It’s one thing to want to buy a house, but a whole other matter to actually be ready to buy one. That means more than being ready for the responsibility – it also means being financially prepared. Your home will almost certainly be the most expensive thing you own, and that’s to say nothing of repairs, upkeep, insurance, and mortgage interest costs that add up. But if you know how to budget to buy a house, the path to homeownership becomes a whole lot less stressful. Here’s how to do it.
How To Budget To Buy a House
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Gathering the money for a home purchase requires advanced planning to save for a down payment and your first monthly mortgage payment. Here’s how to do it the right way.
1. Calculate How Much Home You Can Afford
Some basic math will provide a solid start to calculate how much money you can spend buying a house. To start, multiply your annual pre-tax income by 2.5. This number, though, is only a starting point. The below three factors are more important:
- Your credit history and score. Great borrowers get offered great deals. If your credit score is stellar in the 800 or above range, then mortgage lenders might offer you lower interest rates and better terms. If your credit score is 650 or even 700, you might not get offered these friendlier loans.
- Standard mortgage rates. Average mortgage rates are always in flux, with adjustable-rate mortgages (a.k.a. 10/1 ARMs) experiencing especially sharp, frequent changes. Try to wait until mortgage rates are lower to find more affordable homes and save money.
- Other home-buying costs. Your down payment is just one of the costs you’ll need to pay when buying a home. You’ll also need to figure out closing costs, inspector costs, and how much it’ll cost to move your belongings and purchase new ones.
Admittedly, these factors are quite variable, making it tough to determine precisely how much home you can afford. Mortgage calculators can help. Try the Bank of America mortgage calculator to start.
2. Decide How Much You Will Budget
You should budget based on the 28/36 rule. This rule suggests capping your monthly mortgage payments at 28 percent of your pre-tax monthly income. That’s where the “28” in its name comes from. The “36” comes from the other part of the rule: Your total debts should comprise no more than 36 percent of your pre-tax monthly income. That means your mortgage alongside credit card bills, medical debt, student loans, and other outstanding bills should not exceed this percentage.
3. Find Out How Much You Need for a Down Payment
The size of a down payment varies. You can put down as little as 3 percent or as much as 20 percent, depending on your circumstances, bank terms, and the cash you have on hand. A 20 percent down payment is ideal, as it eliminates your need for private mortgage insurance (PMI). A smaller down payment requires you to pay for PMI until you’ve paid off 20% of your home’s total price.
4. Find Out How Much You Need For Closing Costs
Your down payment is independent of how much it costs to finalize the transaction. To buy a home, you also need to put aside two to five percent of the home’s price to cover several additional fees. These costs include, but are certainly not limited to, your appraisal fee, tax services fee, and lender’s origination fee. Collectively, these fees are known as closing costs.
5. Include New and Ongoing Expenses in Your Budget
As you save money to buy a home, it’s easy to forget that other initial home costs should be considered as well. Your new home will have ongoing expenses that should be accounted for. Such new and ongoing expenses may include:
- Moving. Very few home buyers are willing to do a DIY move. Those were great back when you were renting a small apartment, but moving into a home you own is an entirely different affair. It’s also quite an expensive one. You’re best off putting aside at least $1,000 for your move, a cost that will vary widely depending on the distance moved, the season, and your location.
- Furniture. When you buy a home, you don’t buy the furniture in it unless the previous owner has agreed to sell or give some to you. And if your home is brand new, it certainly doesn’t come with furniture. Account for all the furniture you need when you move: You may take this time to replace some older items, or you may need new items to fit a different sized space. None of these things come for cheap, and together, their costs can rapidly add up.
- Paint. Generally, paint and painting supplies aren’t too expensive, but as a renter, you had no reason to budget for them unless you wanted to change the color of your walls. Now that you’re moving into a permanent place to live, you’ll likely want to invest in the colors that make your home a happy, vibrant, and comfortable place to be. Good painters can cost a pretty penny, an expense to budget for as you plan to buy a house.
