When it comes to the costs of homeownership, most of us tend to focus on monthly payment and the size of the needed down payment. Sometimes, the cost of repairs and maintenance will come into the discussion as well, but there’s another cost that seldom enters the picture: transaction costs.
We do think about transaction costs when it comes to buying and selling stocks, mutual funds and other types of investments, but seldom housing. Perhaps this is because transaction costs are not recurring costs, but entry and exit fees we pay on an asset that we don’t trade too frequently. Maybe that’s true, but when we do pay them, we really pay them, and that’s because where housing is concerned, transaction costs can be incredibly high.
Photo via Wikimedia Commons.
Transaction Costs
Typically, transaction costs for housing only enter the picture when we’re buying or (mostly) selling a home. And when it does, we tend to write it off as part what it costs to sell a house, or to buy one. In between, or in regard to the ongoing cost of homeownership, it usually isn’t a consideration.
In truth they really should be, especially since a house is a long term asset. The transaction costs either to buy or sell that asset have a material impact on the viability of that investment.
Consider the amount of typical transaction fees associated with either buying or selling a home. On the buying side, your closing costs: attorney fees, loan fees, origination points, transfer taxes and a host of other fees — that average about 3% of the cost of the home. On top of that however, there are also escrows for property taxes and homeowners insurance, plus utility allocations, home owner’s association dues and other fees. Taken together, all transaction costs associated with the purchase of a home average somewhere around 5% of the purchase price of the home. Sometimes sellers will help you pay these fees, sometimes not.
Transaction costs for sellers are usually higher — much higher. A typical realtor fee is 6% of the sale price of the home. There are miscellaneous closing costs — attorney fees, transfer taxes and other fees, plus the seller portion of utility and home owner’s association dues allocations — that easily add another 1%. State and local transfer taxes can make this number even higher depending on where you live. Then, as an incentive, you may pay part of the buyers closing costs — maybe 2-3% — as an incentive to sell your home. Taken together, transaction costs for a seller average about 10% of the sale price.
Five percent on the buy side, ten percent on the sales side — added together that’s an incredible 15% of the cost of your home!
Transaction Costs Didn’t Use to Matter
Perhaps part of the reason homeowners don’t factor transaction costs in to the cost of homeownership is that, until recently, real estate price appreciation made it largely a non-factor. If house prices rise by an average of 7-8% per year, as they were doing reliably until about 2007, 15% transaction costs could be overcome in as little as two years. If you lived in an area that had double digit appreciation rates, transaction costs might have been wiped out in the first year of ownership — everything after that was pure gain.
That’s hardly the housing market we have today. With property values being flat or even declining in much of the country, the full force of 15% in transaction costs will be a major factor in the decision either to buy or sell a home. On a $200,000 home, that will translate into $10,000 (5%) in transaction costs buying in, and $20,000 (10%) when it’s time to sell. Absent appreciation, those costs are tough to absorb.
Make Sure You Can Afford the Home You’re Buying
In a market of flat to declining home prices, you want to do your best to avoid having to pay transaction costs where ever possible. One of the ways to do that is by being sure to buy a home you can well afford and can stay in for many years. That’s why it’s absolutely critical that you’re conservative in determining how much house you can afford to buy.
Though you may consider the option of selling the home if it’s too great a strain on your budget, doing so with potential selling costs in the range of 10% will make it much harder.
It’s probably best to buy a home that’s a little beneath your ability to afford. Lenders normally allow you to buy a home with a payment (principal, interest, real estate taxes and insurance) equal to at least 28% of your stable monthly income. But it may be better for you in the long run if you keep the payment to no more than 25% or even 20%. By doing this, you won’t be forced into selling your home and incurring large transaction costs.
Have you ever figured transaction costs into the cost of owning your home? Have they ever discouraged you from either selling your home, or buying a new one?
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Peter Anderson is the owner of Bible Money Matters, husband to his beautiful wife Maria, and father to one cute little boy. He loves reading and writing about personal finance, and enjoys finding new ways to save money. You can find him most days on Twitter and Facebook.
I did not even consider why transaction costs never mattered in the past but you make a pretty valid point, with appreciation what it was it really didnt matter too much. However now we are stuck with the remnants of that and costs are not coming back to Earth much like the housing prices have.
Something to keep in mind. But closing costs vary depending on the date you close.
The transactions costs really come into picture when you want to flip a house. You have to bare many of those costs twice.
@Peter: Are you a homeowner?
Yes, I am a homeowner. We currently own and are living in a home that we bought at the height of the real estate bubble back in 2006, so our home value has dropped significantly since we bought. That will probably mean we’ll be in our current location for a while, or barring that, we may become landlords and rent out our current house. We know quite a few people locally that bought around the same time that we did that are now renting out their homes and living in their new homes. I imagine all of those transaction costs… Read more »
Not always discussed when a real estate transaction is being contemplated are the disbursements and the adjustments. People end up on closing day to find out that they are being billed hundreds and thousands of dollars unexpectedly because they had no idea as to what these amounts would be when making the initial offer.
this is so true. It really helps talking to someone who has made a home purchase recently to get a sense of these additional costs.
I think your article is presenting a worst case scenario. I am a veteran real estate broker and investor for over a decade in FL. Items tied to obtaining financing are not “transaction costs” but rather fees to get a loan. And the escrow funds required by the lender for taxes and insurance are not expenses, the lender is simply forcing you to set your money aside, it’s still your money, just in a different place (the escrow account). if you paid cash for your real estate purchase then none of these “expenses” would apply. For sellers there are many… Read more »