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How to Budget for Buying a House

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first-time homebuyers

I have talked a few times here about my journey into the real estate market again. It has been a little over seven years since we bought our first house, but it is time to move out and get in the business of buying a house again. I have saved for a down payment, hired a Realtor to sell our current home, learned home staging tips, and more. I am determined to not only sell our current home, but also get to the act of purchasing a house our family can grow up in.

One thing I learned from my first experience buying a home is that budgeting is more important than ever. Buying a house is not cheap, but add the fact that owning a home can be costly, you need a budget. I will admit that I am not the most strict budgeter out there, but I do think creating a tight budget for home buying is necessary.

This will help as you determine what you’d like to look for in a house – like a basement, storage ideas for your kids’ bedroom or a deck so you can go in knowing what you might need to cover those added things. Since I am in the midst of selling our home and looking to buy another one, I thought I would share some of my budgeting tips for home buyers.

Analyze Your Current Financials

 

How do you know where you can go, if you don’t know where to start? By analyzing your current financials, you can see what your financial picture currently looks like. Besides, buying a house is a process riddled with questions so best to get used to asking yourself a few upfront. Do you already own a home? Do you have debt?  What is your debt-t0-income ratio? Do you have excess cash flow each month? These are just a few things to look at when you are analyzing your financials.

If you already own a home, then look at how much you are spending per month and per year on your mortgage payments. Add in your utilities, homeowners dues, taxes, insurance, and everything else that involves home ownership. On top of all your other bills and expenses, how much money do you have left at the end of the month? Is it a comfortable amount? If not, what can you do to change that?

Get Pre-Qualified for a Mortgage

 

As a current seller in the real estate market, I can tell you that I will only work with pre-qualified buyers. Why? Pre-qualified buyers know more information about their financial picture and have a better chance of actually getting the loan approved. When we first put our home up for sale, we had a very nice couple look it over on the second day. They loved it and wanted to put in an offer immediately. While this was exciting for us, we asked our Realtor if they were pre-qualified. They weren’t, so our Realtor asked them to go do it. One day later we heard back that they couldn’t even qualify to purchase our home.

Getting pre-qualified when buying a house is important because it gives you some insight into how much you can get approved for. It does not give you a picture into how much you can actually afford. That scenario is all on you. Most mortgage lenders will give you the monthly payment amount, which usually includes taxes and insurance. This payment amount is what you will be paying each month for the life of your loan.  My advice is to get pre-qualified for the highest amount you feel comfortable paying. Once you get that number, then the mortgage lender will break down how much it will be each month. Make sure you are comfortable with that number.

Save for a Down Payment Before Buying a House

 

My wife and I bought our home right before the mortgage bust. Talk about bad luck. We were fresh out of college and just got jobs. We didn’t have any financial security and I was in over $50,000 of credit card debt. Our financial picture was bleak. The issue back then was that the banks were giving away money. Since we both had great credit scores, we were able to apply and get a loan for 100 percent financing. We didn’t have to put down any down payment. It was great for us, until we learned about PMI (private mortgage insurance).

PMI costs money every month and it doesn’t go away until you have 20 percent equity in your home. Its purpose is to protect the lender in case you go into default. Ever since we signed the mortgage papers, I have vowed to never pay PMI again. Now that we’re looking at buying a house again, I plan on living up to that vow.

My tip here is that if you can’t come up with 20 percent down when buying a house, then you shouldn’t be purchasing it. It should be a red flag if you can’t come up with the 20 percent down. Remember that 20 percent is the least amount you need to put down in order to get rid of PMI.

Your down payment should be a part of your budget. You can’t just save up for the down payment and then be happy. Remember, that money will go away all in one transaction. You will no longer have it. The key to a proper home buying budget is to have not only the down payment, but also cash reserves on top of that. Anyone that has bought a house can tell you that they are costly. It costs money to move in, buy furniture, make repairs, and keep up with the maintenance. Don’t save up just enough, you need to save up more than enough.

Watch Your DTI

 

Your debt-to-income ratio is an important number to keep in mind when buying a house. Mortgage lenders look at it closely and won’t lend to you if you are over a certain percentage. Your DTI is just a simple calculation of your monthly gross income compared to your monthly debt payments. These include unsecured loans, mortgages, student loans, credit cards, and anything else that is considered debt.

I have spoken with a few mortgage lenders and they want to see numbers below 28%/35%. What does this mean? Since this is about buying a house, then we are speaking of mortgages. In my example, the 28 percent is your DTI without the monthly mortgage payment. The 35 percent is with the mortgage included. Many lenders won’t approve your loan if you are over that.

