If owning a home is one of your dreams, it’s important to understand the real cost of homeownership.
According to the recent Housing Vacancies and Homeownership Report from the Census Bureau, home buyers under the age of 35 are out-buying older buyers. So, if that’s you, keep reading to learn about your total costs.
Upfront Costs of Purchasing a Home
Granite countertops, walk-in closets, and ample garage space may top a home buyer’s priority list. However, priorities mean nothing if you don’t have money left over after purchasing your dream home. Some buyers may spend a larger percentage of their income on housing, leaving them “house poor” every month.
Whether you’re a first-time homebuyer or a home-buying expert, it’s important to understand your up front costs before making the plunge into homeownership. Evaluating the real cost of homeownership before closing on your dream home can save you from financial disaster. Here are some of the costs you should expect when purchasing a home.
It’s recommended that you put at least a 20% down payment on your home. This means that a $200,000 home would require at least $40,000 cash for the purchase of the house. Since the 2008 housing crash, lenders have increased their lending requirements. If you don’t have a 20% down payment, a lender may require you to purchase private mortgage insurance, which can increase your monthly payment.
However, if you can afford it, the more you put down on your home, the less your debt will be.
In addition to putting down a large chunk of change, you also need to factor in your closing costs. You should expect to pay anywhere from 2 to 5 percent of the home’s total purchase amount in closing costs alone. Closing costs include title insurance, appraisal, attorney fee, title search, credit report, underwriting fees, survey, and loan origination.
If we use the $200,000 example from above, you can expect to pay about $4,000 to $10,000 in closing costs. Sometimes the seller will pay the closing costs, but this is a negotiation that occurs upfront prior to the sale of the home.
Unless you pay cash for the entire purchase price of the home, you will need to apply for a mortgage. Your mortgage payment will include:
- Principle amount: Your principle amount is the amount you borrow from a lender. Using the $200,000 example, with a 20% down payment, you would need to finance $160,000.
- Interest: Your interest is a payment to the financial institution for lending you money. Your interest amount is the combination of your financial health, down payment amount, and loan terms.
- Homeowners insurance: In order to cover vandalism, theft, fires, and other weather damage, lenders require homeowners insurance. Keep in mind policies vary so you want to ensure you select the right policy for your needs.
- Property tax: Your local government levies taxes on your property to cover the upkeep of city services. These services can include snow plowing, street maintenance, fire department, tree maintenance, and other services. Your property tax amount factors into your mortgage payment and is kept in a separate account until the payment is due. Property tax amounts vary by state.
- Private mortgage insurance: If you’re unable to put 20% down, a lender may require you to purchase private mortgage insurance (PMI). Lenders want to protect their liability if you default on your loan; therefore, they might require additional insurance.
Recurring Costs of Owning a Home
Your upfront purchase expenses are only a portion of the real cost of homeownership. There are recurring costs that you should budget for as well.
If you previously rented a property, you’re likely aware of utility expenses. You will have to budget for heat, electric, gas, sewer, water, trash, recycling, and other elective bills such as internet and cable.
When you own a home, a lot of things can go wrong. From your furnace going out, to pipes bursting in the winter, issues are bound to occur. As a renter, you can call the landlord to handle your maintenance problems, but when you own a home you’re responsible for all the issues that arise.
Some of these issues may receive coverage under your homeowner’s insurance policy, while others, like sewage back up or mold, may not. Even if you choose to file a claim, you may have to pay a deductible. This could cause your premiums to increase, ultimately costing you to pay more each month.
It’s recommended to stock away least 1% of your home’s purchase price for ongoing maintenance.
One of the benefits to purchasing a home is the ability to mold it into exactly what you want. You can select paint colors, furniture, flooring, lightening, and more to fit your personality and style. Some of these home improvements may be a little less expensive than others, but they can make a big difference in the look and feel of your home.
You may also want to make larger renovations to add value to your home. Home renovations can be costly. Therefore, you may want to either factor this cost into the purchase price of your home or save for them prior to hiring a contractor.
Can You Afford a Home?
A good rule of thumb to follow is your total household expenses should not exceed 28% of your gross income, and your total household debt should not exceed 36% of your gross income.
So, if you make $4,000 a month, your mortgage payment should not exceed $1,120, and your total debt amount should not exceed $1,440. Many American consumers have other debt in addition to their mortgage. If you don’t have other debt, you may be able to afford a higher mortgage payment.
Of course, everyone has a different financial situation that may require a more detailed calculation. This rule of thumb is to give you a good starting point for determining your purchase price.
The Bottom Line
There are numerous benefits to purchasing a home, such as tax deductions and the potential return on your investment. But, remember to consider the real cost of homeownership before making such a big financial decision.