One of the first questions a would-be home buyer asks is, "How much money do I need to buy a house?" It may be a basic question, but the answer is far from simple. There are several types of expenses you need to be prepared for to make sure your home buying experience is a success.
Keep in mind that such success is not measured solely by getting into a home. Planning for the expense of buying a house should cover not just the initial purchase, but also what it takes to keep up with the ongoing costs of owning a home.
How Much Money Do I Need to Buy a House: Getting In
Here are four types of expenses you will need to take care of to get over the initial hurdle of buying a home:
1. Down PaymentRaising money for a down payment is generally considered the biggest barrier to buying a home, but it does not have to be all that formidable. FHA mortgages allow you to get into a home with as little as 3 percent down. With that said though, there are advantages to offering a larger down payment if you can. For example, with FHA mortgages you can reduce your mortgage insurance payments with a 5 percent down payment, and reduce those payments further with a 10 percent down payment. On a conventional mortgage, a 20 percent down payment should eliminate the need for mortgage insurance. So, consider 3 percent the minimum goal to shoot for, but keep in mind the merit of aiming for the higher end of the range with a 20 percent down payment. Plus, a larger down payment will significantly reduce the amount of interest you pay over the life of the mortgage.
2. Closing CostsIf you've ever heard the phrase "death by a thousand cuts," you may have some picture of what closing costs are like. Compared to your down payment, individual closing costs are relatively minor, but there can be so many of them that they add up to something significant. Bank fees, appraisal fees, credit and underwriting fees, inspection, and title search fees are among the common components of closing costs. There are many variables that determine the extent of these fees, including location and the cost of the home. At minimum expect them to total a few thousand dollars, and this may run significantly higher for more expensive properties.
3. Mortgage InsuranceLow-down payment mortgages will typically require you to pay for mortgage insurance to help protect the lender against the possibility of default. Such mortgage insurance premiums often consist of an upfront component and then ongoing annual amounts. That upfront component can add a meaningful amount to your closing costs. For example, for FHA mortgages the upfront mortgage insurance premium is currently 1.75 percent of the loan's total value.
4. Prepaid ExpensesThe mortgage company has an interest in making sure the property is protected, so they will typically require that property insurance and tax payments be made through them. A common way of doing this is to collect a year's worth of such payments up front and place that money in escrow until it is needed, and then add an amount to your monthly mortgage payments to keep replenishing the money available for these payments in future years. These insurance and property tax payments are significant expenses, so before you buy you should get an idea of what to expect by finding out what the current homeowner is paying for these items.
5. Cash ReservesDepending on the type of loan that you are getting, your lender might require you to prove that you have enough money in reserve to pay your bills for several months should you experience a financial setback such as the loss of your job. In your early planning stages, talk to prospective lenders about whether or not they will require this of you. Even if the lender doesn't require it, building up this kind of reserve can be a wise move for homeowners.
How Much Money Do I Need to Buy a House: Keeping Up
Overcoming the hurdles described above will help you get into a house, but the real measure of successful home ownership is your ability to stay in the house by keeping up with your financial responsibilities. Here are some of the things that entails:
1. Mortgage PaymentsWhile there are many rules of thumb about the relationship between how much money you make and how much house you can afford, keep in mind that these are only generalities that might not accurately measure your true ability to make your payments month in and month out. One key variable is how much of a strain other expenses, including non-mortgage debt, puts on your income. Another thing to consider is whether your income is regular or if it tends to run in peaks and valleys throughout the year – something that may leave you a little short when it comes time for some of your regular monthly mortgage payments.
2. Annual Mortgage Insurance PremiumsAs described in the section on upfront expenses, unless you put down a big down payment, you will probably have to pay mortgage insurance premiums. After the upfront premium, you may see an ongoing premium added to your monthly payments. For example, on a 30-year FHA mortgage, these insurance premiums would range between 0.80 percent and 1.05 percent annually, depending on the size of your loan and the amount of your down payment.
3. Property TaxesProperty taxes are typically assessed as a percentage of the home's estimated value, and this can represent a significant sum. Before buying a home, you would be wise to check out both how much the current property taxes are and how up-to-date the latest tax assessment of the home's value is.
4. Home InsuranceBesides the aforementioned mortgage insurance, you will need to get property insurance to protect against accidental damage to the home. The cost of this will be partly a function of the home's value, and partly a function of where it is located - with things like proximity to fault lines, flood hazards, and location in areas prone to frequent tornadoes all potentially adding to the cost. Before buying a home, find out how much the current owner is paying for insurance, but also talk to your insurance agent to make sure there aren't any unpleasant surprises awaiting you.
5. UtilitiesYou may have paid for utilities like heat and electricity before, but the jump in utility costs can be a shock when you go from a small apartment to a full house. Ask to see a year's worth of prior utility bills, so you can both get a sense of the overall costs and see how much the monthly costs vary seasonally.
6. MaintenanceMost houses need periodic repair and maintenance for things like roofing, paint, appliances, and the heating, ventilation and cooling system. Start to budget a regular amount so you can build up a reserve fund for such expenses, because if you wait and try to pay for them only when they arise you might find these expenses impossible to afford.
While a mortgage will likely be the biggest expense you face in buying and keeping up with a home, it is just one of several costs involved. Identifying and budgeting for the above items will help you meet the financial obligations involved in buying a house both initially and for years to come.