Saving up for a down payment on a house is one of the most important things you can do before starting your house hunt. But even a 20% down payment won’t help you much if your monthly payments on a new house stretch your budget too thin.
This is what is often referred to as house poor and it’s a wise idea to avoid this. So, how do you really know how much house you can comfortably afford to buy? You can start by estimating all of your eventual monthly housing costs, including your mortgage, insurance, taxes, repairs and more.
Read on to learn about the costs involved in buying a house. From there you can best determine what you’ll actually be spending every month.
Principal and interest
This is the basic monthly cost of your mortgage loan, which you pay directly to the lender. This includes your monthly principal as well as any interest that you pay on the life of your loan.
Keep in mind that if you’re making a down payment or have closing costs, the loan amount will be different than the sales price of the home. As an example, let’s say you have your eye on a home with a sales price of $250,000 and can afford a $25,000 down payment.
The closing costs, which are fees and expenses you pay to complete the sale of the home, will be three percent of the sales price or $7,500. You’ll be expected to pay this amount when you close on the sale of your house.
Getting back to the actual mortgage, in this scenario your total loan amount is $225,000. Let’s say you choose a 30-year fixed-rate mortgage with a 4.5% interest rate. Using a simple loan calculator, your monthly principal and interest payment would be $1,140.04.
Depending on the type of loan you apply for and the size of your down payment, you may be required to pay mortgage insurance. The beneficiary of the insurance policy is the mortgage lender and this coverage protects the lender if you default on your loan.
To give you an idea of what to expect, here’s how much mortgage insurance typically costs by loan type and your loan-to-value ratio, which is calculated by taking your total loan amount and dividing it by the value of the home.
|Loan type||Loan to value||Mortgage insurance cost|
|Conventional loan||0% to 19.99%||$30 to $70 per month for every $100,000 borrowed|
|FHA loan||All loans||Upfront cost at closing of 1.75%; annual cost of 0.45% to 1.05%|
|USDA loan||All loans||Upfront cost at closing of 1%; annual cost of 0.35%|
|VA loan||All loans||Upfront cost of 1.25% to 3.3%; no annual cost|
So, let’s take our previous example to calculate your monthly mortgage insurance costs. You opt for a conventional mortgage, and your loan-to-value ratio is 90%, so you’ll need to pay what’s called private mortgage insurance (PMI). The lender’s insurance company charges $50 per $100,000 borrowed. So, with a $225,000 loan, your monthly PMI bill would be $112.50. This premium will be added to your monthly mortgage payment.
With conventional loans, your PMI requirement will “fall off” your loan automatically once your loan-to-value ratio reaches 78%. That said, you can request to have it removed once your loan to value is 80%.
Once you buy a house, it will likely be the most valuable asset you’ve ever had. As such, you’ll want to insure it against damage, loss and other hazards.
In addition, if you have a mortgage, the lender will require an adequate homeowners insurance policy because it technically owns the property until you pay off the loan. Homeowners insurance costs can vary depending on where you live and other factors. But the average annual premium in the U.S. is $1,083 or $90.25 per month.
Depending on your mortgage lender and situation, you will either pay this directly to the insurance company or to the mortgage company into an escrow account. In an escrow account, your lender collects your monthly insurance premiums and then pays for the insurance on your behalf. By tacking your homeowners insurance premium onto your monthly mortgage payment, it ensures that you don’t accidentally miss a payment and lose your coverage.
State and local government agencies collect property taxes every year based on the value of your home and the property upon which it stands.
Property tax rates not only depend on the state where you live but also your county, township or school district. So, let’s say you live in Arizona, where the average property tax rate is 0.77%. With a home value of $250,000, your property tax bill would be $1,925 annually or $160.42 per month.
Maintenance and repairs
Whether your home is brand new or 100 years old, you can expect to pay for regular maintenance and unexpected repairs. The worst part about this is that there’s no way to know for sure how much these expenses will cost.
For this reason, it’s wise to have an emergency fund with enough money in reserves. Consider opening a separate bank account to keep the money away from your everyday spending. As for how much you should have saved up, experts recommend that you save between one to three percent of the home’s purchase price. If you split the difference and save two percent on a home worth $250,000, that’s $5,000 a year or $416.67 per month.
Calculating your monthly payment
Once you determine the budget for your new home, you’ll have an idea of whether or not you can afford the house you’ve got your eye on.
For that $250,000 home, here’s how the costs add up:
- Principal and interest: $1,140.04
- Mortgage insurance: $112.50
- Homeowners insurance: $90.25
- Property taxes: $160.42
- Maintenance and repairs: $416.67
All told, the total monthly budget to afford that house is $1,919.88 — or $1,503.21 if you already have the $400 plus a month saved up in your emergency fund.
So, take a look at your budget before you decide whether you can comfortably afford to buy a particular house – without becoming house poor. If you discover that it’s just too expensive, no worries. You can either keep looking for another other house that fits your budget or continue to save more money for a bigger down payment.