How Much Money Do You Need to Buy Your Dream Home?

The moment has arrived; you've had your eye on a certain house in your neighborhood for years, and it just hit the market. This is the dream home of all dream homes - everyone in your family agrees. So, what's stopping you from snatching it right up?

Affording a house

The first step in buying a house is knowing how much you can afford. You might be thinking, okay – so to find that out, I go meet with a mortgage lender or go online to a lender’s site and they will tell me how much I can afford. Easy, right?

Not so fast. Just because you’re approved for a certain amount doesn’t mean you can afford it. Lenders and banks — and even a lot of real estate agents — are generally looking out for their own best interests first. Not yours. That means if it benefits them for you to buy a house slightly outside your comfort zone as far as budget, they’ll likely encourage it.

You need to be the one looking out for your own interests and deciding the amount you feel comfortable spending. To know that, it helps to understand the key costs.

Homeowner costs

1. You need to have money saved for upfront costs.

Before you start paying a monthly mortgage, there will be some costs you’ll need to pay upfront:

• Earnest money. When you find a house you want to make an offer on, you’ll be expected to provide money along with your verbal offer. Earnest money is a good-faith deposit that shows the buyer you’re serious about obtaining financing. How much you’ll pay in earnest money will depend on your housing market, so you’ll want to check with your realtor or real estate agent. A good rule of thumb is to plan on about 1-2% of the purchase price.
• Down payment. If you’re pursuing a conventional home loan, you’ll be expected to put a chunk of money down when you buy the house (i.e. if the home price is $200,000 you can’t take out a loan for the entire $200,000). The rule of thumb for a down payment is that you should put down 20 percent of the purchase price. However, this amount will vary based on your credit score and your lender. Plus, if you are a first-time home buyer or a veteran, there are home loans available that require smaller down payments.
• Closing costs. These are all the administrative fees and expenses that go along with the purchase of the home (like attorney fees, appraisal fees, underwriting fees, title search fees, etc.). Generally, the buyer and seller split closing costs in some way, but you can make the payment of closing costs part of your purchase negotiation — either asking the seller to pay closing costs or offering to pay them to sweeten the deal. Plan on total closing costs being at least 3% of your home’s purchase price (but they can be as high as 7%, depending on the deal you work out).

If you do the math, these three categories could add up to nearly 1/4 of the purchase price. Be prepared!

2. You need to determine how much you can spend per month.

If you don’t have a budget, you’ll need to list out your regular monthly expenses (phone, car, loans, debt, groceries, etc.) and then compare that to your regular monthly income (after taxes). How much of the amount left do you feel comfortable putting toward a mortgage payment?

Keep in mind that you’ll want to budget not only for the mortgage but also for insurance, potential homeowner association (HOA) fees and taxes. Once you decide on an amount you feel comfortable with, you can use home mortgage calculators or talk with a lender to see how much home you can afford with that sort of monthly payment.

3. You need to plan for additional (and sometimes unexpected) costs as a homeowner.

If you’re a first-time homebuyer, certain expenses can sometimes come as a surprise — there’s not going to be a landlord  to fix a leaking faucet or a yard service to mow the lawn and plow your driveway. When you own a home, all that is on you and comes with costs. You’ll want to make sure you aren’t stretching yourself so thin with your monthly payment that you can’t afford things like insurance, yard work costs, utlilities, any unexpected repairs, etc.