Setting a realistic homebuying budget and saving is an important step toward being financially prepared to own a home.
KNOW YOUR CURRENT BUDGET
Take an honest look at your monthly income and spending habits. Consider your other regular monthly expenses, this includes but is not limited to:
• Groceries
• Car payment
• Utilities (electric, water, internet, etc.)
• Health and car insurance
• Credit card and other debt payments
• Childcare
• Subscriptions (streaming services, gym memberships, etc.)
Evaluating your current situation and deciding which are a necessity and which you could do without will put you on the path of future homeownership.
KNOW YOUR HOME AFFORDABILITY
Freddie Mac’s guideline is to roughly estimate an affordable price range for a home, multiply your annual gross income (what you earn before taxes) by 2.5.
Your income isn’t the only factor to consider when planning to purchase a home, however. Three additional factors also play a role in determining how much you can afford to spend on a home:
• Your credit: Generally, the higher your credit score, the more options will be available to you for a mortgage. That could mean a lower interest rate or a better loan term.
• Mortgage rates: Small changes in mortgage rates can have a big impact on how much you can afford. Lower rates make homes more affordable, which increases your purchasing power.
• Home-related costs: Your down payment is probably top of mind, but you’ll also need to cover closing costs, moving expenses and other incidentals.
For help assessing your financial situation, building or improving your credit, and ensuring you’re well-prepared for homeownership, reach out to a HUD-certified housing counselor.
BUDGET FOR YOUR DOWN PAYMENT
The exact amount you’ll need to put down depends on factors like your lender and the type of loan. This amount can sometimes be as high as 20% of the sale price, but most lenders won’t require this much. In fact, you may be able to buy a home with as little as 3% down for a conventional loan, 3.5% down for an FHA loan and zero down for a VA loan.
It’s important to note the benefits of a larger down payment if you can afford it. For example, you may get a better interest rate and avoid the need for private mortgage insurance if you can put down the full 20%.
DETERMINE HOW MUCH HOUSE YOU CAN AFFORD
Once you know how much income you have to work with and the amount you plan to put down on a home, you can start determining how much you can afford to spend on housing each month. One common rule that many home buyers consider when budgeting for a house is the 28% rule, which states that you should spend no more than 28% of your gross income on housing expenses including principal, interest, taxes and insurance and no more than 36% on total debt (such as your mortgage, student loans or credit cards). Keep in mind that while the 28% rule can be a great starting point, it’s not a hard and fast rule that will work for everyone.
Let’s take a look at some components that may need to be included in your housing budget.
• Mortgage principal and interest: The biggest part of your monthly mortgage payment is your principal and interest. Your principal is the amount you owe on your mortgage, while your interest is the percentage of your loan that your lender charges in exchange for you borrowing the money.
• Homeowners insurance: When you buy a home, you’ll also need to factor in the cost of homeowners insurance, which will protect you in the case of an accident or natural disaster.
• Private mortgage insurance: Depending on the type of mortgage you’re getting and the size of your down payment, you may need to factor in the cost of private mortgage insurance (PMI).
• Property taxes: Another factor you’ll need to consider when buying a home is the cost of your annual property taxes. Some lenders factor this into your monthly mortgage payment, holding the money in an escrow account until the bill is due and then paying it on your behalf.
• Homeowners association fees: Depending on where your new home is located, you may also need to pay an annual or monthly homeowners association (HOA)
CLOSING COSTS
When budgeting for a home, you’ll also need to make sure you can cover the closing costs. These include any fees and additional costs, such as the appraisal, that are associated with the home buying process. Typically, you can expect to pay 3% – 6% of the total loan amount in closing costs.
HOME MAINTENANCE & EMERGENCY FUNDS
Your down payment, monthly mortgage payment and closing costs aren’t the only costs you’ll need to consider when budgeting for a house. Additionally, you’ll also want to leave room in your monthly budget for home maintenance costs. Along maintenance costs into your monthly budget, it may be a good idea to establish an emergency fund for other houserelated costs that could pop up. Larger costs like a new water heater aren’t required often, but when they are, they have the potential to cause financial stress if you don’t have some emergency money tucked away.
Conclusion
It is crucial to create your own personal budget for your home buying to determine the amount you can comfortably afford, both now and in the future.
