How much money do you really need to buy a house?

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Understanding the different costs of buying a home

Buying your first home can be as nerve wracking as it is exciting. That’s because it’s hard to know what goes into purchasing a house—specifically, how much money it really takes.

In this article, you’ll discover exactly how much money you need to become a homeowner, what to do if you don’t have enough, and how to assess if you’re ready to take on the financial responsibility of owning a home.

Key takeaways

  • All up-front costs associated with purchasing a home 

Aside from the down payment, there are a considerable amount of smaller, upfront costs that often surprise first-time homeowners. These costs vary depending on where you decide to purchase your first home, so it’s smart to be aware of all of them when putting together your savings plan. 

  • How to assess whether or not you can afford to buy a home 

Deciding you’re ready to buy a home takes more than just making sure you have enough to cover mortgage payments. You’ll need to have good credit and a certain amount of savings if lenders are going to consider you financially healthy. 

  • What to do if your finances don’t line up with buying a home right now 

Purchasing your first home is no small feat. Luckily, the government understands this and has developed programs to assist first-time homeowners in achieving this important milestone. However, keep in mind that, while upfront costs may be lower, the long-term costs associated with these programs are often higher due to insurance fees.

Down payment

The down payment on your home will most likely be your biggest cash expense. It’s recommended that you put down at least 20% of the total home price in order to avoid paying Private Mortgage Insurance (PMI). 

PMI is a type of insurance that protects lenders from losing money in case the borrower is unable to make their mortgage payments. Given all the expenses you’ll be taking on as a new homeowner, it would be wise to avoid adding on an unnecessary monthly expense, if at all possible. 

However, a 20% down payment is a hefty amount of cash up front for many aspiring homeowners. Government-insured loans from the FHA, VA, and USDA are available for qualified buyers who are unable to make a 20% down payment up front. We’ll explore those options a bit later in this article. 

Closing costs 

After calculating your down payment, take stock of all closing costs. While saving up for a solid down payment should be your priority, saving up for related closing costs is next in line. Closing costs vary from state to state and include expenses such as taxes, appraisal fees, and title insurance, just to name a few. 

Closing costs are generally 2-3% of your home’s purchase price. For example, if you’re buying a home for $400,000, you’ll need $80,000 for a down payment and an added $12,000 for closing costs to total  $92,000. Remember, there are alternate ways of achieving homeownership when cash is tight.

Below you’ll find a list of common closing costs associated with purchasing a home. Keep in mind not all may apply, given that closing costs differ based on your geographical location.

  • Application fee 

Generally between $300 and $500, this expense covers the appraisal and credit report fees. However, not every lender may charge this fee.

  • Appraisal fee 

This expense also ranges from $300 to $500 and covers an independent appraisal used to establish the market value of your property. If you don’t pay an application fee, your lender will probably require you to pay an appraisal fee.  

  • Title search 

Typically between $200 and $300, this is necessary in order to ensure the property will transfer with a clean title. If there are any liens against the property, they will show up here. 

  • Title insurance 

This covers any liens that may not have appeared during the title search. It’s required in order to protect the lender against any undiscovered liens. The cost of title insurance is based on the value of the home, and can run up to several hundred dollars. 

  • Owner’s title 

It’s also recommended that along with purchasing title insurance, you purchase an owner’s title which allows you to refinance or sell your property if a prior lien is discovered. Owner’s title insurance is usually around $200.

Attorney fees 

Ranging from $400-$1000 (or more, depending on the complexity of the transaction) attorney fees are necessary if real estate closings are not handled by title companies in your state. 

  • Home inspection 

Generally, you can expect to spend between $200 and $400 on a home inspection. It’s not required, but it is recommended. Problems with the home can end up costing you a lot of money in the long-run, and even reduce your home’s property value, if you don’t catch them before you purchasing. It’ll be money well spent if a problem is discovered, and may even be grounds for renegotiating the home price.

  • Real estate transfer and mortgage taxes 

Lastly, there are taxes associated with property and property transactions. Similar to title insurance, this expense is calculated based on the home’s property value or mortgage payments, and it varies from state to state.

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It’s important to assess your other financial goals like starting a family or going back to school before you buy a home

Lender-required cash reserves 

Lenders require borrowers to have a certain amount of cash in the bank after all closing costs are paid. This is to ensure that homebuyers are not left financially unable to make their mortgage payments after the first few months. 

Typically, lenders will require a cash reserve of at least two months of your mortgage payments. So, for example: if your principal, interest, taxes, and insurance amount to $2500 every month, you’ll need to have at least $5000 saved up after paying your down payment and closing costs. 

Your lender will want to verify that your funds are liquid, meaning they’ll be readily available to use for payment. Liquid sources of funds include a savings account, checking account, or a money market fund. Lenders generally frown upon using retirement assets, as these funds are not easily liquidated. 

Prepaid expenses 

One of the most confusing charges for new homeowners are prepaid expenses. Lenders will usually put a month’s worth of your real estate taxes and homeowner’s insurance in escrow for up to a year. In order for them to do so, they need to collect the amount up front, ensuring that you’ll be able to make the payments when they’re due each month. 

These expenses vary depending on where you live and how frequently real estate taxes are collected. If your real estate taxes come out to $300 per month, and the lender requires a six month escrow, then you’ll need to pay $1800 up front to fund your real estate tax prepaid expense. That same logic can be applied to homeowner’s insurance. 

