At a glance
- Consider both onetime and recurring expenses before settling on a price range.
- Understand how monthly mortgage costs impact your bottom line.
- Understand how equity works.
- Prepare for your future purchase by choosing an investment that matches your time frame.
- When you’re ready to shop: know your credit history, keep the value of your savings stable, and understand your loan options.
A house is probably the biggest purchase you’ll ever make. But it’s more than a house—it’s a home. These tips can help you prepare to be a homeowner.
Think long-term when picking a price range
A long-term outlook can help you save and plan ahead for the purchase of your new home. When determining how much you can afford to spend, a good rule of thumb is to follow the 28%/36% rule, according to bankrate.com. Here’s how it works: Allocate no more than 28% of your gross monthly income for housing expenses and no more than 36% on your total debt, including housing and other expenses like credit card bills and car loans.
As you work to settle on a price that works for you, it’s important to consider:
- Your down payment, mortgage interest rate, and the length of your loan to ensure your monthly payment fits within your budget.
- Other recurring housing expenses including taxes and homeowners insurance.
- Onetime expenses such as closing costs that don’t count toward your down payment. You can expect to pay between 2% and 5% of the purchase price of your home in closing costs.
- Incidentals such as the cost of maintenance and home improvements. You can’t assign a dollar amount to every expense associated with buying a house—but you can be realistic. Factor in what it will cost to make the house comfortable, both now and in the future.
Understand your mortgage costs
Your monthly mortgage payment consists of principal and interest. However, mortgage lenders allow you to combine annual property taxes, homeowners insurance, and any applicable private mortgage insurance (PMI) into your monthly payment for added convenience.
Property taxes vary greatly by region, with the average American household paying about $2,279 in property taxes according to data from WalletHub.
No one wants to be caught off guard when their property taxes come due. To avoid this type of financial shock, many homeowners pay their mortgage lender a certain amount each month that’s earmarked for property taxes. That money is then held in an escrow account until the lender pays the taxes on behalf of the homeowners.
Home insurance isn’t only a mortgage requirement, it also provides you with financial protection from loss as a result of theft, disasters, and accidents. There are many factors that can impact your insurance rates, which vary greatly by state. Learn more* and get a sense of what average rates look like for the state in which you’re looking to buy.
If your down payment isn’t at least 20% of the purchase price of a house, your mortgage company will generally require you to get private mortgage insurance (PMI). PMI allows you to become a homeowner without having a 20% equity stake in your home, while protecting the lender in the event you default on the loan. This added expense is tacked on to your monthly payment (or you may have the option to pay it annually in one lump sum) until your outstanding loan balance drops to 80% of your home’s value.
Determine your down payment & understand equity
Before investing for a specific goal like a down payment on a house, first decide how much you want to save. The more you put down up front, the greater your equity, which will continue to grow as you make monthly payments. If the value of your home appreciates over time, your equity will increase even more—an important benefit if you decide to sell your home.
But remember, only a portion of your regular monthly payment goes to principal (your original loan amount), with the remainder going to taxes, interest, and homeowners insurance. For example, let’s say you purchased a house 2 years ago for $175,000—putting down $25,000 and taking a loan for $150,000. Since then, you’ve made regular monthly payments to your mortgage company totaling $20,000.
However, not all of your $20,000 was applied to your principal. It’s likely that only one-quarter of your payments—$5,000—was applied to your original loan amount, while the remaining three-quarters went to taxes, interest, and homeowners insurance.
If you want to increase your equity and pay off your mortgage early, consider making an extra principal-only payment either monthly or annually. But check with your lender first to make sure you won’t be charged a prepayment penalty.
Invest for your down payment
Once you know how much you want to save, it’s time to choose an investment that will work with your time frame. For example, let’s say you want to make a $10,000 down payment on a house in 6 years. If you open an account with $100, you’ll have to save around $114 a month in a moderate-risk fund (with a 6% average annual return) to meet your goal.
If you choose a lower-risk fund and expect to receive an average annual return of 1%, you’ll have to save about $20 more a month to meet your goal—assuming you open the account with $100 and have 6 years to save.
You can save less when you earn more
The more risk you take, the more reward you can receive. But the opposite is also true—the more risk you take, the more you can lose. Nothing is guaranteed. When you’re about a year away from needing the money for your down payment, consider moving it into a low-risk money market fund or a savings account to help keep it from fluctuating in value.
These hypothetical examples do not represent the return on any particular investments, and the rates are not guaranteed.
Get ready to shop
- Review your credit history by getting a free annual credit report.* Your rating will impact whether or not you’re approved for a loan as well as the interest rate you end up paying if you’re approved.
- Make sure the money you plan to bring to settlement is stable in value and easy to access.
- Learn about the type of loan* you want (time frame, how interest is charged, etc.) and compare lenders’ terms and conditions, rates, and fees. Remember, fixed-rate loans are safer than variable-rate loans because the interest rate remains the same for the life of the loan.
- Consider getting prequalified for a loan. Doing so can give you an idea of what your monthly payments will look like based on a hypothetical home purchase and lets sellers know you’re serious.
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All investing is subject to risk, including the possible loss of the money you invest.
We recommend that you consult a tax or financial advisor about your individual situation.