How to budget for homeownership

• How much can you afford?
• Create a need vs. want list
• Where can you afford a house?

Every major purchase should begin with a carefully-constructed budget,  which should include your debt, income and assets. You’ll also want to realistically assess costs associated with homeownership. How much will you be able to afford altogether for monthly mortgage payments, property insurance, taxes and homeowners association fees (if applicable). Make sure you leave some breathing room for unexpected expenses, too.

This will give you a clearer picture of what you can afford and how much you have available for a down payment. Bankrate’s housing affordability calculator  can help you start crunching the numbers.

Would-be buyers who live in expensive areas might need to think creatively when it comes to buying a home.

“One option might be to find a seller that is willing to do a ‘rent to own.’ In this situation, you start off by renting, and at some point, exercise an option to buy,” says Chuck Czajka, founder at Macro Money Concepts. “You might also be able to find a seller that would be willing to give a private mortgage. Looking for an affordable home might mean a smaller home or even a condominium.”

Getting your credit in shape

Get your credit in order, because it has a direct effect on your interest rate.

Whether you have no credit, average credit or bad credit, getting your FICO score in the best shape possible is a key step in buying a home. To qualify for a conventional mortgage, most lenders will require you to have a minimum credit score of 620.. There are other loans, such as FHA and VA loans, with looser or no credit score requirements, so you may still be able to buy a home with a lower score.

However, the second reason for improving your credit score is that you’ll qualify for a better interest rate with a higher credit score. The lower your interest rate, the less interest you’ll pay each month and over the life of your loan.

If you need help managing your money or figuring out how to improve your credit, meet with a financial adviser.

“Find someone that not only has a good reputation, but also someone you feel connected with,” says Peter Boomer, executive vice president at PNC Bank. “Someone who is willing to build a relationship with you, not only help you with figuring out how much you can afford but one that will help you figure out how much you want to afford.”

Saving for a down payment

A down payment is one of the major barriers to homeownership for most first-time buyers. As home prices continue to rise, so does the cost of a down payment — especially if you want to avoid private mortgage insurance (PMI). PMI is an additional charge on top of your regular monthly mortgage payment, usually — about 0.58 to 1.86 percent of your loan payment. Homeowners who put less than 20 percent down must pay PMI if they have a conventional or FHA loan (VA loans don’t have this requirement). The charge goes away once you’ve built up 20 percent equity in your property.

If you have less than 20 percent saved for a down payment, you should add PMI to the list of housing costs when you’re figuring your budget.

Most first-time buyers have to dip into savings or investments to have enough for a down payment. Family members can also chip in for your down payment, which usually requires a gift letter. A real estate agent can help you write up this document, just be sure to include all of the necessary information such as the amount of money that’s being given to you, a statement that the money is a gift and not a loan and where the money is coming from (checking account, etc.).

Once you know how much you can put down, you might decide to postpone homeownership until you have more saved. For people with less than 20 percent who want to minimize their long-term costs, another option is to pay off your loan faster by making larger-than-required monthly payments. And, if your home appreciates in value quickly, you can get a new appraisal to show that the balance has dropped below 80 percent of the home’s value, which can also eliminate the PMI requirement. During 2020 and 2021, rapid increases in property values made this a feasible option for more homeowners than ever. 

If you plan to buy in the next year or two, the safest place for your down payment money is a high-yield savings account.

Identify the best mortgage type for you

It’s important to determine the kind of mortgage you want as well as what you qualify for. A real estate agent can help you identify loans and lenders that fit with your goals and financial situation. This is a good time to get recommendations from friends and colleagues.

If you have a FICO score lower than 620, you might not be able to get a conventional mortgage. But other options, such as FHA, VA and USDA loans may be available.  However, these loans come with certain restrictions conventional mortgages don’t have.

For instance, it’s harder to get a fixer-upper with an FHA loan, and in this hyper-competitive housing market, some sellers are avoiding buyers with loans that are viewed as more bureaucratically complex. Here’s where you have to go back to your balance sheet and compare what you have with what you need and want. Different loans offer their own set of advantages and drawbacks, so it’s important to research them carefully.

Those who want to pay off their loans early and get a lower interest rate can opt for a 15-year mortgage rather than the traditional 30-year mortgage. A shorter term means higher monthly payments, but an overall lower loan cost, because you pay less interest over the life of the mortgage.

Homebuyers on a fixed budget are usually better off with a longer loan, and they can still make extra payments toward their principal as their budget allows,) without the ongoing obligation of larger monthly payments. If someone loses their job or an emergency expense arises, they can stop making extra payments and pay only the minimum required, until they can afford to increase their spending again down the road.

“I advocate for taking a 30-year mortgage as opposed to a 15-year mortgage, simply because the monthly payments will be lower,” Czajka says. “This way, buyers can grow into their home. Should they decide to pay the home off early, they can pay a little more to the principal as they get used to the new budget.”

Get preapproved for a mortgage

Before you start shopping for a house, find out how much mortgage you qualify for. The best way to do that is by getting preapproved.

To do so, you’ll provide lenders with detailed information about your work history, income, debt, assets and credit profile. The lender will verify the information you provide, including running a hard credit check.

If you’re preapproved, you’ll receive a loan estimate with how much you can borrow. A preapproval letter is a great asset when you’re shopping for a home, because it lets sellers know you’re a serious and qualified buyer.

Before you sign a home purchase contract

With your preapproval letter in hand, you can start shopping. This is the exciting part of buying a house. You might imagine the parties you’ll host by your new pool or the long baths you’ll take in your oversized master bathroom.

But, avoid being guided solely by your emotions, Boomer warns. It’s important to take time and research everything from the neighborhood to the schools, particularly if you have a family or plan on starting one — even if it’s down the road. As more homeowners are staying in their houses longer, it’s wise to think of what you might want a few years from now.

“Don’t be in such a rush to make a buying decision. Start by investigating the area that you want to live in. If starting a family is in the cards, check out the schools in the area. Look at other nearby homes to see if the neighborhood is growing and if prices will be increasing,” Boomer says. “The last thing you want to do is purchase the biggest and best home in the neighborhood. Starting out with a house that needs a little attention can pay dividends later when it’s time to upgrade. Purchase a house for a lower price, fix it up and sell it at a higher price later.”