The cost of buying a home is on the rise. In the last 10 years alone, prices have increased in almost every major U.S. city, according to home investment company Unison's 2018 Home Affordability Report.
Becoming a homeowners is a huge financial undertaking, requiring far more than a simple down payment. So how do you determine exactly how much you need to save to be able to afford to buy a house?
First, start by figuring out where and how you want to live. The more you can flesh your ideal area, the better. Eric Roberge, CFP and founder of Beyond Your Hammock, recommends asking yourself the following four questions:
- Do I want to live in an urban or rural neighborhood?
- Would I be okay with neighbors in my building or do I want a standalone house?
- Do I care how long my commute is?
- Do I want to drive, ride the train or walk to my normal destinations?
"These questions will help you narrow down the areas that fit with your vision," he tells CNBC Make It.
Next, figure out how much home you can afford, based on your current income, expenses and future goals. Keep in mind that just because you can afford a bigger space doesn't mean you necessarily need one, and more space can mean higher real estate taxes.
Roberge recommends researching the average price of a home in your dream neighborhood and taking 20 percent of that number: that equals your hypothetical down payment. How many months would it take you to save up that amount?
"Although you do not have to put 20 percent down on a home, this will give you a framework to help you decide if it's possible to own a home in that neighborhood," Roberge says.
To truly afford a house, you need more than just a down payment. Ultimately, you'll want to be able to comfortably cover six factors: the down payment, closing costs, moving expenses, repairs and maintenance, the first few months' mortgage payments and your emergency fund.
Let's break down what that entails:
The down payment can range from 3.5 percent to 20 percent of the total cost of the home, depending on your credit score, mortgage interest rate and current financial situation. Cathy Derus, CPA and founder of Brightwater Financial, recommends putting down closer to 20 percent because it gives you a bigger stake in the property right away.
"You're going to be lowering your monthly payment in the future, and you also have a buffer," she tells CNBC Make It. "If housing prices decrease and you need to sell your home, you're not going to be as much underwater if you have more of that equity in the home up front."
Closing costs, including inspection fees, property taxes and prepaid interest, will typically tack 2-5 percent of the total cost of the home onto the final price.
Don't overlook the money it will take to make your new house a home. In addition to physically getting your stuff there, immediate expenses crop up. Do you need new furniture to fill a larger space? Do you want to decorate as soon as you move in?
"Unless your home is brand new, there could be things that you'll need to upgrade or add," Roberge says. "It's human nature to want to make the home feel, well 'homey' and comfortable, so people often end up buying furniture after they move in."
Will you be able to comfortably keep up with your mortgage in the first few months after purchase? Some lenders require additional cash reserves to prove that you're able to make payments, Derus says. Even if it's not required, it's smart to know that you're set.
"What's to say that a week after closing, the company you work for goes bankrupt and you lose your job, or something like that?" Derus says. "You want to make sure that you have additional money set aside, just in case something happens."
You should include taxes and insurance payments in this category as well.
Chances are, your house won't be perfect on move-in day. Whether it's adding a fence or getting rid of that garish yellow paint in the living room, you'll want to have cash ready for repairs and maintenance.
Going forward, homeowners should expect to pay 10-to-20 percent of the price of the home each year, according to Derus. That covers expected costs, such as mortgage payments, insurance, utility bills and taxes, and also maintenance costs.
Plan to have a savings cushion for irregular expenses, too, such as replacing a leaky roof or installing a security system.
Buying a home typically signifies that you've reached a major savings goal, so it's normal to see your accounts drain. But you should still have a separate emergency fund stocked with three-to-six months' worth of living expenses.
If closing on your house means emptying out your entire savings account, you might want to rethink whether you can truly afford a home right now.
All of these factors added together will allow you to calculate a ballpark figure for how much you'll need saved up to be able to afford a house. Keep in mind that you don't want this number to exceed 25-to-30 percent of your income for the year, Derus says.
But if you do the math and would be barely able to scrape by, consider holding off until you're in a more stable financial position.
"If your top priority [for buying a home] is 'because it's a good investment, I'm wasting my money on rent, or because it's just that time in my life when I need to grow up,' run fast the other way," Roberge says. "Those are emotional decisions, not financially responsible ones."
Remember, planning for the future is important. Before making any major purchases, always take stock of your individual situation and do what works for you and your family.
"Being smart with your money can look like living in an affordable rental and continuing to save and invest for future goals," Roberge says. "Breaking even or overspending is not a viable solution for anyone."
This is an updated version of a previously published article.
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