The home buying process can be exciting. Going house hunting and attending open houses can understandably get you pumped about the potential life changes ahead. But, in addition to finding a house with your desired square footage and number of bedrooms, you’ll need to find one you can afford. Knowing what monthly mortgage payment you can manage requires having a budget in place.
Let’s take a look at how to approach creating a house budget that will work for you.
A lot goes into budgeting for a home, and it’s understandable that you may not know where to start – especially if you’re a first-time home buyer. Let’s review the steps to budgeting for a house.
Before you can begin determining how much house you can afford, you’ll need to take an honest look at your monthly income and spending habits. Your gross income is the total amount of money you earn before any deductions are taken out, such as taxes, retirement contributions or health insurance premiums. Your gross income includes wages, salaries, bonuses and any other income streams you may have. Understanding this figure provides the foundation for determining how much house you can afford without overstressing your finances.
Once you've identified your gross monthly income, the next step is itemizing and categorizing your monthly expenses. Categorizing your spending by fixed and variable expenses helps pinpoint areas where you may be able to cut back, while also clarifying the portion of your income that can be put towards a down payment and future mortgage payments. For example, groceries are a variable expense, and your spending in that category can sometimes be reduced through more careful meal planning. However, you likely won’t want to make a house budget that will require you to cut back too far, especially in such an essential category.
Don’t forget to include expenses that occur less frequently than monthly, such as vehicle maintenance or annual memberships. Work these into your home buying budget by averaging their cost over 12 months.
It may be helpful to break down your recurring monthly expenses into categories, evaluating which are a necessity and which you could do without. That way, you’ll know if there's any wiggle room in your budget.
Another important number to know when you buy a home is the amount of money you plan to put down. Knowing how much you can afford as a down payment will help you calculate your potential loan principal for any house you’re thinking of buying.
The exact amount you’ll need to put down depends on factors like your lender and the type of loan. This amount can sometimes be as high as 20% of the sale price, but most lenders won’t require this much. You may be able to buy a home with as little as 3% down for a conventional loan, 3.5% down for an FHA loan and zero down for a VA loan.
It’s important to note that there are benefits of a larger down payment if you can afford to make one. For example, you may get a better interest rate and avoid private mortgage insurance if you can put down the full 20%.
Once you know how much income you have to work with and the amount you plan to put down on a home, you can start determining how much you can afford to spend on housing each month. One common rule that many home buyers consider when budgeting for a house is the 28% rule, which states that you should spend no more than 28% of your gross income on housing expenses. Keep in mind that while the 28% rule can be a great starting point, it’s not a hard and fast rule that will work for everyone.
Let’s take a look at some components that may need to be included in your housing budget.