, investors need to understand: start planning for cash to close far ahead of the actual closing date. If you wait until the last minute to put together that much money, you may fall short.
In this example, if the investor doesn’t bring $46,000 to the closing, he or she has failed to bring all the necessary money to closing. This leads directly into the next section.
What Happens When You Don’t Have All the Money at Closing?
Homebuyers face one of three outcomes if they don’t have all the money at closing. These three outcomes share a common trait – if you don’t have all the money, you won’t close on the purchase when you’re supposed to close.
- Possibility 1 – Seller sues for enforcement of contract: Known as “specific performance,” this lawsuit legally compels a buyer to go through with the purchase. Not every state allows for such recourse, but you may need to follow through on a contract, even if you fail to bring all required money to closing.
- Possibility 2 – Seller takes your earnest money deposit: In some states, this deposit constitutes the “liquidated damages” the seller can collect in case of a breach of contract. And, failing to bring all money to closing absolutely constitutes breach of contract. As such, if you fail to bring money to closing and provided a $1,000 earnest money deposit, the seller can keep that money and walk away from the deal.
- Possibility 3 – Seller sues you for damages: The seller can also sue for money damages when the buyer breaches the contract. Typically, courts use a formula that awards damages in the amount to put sellers in the same financial position as they would’ve been had the breach not occurred. This calculation can become convoluted, but the important thing to note is that buyers can be sued for damages.
Calculating Closing Costs
Buyers want to avoid all of the above possibilities. Bottom line, failing to bring all required money to closing won’t lead to any positive outcomes for buyers. To avoid this situation, buyers need to accurately calculate their closing costs. As I stated above, closing costs average between 2% and 5% of purchase price. On a $250,000 home, that’s a $7,500 swing – a lot of money. If planning on the low end of that average and final closing costs come out on the high end, you may not have enough cash to close.
Rather than leave closing costs to chance, buyers can calculate them a couple ways:
- Option 1 – Talk with your lender: When you secure a loan, the lender’s letter of intent will break down all of the estimated closing costs. These projected closing costs can – and frequently do – change, but they’re typically pretty close to the final number.
- Option 2 – Use a closing costs calculator: These let you project closing costs – and total cash to close – before committing to a deal. Our Advanced Deal Analyzer accomplishes these calculations and more. With this calculator, you plug in some basic information about a potential deal, and you’ll receive a detailed breakdown of all loan, holding, and selling costs. With this information, you’ll know exactly how much to expect in closing costs on a particular deal – before you commit to the deal.
However you decide to calculate your closing costs, make sure to run the numbers early. If you find out you owe $10,000 in unexpected closing costs the day before a deal, it may be hard to pull together that much cash. On the other hand, if you know about that $10,000 before committing to a deal, you can factor it into your budget and plan for it.
Financing Options to Cover Closing Costs
If you don’t have all the money necessary for closing, options exist. With experience and a little creativity, you can even 100% finance a property, especially with the right hard money lender. But, if you find yourself in a situation where you need to quickly pull some money together to cover closing requirements, here are a couple options:
- Business line of credit: This allows you to tap into revolving credit secured by your business operations. With a line of credit, you don’t need to draw money, but you can whenever you need to (up to a given limit).
- Credit card loans: If you have solid credit, your credit card may offer you the opportunity to take a loan out against your limit. The interest rate will be higher than a mortgage – but far lower than interest on outstanding credit card payments.
If you don’t have all the money at closing, both of these options can help you bridge the gap.