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How to figure out if you actually have enough money to buy your first home
Select asked Paula Pant what factors to consider when figuring out if you saved enough for a house.
Buying your first home can feel daunting, especially with the recent dramatic rise in home prices. It's one of, if not the biggest purchase, that you'll ever make.
So Select asked Paula Pant, a financial expert and real estate investor, to break down what factors should be considered when figuring out if you actually have enough money to buy a home.
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Examine where you currently stand on other financial goals
Before you start calculating how much you need for a down payment or shopping around for mortgages, you'll want to make sure you have a few financial bases covered. Staying on top of the basics can help you stay in control of your money and set you up to achieve long-term goals, like retiring with enough money to keep you afloat in your golden years. And, these basics can help you maintain some financial security even if buying a home ends up being more expensive than you initially thought, or if costly events occur in the process.
"Start by asking yourself: Do I have credit card debt?" said Pant. "If the answer is yes, then you're not ready to buy a home. Pay it off first. Next ask, do I have an emergency fund that can last me at least three months? If the answer is no, you aren't ready. Am I contributing to my retirement account up to at least match? If the answer is no, you aren't ready."
Be aware that the mortgage you qualify for may not always be the mortgage you can afford
When applying for a mortgage, an underwriter will approve you for a loan amount that will be repaid in fixed monthly increments over the course of 15 or 30 years (with interest, of course). Lenders base this amount off of your gross monthly income — aka, how much you earn each month before taxes, 401(k) contributions, insurance premiums, etc.
"The bank may approve you for a loan that's bigger than what you may actually be able to afford to take out," Pant explains. "But what you qualify for and what you can afford are two different questions."
Your circumstances can affect how much of a monthly payment you can actually afford. Take a married couple for instance, Pant says. If the couple plans to have a child and have one person quit their job after buying a home, they'll need to consider a house they can maintain on just one person's income.
These are some expenses that mortgage underwriters don't consider when approving you for a loan, yet they can impact how much you can comfortably afford to spend on housing each month. Another circumstance that can affect how big of a mortgage you should consider is whether or not you currently offer family members financial assistance.
"Maybe you have family overseas and you send them remittances. That's not the type of thing an underwriter will screen for but that's a responsibility you have that will take a bite out of your budget," Pant explained.
You can use a mortgage calculator to start getting an idea of how large of a mortgage you can afford, but remember to take an honest look at your monthly expenses and other financial responsibilities you're on the hook for — a budgeting app like Mint or Empower (formerly Personal Capital) can help you do this. This way, you can avoid feeling like you're stretching yourself too thin between paying for a home, saving for retirement and financing other necessary monthly expenses.
Know all the costs before you begin the process
One of the biggest (and most well-known) aspects of buying a home is the down payment, which is a portion of the home's price you'll pay upfront. The down payment amount you ultimately pay can depend on the home's price and the type of loan you take. With an FHA loan, which you can qualify for if you're a first-time home buyer, your down payment can be as little as 3.5% of the home's value. With a conventional loan, you can put down as little as 3% but conventional loans tend to have stricter guidelines for qualification, like higher credit scores and a lower debt-to-income ratio. However, the average down payment in the U.S. is about 6% of the cost of a house.
There are also USDA loans, which are low-interest loans that don't require a down payment. They're geared toward low-income individuals who don't qualify for traditional loans and are interested in purchasing a home in rural or suburban areas.
Also keep in mind that if you put down less than 20%, you'll be required to pay a monthly private mortgage insurance (PMI for short for a conventional loan) or a mortgage insurance premium (MIP for short for an FHA loan). You'll pay the PMI or MIP until you've made enough monthly mortgage payments to have built up 20% equity in the home.
And while homeowner's insurance is not required by law, some lenders may make it mandatory in order to take on the mortgage. So this may be another monthly cost you have to consider when figuring out how much of a monthly payment you can afford.
Then in order to officially call this place your home, you'll need to pay closing costs. Closing costs are made up of a bunch of smaller fees and costs associated with buying a home. They can include an application fee, an appraisal fee, a credit check fee, underwriting fees, title insurance and a title search fee. These can all add up to around 2% - 5% of the loan amount, however, you may be able to negotiate to have the seller cover all or some of these costs.
So keep in mind that all these costs can influence how much you're willing to spend on your home each month, which can, in turn, affect how much you save for your down payment.
Don't forget to account for all the "little" costs of homeownership
There are also upfront costs of settling into your new home that can impact how much money you decide to save up when buying property.
"There are highly variable costs that take a bigger chunk out of your budget than you may anticipate," Pant explained. "You have moving costs like getting truck, hiring movers and buying boxes and tape for moving your stuff. And there are lots of little things you'll want almost immediately for the home like curtain rods, a shoe rack, a bath mat and more. These costs add up quickly."
Pant asserts that not accounting for these costs is actually a huge mistake that many first-time home buyers make. So you might also want to consider saving up separately for these expenses.
Buying your first home can feel daunting. But before diving in, the first thing you should do is analyze your financial picture to figure out if buying a home is a good idea for you at the moment. If you have credit card debt, haven't been making adequate retirement account contributions and don't have an emergency fund, you should press pause on the idea of home buying until you take care of those obligations. FYI, you may be able to pay down your credit card debt a little faster with a balance transfer card that won't charge you interest for an introductory period, like the U.S. Bank Visa® Platinum Card or the Citi® Double Cash Card (see rates and fees).
Bear in mind all the costs of buying a home. The amount you save for a home will depend on the type of loan that works best for you and whether or not you're willing to take on a monthly mortgage insurance. You'll also want to be prepared to cover closing costs, moving expenses and new furniture for your home
All things considered, if you think you can put a checkmark next to all of these costs, you may have enough money to move forward with a home purchase. But even if you find that you don't have enough to cover everything, it's always ok to keep saving and not rush into a decision.
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