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Determining how much money you need to buy a house has always been daunting for first-time homebuyers, but 2022 feels like a new level of frustration. Between home prices hitting record highs and mortgage rates surging, thinking about your budget can feel downright maddening. While it is definitely a seller’s market, buying a home is still a smart move that can help you lay a strong financial foundation for your future. 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. By increasing the size of your down payment, you can lower the amount of money you need to borrow. Plus, lenders like to see larger down payments because they indicate a lower level of risk if you default on the loan.
How much should you put down on a house?
There is a common misconception that you need to put down 20 percent of the purchase price. So, for example, if you’re buying a home that costs $400,000, a 20 percent down payment would be $80,000. In fact, according to the National Association of Realtors, the typical first-time homebuyer makes a down payment of 7 percent of the purchase price.
Several low- and no-down payment mortgages 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.
Ultimately, figuring out your down payment means thinking about the rest of your budget. You shouldn’t plan to spend every penny you have to cover your down payment. You’ll stretch yourself too thin and stress yourself out as you try to cover all your other necessary expenses. Plus, a lender will evaluate your entire financial portfolio and want to see some cash reserves that you can use to pay back your loan if you find yourself in a tough spot. And you should make sure you have enough set aside in an emergency fund to provide a cushion if you receive an unexpectedly large medical bill, lose your job or find yourself in any other worst-case scenario.
Tips to build your down payment fund
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 local support: Be sure to browse first-time homebuyer programs in the city and state where you want to buy. Some programs offer grants or zero-interest loans for your down payment costs if you can meet certain low- to moderate-income requirements.
- Identify every expense you can cut: Saving more starts with spending less. Can you cancel your cable? Are you overpaying for your cell phone service? Should you be dining out less? Look at your weekly and monthly expenses to find ways to trim your spending.
- Put your savings to work: 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. 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
The down payment isn’t the only upfront expense you need to consider. You can expect to pay 2 percent to 5 percent of your mortgage loan principal in closing costs. In 2021, borrowers paid an average $6,387 in closing costs and taxes, according to ClosingCorp. Closing costs vary widely based on where you’re buying, however. For example, average closing costs in Washington, D.C. in 2021 were more than $30,000, but they were just $2,102 in Missouri.
What is included in closing costs?
Closing costs include a range of fees charged by your lender and other companies involved in approving your loan and finalizing the sale:
- An appraisal fee
- Credit report fee
- Origination fee
- Application fee
- Title search fee
- Title insurance
- Underwriting fee
Closing costs vary from lender to lender, so you’ll want to pay close attention to the origination fee and underwriting fee to see where you might be able to save. 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.
Can you avoid closing costs?
You can’t avoid closing costs, but you can avoid paying them all at once. So, 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.
And 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 will 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 will 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 5 percent, you’d pay $1,288 in monthly principal and interest.
How can I get the best mortgage rate?
Your mortgage rate has a big impact on your monthly mortgage payment, which makes it crucial to shop with multiple lenders for the best mortgage rate. For example, if you got that same $240,000 loan at a 5.5 percent rate, the payment for monthly principal and interest increases to $1,362. 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.
What is mortgage insurance?
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. The annual premiums will likely last for the entire loan. 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 – at which point you can cancel the PMI. The cost of PMI varies based on your credit and your loan, so be sure to ask your lender for an estimate of how much it adds to your bill.
What else will impact my payments?
In your long-term outlook of 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 much should I budget to buy a house?
Okay, so how much money do you need to come up with to buy a house? Let’s say that you want to buy a $350,000 house and you want to avoid paying mortgage insurance. Here’s a look at how that could break down:
|Down payment||$70,000 (20 percent)|
|Moving||$1,638 (average cost for a move under 100 miles, according to HomeAdvisor)|
Remember that there are ways to dramatically lower the upfront budget. If you’re okay with paying mortgage insurance, your down payment is just $17,500 – shrinking your budget by $52,500.
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 AnnualCreditReport.com through the end of 2022 (you can typically do it every year, but the credit agencies extended this benefit during the pandemic at least through the end of 2022).
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.
Take a look at all your expenses – your car payment, outstanding student loans, monthly transportation and food costs, utilities and more – to 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. Don’t let the mortgage insurance cost scare you, though. With a conventional loan, you’ll be able to eliminate that pesky fee after you’ve accumulated 20 percent equity in the property, which happens both through payments and through an appreciation in value.
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.
Home prices may be rising, but that doesn’t mean your budget can, too. 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. Remember that once you own the property, you can always work to make improvements and upgrades in the future.
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.