Buying a home is likely the biggest purchase you’ll ever make. Inasmuch, it’s worth investing energy to understand what costs you may encounter along the way. In addition to the down payment, there are transaction fees, taxes, and repair costs to consider. Set yourself up for success by being real about the house you can afford so you can completely enjoy the ownership benefits.
If you’ve put it out into the universe that you’re house hunting, your mailbox will quickly fill with pre-approval offers listing the amount a bank is willing to loan you for your purchase. Typically this amount is much higher than you may actually be able to afford. Instead of relying on their assessment, consider the factors below and set a budget for yourself.
How Much to Save for a Down Payment
The first thing that comes to mind when considering buying a home is the down payment. This is the amount you put down when financing a mortgage. Most banks require a minimum of 20%. So a $200,000 house would require $40,000. A $400,000 house would require $80,000. It’s difficult to save that much money, so banks offer options. However, you can expect them to come with high fees.
Factor in PMI
Many banks will offer a loan that requires less than 20% down. For example, they may ask you to provide 10% instead. Loans structured this way will most likely require private mortgage insurance, or PMI. This is insurance that protects the lender if you are unable to make your payments. Using the example above, you would provide 10% down, so $20,000 on a $200,000 or $40,000 on a $400,000 home.
The next 10% is taken as a second loan on your mortgage. So, for the $400,000 house, you would have one loan structured with your $40,000 down payment. You would have a second mortgage at another $40,000. This allows buyers who don’t have the 20% down payment to get into a home sooner.
Calculate the Interest Rate
Like it or not, the interest rate on your loan is a huge factor. The first thing to note is your PMI rate will be substantially higher than your primary mortgage. For example, your first mortgage might be at 3% while that other $40,000 is at 6-7%. In short, you’re going to pay a lot more if you don’t have 20% to put down.
As for the interest rate, let’s compare the difference between 2.8% and 3.3%. On a $400,000 house with 20% down and no additional fees, you’d be taking a loan for $320,000. For a conventional 30-year loan, a 2.8% interest rate would cost you $153,350.40 in interest over the life of the loan. At 3.3%, the same $320,000 loan will see $184,524.41 in interest. As for monthly payments (without taxes and insurance), the 2.8% loan would equal $1,314.86, while the 3.3% loan would cost you $1,401.46 monthly.
Include Taxes and Insurance
Property taxes are a way of life when you own a home. Each county calculates their own rate, which varies depending on bond measures that have been passed and other regional factors. Be sure to consider the taxes for any property you think of buying. Taxes that equal $3,600 annually will run you $300/month. Just across the county line, the taxes might be $6,000 a year, costing $500/month for a similar home.
Homeowner insurance is required by lenders too. You might get away with $600 per year or it might cost several thousand dollars. The rate depends on many factors such as whether it’s a log cabin and the age and location of the home.
Both taxes and insurance can be held in escrow and paid by your mortgage company, meaning you pay them along with your monthly mortgage payment. You can also pay them separately. If you lump them in with your mortgage payment you don’t have to worry about when they are due or maintain a separate savings, but note your mortgage payment will be higher. In the example above with a $1,314.86 payment, it could easily run about $500 more with the addition of taxes and insurance, so now your monthly payment is $1814.86.
Add up Closing Costs
Once you’ve tackled the amount you plan to save for your down payment, have a lock on the interest rate, and understand the taxes and insurance, you’ll need to tack on closing costs too. Closing costs are the transaction fees that take place during the process of buying a home. They include things like the bank processing fees, the home inspection required by the bank, and paying the property taxes. Most lenders will allow you to roll closing costs into your loan, but again, this means raising your monthly mortgage. Plan to save $7,000-$15,000 for closing costs.
The point is, it’s crucial to consider all factors and not just the monthly payment you can afford. When calculating how much to save before buying a house, the more you pay up front, the less you’ll pay both monthly and over the life of the loan.