How To Create A Budget For Your House
You’re ready to buy your first home. Or maybe you plan to move to a larger residence as your family grows. You might even be considering downsizing to a smaller residence as your adult children move out. But no matter your future housing plans, you’ll need to know exactly how much you can afford to spend on your new mortgage payment each month.
If you don’t create a household budget outlining your monthly expenses and income, you might spend too much on your new home. That could make paying your mortgage and other housing costs each month a financial burden, erasing much of the excitement of buying your new home.
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The 28% Rule And Your Gross Monthly Income
The 28% rule is a good place to start when determining how much home you can afford. This rule states that you should spend no more than 28% of your gross monthly income on your mortgage payments. Your gross monthly income is the total amount of money you make each month before any taxes or other deductions are removed.
Say your income from all sources, before taxes or other deductions are removed, is $6,000 a month. According to the 28% rule, you should spend no more than $1,680 on your monthly mortgage payment. You should buy a house, then, that gives you a monthly mortgage payment of that amount or lower.
This rule is helpful, but it is not absolute. This is especially true depending on where you live. If you live in a part of the country in which housing prices are high, you might struggle to spend no more than 28% of your gross monthly income on your monthly mortgage payment.
Know Your Monthly Expenses
Your debt-to-income ratio is important, too. This ratio measures how much of your gross monthly income your total expenses consume each month. Many lenders say that your total monthly expenses, including your new mortgage payment, should equal no more than 43% of your gross monthly income.
You can’t calculate your debt-to-income ratio, though, if you don’t first calculate your monthly expenses, both those that stay the same each month and those that vary.
These expenses could include:
- Clothing: You can control how much you spend on clothing, but don’t forget that you will need new shoes, work clothes and even summer shorts eventually. Estimate how much you spend each month on clothing to help determine your monthly expenses.
- Food: You have to eat, right? Look at your monthly grocery bills and come up with an average for how much you spend at the supermarket. Take an honest look, too, at how much you spend on meals out. Calculate how much you spend at restaurants or on takeout during an average month and include that in your monthly food budget.
- Transportation: This might include train or bus fare if you use public transportation to get to work or the cost of gas if you drive each day.
- Medical: It’s not easy to estimate how much you’ll need each month for medical care – emergencies do happen – but when you factor in doctor’s visits, trips to the dentist and the money you spend on prescription medication, medical costs can be some of your largest expenses each month, even if you have health insurance. Look at the money you’ve spent over the last several months on medical treatment to come up with a reasonable monthly estimate.
- Child care: The money you spend on daycare, babysitting, preschool or other forms of childcare can add up, too. Be sure to include this amount in your monthly expenses.
- Student loans: If you are paying back student loan debt, be sure to include your monthly payment in your expenses.
- Car loans: Your car payment is another fixed expense that you’ll need to include in your monthly expenses.
- New mortgage payment: Your new mortgage payment will be one of the largest of your monthly expenses. Estimate how much you’ll pay for your mortgage loan and include it in your list of expenses.
- Utilities: How much you pay for electricity, water, gas and garbage pick-up can vary. But it is a regular monthly expense that should be included in your budget.
- Subscriptions: You might be surprised at how much those subscriptions to Netflix, Pandora, Amazon Prime and Hulu cost. Add them up to see how much of an impact they are having on your expenses.
- Phone and internet service: Your phone and Internet service are two more monthly costs to include in your list of expenses.
Save For A Down Payment
You’ll need to include the costs of saving for a down payment when budgeting for a home purchase. How much you’ll need to put down varies, though.
If you come up with a down payment of at least 20% of your home’s purchase price, you won’t have to pay for private mortgage insurance, or PMI, a type of insurance that protects your lender if you stop making your mortgage payments. The challenge is that 20% can be a lot of money if you live in an area with high housing prices. Consider that 20% of a home costing $425,000 (the median national list price according to realtor.com) comes out to $85,000, not an easy sum to scrape together.
