How to save money for a house depends on our personal goals and expectations. The information discussed here illustrates a framework or checklist we used for exploring how much we could afford. There may be items we do not discuss that may be important to your financial circumstances. You will also need to factor those in. We hope that this article will provide a good starting point for your personal assessment. After all, buying a house is a big and fairly complex purchase.
Below is a three step process for how we budgeted and saved money for a house. The process includes establishing a budget for your purchase, developing a timeline for when you plan to purchase a house and determining where to save your money.
#1 – Start by determining your budget
When starting to determine a budget so we can save money for a house, we need to consider the total cost of the house from purchase through ownership. The “through ownership” part is what many tend to overlook. By default we start with the price of the house. This is after all the largest dollar value of the overall purchase. However, there are many other components to consider that will affect how much you end up spending. Generally the most obvious costs are those that roll up into your monthly payment. The less obvious are closing costs and the costs to live in and operate your house. Finally and possibly most importantly, we have to think about how this fits into our household budget.
If you want more information on creating a home budget please see our post here: Home Budget: For Your Improved Financial Situation).
Monthly House Payment
When discussing a monthly house payment, you will likely hear the acronym PITI thrown around. This is the sum of multiple items to form your monthly housing payment. These include your Principal, Interest, Taxes and Insurance (PITI).
Principal
The principal payment is the amount going to pay off the face value of your loan. The principal is not all you will be paying to satisfy the debt however. Yet, of the PITI components, this is the largest. When choosing a home price and accompanying mortgage to fit our budget, the principal is typically the largest impact to the budget. Lower the principal amount on our loan and we can significantly reduce our monthly payment.
Interest
Interest is how the bank makes their money on the mortgage. Hey, we all have to make a living. Interest is also one of the ways we end up paying much more than the face or principal value of the loan over time. We have to be sure to understand how much interest we will be paying through the duration of the loan. It may surprise you. It certainly surprised us the first time we saw that calculation. Take a look and make sure you are comfortable with the interest you will be paying. Or, in our case, don’t get comfortable with it, but find ways to accept it and plan to pay it off sooner.
The better our credit score, the better the interest rate our bank/credit union will offer us. If we want to afford more house or spend less on our mortgage interest, improving our credit score can help. This may take time if we have a lot of work to do, but we shouldn’t be discouraged. We just have to do our best to build it as high as we can.
Taxes
Taxes include our real estate/property tax and any other tax that may be unique to our situation. In some geographies this isn’t a huge financial commitment, in other areas you will feel it significantly. Each jurisdiction or governmental entity has different requirements. There may even be a big difference between taxes just by crossing the street or into a different jurisdiction/district. Therefore, there is no one overarching calculation we can give that everyone can use. We have to look at the location we are buying in to determine the formula and rates to use. We should be able to find the calculation on our local assessors website. The information on the previous taxes should be publicly available too.
Insurance
Insurance includes your homeowners insurance. This is used to protect your home and the valuables in it. You can shop around between companies to find the coverage and costs that fit your needs. In our experience the price stays fairly consistent over time and isn’t a huge part of PITI. We opted for a little higher priced insurance because it afforded us better coverage. Having that extra safety net seemed worth it to us. Not everyone may feel the same way. Regardless, the difference in cost wasn’t all that much in the grand scheme of things.
Insurance also includes, if necessary, Private Mortgage Insurance (PMI). This insurance is often required if you supply less than a 20% downpayment as part of the home purchase. This insurance is used to protect the bank/lender in the instance that you default on your loan. This wasn’t particularly high for us. So, it didn’t impact our budget too much. It isn’t insignificant however. We have to admit that it stings a little seeing that we are paying PMI when we get or mortgage bill. Our PMI will cease after we reach 20% equity in our house.
You can learn more about PMI here: https://www.consumerfinance.gov/ask-cfpb/what-is-private-mortgage-insurance-en-122/
Upfront Costs
Our monthly payment tells us what we will be paying in the future (but only for the purchase itself). There are some other upfront costs to factor into the equation when planning to save money for a house. Your down payment is one such factor. This is your upfront skin in the game. There are also closing costs to consider.
