Buying a home can feel exciting—and overwhelming. Especially if you’re tackling it for the first time or the housing market is super competitive. Feelings of doubt can be quick to creep in. Have you made a choice you’ll be able to afford, not just today but in 30 years? What about if something breaks or goes wrong?
The best way to stamp out that doubt and embrace your home ownership is to feel confident in what you’re spending. What do you need when buying a house in order to figure out your budget? Before you review listings or visit open houses, work through this five-step list to prepare.
1. Dig in to your debt, potential home budget, and credit score.
Reducing overall debt and boosting a credit score take time but help you get a loan with a better interest rate.
Debt and budget
A careful review of your current and future spending can help you determine what you can afford. Start with the expert recommendations: Total debt payments, including a future mortgage, should be less than 36% of pre-tax income. Total monthly housing costs should be less than 28% of pre-tax income.1
| Household income | Total monthly debt payments (36%) | Total recommended mortgage payment (28%) |
|---|---|---|
| $75,000 | $2,250 | $1,750 |
| $100,000 | $3,000 | $2,333 |
| $150,000 | $4,500 | $3,500 |
If your debt total currently exceeds that recommendation, you may want to focus on paying off what you can before you start house hunting.
Credit score
It directly impacts the interest rate you’ll get. “If you have any concerns on your credit report, try to get them resolved,” says Stanley Poorman, a financial professional with Principal®. Remember: The higher the credit score (aim for over 700), the lower the interest rate. Each year, you can get a free copy of your credit report.
Tip: Live with a future house payment for a few months to test out your potential home budget. For example, if your current rent or mortgage is $1,000 a month and the mortgage and maintenance you think you can afford is $1,500 a month, deposit that extra $500 in a savings account. Are you able to live life as you want and still meet other financial goals?
2. Build down payment and emergency funds.
Emergency funds
If you’ve been renting and your dishwasher breaks, it’s the landlord’s responsibility. Once you own a home, it’s yours. Those outlays are in addition to other expenses—car repairs and medical bills, for example. Unexpected home maintenance can quickly upend a budget, so a cushion is important. Learn how to build yours.
Down payment
The more you have saved for a down payment, the more mortgage options you’ll have. And if you’re able to get to 20% down, you’ll avoid paying monthly private mortgage insurance (PMI). PMI protects the mortgage company if you default on your loan, and typically costs 0.05%–1% of the entire loan amount on an annual basis. You’ll continue to pay PMI until the total equity in your home reaches 20%.
3. Plan your financing.
Lenders and interest rates
All sorts of financial institutions, from mortgage brokers to banks and credit unions, offer mortgages. Button up your financing as you get closer to looking and making an offer on a home.
Paperwork
Gather everything you need ahead of time to avoid a last-minute scramble. A list to get you started:
| Income |
Two most recent state and federal income tax returns Two months of pay stubs (for job and income verification) Self-employed, a freelancer, or independent contractor:
|
|---|---|
| Expenses and debts |
Two months of bank statements List of all current debts:
|
| Investments |
Most recent quarterly statement for IRAs, investment accounts (stocks and bonds), and CDs Most recent quarterly statement for 401(k) showing the vested balance |
Tip: Closely monitor your spending when you start the home buying process. Lenders check your account balances when you submit your initial paperwork for a loan. They’ll check them again before you close.
4. Sketch out home-related expenses.
There are two types of expenses to think about when you’re house hunting:
One-time expenses
If you’ve been a renter, chances are you don’t have some of the necessary tools that you need—like a lawnmower. If you’re moving from a small home to a big home, you may need furniture to fill extra rooms. Those things can add up.
“Some of this you purchase over time, and some is about what you want to prioritize,” Poorman says. When he and his husband bought their most recent home, they knew interior paint and an outdoor fence were musts and planned accordingly.
In addition, there may be one-time costs associated with the home purchase, such as an inspection. “It’s always better to overplan with expenses and come in below, versus the opposite,” Poorman says.
Ongoing expenses
Do as much homework as you can now to avoid unexpected surprises later. Some expenses such as homeowners insurance may be obvious. Others, not so much. For example, will your utility costs take a big jump if your next home is significantly larger?
“If the property is part of a homeowner’s association, your budget should include monthly fees and possible assessments for shared spaces like a community pool or landscaping,” Poorman says.
Research the local and state property taxes so you understand the impact those will have on your budget. And think about protection from the unknown, too. For example, disability and life insurance can help your family pay for your mortgage if you become injured or too sick to work, or if you were to pass away. (You can use our disability insurance calculator to get a sense of your coverage needs.)
5. Negotiate and note the details.
Double-check these last two things when you get serious about your house hunt.
Legal details
Carefully review the deed and title on any purchase to ensure ownership is clearly outlined.
Your emotions
Try to separate them from negotiations. “You’re in a business transaction,” Poorman says. “The seller doesn’t care about your emotional attachment to the house. Focus on whether this is this best decision for family.”
What's next?
- If you don’t already have a financial professional, consider getting one. (We can help you find one near you.) A financial professional can help you juggle new life stages like this one and thinks of things you may have forgotten when it comes to financing new ventures in your life.
- For a good primer on the whole process, read the Consumer Financial Protection Bureau’s site about buying a home.