Before you decide to make one of the largest purchases in your life, it’s important to figure out whether or not you are financially ready to be a homeowner. Too many times, people jump into home ownership before they are able, and end up being “house poor” for the rest of their time in the home. Unable to keep up with the financial demands of home ownership, they can’t afford some of the things they enjoy doing like going to restaurants, taking vacations, and going shopping. Or worse, they fall behind on bills and the mortgage, and eventually must sell or go into foreclosure.
Here’s what to expect on the financial side so you do not become one of those people.
- Down Payment:
This is what most people think of first when discussing the cost of home ownership. Your down payment is the upfront cash payment that you make on your home at closing. It is also usually the largest amount owed prior to moving in.
Your down payment will always be some percentage of the purchase price of your home. What that percentage is will depend on the type of loan you get. We’ll discuss types of loans later on in this manual. But in general, you can expect that amount to be between 3-20% of the purchase price. So for example, if you purchased a $250,000 home using an FHA loan, you would need to come up with 3.5% of the price for your down payment or $8,750.
- Closing Costs
As we’ll discuss later on in this book, when purchasing a home, you will have a “home team” working with you to get you to the closing table. Those folks do not work for free. Their fees, as well as other necessary expenses, will need to be paid as well for you to close on your home. We refer to all these costs together as “closing costs”.
By law, any vendor that you work with in real estate is required to disclose their fees and costs upfront in writing. You also have the right to shop for those services and choose them based on criteria such as price and services. Because of this, closing costs will vary depending on many things.
However, usually these fees will amount to no more than around 3% of the purchase price of your home. I recommend that you use this percentage as your minimum while calculating how much money you need to save. If costs are less than that, then you will have extra money for any repairs that come up after closing, or for improvements, furniture, or other items once you move in.
- Earnest Money
All of the fees and costs that I described above are not due until the day of closing. Earnest money is the exception to that rule. Earnest money is due and owing 3 days after you write a purchase agreement on a home. You can think of earnest money as the advance on your down payment (or as I joke, your “down, down payment”). It is a smaller amount of money that is held by the listing agent’s company to secure the transaction while your home team gets everything ready for closing.
Traditionally earnest money is approximately 1-2% of the purchase price of your home. So, for a $250,000 home, you would put down earnest money of $2,500 to $5,000. It can be more or less than that depending on things such as the home you buy or its location. Your agent will give you advice as to the best amount of earnest money to offer.
Even though you don’t owe earnest money in addition to the costs above, I always mention it very early on so you can prepare. You will need to write a check or do an ACH to transfer this money very soon after finding a home. Therefore, you will want to have this money somewhere that you can access it quickly. A checking or savings account is best.
- Mortgage principal and interest
The balance on your mortgage as well as the interest charged on that loan will be the bulk of your monthly payment towards your home. What this number is depends on things like the length of your loan, the interest rate, and whether it is a fixed or variable loan. I won’t go into much detail here as this is a subject that is better discussed with your lender. They will be able to work with you to make this number something you can live with.
- Taxes and Insurance
Property taxes are a yearly fee charged by your city or township on your property in an amount that depends on your home value. Your home insurance is also a yearly fee to insure your home against damage and loss.
Most lenders will require that you “escrow” or pay monthly the costs of your property taxes and insurance, and they will calculate these costs in with your mortgage payment to give you a total monthly obligation. The lender will take this escrowed amount and use it to pay your property taxes and insurance for you.
- Association Fees
Some homes such as townhomes, condos, and villas, will have a homeowner’s association (HOA) that provide services for you such as snow removal, lawn care, security, maintenance, and recreational facilities. In exchange, these HOAs may charge a monthly or yearly fee to cover the cost of these items. These fees can be paid along with your mortgage, or sometimes they will be paid directly to the HOA.
- Utilities and Repairs
One thing that does not get discussed enough in the home buying process are the hidden costs of purchasing a home. Your monthly obligation does not just include the mortgage payment and taxes. You’ll also be responsible for all of the utility bills as well as any repairs that come up. You will want to make sure you account for those in your purchase as well.
Usually either the current homeowner or the vendor of a utility can give you information about the average energy, water/sewer, and heating/cooling bills for a property. As for this information before making a final decision on a home, and always take it into account when making your decision. It doesn’t make a ton of sense to purchase a home if you can’t afford to run it.
Repairs for a home can range from a couple hundred dollars to several thousand depending on what it is. A great way to hedge against that cost is to save a little bit of money monthly so that you have it when you need it. I usually recommend that my clients save a little of each of their paychecks each month that they keep in an account dedicated to home repairs. Another great way to save for this is to use so-called “round up” apps like Acorn that round up and save any change when you use your debit card (for example, it would save $0.85 on a $5.15 purchase). That sort of saving quickly adds up to a nice cushion against these costs.