Down Payment
Your required down payment depends on the type of loan you take out, but it typically ranges from 3-20% of the property cost. As noted before, we usually pay an additional monthly fee for Private Mortgage Insurance (PMI) if we put down less than 20%. That’s because the bank is taking on some risk by allowing you to not put down more.
What we just discussed above for down payments are minimums. You could choose to put down more. The more you put down, the lower your monthly payment will be, because you are taking out a smaller mortgage. That may be enticing if you are able to wait and save up more money. If you delve into the way mortgage payments work, you will notice that the earlier on in your term, the less principal you pay. This means you are paying down less of the actual mortgage and instead paying more on the interest. As a result, it takes time to build equity for this reason. By putting a bigger down payment on the house, you gain more equity (or more ownership) upfront. That may also be enticing for some.
Closing Costs
Closing costs are tricky for many of us to understand. There are many fees, taxes and insurance that get bundled in here. Many of these are tied to legal components of the sale. Closing costs 2-6% of the principal of the mortgage. Different sources have this range as slightly smaller or larger, but from our research 2-6% seems the most likely range. Included in closing costs are real estate commissions, many fees, title searches, taxes, inspections, and the list goes on. Some of these costs are covered by the buyer and some by the seller. To reduce these costs we can try to negotiate with the seller (sometimes this works and other times it does not). Additionally, we can also look for lenders with lower fees.
Nerdwallet has a nice breakdown of some anticipated closing items and their associated costs. You can find that here: https://www.nerdwallet.com/article/mortgages/closing-costs-mortgage-fees-explained
Online Calculators
There are plenty of online calculators that allow you to play with these numbers and see what works for you. A simple internet search will supply us with numerous options. We have noticed that not all calculators are created equal. Some are very simple and others are very detailed. The simple ones were nice for some quick, high level numbers. We used those when we were trying to establish a home buying budget. The detailed ones provided more accurate costs. We checked our projected costs by using multiple calculators. As we identified how much money to save for a house we could afford, we switched to the more thorough calculators. When making a massive purchase like buying a home, spending the extra time was well worth it for us.
Cost of Ownership
The cost of ownership is next up on the list. Up until now, we have been taking about the costs of purchasing the house. But, there are plenty of costs for owning the house. This contributes to how much money we need to save for a house. Below we talk about our emergency fund, operating costs, capital expenditures and furnishing costs.
Emergency Fund
As homeowners, we are entirely convinced that an emergency fund is a must. It certainly is for us. Between our downpayment and our closing costs, our savings took a big hit. We were planning for these expenses, but we needed to make sure we had enough money left over for for those rainy days sure to come. In our situation we were moving from a small apartment to a much larger and expensive dwelling. This meant we were about to incur significantly more expenses. Having that emergency fund meant that we would be able to weather the storm should something unforeseen happen to the house or our incomes.
Within the first few months of home ownership, we were already dealing with issues that required use of our emergency fund. We wouldn’t want to imagine not having one. It’s stressful enough dealing with unforeseen headaches. Not having the money to fix those problems would only make the situation worse.
Because we built up funds for a downpayment, closing costs and an emergency fund, it took a while before we could afford a house. Do we wish it could have happened sooner? Absolutely. However, we would have regretted not adequately building those funds. It took a lot of focus to get there, but it was worth it!
Operating Costs and Capital Expenditures
If having an emergency fund was a hit or miss topic in the articles we read before buying a house, operating costs and capital expenditures were even more rare. That makes sense as both of these terms are used in business rather than home ownership. But, as homeowners we do incur costs to operate our homes and we do have to make repairs.