- Appliances. A single appliance can cost hundreds, if not thousands, of dollars. If you buy a home with appliances in poor condition, fixing or replacing them is something you’ll have to account for. When you save for these concerns in advance, you won’t feel financially stressed the next time your fridge goes lukewarm or your oven stops heating.
- Landscaping: If your home comes with a yard, you’ll have to consider how that property will be maintained. Do you want to go the DIY route or hire a landscaping company to trim the grass and bushes? Related, when you first move in, you may want or need to remove some shrubbery or trees to get the look you want. This type of heavy-duty landscaping can come at a hefty price.
6. Figure Out The Monthly Cost Of Homeownership
Your mortgage comprises only a part of your total housing costs. Beyond your mortgage principal, your monthly expenses will also include:
- Interest. The good news about American mortgages is that you’ll generally pay simple interest, rather than compound interest that can rack up your bills over time. The not-as-good news is that interest is another monthly housing expense. Use a mortgage calculator to determine the amount by which your interest increases your mortgage.
- Property taxes. All homeowners pay property taxes, but two homeowners in different locations can pay vastly different tax rates. Research the property taxes in your location to determine how much you’ll spend per month and how often they need to be paid. Consider moving to a nearby town with lower property taxes if what you see proves a cause for concern.
- Homeowner’s insurance. Without homeowner’s insurance, you might violate the terms of your mortgage. The thing is, homeowner’s insurance can be costly. Although it’s as low as $500 per year on average in some states, the equivalent figure in other states is $2,600.
- Private mortgage insurance (PMI). As explained earlier, until you’ve paid off at least 20 percent of your mortgage, you’re required to pay for PMI. This type of insurance can cost hundreds of dollars per month.
- Homeowners’ association (HOA) fees. HOA fees are common charges assessed to every homeowner in a certain neighborhood to pay for shared amenities, such as security, a pool, a playground, or property maintenance. If your neighborhood charges HOA fees, you need to account for those in a monthly budget. These fees may also be referred to as “maintenance fees,” depending on where you live.
Tips When Budgeting to Buy a House
As you prepare to buy your home, you can make your budgeting easier if you:
- Start searching early. As a renter, you were able to start looking for a new place a couple of months before your lease ended. As a homeowner-to-be, you might need way more time to find the right place, depending on the housing market where you want to live. Start by determining your must-haves and nice-to-haves, then look at the price ranges for homes that meet your criteria. The earlier you do so, the more time you have to save to reach your goal.
- Be firm about your budget. If you determine that you can afford a home that’s at most $350,000, don’t buy the $400,000 dream home. Stay strict with yourself – there’s a reason you set that budget in the first place. You might regret going against it later.
- Set aside money for maintenance. Your home might appear to be in tip-top shape on closing day, but all it takes is one intense rainstorm to turn up surprise leaks. If you have money set aside for these types of unexpected issues, you’ll feel far less worried about them. That’s why you might want to set aside two percent of your mortgage as an annual maintenance budget for your home.
- Start smaller. Although buying a home may feel like finally settling down, taking such a big leap can be unwise. You might fare better if you initially purchase a starter home. This smaller, lower-price home can help you settle into the potential intensity of homeownership without completely draining your wallet. And if you do want to step it up later, you can always sell your starter home.
- Be realistic. If you can only afford a $400,000 house by neglecting an annual maintenance fund, then don’t buy that house. Realistically, you can’t actually afford it. Sure, you can buy it, but you might struggle to afford actually maintaining it at a livable quality. Be realistic with yourself to avoid this trap. If you’re unhappy in your home, then even if your name is on the deed, it just won’t feel like home.
Is It Time To Take The Big Leap To Home Ownership?
Let’s say the day finally comes when you’ve determined your mortgage budget, set aside money for all your other costs, and found your dream home. In that case, it’s time to close on the home in question. We have answers to all your questions on that front in our guide, How Long Does It Take To Close on a House?
