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.
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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?
I’m John Schmoll, a former stockbroker, MBA-grad, published finance writer, and founder of Frugal Rules.
As a veteran of the financial services industry, I’ve worked as a mutual fund administrator, banker, and stockbroker and was Series 7 and 63-licensed, but I left all that behind in 2012 to help people learn how to manage their money.
My goal is to help you gain the knowledge you need to become financially independent with personally-tested financial tools and money-saving solutions.
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.
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.
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.
Not only will you avoid PMI, but it shows that you really can afford the home.
Awesome tips, Grayson. We made the mistake too of buying our house without 20% down. Never again!
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.
That is how my down payment fund grew. I just started over funding my emergency fund and then created a down payment fund.
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.
I assume that is due to the wedding?
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.
You should always analyze your current financials to see if buying a home is right for you.
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.
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.
Yeah, the pre-qualification is usually going to be the most you can afford without any other expenses.
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.
You are right there Brian. You should rent if you can’t make a down payment. That would be the best way to save up until you reach the 20%.
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.
I would never be able to afford a home in NYC. I think that is why it is such a huge rental market up there.
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.
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.
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.
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.
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!
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.
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.
It does take some time to save up for, but it is worth it. I have been paying PMI for 7 years because I didn’t want to save up. That was a mistake.
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!
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.
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!
Our world makes it hard to not be a consumer. Banks give you more money that you should have. Credit cards encourage you to spend outside your limits. Advertisers scream at you for your money. We need to get more non-pf bloggers reading our blogs.
I have to agree with you there Lee!
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.
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!