Depending on where you live, prepaid expenses can come out to as much as 2% of your total loan amount. So if you’re putting a down payment of 20% on a $400,000 home, 2% of your $320,000 loan will be $6,400. 

Keep in mind, however, that it could amount to less. You may even be able to negotiate for the prepaid expenses to be paid for by the seller at closing. You also have the option of declining the escrow arrangement by the lender, which would require you to meet the 20% down payment in full.  

This is yet another reason it’s recommended you place a down payment of 20% on your home. This way, more of the money you’re allocating to your home up front is going towards the principal, instead of associated fees. 

Utility adjustments

These expenses are incurred by the seller prior to the sale. Upon closing, the seller will require reimbursement for any utilities that have been prepaid such as water, sewer, and trash removal expenses. Utility adjustments are typically small in comparison to the other expenses mentioned above. 

Moving costs

Last but not least, moving costs should be taken into account. If you’re moving from a studio apartment into a 4 bedroom home, you’ll need to purchase new furniture and allocate some cash to either hiring a moving company or renting a moving truck. There’s a few different ways to complete a move, so moving costs can range anywhere from a few hundred to a few thousand dollars.

Assessing your savings

To become a homeowner, you’ll need to have a good amount of cash saved up to afford a home. We’ve already identified what you’ll need cash for, so now it’s time to come up with a savings plan to grow your cash reserves. 

Pro tip: Open up a high-yield savings account, exclusively for your home fund. 

Short-term savings

If you’re looking to purchase a home relatively soon, you’ll want to start putting away 25% of your net income every month. If you make an average of $7500 in net income on a monthly basis, putting aside $1875 every 1st of the month is a good start. In two years you’ll have $45,000 saved up. When combined with a partner’s savings of equal value, you could have $90,000 to put towards a sizable down payment, closing costs, and other home-related expenses. 

Longer-Term Strategies

$7500 per month is a healthy income. Unfortunately, not all Americans earn that much. The median household income in the US in 2020 was $67,521, according to Statista. This amounts to a monthly income of $5,626.75 before taxes. 

In this case, saving 25% of your income might not be possible—but saving 10% probably is. By putting away less every month, you’ll be delaying your closing date. However, you would also be more in control of when and where you’d like to purchase your first home. 

The real estate market is constantly changing. Home prices are on the rise, but changes in interest rates and inventory will likely slow the trend in the future.  When this happens, it’s considered a buyer’s market and you’ll most likely be able to negotiate a better price on your new home.

Examine your other financial goals

Although buying a home is a major milestone, it’s certainly not the only one that requires financial discipline. If you intend on going back to school or starting a family in the near future, make sure you’re saving towards those goals, as well. 

However, if purchasing a home is your primary financial goal at the moment, ask yourself the following questions:

  • Do I have an emergency fund that can hold me over at least three months?
  • Do I have any outstanding credit card or high-interest debt to pay off?
  • Am I contributing to my retirement account each month?

If you answer no to any of the questions above, you’re probably not financially ready to take on a mortgage payment just yet.

Rethink your mortgage payments 

The mortgage you qualify for may not be the mortgage you can afford. A mortgage underwriter will approve you for a loan amount that is based on your gross monthly income. This means that they won’t be taking into account the money you pay towards taxes, 401(k) contributions, insurance premiums, or remittances for family abroad. They most certainly won’t be taking into account your lifestyle expenses, either. 

So, it’s up to you to realistically assess what you can and can’t afford as a new homeowner. For most Americans, buying a home comes with a necessary reduction in other monthly expenses. Whether that requires eating out less, cutting back on memberships, or forgoing a trip at the end of the year, is ultimately up to you. 

white and red wooden house beside grey framed magnifying glass
Your down payment will be the largest upfront cost of buying a home but there are other expenses to prepare for as well

Buying alternatives for first-timers

If saving up for a home seems like too big of an undertaking, but you still want to become a homeowner, there are assistance programs that can help you achieve that dream. Starting off the homeownership journey with one of these government-insured programs can dramatically reduce the need to save large sums of cash.

FHA Loan

The Federal Housing Administration provides home loans to qualifiedying buyers who can’t afford a 20% down payment. Under an FHA loan, borrowers are expected to make a down payment of only 3.5% at a 4.25% interest rate. 

VA and USDA Loans:

The Veterans Administration and the Department of Agriculture offer a 0% down -payment housing loan for active members of the military, designated veterans, and qualifying residents of rural areas. These loans are mortgage-insurance free as well. Under these circumstances, buyers could potentially walk into a new home having to pay only the closing costs.

Wrapping Up

Purchasing a home can seem like a daunting task. However, millions of Americans have been able to become homeowners for the first-time, so don’t doubt your ability to do the same. Keep in mind that the most important thing to do is save. Ideally you’ll have all of the following:

  • Down payment of 20%
  • Closing costs funds amounting to 2-3% of home value
  • Cash reserve covering at least two months of mortgage payments. 

Once you’ve identified a price range for the home you’d like to purchase, it’d be wise to open up savings accounts for each of the above mentioned expenses. In this way, you’ll be able to clearly see whether or not you’re hitting your targets. 

About the authorVivian Tejada is a freelance writer and small business strategist based out of Providence, RI. She specializes in writing SEO blogs, property descriptions and website content for real estate companies. She’s also an avid traveler, location-independent and enjoys trying out new restaurants.