Before you begin the home buying process, it’s important to take the time to understand how to budget to buy a home. In the time leading up to closing you’ll need to make smart financial decisions and save strategically for your home buying budget.
By Jordan Watts
Buying a house is an exciting and expensive milestone. You should be proud of yourself for making the decision to invest in your dream home, but that doesn’t mean it isn’t overwhelming. There are hundreds of little details that need to be accounted for when buying a home– from mortgage payments to plans for your future utility bills. That’s where your home-buying budget comes in.
Before you begin the home buying process, it’s important to take the time to understand how to budget to buy a home. In the time leading up to closing you’ll need to make smart financial decisions and save strategically for your home buying budget. Over time though, you’ll be able to secure your dream home. Even in this economy! To help, we’ve put together our tips and tricks for how to budget to buy a home.
Whether you’ve already started saving up or you’re looking to start squirreling away some cash for your future home, it’s wise to calculate how much house you can afford on your current income. Remember, it’s important to be realistic about your gross monthly income and total monthly debt payments to get the most accurate estimate.
The 28/36 rule is a commonly used principle for homebuying, it states that you shouldn’t spend more than 28% of your monthly gross income (or pre-tax income) on home-related costs and no more than 36% on total debts. Your total debts include everything from monthly mortgage to credit card payments and student loan payments.
Example: Let’s keep the numbers simple and say that you earn $10,000 a month. If you’re following the 28/36 rule then your monthly expenses for housing shouldn’t exceed $2800 and your total debt shouldn’t exceed $3600. In terms of how much house you can afford, this would mean your monthly payments shouldn’t exceed $2800 for a mortgage.
While the 28/36 rule is a solid starting point for determining your home affordability, there are a number of additional factors that you’ll want to take into consideration. To assess your entire financial situation we recommend using a home affordability calculator, like the one offered by NerdWallet.
Your gross monthly income is your total monthly income before taxes or deductions are taken out. This number helps to determine how much house you can afford based on what you can comfortably spend on a monthly payment.
To calculate your monthly gross income, you’ll need to add up all your monthly sources of income– including any side hustles that bring in steady income. If you have a yearly salary, you can divide your annual income by 12 to find your monthly income.
Your income isn’t the only factor influencing how much house you can afford. Other factors that affect affordability include current mortgage rates, cash reserves, home ownership costs, and credit score.
Interest rates will impact your mortgage payment and how much home you can afford. When you apply for a mortgage, you’ll get a quote based on your current personal finances situation. Mortgage rates can vary daily depending on the mortgage lender and large-scale economic factors. Some even change daily.
The interest rate you’re quoted is relative to a lender’s base rate on the day you apply. A higher credit score, steady income, and solid purchasing power for your down payment will put you at the lowest interest rate possible– lowering your monthly mortgage payment.
Pro Tip: If you’re looking to lower your estimated mortgage rate consider building your credit score, paying down debts, and doing your best to pay bills on time. A healthy household budget is a great way to get started taking control of your financial situation.
Your cash reserves are the amount of money you have available for a down payment and closing costs. This can include savings and investments. Some lenders may want you to have enough cash readily available to cover a few months of mortgage payments, too.
When you buy a home you’ll have additional expenses that extend beyond your monthly mortgage payment. Some things, like utilities, you’ll incur no matter where you live or how energy efficient you are. However, it’s important to remember that even universal expenses can shift in price point. Heating and cooling a house is likely to be more expensive than an apartment. You may want to budget an emergency fund for unexpected expenses and regular upkeep, too.
Pro Tip: Use our home energy usage calculator to estimate how much your electricity bill might increase when moving into a new house.
Your current credit score and any debt you owe can influence a lender’s view of you as a borrower. A lower credit score can result in less money available to borrow and potentially higher interest rates for mortgage loans. On the other hand, if you have one of the highest credit scores possible you’ll likely see a higher loan amount available.
Budgeting to buy a home involves more than just the upfront cost of a down payment. You’ll also need to consider your mortgage payments and debt to income ratio in your housing budget.
Think of your mortgage payment as your monthly "rent" for owning a home. Lenders figure out this number based on your loan amount, interest rate, and how long you’ll be paying it off. But that’s not the whole picture—your housing budget also has to cover things like utilities, property taxes, and homeowners insurance. These are the recurring costs of keeping a roof over your head, so it’s smart to plan for them upfront.
If you want to lower your monthly mortgage payment you have a couple of options. Start by shopping around for the best mortgage rates to ensure that you’re not overpaying in the long run. You can also consider longer loan terms or a larger down payment to help lower you mortgage payments.
Your debt to income ratio (DTI) is the percentage of your monthly gross income that goes toward paying off debt, such as car loan or student loan payments. When you’re applying for a home loan, most lenders will also include your future monthly mortgage payment in the calculation.
Your debt to income ratio is used to gauge if you’ll be able to pay off a mortgage loan, considering other debt obligations. Debt to income ratio also plays a role in determining how much you can borrow.
You’ll want to aim for the lowest debt to income ratio possible– not just to qualify with the best mortgage lenders for your housing budget, but also to ensure stable personal finances for your home.
Most folks will need to get a home loan to help with their down payment or help bring down mortgage rates. There are a wide range of loan options available depending on your personal and financial circumstances, including conventional loans, FHA loans, and VA loans.
Be sure to ask your mortgage lender what type, if any, would be best for your family.
Some of the biggest categories in your housing budget will be your down payment and closing costs. These housing costs won’t be part of your monthly payments, but can have a big impact on them in the long run.
While there’s no one right answer as to how much you should put down for a down payment, a good rule of thumb is at least 20% of the total purchase price. With a down payment of 20% or more you’ll be able to avoid private mortgage insurance (PMI). Unlike the principal of your loan, private mortgage insurance payments do not go into building equity in your home or, in other words, is money that cannot be recouped if you choose to sell your house.
As previously mentioned, putting down a larger down payment can also help reduce your monthly mortgage payments. Make sure to use a mortgage calculator to determine how much you can afford to put down.
Closing costs are fees paid when you buy or refinance a home in addition to the purchase price. Typically, closing costs range from 2%-6% of the purchase price, meaning that they’re definitely worth including in your housing budget.
While your down payment and mortgage will make up a large portion of your homebuying budget, they’re not the only expenses that you need to consider. Although home ownership is often a better investment than renting, that doesn’t mean it’s cheap. Before you buy it’s important to calculate other housing expenses that go beyond your home’s purchase price to determine how much you can afford.
Property taxes are an annual or semiannual charge from the local government paid by homeowners within the jurisdiction. While property taxes vary based on the value of your home and the municipality you live in, you can typically find property tax calculators for your area online.
While homeowner’s insurance is not a required expense, it is often highly recommended. Homeowner’s insurance protects your home and property in case of an emergency, including events like a fire, flood, or theft. It also acts as a safeguard for your personal finances and can supplement an emergency fund if you need it.
No matter how good you are at reducing other expenses to save money, your utility bills will be a consistent monthly expense. Utilities typically include water, electricity, and natural gas, although they can include more services.
Pro Tip: If you live in an area with a deregulated energy market, make sure that you’re shopping around for the best electricity plans and providers. Customers who compare rates with EnergyBot typically save an average of 20% on their monthly bill.
Depending on where your new home is located, you may be subject to the rules and regulations of a homeowner’s association– as well as HOA fees. These HOA fees often help to pay for neighborhood events, upkeep, and more.
Ready to finalize your home buying budget? By beginning the home buying process with a well-informed and clear perspective on your budget, you can ensure that you’ll save money in the long run.
Make sure your new home has power the day you move in by comparing electricity rates with EnergyBot.