Fortunately, you don’t need 20% down. You can qualify for an FHA loan with a down payment of just 3.5% of your home’s final purchase price if your FICO® credit score is at least 580. And you can also qualify for conventional loans that require down payments as low as 3% of your home’s purchase price. That’s a big difference: 3% of a home costing $425,000 is $12,750, still a lot of money, but not nearly as much as you’d pay for a down payment of 20%.
It might make financial sense to come up with as large of a down payment as you can afford. Lenders usually reward borrowers with lower interest rates based on larger down payments, something that could save you tens of thousands of dollars during the life of your loan.
If you need help saving for a down payment, you can turn to public and private sources for down payment assistance. You might find several down payment assistance programs at the state level.
Don’t Forget About Closing Costs
Your mortgage’s closing costs can run from 3% to 6% of your home’s final purchase price. These are the fees that your lender and third-party providers, such as title companies and inspectors, charge when closing your home loan. If you buy a home that costs $350,000, your closing costs could run from $10,500 to $21,000. That’s another cost you’ll have to include in your budget for buying a home.
If that makes you concerned about home affordability, keep in mind that you might be able to roll closing costs and fees into your mortgage loan instead of paying for them upfront. Say your closing costs are $15,000 on a mortgage loan of $350,000. If you roll your closing costs into your mortgage, you’d pay back $365,000 after closing.
Budget For House Repair and Maintenance Costs
Owning a home comes with extra costs, including repairs and maintenance, both of which can add up. Every house is different, but you can expect to pay from 1% to 4% of your home’s value in home repairs and maintenance each year. If your home is worth $300,000, then, you should expect to pay from $3,000 to $12,000 a year in maintenance and repairs. Again, that’s another big expense you should remember when budgeting for home ownership.
Additional Costs Of Home Ownership
That’s not the full list of homeownership costs, either. There are other items you need to include in your home buying budget.
- Private mortgage insurance (PMI): PMI is a type of insurance that protects lenders if you stop making your mortgage payments. You'll pay for PMI if you put less than 20% of your home's purchase price as a down payment. How much you'll pay varies, but Freddie Mac has estimated that most borrowers will pay $30 to $70 a month for every $100,000 they've borrowed. If your mortgage is $300,000, expect to pay from $90 to $210 a month for PMI. Fortunately, you can request that your lender remove PMI once the principal balance of your mortgage falls to 80% of the original value of your home. Your loan servicer must automatically eliminate your PMI payment when your home's principal balance reaches 78% of the original value of your home.
- Homeowners insurance: Your lender requires that you carry a homeowners insurance policy on your new house. If you don’t, you won’t be able to qualify for a mortgage. Paying for homeowners insurance would make financial sense, though, even if it wasn’t a requirement. This insurance covers your home if it is damaged or destroyed. The cost of a homeowners insurance policy varies depending on your location, the size and age of your home and on several other factors. Insurance.com said that the average cost for homeowners insurance in the United States was $2,777 a year for a policy providing $300,000 in dwelling coverage and a $1,000 deductible in November of 2022.
- Property taxes: When you own a home, you must pay property taxes. The amount you pay is based on your home's assessed value and will vary depending on your state's property tax rate. If you're paying off a mortgage, you'll typically pay a portion of your property taxes with each monthly mortgage payment, with your lender holding these funds in an escrow account. When your property taxes are due, your lender will pay them on your behalf.
How Much House Can You Afford?
When determining how much home you can afford, consider all the costs involved in owning, from a down payment and your monthly mortgage payment to property taxes, homeowners insurance and closing costs. The 28% rule remains a good guideline for how much of your gross monthly income your monthly mortgage payment should consume. But remember, it’s just a guideline. The amount you can afford to spend on a monthly mortgage payment could vary depending on your income and how much homes typically cost in your community.
The Bottom Line
Buying a home will be one of the biggest purchases you make. It’s important, then, to analyze your household budget and your monthly income to determine how much of a mortgage payment you can afford. You don’t want to overspend on a home. A mortgage payment that you struggle to pay each month could suck the joy out of owning a home. If you are confident in your budget and ready to make the move to owning your own home, you can start the mortgage approval process and find your perfect, and affordable, home today!
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