Saving Money for a House You Can Afford

Saving money for a house may seem like a daunting task for a potential new homeowner. For most people, buying a home will probably be the biggest purchase of their lifetime and shouldn’t be taken lightly. That is why it is so important to have a plan and begin saving the right way.

Here are 5 tips on saving money for a house that any future homeowner should consider.

1. How Much Mortgage Can You Afford?

Before you start saving for a house, you need to know how much mortgage you can afford. The simple way to do this is to tell your real estate agent how much you can afford for housing. He or she can then use that number to calculate how large a loan you can afford.

Let’s use an example. Jim pays $20,000 a year in rent right now and that’s all he can afford. In our case, we know that Jim could use that same $20,000 that he spends for rent now and use it instead on paying down a mortgage.

(In reality, it’s not that simple. Because of the tax deduction for home interest mortgage, Jim could actually spend more on a mortgage than he does on rent and still have the same out-of-pocket expense. On the other hand, owning a home is more expensive than renting. You have to pay for taxes, insurance and maintenance. For argument’s sake, just assume that Jim has $20,000 a year to spend on housing and that’s all he has.)

The real estate agent can use that number to calculate the maximum loan that Jim could afford. The size of the loan will be determined by the payments you are able to make and whether or not you take a 15 or 30-year mortgage. Also, the maximum loan value will be impacted by prevailing interest rates.

Keep in mind that your interest rate will be lower if you have good credit. Find out what your credit score is before you apply for a loan. If needed, there are plenty of ways to improve your credit score quickly. After you’ve made those changes, apply for a loan and save money. To illustrate our point, let’s assume that the agent determines that Jim can afford a 30-year fixed loan of $400,000.

2. Save 20% for a Down Payment

Now that you know how large a loan you can afford, let’s determine how much you need to put down. In Jim’s case, he can qualify and afford a $400,000 loan. That means he can safely buy a $500,000 home, put down 20% ($100,000) and start enjoying the benefits of home ownership. A borrower who does not put down at least a 20% deposit on their home with the lender will be subject to private mortgage insurance (PMI). Paying PMI would be an added expense that new homeowners should try and avoid if at all possible.

So Jim’s goal is to save $100,000 in this example.

3. Don’t Forget about Closing Costs

Your down payment will most certainly be your largest expense that you will need to save for when buying a home. However, there are several other costs that you will need to plan for when saving money for a house. The most notable expenses (other than your down payment) when taking out a mortgage are title fees and closing costs.

There are a wide range of costs and fees that are passed on to the homebuyer when taking out a mortgage. These fees are usually unavoidable and should be factored into your plans for saving money for a house. The average homebuyer should plan on paying 1% to 2% of the price of the home in closing costs. That means you would need to pay $5,000 to $10,000 to your lender at closing for these onetime expenses.

Some lenders may allow you to roll a portion of the closing costs back into the loan. While this allows the homeowner to bypass these fees at closing, there are long-term implications. By adding the costs to the total loan amount, the homeowner will pay interest on that money for the terms of the mortgage.

4. Update Your Monthly Budget

Do you have a monthly budget? If so, it is probably time to update it to include your goals on saving money for a house. You will need to start stashing away funds that are allocated towards your down payment and other related expenses. If you don’t track a budget, it is time to start one since you will soon become a homeowner.

As you work through your budget, look for expenses that can be cut and the money be used to save for your house. It is also a good idea to factor in your estimated monthly mortgage payment and other expenses. If you currently pay rent, then include the difference you will need to pay for your mortgage in the budget. Assuming your mortgage payment is higher than your rent, allocate the difference towards saving for a house. If you don’t pay any rent, then use all of the new budgeted monthly mortgage payment towards your down payment.

5. Put Your Money to Work

Since it will probably take some time to save for a down payment and closing costs, you need to put your money to work. As you are saving money for a house, let your money earn a little interest while you wait. Most down payments require a significant amount of capital (i.e. $30,000) which can earn some decent interest.

Even in a low interest rate environment, you can still earn a couple extra hundred dollars. For example, putting $15,000 in a one-year certificate of deposit at 1% would earn you close to $150. That extra money could come in real handy at your local home improvement store when you move into your house.

Final Thoughts

Buying a home will probably be the biggest purchase of your lifetime. For this reason, it is imperative that you educate yourself on the process of buying a home and planning for the event. A well-thought-out and implemented plan can save a homeowner thousands of dollars and take a lot of stress out of owning a home.

What other tips can you provide on saving money for a house?