How much money do you need to buy a house?

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Determining how much money you need to buy a house has always been daunting for first-time homebuyers, but in 2021, thinking about your budget can feel downright maddening, with home prices hitting new highs across the country. Despite the challenges of a seller’s market, buying a home can help you escape renting and build equity. Here’s a rundown of the key costs in making homeownership a reality.

Breaking down the cost of buying a home

As you consider the price tag of a home, it’s important to calculate the three major expenses you’ll need to cover in order to call it your own:

1. Down payment

The down payment is the amount of money you can afford to contribute to the home purchase. You’ll get the most favorable mortgage rates and avoid paying mortgage insurance by making a down payment of at least 20 percent. That’s because lenders take on less risk with borrowers who put more money down.

With a 20 percent down payment, you’ll pay $20,000 for every $100,000 of the home’s price. For example, on a $300,000 home, a 20 percent down payment would be $60,000.

However, the belief that you have to have 20 percent of the purchase price is a myth. There are several low- and no-down payment mortgages out there that allow for less money upfront. Some conventional mortgage programs backed by Fannie Mae and Freddie Mac require just 3 percent down. The caveat with these types of loans is that they can have income restrictions and require a higher credit score.

FHA loans require just 3.5 percent down, and you’ll need a credit score of at least 580 to qualify. VA loans and USDA loans don’t require a down payment at all, although you’ll need to meet certain criteria in order to be eligible.

Be sure to browse first-time homebuyer programs in the city and state where you want to buy, too. Some programs offer grants or zero-interest loans for your down payment costs if you can meet certain low- to moderate-income requirements. 

You shouldn’t plan to spend every penny you have to cover your down payment. A lender will evaluate your entire financial portfolio and might want to see some cash reserves that you can use to pay back your loan if you find yourself in a tough spot. You’ll also want to have enough set aside in an emergency fund (three to six months’ worth of expenses or more).

Regardless of how much you plan to put down when you buy a home, coming up with that big upfront cost requires some work. Consider these helpful tips to build your down payment funds:

  • Look for little ways to spend less. Take a look at your spending habits, and identify every area where you can trim a few bucks. Can you cancel your cable? Are you overpaying for your cell phone service? Should you be dining out less? 
  • Earn interest. From CDs to high-yield savings accounts, every extra penny counts. Rather than saving in an account that pays little to no interest, compare interest rates on options where you can park your money. You can estimate your potential earnings with Bankrate’s compound interest calculator. Whichever instrument you use, just be sure you’ll have access to the funds when you need them. If you’re planning to buy a home in the next year, for example, a savings account might be your best bet.
  • Ask for help. If you have a relative or close friend who has the money — and loves you enough to give it to you with no strings attached — a gift can be used for the down payment. A lender will want reassurance that it is, in fact, a gift, so plan to submit a gift letter from the friend or family member that explains you won’t need to pay it back.

2. Closing costs

Generally, you can expect to pay 2 percent to 5 percent of your mortgage loan principal in closing costs. In 2020, borrowers paid an average $6,087 in closing costs and taxes, according to ClosingCorp. Closing costs vary widely from state to state, however. For example, average closing costs in New York in 2020 were $13,261, but just $1,571 in Missouri. 

Closing costs include lender and third-party fees, which can include an appraisal fee, credit report fee, origination fee, application fee, title search fee, title insurance and underwriting fee.

If you don’t have cash to pay for closing costs, ask your lender about no-closing-cost options. Some lenders will roll the expenses into the overall loan. Just keep in mind that doing so will cost you more in the long run, since you’ll be paying interest on the additional amount.

It’s important to note that you’ll likely pay some additional expenses on closing day that aren’t considered closing costs. These are known as prepaids, and can include homeowners insurance premiums and property taxes. You’ll also prepay interest on any days remaining through the end of the month. For example, if you close on April 20, you will prepay on interest through April 30.

On top of closing costs and prepaids, you’ll also want to earmark money for moving expenses, furniture, repairs, storage or any other costs you might encounter as you move into your new home.

3. Mortgage payment

As you’re thinking about how much money you need to buy a house, it’s crucial to know how much it’ll cost you every month, not just on closing day. 

Your monthly mortgage payment is one of the most predictable ongoing costs. You can use a mortgage calculator to figure out how much you’ll owe each month. For example, if you borrow $240,000 and finance it with a 30-year, fixed-rate mortgage at 3 percent, you’d pay $1,011 in monthly principal and interest.

Your mortgage rate has big impact on your monthly mortgage payment, which makes it crucial to shop with multiple lenders for the best mortgage rate. According to a Consumer Financial Protection Bureau study, more than three-quarters of all borrowers only applied for a mortgage with one lender, and failing to comparison-shop could cost you thousands over the life of the loan.

In addition to paying the principal and interest, your mortgage payment will likely include mortgage insurance if you put less than 20 percent down. Mortgage insurance is a protection for the lender in case you ever cannot pay the loan back.

If you have an FHA loan, you will almost certainly pay mortgage insurance, which includes a premium upfront and additional premiums built into your mortgage payment. If you have a conventional loan with a down payment less than 20 percent, you’ll pay private mortgage insurance (PMI) until you have built up 20 percent equity in the home. While the cost of PMI varies based on your credit and your loan, Freddie Mac estimates that borrowers pay an extra $30 to $70 per month for every $100,000 borrowed.

For your long-term outlook for the costs of being a homeowner, be sure to factor in homeowners insurance, property taxes, any HOA fees if your property is part of an association and regular maintenance expenses. Consider budgeting for emergency home repairs and maintenance in the amount of 1 percent or more of your home’s value every year. For example, on a $300,000 home, your budget for maintenance-related items would be $3,000 annually.

How to prepare to buy a home

Once you’ve answered the big question of how much money you need to buy a house, it’s time to answer another one: how to get ready to make the actual purchase. Here are some steps to take to prepare to buy a home.

1. Check your credit 

Mortgage lenders use your credit score, along with other criteria, to determine your creditworthiness. You can get your credit score from each of the three major credit reporting agencies (Equifax, Experian and TransUnion) for free every week from through April 2022 (you can typically do it every year, but the credit agencies extended this benefit due to the pandemic).

There are also many online services now offering credit scores for free — and your bank might offer this, too. If your score is on the lower side, try to take steps to improve your credit before seeking out a mortgage.

2. Create a budget

Based on the costs listed above, create a realistic budget. Many experts recommend following the 28/36 percent rule, with which you should spend no more than 28 percent of your gross monthly income on housing and no more than 36 percent total on debt, including your housing costs.

3. Save for a down payment

You’ll typically need at least 3 percent of the purchase price of the home as a down payment. Keep in mind that you’ll need to put at least 20 percent down to avoid having to pay for mortgage insurance, however.

4. Shop for a lender

Getting preapproved by a lender for a mortgage is helpful when shopping for a home. Not only does it make you a more serious buyer to sellers, but it also provides you with a better idea of how much home you can truly afford. Start by shopping around and getting quotes from at least three lenders.

5. Be willing to compromise 

While home prices are rising, that doesn’t mean your budget can, too. Nearly one in five first-time homebuyers have had to eliminate some items on their wish list in order to afford a property, according to a recent survey. From being willing to give up on a garage as a must-have to ditching the need for a finished basement, buying a home might require you to bargain with yourself.

Bottom line

When it comes to how much money you need to buy a house, there’s much more than the listing price to consider. Make sure to account for both upfront and ongoing expenses when creating a budget, and take a close look at your monthly finances to make sure that carrying a mortgage and paying for continuing expenses won’t be a financial burden long-term.

With additional reporting by David McMillin

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