Buying a house is an exciting time. When my wife and I bought 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, this guide shares the steps you need to follow to budget for a home.
Table of Contents
How to Budget For Buying a House
Purchasing a new home is much more than a monthly mortgage payment. Yes, that is an important piece of the situation, but it goes significantly beyond that.
Your homebuying budget needs to include that, but it should also include the various fees you will incur.
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 identifying how much you can comfortably afford. It’s easy to allow emotions to get interfere, especially when buying your first home and overspend.
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 cause you to be house poor and 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 when you pay towards the purchase of a house. This is a cashier’s check you bring when you close on your mortgage.
The amount you put down directly impacts interest rates, so the more you have the lower your rate.
Banks love to see large down payments as it communicates 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), freeing you up from that being included in your loan payment.
However, you can still purchase a home without that amount. Some loan options allow for down payments as low as three and a half percent, and 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, it’s essential to have a healthy savings account. 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 it. Read our guide on ways to save money every month to get some ideas of where to start.
A high yield savings account is often best to store your savings. CIT Bank is our top choice, with its Savings Connect account.
If you can start with at least $100, and electronically deposit $200 a month, you earn 3.25 percent on your cash. They have other account options, with competitive rates, if you’re unable to 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, and this is separate of your down payment.
Closing costs are just one way the lender makes money on 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 them to budge much.
You also need to 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. It’s 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 good credit is an essential piece 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 TrasUnion) 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 what you need and ways to improve your credit.
Make a Budget
Having a budget is vital, especially for first-time homebuyers. You want to analyze all of your expenses to identify which are necessary to have 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 use 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.
Before you begin your house search start saving as much as you can. Look for ways to cut costs, and pick up side hustles if you must to bring in additional income.
If you don’t have one already, think of your down payment as the beginning of having an emergency fund. Unexpected expenses are inevitable and home repairs can be costly.
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 more 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 make in their lives. As a result, 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 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.
When you decide on a lender ask them to make you preapproved for a mortgage. This is an official document showing how much they’re authorizing you to borrow, which 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 one without substantial cost. It’s best to use the 28 percent rule as your guide to determine how much you need to save.
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, to equate 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 likely need tens of thousands of dollars to budget for your first home. As you upgrade that amount will increase.
That can be an overwhelming amount, but it is possible to accomplish with wise steps. A prudent banker or realtor should also help walk you through the process to formulate a plan.
Bottom Line
Buying a house is one of the largest financial goals many people have. The process is not a quick one, but it’s one to plan wisely.
With some shrewd managing and a focus on saving, it’s one you can accomplish to build a home for your future.
What’s one home buying mistake that’s best to avoid?
