How to Budget for Buying a House

Buying a house is exciting, but it can also be confusing. When my wife and I purchased our first place, we had no idea where to start.

It was an overwhelming time, and that doesn’t begin to cover the financial side of the homebuying process.

If you’re in the market for a house, this guide shares the steps you need to follow to budget for a home.

What Should My Budget Be For Buying a House?

Purchasing a new home consists of much more than a monthly mortgage payment. While that is an important piece of the puzzle, it goes beyond that.

Your home buying budget needs to include the mortgage, but it should also include the various fees and expenses you will incur. The standard rule of thumb is your housing expenses should not exceed 28 percent of your gross income each month.

Here’s how to start saving for a house.

Determine How Much House You Can Afford

One of the most important steps to buy a house is to identify how much you can comfortably afford. It’s easy to allow emotions to interfere and overspend, especially when buying your first home.

Lenders simplify the process by following the 28 percent rule. The guidance dictates that your mortgage payment should be no more than 28 percent of your monthly income.

It’s important to note that your monthly loan payment includes several costs, including:

• Property taxes
• Interest
• Homeowners insurance
• HOA fees

Essentially, it includes everything but your utilities.

For example, if you earn a gross income of $5,000 per month, your home loan payment can’t exceed $1,400. Going over that will put a strain on your finances.

Furthermore, the lender will also look at your total indebtedness when you’re applying for a mortgage. Your total debt, including your mortgage, should not exceed 36 percent of your monthly income.

If your debt-to-income ratio is too high, they may not approve your loan. They may also encourage you to consider a more affordable house.

Read our guide on ways to pay off debt fast if you’re facing this situation.

Start Saving For a Down Payment

A down payment is what you’re expected to pay towards purchasing a house. This is a cashier’s check you bring when you close your mortgage.

The amount you put down directly impacts your interest rates. The more you put down, the lower your rate.

Banks love to see large down payments since it communicates that you’re less of a risk. A good rule of thumb is to have a 20 percent down payment.

For example, if you want to buy a $500,000 house, that would require a $100,000 down payment.

This often lets you avoid Private Mortgage Insurance (PMI), saving you money on your loan payment.

However, you can still purchase a home with less than that amount. Some loan options allow for down payments as low as three and a half percent if you have a good credit score.

While buying a house with no money down is possible, it’s not advisable and negatively impacts your available mortgage rates.

Regardless of how much you put down, having a healthy savings account is essential. Look at your monthly expenses and identify where you can cut costs.

Take all of your savings and put them in your savings account to grow. Read our guide on how to save money every month to get ideas of where to start.

A high-yield savings account is often the best place to store your savings. CIT Bank’s Savings Connect account is our top choice.

If you can start with at least $100 and electronically deposit $200 a month, you earn 4.50 percent on your cash. That rate is 11x the current national average.

They have other account options with competitive rates if you cannot make that commitment.

Plan For Expenses

Home ownership is an expensive endeavor. Your loan payment is only one part of the cost. When you finalize your mortgage, you must also pay closing costs.

You can expect to pay two to five percent of the loan principal in closing costs. This is separate from your down payment.

Closing costs are just one way the lender makes money in the process. Fees included in closing costs are:

• Appraisal fee
• Credit report fee
• Origination fees
• Application fee
• Title search fee
• Title insurance
• Underwriting fees

Lender fees do vary, and some institutions will have additional fees. You might be able to negotiate some, but don’t expect your lender to budge much.

You should also expect to pay for a home inspection for any house you’re interested in purchasing. This must be paid out of pocket.

Additionally, you must anticipate needing to make an earnest money deposit with the current owner of the house. This is typically a small amount, roughly $500 to $1,000, and is applied to your down payment upon closing.

How to Prepare to Buy Your First House

Buying a house for the first time can be an overwhelming process for many people. However, following a few steps will put you on the right path.

Here’s what you need to do before starting your house hunt.

Check Your Credit

Having good credit is an essential part of managing your mortgage payment. Lenders will use your credit score to determine the interest rate you can receive.

If it has been some time since you last checked your report, go to AnnualCreditReport.com to get your score for free.

All three major reporting bureaus (Equifax, Experian, and TransUnion) make your score and report available for free once every 12 months.

Your bank or credit card may also provide your credit score for free. Read our guide on credit score ranges to learn about ways to improve your credit.

Make a Budget

Having a budget is vital, especially for first-time homebuyers. You want to analyze your household expenses to identify which are necessary and which you can cut.

You can read our guide on how to create a budget if you’re new to the concept. It’s best to use the 28 and 36 percent rules to guide your planning.

If you need guidance on your budget, Tiller is a helpful service to stay on top of your finances.

Begin Growing Your Down Payment

A healthy down payment is the best way to save money over the life of your loan. It’s also a proven way to earn lower interest rates.

This is of utmost importance in a climate of higher rates. Not too surprisingly, more prospective homeowners are dealing with struggles getting into a house, according to the International Monetary Fund. This makes having your ducks in a row before starting the process essential.

Before you begin your house search, save as much as possible. Look for ways to cut costs and pick up side hustles to bring in additional income.

While it’s best to have a 20 percent down payment, save as much as you can. It’s possible to get some loans with as little as five percent or less.

Having a larger down payment will help you build equity faster, but it’s best to do it wisely. In fact, a thoughtful mortgage lender will encourage you to hold back some of your savings for an emergency fund.

Again, CIT Bank is our top choice to grow your savings in a smart way.

Comparison Shop For a Lender

Buying a house is the largest expense many people will have in their lives. Interest rates have a direct impact on your monthly payment.

Speaking with numerous mortgage lenders is the best way to find a competitive rate. You can even check with multiple lenders in a short time span, and it won’t negatively impact your credit.

It’s best to speak with at least three lenders to get an idea of the rate you can receive.

You have a 45-day window to get multiple credit checks from mortgage lenders. If you keep them all within that timeframe, it will only count as a single inquiry on your credit report.

After choosing a lender, get preapproved for a mortgage. This is an official document showing how much they’re authorizing you to borrow. It makes you more attractive to prospective sellers.

How Much Should You Budget For Buying a House?

Owning a home is a big part of the American Dream, but it’s not without substantial cost. It’s best to use the 28 percent rule as your guide to determine how much you need to save so you don’t become house poor.

Use that with your gross monthly income to determine what you can afford. Your downpayment should be at least three and a half to five percent of the total purchase price.

It’s also best to assume you’ll need closing or upfront costs that are equal to two to five percent of the total loan.

Additionally, you will want to save at least three months of household costs in an emergency fund.

Ultimately, you’ll need tens of thousands of dollars in your budget for your first home. As you upgrade, that amount will increase.

This can be an overwhelming amount, but it is possible to save this much if you take the appropriate steps. A prudent banker or realtor should also help walk you through formulating a plan.

Bottom Line

Buying a house is one of the largest financial goals many people have. The process is not quick, and you should plan wisely.

With some shrewd managing and a focus on saving, buying your dream home is a goal you can accomplish.

What’s one home buying mistake that’s best to avoid?