It’s finally time. You’ve moved out of your parent’s house, gained financial independence, and have gotten a stable job. Now you’re looking at purchasing your first home! The entire process can be a bit overwhelming to those who have never been educated on it. There are many complicated steps you’ll have to take on your journey to owning a home, but it’s always best to start at the beginning.

The budget. This word frightens many new potential home-owners, and for good reason! Creating a budget can be a difficult process to work through and involves a lot of number crunching. This is no reason to be scared of creating a budget, however, and it is certainly no reason to not create one at all!

With the help of this article, along with professional help you may receive through your buyer’s agent, you’ll be on your way to creating a solid budget that factors in any speed bumps you may run into on your road to home ownership! 

To begin, we’ll walk you through all of the different facets to budgeting you must understand before creating your own. Once you’ve gotten a sound knowledge base, we’ll take you through the process step-by-step so you can apply it to your own financial needs and end up with your own home-buying budget!

Understanding budgeting

What is a budget?

Simply put, a budget is the total amount of money you are able (or willing) to spend on a house. It takes into account your personal or joint salary, savings, and any extra money you have to put towards the home you’d like to purchase. 

The budget accounts for nearly every expense you will need to pay when buying a home. From the down payment to the closing costs, a well-planned budget should cover it all. That being said, there are almost always hidden costs that, no matter how well you plan ahead, will arise. This is why it is almost always wise to leave a little bit of wiggle room within your budget for that situation. 

The purpose of a budget is not to restrict what type of home you can buy, but to ensure that you are not biting off more than you can chew. If you only make $60,000 a year and decide to take out a loan (if any bank would give it to you) to purchase a $600,000 home, you are going to have a very difficult time finding the fund for your monthly payments. That is why budgets are essential to ensure you purchase a home that is well within your means of affordability. 

What is a down payment?

One facet of the budget that you must account for is the down payment. A down payment is a payment made at the beginning of a large purchase. This payment works to lower your interests rate so you can save money in the long run. Even if it only saves you a single percent on your interest rate, that percent can add up to a large chunk of money over a 15 year period. 

Down payments also work to lower the risk of investment in the lender’s eyes as they are the ones providing the upfront money for the purchase of the house. A larger down payment equates to lower risk for the lender. The size of your down payment should depend on a wide variety of factors including cash available, type of loan, and the loan-to-value ratio you’re looking for. 

Interest rates on mortgages

Whenever you receive a loan from a lender for a house, you will have to pay the money back to the lender with interest. For example, if you took out a loan of $100,000 at a five percent annual interest rate to be paid back over a ten year period, you would owe a total of $127,278.62 back to the lender in total.

You may have guessed that you would only owe back $105,000, but interest gets compounded annually. This means that the interest is applied to your payments every year that you are paying it back. The math behind the total payment can be quite complicated. 

Thankfully, there are handy calculators available online to do the math for you. Simply plug the numbers in and you’ll get the answer. These calculators can also be a useful tool for figuring out interest rates on prior debts or monthly expenses which will be discussed later in this article. 

Considering prior debt

A mortgage is often the highest amount of debt someone will owe within their lifetime, although this is not always the case. People often have other forms of debt such as:

• Student loans
• Credit card debt
• Personal loans
• Business loans
  

It is commonly recommended that you pay off most of, if not all, of your prior debt before buying a home. If this is possible, definitely do it! Being able to worry solely about your mortgage without the added stress of having a large amount of student loans would be a massive weight off of your shoulders. 

Unfortunately, this is not always possible. If it is not, be sure you factor in other debts into your budget. Creating an entire budget without considering your other monthly payments will completely mess up the numbers and leave you in a pile of debt with no way to meet the monthly payments. As long as you consider all of the debts you have, you should be fine!

