How to Budget For a House: Get the Best Bang For Your Buck

How to Determine Your Home Buying Budget

Let's talk about one of first-time real estate buyers' biggest questions: how much money do I need to buy a home? Getting a realistic estimate of what you can afford will allow you to narrow your home search for homes for sale within your budget.

Most people evaluate affordability using an online mortgage calculator. These tools are a helpful starting point, they don't to consider lesser-known factors like low down payment loan options, your debt-to-income ratio, and tax write-offs.

Everybody's home buying experience is different. The amount of money you need to buy a home will be drastically different than what anyone else needs to buy a home. To get pre-approved for a home you can afford, you need to break away from generic estimates, explore low down payment options, and research financing options and tax implications that improve your buying power.

Use The 28/36 Rule to Determine Your Debt to Income Ratio

How to Use the 28/36 Home Buying Rule

Knowing the limits of your debt-to-income ratio is one of the most effective ways to conceptualize how much you can spend on a home. There are two types of debt-to-income ration: your total debt-to-income and your housing debt-to-income. The 28/36 Rule expresses each ratio so you best balance your home purchase with any other debt.

Your total debt-to-income ratio is determined by calculating your monthly debts and dividing them by your gross monthly income. This number lets you know how much of your income goes towards debt payments each month. Most lenders like to see a debt-to-income ratio of 36% or below.

For budgeting purposes, you must also know your housing debt-to-income ratio. Calculate this amount by tallying everything you spend on housing (or would spend if you bought a house in your budget) and divide it by your total income. Most experts suggest that 28% of your total debt should be dedicated to housing expenses.

This well-known rule of thumb makes it easy for new homebuyers to establish a budget.

Imagine a homebuyer earns $100,000 per year. According to the back-end of the ratio (36), that household could spend up to $36,000 per year on all debt, including housing. Meanwhile, the front-end of the ratio (28), dictates that they can reasonably afford $28,000 worth of housing debt per year.

Start By Setting an Attainable Down Payment Goal

Once you've established a budget-friendly debt-to-income ratio, you'll have a better idea of how much you need to save for your down payment. The down payment is likely to be your most significant out-of-pocket expense, so you need to be strategic about it.

Many people think they need to put 20% down to be able to buy a home, but that just isn't true. It's awesome if you can afford a large down payment, but it's still just one piece of the puzzle. There are many expenses involved with buying a home, and overextending your budget on any one aspect can cost you your dream home.

Home prices are reaching record highs across the country, and a 20% down payment deters would-be buyers from building equity with a home of their own. Conventional down payments may seem attractive if you're using a mortgage calculator because they provide the lowest monthly rates. Unfortunately, this estimation rarely accounts for closing costs, HOA fees, utilities, and maintenance—which can add thousands to your annual expenses.

If you want to afford a home, don't put all your eggs in the down payment basket. Spreading your savings across the numerous home buying expenses helps you buy a home faster and remain liquid.

Low Down Payment Financing Options

The very first thing you need to do if you're getting ready to purchase is to talk to a mortgage broker. After deciding on your broker, they'll answer your mortgage questions and help you through the process of getting pre-approved, so you can start looking for homes. When you get pre-approved, you can find the type of financing that best fits your needs.

Several financing options accept low down payments and provide low interest rates.

FHA Loans

The Federal Housing Administration offers a loan program that only requires a 3.5% down payment. FHA loans are available for first-time homebuyers and people who have owned a home before, but they require borrowers to pay mortgage insurance no matter how large the down payment is.

PMI rates for FHA loans vary based on how much you borrow, how much you provide upfront, and how long you take to pay off the loan. Generally, FHA insurance costs .45% to 1.05% of the total loan every year.

USDA Loans

The U.S. Department of Agriculture offers a USDA Loan program that requires zero down payment for qualified borrowers. USDA loans are only available in specific rural areas and come with income limitations.

To qualify, the combined household income of the applicant cannot be more than 15% greater than the median income in the area where the home is purchased. To keep things affordable, the mortgage insurance fees are 1% upfront, followed by .35% per subsequent year.

VA Loans

Veterans Affairs (VA) loans are available to veterans and active military personnel who've served 90 days of wartime or 181 days of non-wartime. These loans don't require a down payment or PMI insurance on homes within the VA loan limits.

VA loan limits vary based on various factors, but they can exceed $900,000 in some of the country's most expensive areas.

How to Improve Your Buying Power

In your first year of home ownership, you can potentially write thousands of dollars

off of your income as a result of mortgage payments. 

The best way to improve your buying power is to increase your income, minimize your tax obligations, and keep your expenses as low as possible. Maximizing your buying power ensures you get the best bang for your buck.

Compare Mortgage Rates

Remember when we said talking to a mortgage broker is the first step toward buying a home? Well, the second step is talking to multiple mortgage brokers. Shop for the best mortgage rate and the most common mortgage questions to ensure you get the best deal. Some lenders offer a low rate but make up for it in other fees.

Optimize Your Credit Score

Your credit score will directly impact the interest rate you're offered. The higher your score, the lower your interest rate (and monthly fees) will be. You can get free annual credit reports from the three major credit bureaus to check your score and identify any errors that might be dragging it down. Optimizing your credit score increases your buying power by creating extra space in your debt-to-income ratio and lowering your monthly expenses.

Finance Your Closing Costs

Did you know you can roll your closing costs into your total borrowed balance? This means you don't have to come up with the cash to cover those expenses upfront. Be sure to compare lenders to see which one offers the best terms for this type of financing.

Use Tax Write-Offs to Increase Your Income

In your first year of home ownership, you can potentially write off thousands of dollars off of your income as a result of mortgage payments. Things like the mortgage rates, interest, and taxes can be written off and may increase your usable income.

With this “added” income, you can either save it or use it for improvements on the property; or you can do an instant tax filing and effectively receive a bigger paycheck every month. As an example, if your paycheck was $3,000 a month, now with these tax write-offs your paycheck could become $3,400 or so a month instead. So even if your mortgage payment is $2,000 a month, it is effectively more like $1,600 because of the increase in your paycheck to offset it.

Consult with a tax expert to make sure you're taking advantage of all the deductions and credits you qualify for.

Keep an Eye on Refinancing Opportunities

Refinancing is essentially the act of swapping your old mortgage for a new loan with new terms. If interest rates drop significantly after you've locked in your mortgage rate, it might make sense to refinance and get a lower rate (and monthly payment).

If PMI costs due to a low down payment are inflating your monthly expenses, jumping on refinancing opportunities can realign your budget with The 28/36 Rule.

Discover Your True Home Buying Budget

So, how much money do you need to buy a home? The answer is that it depends on your unique financial situation. Providing a 20% down payment has many fantastic benefits, but many people don't realize that it can cause problems when it's time to fund other homebuying expenses.

Determine the best down payment size for you by knowing your debt-to-income ratio and keeping it aligned with The 28/36 Rule. Explore all of your financing options and speak with multiple lenders to get the best deal.

There's no one way to buy a home. Consider your situation as a whole and do what's best for your needs.

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