How to Budget for Buying a House
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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