Understanding the home inspection

After the seller of a home has accepted the buyer’s offer, the transaction enters a pending sale period. During this period, it is highly recommended that you get a home inspection on the house you are looking to purchase. The home inspection will give you valuable information on any hidden costs the home may have. It can also be utilized as a negotiation tool when finalizing a purchase on a home. 

Once you’ve gotten the home inspection, work in the extra costs you’ll have to cover into your budget. The home inspection is an often overlooked detail when buying a home, but it is a crucial money-saver. If you’ve purchased a house without it, you may end up paying hundreds of thousands to fix hidden structural damage that would have been spotted during the home inspection. 

28% rule

The 28% rule is a very useful tool when creating a budget for purchasing a house. It really isn’t a rule, but a recommendation. It goes as follows-- figure out your gross income each month and then take 28% of that. The number you reach should be a reasonable estimate on what you can afford for your monthly mortgage.

It is important to note that this is both a recommendation and an estimate. The size of your mortgage (in a ratio of income to mortgage) will vary from person to person depending on the amount of debt you are comfortable with taking on, how much prior debt you have, and any monthly expenses that are unique to you. Be sure to make your own financial decisions after doing considerable research and remember that this rule is only a guideline.

Creating your budget

Now that you’ve gotten a firm understanding of what factors go into budgeting for a house purchase, let's get into the nitty gritty of creating a budget.

Personal income

The first step to creating your personalized budget is considering your income. It is important that you only utilize your net income, not gross. You can’t budget for a home with money you’ll end up owing in taxes. If you have a partner you are purchasing the home with then also factor in their net income. 

Once you’ve figured out your total net income, you’re halfway there. Now all you have to do is subtract the expenses you have and you’ll have a solid idea of how much money you have available to go towards the purchase! 

Monthly expenses

Monthly expenses are any sort of expense you are currently paying prior to the purchase. Some examples are:

• Food
• Clothing
• Transportation
• Medical
• Personal
  

There are loads more expenses a person usually has to consider so be sure you factor in every expense you pay on a monthly basis! Don’t be afraid to add in a ‘miscellaneous’ expense that may arise every now and again, but not necessarily every month. It is always good practice to have some money left over rather than not having enough. 

Additional expenses for the home

On top of your personal monthly expenses, you’ll now have to integrate the expenses that will come with the house you plan on buying. These include: 

• Utilities
• Repair fund
• Maintenance
• Appliance/furniture replacement
  

These are some of the most common housing expenses you’ll face, but certainly not all. For example, if the house you plan on purchasing has a swimming pool you’ll also have to consider the expense of the upkeep for it. As with the personal expenses, be sure to factor in a small amount for any hidden costs that may arise that are impossible to predict ahead of time.

Emergency fund

While not necessary, we highly recommend you set aside some money for an emergency fund. Life can be chaotic and it is always a good idea to have some extra available money in case of an emergency. If you ever get a flat tire or have a surprising medical expense that you didn't see coming, you will have your emergency fund to fall back on in times of need.

If you never end up using your emergency fund, awesome! It will give you peace of mind knowing that whatever bumps life may present you’re ready for!

Coming to a final number

After you’ve crunched all the numbers including your net income, monthly expenses, and any other miscellaneous expenses, you’re just about done! Simply subtract your income from the total expenses you’ve added up and you’ll have an accurate depiction of the mortgage you can afford. 

With this general idea of the mortgage you can afford, factor in the down payment you’re comfortable putting down on the house. The number you’ve reached will be personal to your own financial situation. Be sure to consult a buyer’s agent to double check the budget you’ve reached. These agents are experts in their field and will ensure you haven’t missed anything or done any calculations incorrectly. 

After all that, you’ve done it! You should now have an accurate semblance of your budget. Congratulations!

Budgeting for a house purchase is no easy task. From complicated numbers and interest rates to sneaky hidden fees no one can expect, the process can be overwhelming at best! Hopefully, with the help of this article, you’ve reached a budget that is accurate to you. Now that you have your budget, go out and find the perfect home for you!