It can be easy to overspend on a home that has all the features you desire.
While you may be able to afford a larger mortgage payment under normal circumstances, a surprise expense or lean month may lead to you raiding your emergency fund. Knowing how to budget for a house can help you avoid financial stress in the future.
How much should I budget?
When budgeting for a home, consider following the 28/36 budgeting rule.
The 28/36 rule: This rule stipulates that your housing expenses shouldn’t exceed 28% of your gross monthly income, and your total debt (including things like credit cards and student loans) should remain below 36% of your gross monthly income.
The latter figure is known as your back-end debt-to-income (DTI) ratio, and it’s the ratio most commonly used by mortgage lenders to help determine whether or not you qualify for a home loan. You can divide your total monthly debt payments by your gross monthly income to calculate your back-end DTI ratio.
Maintaining a debt-to-income ratio of 36% or less can help you qualify for the best mortgage rates. This also provides you with an additional cushion should your take-home pay decrease or your monthly expenses increase after closing.
Mortgage lenders may let you qualify for a conventional loan with a maximum DTI of 43%. However, the underwriting requirements can be stricter and you’ll likely get a higher interest rate.
How much house can I afford?
The 28/36 rule can help you quickly estimate your maximum monthly mortgage payment.
For example, if your gross monthly income is $6,000, your 28/36 limits would be $1,680 (mortgage principal and interest, taxes, and insurance) and $2,160 (total monthly debt payments), respectively.
Here are several factors that impact your potential monthly housing costs:
- Home purchase price: A higher selling price results in a more significant down payment as well as a higher mortgage payment.
- Interest rate and repayment term: A higher interest rate or APR results in you paying more interest per month. Shorter loan terms also require higher monthly payments.
- Mortgage insurance: Putting down a minimum of 20% on a conventional loan allows you to waive private mortgage insurance (PMI).
- Credit score: The higher your credit score, the more likely you are to qualify for the best mortgage rate. Consider reviewing your credit reports for errors before you apply. Correcting these reporting mistakes is an easy way to boost your score.
- Location: Property taxes can vary by county and city. Your desired neighborhood or condominium may also charge homeowners association dues. Choosing a cheaper community can minimize these ongoing expenses, and you may face less competition from other buyers.
- Homeowners insurance premium: A pricier property can be more expensive to insure. Your monthly home insurance premium also depends on which coverage you choose.
Tip: A mortgage calculator can help you quickly compare your estimated monthly payment to your income. Including additional assumptions, such as taxes and insurance, will give you a more accurate idea of what you can afford.
How much should I save for a down payment?
There’s a reason 20% is considered the magic number for a home down payment — by putting down 20% on a conventional loan, you’re viewed as less of a risk to the lender and can waive PMI. If you don’t put down this much, you’ll pay PMI every month until you have at least 20% equity.
If you’re struggling to save enough cash, you may qualify for a first-time homebuyer program that’ll help fund your down payment. Federal-backed loans, such as an FHA loan, are another option. These have low down payment requirements and more flexible income guidelines.
Tip: Your new home budget should also feature a closing costs category. This expense is approximately 2% to 5% of your loan balance, and includes your loan origination fees, home appraisal, and title insurance, among other costs.
Homeownership expenses
In addition to your monthly mortgage payment, your housing budget should also plan for these out-of-pocket homeownership expenses.
Initial expenses
Your move-in expenses can be quite high as you set up your house for daily life. You should plan to set aside a portion of your budget for these items and services:
- Moving services and packing materials
- Furniture
- Appliances
- Internet and cable TV installation
- Utility deposits
- Small repairs and upgrades
These are just a few costs to keep in mind — you may not have a complete list until you start unpacking and realize what’s missing.
Monthly expenses
Your monthly budget will include these recurring expenses, some of which you may not have had to pay for when renting:
- Utility payments: Electricity, water, gas, and trash removal
- Entertainment: Cable, internet, and swimming pool maintenance
- Taxes and fees: Property taxes, HOA fees, homeowners insurance premiums
- Landscaping: Mowing, leaf removal, snow removal, and landscaping
You may also want to include a category for other lifestyle expenses such as commuting costs, outdoor activities, and a gym membership.
Home maintenance
Homeownership can be an excellent way to build wealth and reduce your monthly expenses once you’re mortgage-free. However, one negative consequence of owning your own place is being responsible for the repairs.
An initial home inspection can highlight which repairs are necessary and how soon you need to complete them. In addition, you can use the inspection results to estimate the amount of money you need to set aside.
You should set aside some money — 1% of the home’s purchase price annually is the general recommendation — in case any of these items need to be repaired or replaced:
- HVAC
- Furnace
- Water heater
- Kitchen appliances (i.e., oven, refrigerator, and dishwasher)
- Plumbing
- Roof
- Siding
- Doors and windows
- Basement or crawl space
If you don’t have DIY repair skills or deep cash reserves for repairs, home warranties can minimize your out-of-pocket costs for expensive repairs. You pay an annual fee plus a service call fee for each repair request, but you may not pay any additional costs for most repairs.
Tip: In addition to routine repairs, you may also decide to pursue home improvement projects, like repainting a room or installing new kitchen cabinets. If so, determine how much money you’d need to complete the project, then factor that into your monthly budget.
More budgeting tips for homeowners
Your down payment and upfront home-buying costs will eat up most of your cash during the purchase process.
Here are some additional tips that you’ll want to consider when budgeting for a home:
- Tour multiple properties: Evaluating several homes gives you a better chance of finding the right purchase price and location for your circumstances.
- Compare utility bills: Your monthly utilities may be difficult to estimate before you move in. If possible, find out what the current owner’s heating and cooling bills are.
- Determine necessary repair costs: While a fixer-upper usually sells for a lower price than a turnkey property, the upfront repair costs and time may not be worth the savings. Consider performing a home inspection to identify potential problems.
- Take property upkeep into account: In addition to finding your desired floor plan, look at how much maintenance is necessary for the exterior grounds. For example, you may not want to constantly shovel a long driveway in the winter, mow an expansive yard, or maintain ornate landscaping.
- Review neighborhood and HOA guidelines: Review the community bylaws to verify that they’re not too restrictive. You should also determine if the community benefits are worth your annual dues.
- Make homeownership goals: Have an idea of how many years you want to live in the home. This can help you choose the best home size, location, and mortgage term. For example, if you plan on having kids, you may choose a neighborhood with highly rated schools even if it means a longer daily commute.
- Reduce your outstanding debt: Keeping your DTI ratio and monthly expenses low makes it easier to qualify for the best mortgage rates. And, you can put any savings toward your down payment and closing costs.
- Consider a 30-year mortgage: Choosing a 30-year repayment term lets you qualify for the lowest monthly mortgage payment. As a result, you have more money at the end of the month for groceries and other financial priorities. You can always put more money toward your mortgage payment down the road if your budget permits.
In addition to these suggestions, you’ll want to compare mortgage rates from several lenders. This can save you hundreds, even thousands of dollars in interest.
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