As I said in my DTI post last month, my current DTI is about 15 percent with my mortgage. This shows lenders that I have my debt load under control. Sit down and calculate your DTI to see if you are even close to the 28/35 threshold.

Budgeting for a home purchase is all about understanding that you are going to be paying a good amount of money when you find a home. You will be making payments for years. You need to be comfortable with those payments.

The main thing you should think about is affordability. Check out home amounts that can have a comfortable mortgage payment. Don’t ever give in to the temptation to consider buying a house at your highest pre-approval amount. This will mean that you won’t be able to afford anything else besides your home. There is no need to go all HGTV on yourself and reach for the stars. Buying a home at the high end of your pre-approval amount will strain your finances for a long time. That is no way to live.

I know some people, myself included, have started looking for home purchases that can be covered by just one income. That gives you the flexibility of having more cash flow, but also security if one person loses their job. While my wife might not like it, I am looking out for our best interest when I lower our budget amount. A rule of thumb that I have been using in my home search is stay conservative.

 

Are you considering buying a house? How are you adjusting your budget to cover the costs of purchasing a new home? What mistakes, if any, did you make in your first home purchase?

 

 

Photo courtesy of: Alan Cleaver

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Grayson is the owner of Debt Roundup and Empowered Shopper. He also co-owns Sprout Wealth and Eyes on the Dollar. After going to battle and winning against consumer debt, he decided it was time to learn how to use credit wisely and grow his wealth. He discusses all things personal finance and is not afraid of being controversial. He also is a freelance writer and blog manager.

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38 Comments

  • This is so important -> “The key to a proper home buying budget is to have not only the down payment, but also cash reserves on top of that.” Also as far as DTI go, if you can increase your income somehow you can both lower your DTI and have increased (and hopefully sustainable) increase in cash flow.

    • Grayson Bell says:

      I agree DC. While you can reduce your DTI that way, most banks will need to verify the income and make sure it is not just random. It would need to be consistent for them to consider it in your DTI calculation.

  • MoneyAhoy.com says:

    Saving up for a down payment is such good advice. If you can save up a 20% down payment, you’ll avoid PMI and save hundreds each year.

  • Awesome tips, Grayson. We made the mistake too of buying our house without 20% down. Never again!

    • Grayson Bell says:

      I am trying to offload my mistake now Laurie. I vowed after I bought our current home that I wouldn’t make the same mistake twice and I plan on keeping that vow.

  • Right now my savings account has more than I need for my emergency fund, I’m hoping to use some of it for a downpayment someday.

  • Michelle says:

    We have put our home buying on hold, but have decided that we want to buy our next home in the next 2 to 3 years. We are hoping to save as much as we can and put that towards the down payment of our next home.

  • By preparing a good amount for a down payment is the best strategy when you are planning to buy a house. And I should agree with you Laurie that analyzing your current finances is very important too.

  • I agree 20% down as a minimum! These days though, I’m not sure if banks will even consider you without 20% of the purchasing price.

    • Grayson Bell says:

      There are actually many banks that will consider you if you have a good credit score. You can do a minimum of 5% I think, but then the USDA loans can be 100% financing, but those are few and far between.

  • We saved for quite a while for our down payment, and we factored closing costs in there too. We got pre-qualified for a HUGE mortgage, one that we couldn’t afford (well, we could, but we wouldn’t be able to afford anything else) so I think it’s important to look at your current financials, as you mentioned, and buy something well within your budget.

  • We bought our first home because it seemed as though we were throwing money away by renting. Our monthly payment was going to pay a landlord, not build equity in a house. For that reason alone we pulled the trigger. Looking back, I don’t think that should have been the main reasoning. We could have saved more and put more down to reduce our monthly payment. Renting is the place you need to be if you can’t put down at least 20%. I’d also add that the monthly mortgage payment should not exceed more than 1/3 of your take home pay, and ideally be closer to 1/4.

  • We’ve been house hunting for a few months…and when I say house I mean “co-op.” Here in NYC, the houses in decent neighborhoods with a good school district are over $500,000 to $600,000 at a minimum. Even the co-ops aren’t really that affordable. They might even be harder to purchase as many require 20% down or more and you have to submit your financial information to the co-op board and go through an interview.

  • Kathy says:

    Too often people think that if the bank qualifies them for a specific amount, then they can afford that amount. You don’t have to spend what you get pre-qualified for. And, if you spend less, don’t think that you have all that extra money for updating. The bank doesn’t give you an extra $50K because you didn’t spend it on the house. Also, don’t think that you will get a HELOC if you have no equity in a house. That is how a lot of people got underwater with their homes because the banks gave lines of credit that created a situation where the buyer had no equity to cover a lower appraisal during the housing meltdown. My final tip is to not buy a house to impress all the friends you “entertain”. If they don’t like your house because it doesn’t have granite countertops, they aren’t your friends.

