Saving up enough money to buy a house is a noble goal, but it might require a lot more foresight than you think.
Most people know that they will need some kind of down payment to get the best possible interest rates on a loan. But there’s so much more than that to consider.
Here’s what you need to know about how much money you’re really going to need and how to achieve your goal of home ownership.
Saving to buy a new home? Take these steps
- Figure out how much house you can afford
- Calculate what your down payment needs to be
- Add in PMI (if applicable), appraisal and inspection fees, and closing costs
- Establish your time frame
- Put it in your budget
- Determine where you’re putting your ‘House Money’
- Don’t forget a home fix-it fund
1. Figure out how much house you can afford
The first thing you need to do when you decide you’re ready to buy a home is to figure out what price range falls within your budget. You don’t want to get in over your head with one of the biggest purchases you’re likely to make in your lifetime.
There’s a lot of (sometimes conflicting) advice out there about how much you can afford to spend on a house based on your income.
Some people say the number is two times your annual gross income. Others will tell you that your monthly mortgage payment should be no more than 25% or 30% of your monthly gross paycheck.
Money expert Clark Howard has a simple — and possibly more practical — approach.
“I’ve dealt with this question over the years and my advice hasn’t changed over the years,” he says. “There are so many formulas out there that you hear, but my thing has always been that when it comes to a mortgage, you should step back 10% from what your lender says you qualify for.”
Getting pre-approved for a mortgage is the second of our 9 steps to buying a house, so it makes sense to do this early in the process anyway. Go ahead and go through the pre-approval process to see what you qualify for to get a good sense of what you will ultimately be able to afford.
“If you qualify for a $200,000 mortgage, for example, don’t look at houses above $180,000. By doing that, you will help create extra financial breathing room in your life,” Clark says.
2. Calculate what your down payment needs to be
The next thing you need to plan for when saving to buy a house is your down payment.
Traditionally, people would put down 20% of the total purchase price of the home in almost all cases. These days, you can get mortgages with as little as 3% — or sometimes even 0% — down, but that is almost always going to require you to pay a premium on your loan in the form of a mortgage insurance premium (MIP) or private mortgage insurance (PMI).
The best long-term strategy for your wallet is to wait until you have 20% of the purchase price of the home saved up before you make an offer. So, to use our example above: If you want to buy a house that costs $180,000, you should have at least $36,000 saved up for the down payment.
3. Add in PMI (if applicable), appraisal and inspection fees, and closing costs
Speaking of PMI, that’s something you’ll need to account for if you want to buy a house with less than 20% down. But it’s not the only additional expense you’re likely to encounter when you close on a home. As a buyer, you may also be responsible for things like appraisal and inspection fees, and closing costs.
Here’s how those might typically break out:
- Appraisal: $300-$400
- Inspection: $300-$500
- Closing costs: Typically 3%-5% of the purchase price of the home
Obviously, the closing costs are going to be the big expense here so you need to be prepared for it. To again use our example of a $180,000 home purchase, you should expect to pay somewhere between $5,400 and $9,000 in closing costs.
4. Establish your time frame
Once you’ve established how much money you’re going to need to bring to the table, you’ll be able to figure out how soon you might be able to buy your home.
Let’s look back at the numbers for closing on our hypothetical $180,000 home, using averages:
So, in order to buy that $180,000 home (while avoiding PMI), you’re going to need somewhere between $40,000 and $45,000 in cash at closing.
How will you get there? You can look at it one of two ways:
- Figure out how much you are able to stash in your “House Money” fund each month and establish your time frame from there
- Establish a time frame and rearrange your budget to make sure you reach your goal by a certain date
Taking the first route, if you decide you’re able to sock away $1,000 a month toward your goal of home ownership and you’re starting from zero, you’re looking at somewhere between three and four years before you’re ready to pull the trigger. Obviously, putting away twice as much will cut that time horizon in half to less than two years.
5. Put it in your budget
That said, if you’re determined to buy a house by a certain date, you’re likely going to need to adjust your budget to make that happen.
If you don’t already have a budget, you can use our free budget worksheet to get started. Having a budget will allow you to see exactly what you’re spending your money on so you can decide where to make sacrifices, if necessary, to make sure you have enough money saved by your target date.
You’ll want to set up a “House Money” category in your budget and allocate the amount necessary there for you to reach your goal. Of course, that might mean moving money you might otherwise be allocating to other categories. It’s often necessary to make small sacrifices in order to achieve bigger objectives like buying a house!
6. Determine where you’re putting your ‘House Money’
Once you start saving for your home purchase in earnest, you’re going to need to decide where to stash all of that money you’re reserving. That’s not always as simple as it may seem.
Clark’s advice is to start by looking at your home-buying timeline. If your time frame is several years out, you have a bit more breathing room than if you’re going to need your money for a down payment in, say, 24 months.
If your time horizon is further out, you might consider investing at least some of your savings in the stock market through a low-cost vehicle known as exchange-traded funds (ETFs).
When you’re looking to buy a house in the shorter range, you can’t treat your money like an investment, risking short-term declines. You’ll want to park your cash in stable options like savings accounts, CDs, and high-yield checking accounts.
7. Don’t forget a home fix-it fund
Finally, unlike inspections and closing costs, no one is going to require you to have a home fix-it fund in order to buy a house — but it’s the smart thing to do.
Whether the house you’re buying is 100 years old or brand new, you should expect the unexpected when it comes to maintenance and repairs.
Clark recommends that you save up the equivalent of two mortgage payments a year to deal with those inevitable things that come up in your home that need to be dealt with. Having that cushion in advance of your purchase will put you ahead of the game.
Buying a home is a big deal and not something to be rushed into. But as long as you understand all of the costs involved and make sure you save so you’re prepared financially, it can be one of the most fulfilling things you ever do.
If you’re ready to take the plunge, please make sure to read our guide: How to buy a house in 9 steps.