Buying your first house is one of the most exciting financial decisions you’ll make. It’s also one of the most stressful. Be prepared to start shopping for your new home by learning how to save for a house.
First, How Much House Can You Afford?
Before you can start saving for a home, you need to know how much you can afford.
Experts used to suggest you can afford a home price up to three times your yearly income.
Affordability on paper, however, is a lot different than reality. Everyone’s financial situation is unique.
You’ll want to keep your other debt and expenses in mind when saving for a house, in addition to your credit score.
A better way to think about how much you can afford is by looking at your monthly payment. What monthly payment is within your budget?
There are a few things to look at to help you understand what you can afford.
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Consider Your Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is the amount of your income that goes to your outstanding debt.
This percentage can have a big impact on how you save for a house. The lower your DTI percentage, the better.
A low DTI ratio means you make significantly more money than you owe each month.
Lenders use your DTI percentage as part of the process to determine your home loan terms.
Someone with a lower DTI ratio may qualify for a better interest rate on their mortgage.
A lower interest rate means a lower monthly payment on your home.
Calculate Potential Payments
Breaking down the purchase price of a home into a monthly payment lets you know if you can afford it or not.
You can estimate your monthly payment by using a mortgage payment calculator.
Note: Remember that this calculation may not include the cost of property taxes or homeowners insurance.
Determine How Much to Save For A House
The monthly payment of your new home isn’t the only expense you’ll have. While finding the right monthly payment is important, you also have to think about less-obvious costs.
Some expenses you might have to cover include:
- Pre-buying services: There are services you have to pay for before you even get a mortgage loan. Home inspections and appraisals are usually paid for by the homebuyer. A home inspection helps you make sure the house is in good condition, such as having good electrical components. Home appraisals determine the home’s value.
- Closing costs: The initial costs of buying a home are known as closing costs. These costs are generally between 3-6% of the purchase price. This is in addition to any down payment you make. Closing costs include expenses such as loan origination fees, title fees and mortgage application fees.
- Unexpected repairs: Home inspections don’t always catch everything. Many first-time homeowners move into their new house only to discover something needs repairs. Creating a fund for potential home repairs helps you become prepared.
- Utility costs: You may be shocked at your first utility bill in your new home. Let’s say you move from an 800-square-foot apartment into a 1,600-square-foot house. Doubling the size of your space means doubling how much you have to heat, cool and power. You’ll face higher overall utility costs in a larger home.
How Much Should a Down Payment Be?
You might have heard that you have to have a 20% down payment to buy a home. That’s a pretty big percentage of something that costs hundreds of thousands of dollars.
The good news? You don’t have to put down 20% to get a mortgage. Most lenders don’t require that much for approval. Some conventional loans have down payment requirements as low as 3%.
The benefit of putting 20% down is avoiding private mortgage insurance (PMI).
In addition, the more you put down, the less you’ll have to borrow to buy the home.
Private Mortgage Insurance
Private mortgage insurance (PMI) protects your lender if you can’t make payments on your home.
The cost of PMI is added to your monthly payment. In the event you default on your loan, your lender can use the insurance to recoup the cost of your mortgage.
You can remove the PMI from your mortgage once you have 20% equity in your home.
What Types of Loan Programs Have Lower Down Payment Requirements?
The US government offers various loan programs to help homebuyers get into their new homes.
However, applicants must meet certain eligibility requirements for each program.
It’s important to note that these loans aren’t from the government. Instead, the government backs the loans through the program.
Approved lenders provide the loans and the government insures them. The lender is then protected if you default on the loan.
FHA Loans
The Federal Housing Administration (FHA) loan program lets you buy a home with fewer financial requirements than a traditional mortgage.
Down payments can be as low as 3.5% on FHA loans, which is helpful for first-time homebuyers.
However, you will have to pay mortgage insurance for the life of the loan. That means you can’t remove the mortgage insurance when you reach 20% equity.
The lending requirements also tend to be more relaxed. You may find it easier to qualify for an FHA loan if you have a poor credit score or a bankruptcy on your credit report.
VA Loans
The US Department of Veterans Affairs provides loan programs for active-duty military, veterans, and certain military families.
There’s no down payment requirement for VA loans and you often get access to the best interest rates.
VA loans also have limited closing costs and you won’t have to pay for mortgage insurance.
USDA Rural Development Loans
The United States Department of Agriculture backs loans for those interested in buying a house in a rural area.
Like VA loans, there are no down payment requirements for USDA home loans.
The program does have income requirements, however, and higher earners won’t be eligible for the program.
What is the Best Way to Save for a House?
There are a lot of different ways to save money for a house—and none of them are wrong.
As long as you’re putting money toward your savings goal, you’re making progress.
That being said, some methods can help you maximize your savings, such as:
- Starting a side hustle: Picking up a side hustle helps you earn extra cash. Consider driving for a rideshare company or freelance writing to make some extra income.
- Selling your stuff: Do you have too much stuff? Host a garage sale or sell things in online marketplaces to may a few extra bucks. You also get the benefit of decluttering before you move to your new home.
- Automating your savings: Set up automatic transfers to move money from your checking account to your savings account when your paycheck hits. This stops you from spending money that’s meant for savings by restricting your access to it.
- Paying off debt: Paying off your debt might seem like a low priority if you’re trying to save more money. However, credit card debt and other high-interest debt can cost you a lot of money. The money you save by paying it off will help you buy your home.
- Cutting down on spending: The less money you spend, the more you have to put towards a house. Try to cut down on spending and put that money into your homeownership fund. For example, if you’re tempted to make an impulse purchase, put the money into a down payment fund instead.
Taking the First Step Toward Homeownership
Knowing how to save for a house before you start looking will make home shopping much less stressful.
You’ll be able to save up and buy when you’re ready. Get started on your journey to owning a home by putting these savings tips to work.
