At a glance
- Consider both onetime and recurring expenses before settling on a price range.
- 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 it can also help you spend. When determining your price range, don’t just focus on onetime costs—consider the expenses you’ll be committing to over the long term.
Nobody wants to be caught off guard by a four-digit school tax bill. To avoid the shock of a steep bill, many homeowners pay their mortgage lender a certain amount each month. The money is earmarked for property taxes and held in an escrow account until the lender pays property tax on the owners’ behalf.
“The average American household pays over $2,000 a year in property taxes, but tax rates vary greatly by region, state, county, and property,” said Tony Giordano, a senior financial planner in Vanguard Personal Advisor Services®. “And tax rates are subject to change, so it’s smart to have some room in your budget for potential future rate increases.”
A good rule of thumb is to buy a home that’s less than 2½ times your annual income.
If you can’t put down at least 20% of the purchase price of a house, your mortgage company will require you to get private mortgage insurance (PMI). This added expense is tacked on to your monthly payment (or you may have the option to pay it in one lump sum) until your outstanding loan balance drops to 78% of your home’s original value. (Your lender is legally required to cancel PMI when your loan balance drops to 78% of your home’s original value, but you can request cancellation when your loan balance is 80% of your home’s original value.)
“Say you purchased a house two years ago for $175,000. You put $25,000 down and took a loan for $150,000. Since then, you’ve made regular monthly payments to your mortgage company totaling $20,000.
If your house is valued at $200,000 today, that doesn’t mean you have $70,000 in home equity. It’s likely that only 1/3 of the $20,000 you paid—just over $6,500—decreased the amount you owe (your principal) on your loan, and the remaining 2/3 went toward taxes and interest,” said Giordano.
The average cost of home insurance in 2017 was $1,083 nationwide, according to ValuePenguin.
Keep this simple math in mind when you’re using online calculators that come up with a monthly payment—and ultimately, a purchase price—of a house you can “afford.”
You can’t assign a dollar amount to every expense associated with buying a house—but you can be realistic.
“When you’re settling on a price range, think about the potential costs of maintaining (and possibly improving) the house itself. And factor in what it will cost to make it comfortable, both right now and in the future,” said Giordano. “If you buy an existing house, you may have to replace some big-ticket items within the next few years. On the other hand, if you buy a new house, you may need to purchase some of those big-ticket items, such as appliances and window coverings, right away.”
You can expect to pay between 2% to 5% of the purchase price of your home in closing costs. These are onetime expenses that don’t count toward your down payment.
Invest for your down payment
Before investing for a specific goal, such as a down payment on a house, decide how much you want to save. Then choose an investment that will work with your time frame.
For example, say you want to have $10,000 to put toward a down payment in six 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.
Save 6–12 months of living expenses in an emergency fund so you can keep up with your mortgage payments, at least temporarily, if you lose your primary source of income.
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 still open an account with $100 and have six years to save.
You can save less when you earn more
This hypothetical example does not represent the return on any particular investment and the rate is not guaranteed.
“The more risk you take on, the more reward you can receive. But the opposite is also true—the more risk you take on, the more you can lose. Nothing is guaranteed,” said Giordano. “When you’re about a year away from needing this money for your down payment, consider moving it into a low-risk money market fund or a savings account so it doesn’t fluctuate in value,” he added.
You can get a mutual fund recommendation online by answering a few questions, or you can get advice from a financial advisor. “Even if you create a plan to reach your goal, sticking to it can be hard—and a financial advisor can help you stay on track,” said Giordano.
Get ready to shop:
- Review your credit history. Your credit history and rating will impact whether or not you’re approved for a loan (and your interest rate 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.
- Consider getting prequalified for a loan. Getting prequalified can give you an idea of what your monthly payments will look like based on a hypothetical home purchase, and it lets sellers know you’re serious.
All investing is subject to risk, including the possible loss of the money you invest.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund.
We recommend that you consult a tax or financial advisor about your individual situation.