    • Grayson Bell says:

      You are correct there Kathy. The pre-approval amount typically is how much you can afford on the highest end, but it doesn’t really take into account all of your expenses. If you buy at that amount, you will be immediately house poor.

  • These are great tips Grayson!! Something that I didn’t do (and I know a number of other people don’t) is budget for inevitable future repairs if you are buying a used home. We thought we had enough set aside for it, but there were more issues that popped up that were not discovered during the home inspection process.

    • Grayson Bell says:

      I am with you. I am in the same boat. I didn’t budget for all of the things that need to be repaired when you buy a home. You are the landlord, so you can’t make a call and get it fixed with nothing out of pocket.

  • E.M. says:

    Great tips here, and I love how you said not to go all HGTV. So many people go over their budget on house hunters. We’re not going to buy a house for at least three years, but I would love to have even more than 20% for a down payment. I don’t want anything big or fancy so hopefully it will be possible. You have to be very realistic when looking for houses as it’s so easy to get carried away.

    • Grayson Bell says:

      I just had to put that in. Every time I see that show, it irritates me. They are at the highest end of their budget and they inevitably go over. The problem is that staying within your budget and staying conservative doesn’t make for good television.

  • Completely agree with this statement, “The key to a proper home buying budget is to have not only the down payment, but also cash reserves on top of that”. You really need that buffer as you never know what will come up once you become a homeowner. We had many surprises when we started and our remodel went over budget so it’s good to keep that in mind. The pre-qualification is something that every realtor I spoke to asked for. They really don’t want to start showing you houses without knowing what you can afford and it’s a benefit to the buyer to know this. Great tips!

    • Grayson Bell says:

      A buffer is extremely important. Without one, you are risking running out of money when you need it most. As a seller, I won’t accept any offer from a buyer that hasn’t been pre-qualified.

  • Lauren says:

    These sound like really solid tips. 20% down plus extra cash reserves would definitely take some time to save up, but better to do that than dive into a property that you really can’t afford, when all is said and done. The people on those HGTV shows that buy homes at the top of their price range amaze me! It just doesn’t seem like the smart thing to do.

  • Great tips, Grayson. I see so many people who are house rich but cash poor. They get so excited when the banks offers more than they expected and they buy a home at the maximum amount their bank will give them. Now they may be able to still pay their mortgage but they have no money to do anything else. Our dream house went for sale last Fall and we put in a couple of bids but once it exceeded what we could comfortably pay, we stopped. Sure, we probably could have kept going but I’m not willing to sacrifice all the other things we are able to do to live in a nicer home. My life is good because right now I have both a nice home and money to use on creating fun experiences on my family. Of course, we actually did sell our home, so I’m stilling for a new home. 🙂 Good luck with your house hunting!

    • Grayson Bell says:

      I saw this a lot too Shannon, especially when I did mortgage debt collection. Many people were buying homes at the top of the pre-approval amount. They are instantly cash poor and can’t get ahead. I already have a number that I won’t exceed and have easily been approved for.

  • Kim says:

    We also got stuck with PMI in the beginning. We were so anxious to buy a house, we really didn’t read the fine print. It is crazy how much lenders tell you you can purchase. Our lender told us we could borrow almost double what we did. I’m so glad we didn’t do that!

  • Great tips Grayson. I would say get pre-approved for a mortgage, and whatever amount they approve you for, halve it (or cut it down by 66% if you can). It’s crazy to me how much some people still get approved for. We ended up with a house that was about 25% of our pre-approval amount. That’s not to say we didn’t look at houses at the top of (and beyond) the budget. Just remember when a bank preapproves you, they are the one setting the budget at that point!

  • Good tips. I bought my fist house with 25% saved for the down payment. The sellers and banker were very happy with me. Besides adding equity through accelerated payments, I added a $90k remodel that added a garage and doubled the size of the house. When I sold, I ended up with a bit of profit. I rolled all that into the new house I purchased that was much closer to work (the main reason for moving). My realtor was surprised when I told her how much I would be willing to pay for the new house, even though my savings would have qualified my for a much more expensive house. I told her that I was holding back a 40% down payment. She almost seemed upset by that. She was certainly surprised.

    • Grayson Bell says:

      Nice work Bryce! That is how you do it. The point of the down payment is to have immediate equity in the home. Since we didn’t do it with our first home, we have had to catch up. I am sure your Realtor didn’t like hearing that as that is commission coming out of her pocket. She wants to sell you the highest priced home she can!

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