Operating Costs (Utilities)
For us utilities were a big cost jump. Going from a 560 square foot apartment to a 1,200 square foot home added significant cost to our utility bills. These operating costs needed to be factored into our budget. We went from electric bills that peaked at around $100 in our worst months to over $200. A $100 per month jump isn’t insignificant for most of us. One way to estimate your future utility bill is to ask for the utility costs of the home you are considering buying. There are other items besides utilities that we could add here, but utilities were the biggest for us.
Capital Expenditures (Repairs & Improvements)
While operating expenses like utilities have an impact, home repairs and improvements can be even higher. In business owned real estate these are considered capital expenditures. If we apply the concept of capital expenditure to home ownership, we can start to anticipate future costs. (It is also our experience that it is easier to find information on the web pertaining to capital expenditures for buildings than home maintenance and repair.)
Projecting Costs
When we bought our house, the inspector did a great job of laying out how long he expected things to last and when he expected they would need to be replaced. (Getting a good inspector was worth the cost for us.) The laundry list of items on our house was long. But, we bought a fixer upper, so that was, in part, assumed going in.
Regardless of our decision to go that route, everyone has costs that will arise if they are in a house long enough. There is a life span to every construction material, system and appliance in our homes. Those who own and operate rental housing build (or should be building in) these capital expenditures into their budgets and rents. We as homeowners can do the same. So, when that roof that will cost $12,000 to replace in 10 year and that $20,000 in home tuckpointing comes in five years, we can plan for it. Yeah, it’s no fun to think about, but repairs are in the cards for us all if we plan to live in a home long-term.
As we looked for homes to buy, we considered the costs of future repairs and upgrades. We asked when different items were installed so we had an idea how much life was left on them. We then estimated those costs and placed them in our budget. So that $12,000 roof replacement over 10 year meant we needed to be saving $1,200 per year or $100 per month. These are important considerations for our home buying budget. There are some pretty good sources out there for the average lifespan of these items. We will put together a future blog post on sources we use to price these items out and determine an expected useful life.
Furnishing Costs
Furnishing costs are the last item we looked at. Going from a small apartment to a good sized home, we did not have the furnishings to fill the house. One idea we employed was to not over buy square footage, as it would cost us more to furnish. We also favor quality over quantity. So, we would prefer fewer items that are of higher quality. Regardless of your preference, we feel its important to be able to furnish a house. Aside from storage areas, we didn’t want a bunch of empty rooms. Furnishings cost money. We may be able to re-use some of the furnishings we already have, but sometimes we need or want more or newer furnishings. We just need to make sure to add this to our home buying budget.
Another post will talk about furnishing your home and the ways you can do so that fit within your budget.
#2 – Determine your timeline
Determining a buying timeline is a pretty critical step in the process. This tells you how much time you have to save for things like your emergency fund, closing costs and downpayment. The longer we have to save, the easier it should be (in theory) to save the money we need for a house. If we want to make a purchase sooner, we may have to work a bit harder to get there, depending upon our circumstances. Once we have our timeline and your budget, we can calculate how much we need to be saving a month to reach our target.
#3 – Determine Where to Save
Determining where to save our emergency fund, downpayment, closing costs and furnishing budget is an important step. If we have more time in our savings timeline, there are more ways to store our funds. Your emergency fund should always be highly accessible, so there is a bit of a limitation there. We looked into checking, savings, and money market accounts. We settled on a high interest savings account for fast access with a fairly decent interest rate. For the other savings we looked at additional opportunities like bonds. Given the market, the savings route worked best for us. Its worth noting that we stayed away from more volatile investment offerings like putting our money into the stock market. While the return have potential to be better there is also the risk of losing money. Getting a guaranteed return was the best option for us.
Conclusion
Buying a house is expensive and complex. In determining how much money to save for a house, there are many items to consider. Being comprehensive and conservative with our budget served us well. We recommend that anyone looking to buy a home use a budget to help them make the best possible decisions possible. Since this is a large and long-term expense, we valued the work we put into figuring out how buying a house. It did take some effort to get through all the calculations, but we chipped away at it overtime and it paid off significantly.