Financial planning is an essential element of the homebuying process, one that ideally takes place even before you begin shopping for your new home.
Whether you are a first-time homebuyer or are buying a newly constructed home for the first time, you should develop a personal budget so you can make a smart and sustainable decision about your purchase.
While a mortgage lender should be your ally and consultant during the process of buying a new home, keep in mind that your lender won’t know every detail of your finances outside of what appears on your credit report and bank statements. If you want to maintain retirement savings or invest in college savings, make sure you have room in your budget for those expenses.
Lender Budget Requirements
Lenders prefer to approve loans for buyers whose “front-end ratio,” which refers to the monthly housing portion of your expenses compared to your monthly gross household income, is 28 percent or less. For example, if your annual household income is $150,000, your maximum housing payment including principal, interest, taxes and insurance should be $3,500.
Your “back-end ratio,” which compares the minimum payment on all recurring debt and your housing payment with your gross monthly income, should be a maximum of 42 percent. However, if you have excellent credit or significant assets in the bank, your lender may approve a loan with a higher debt-to-income ratio. If your annual household income is $150,000, your housing payments and minimum payments on things like a car loan, a student loan and credit card debt should be a maximum of $5,250.
Estimating Your Housing Costs
Online mortgage calculators and your lender can help you accurately estimate your monthly housing payment, but there are other expenses associated with homeownership that you need to consider as part of your financial preparation.
Mortgage Loan Payment
Your mortgage payment includes principal and interest and depends on your choice of loan type and term as well as your interest rate. Your principal and interest can be fixed for 30, 20, 15 or 10 years or you can choose an adjustable rate loan in which your payments will adjust at designated periods.
Your property taxes are determined by the rate established by the jurisdiction where your home is located. Many lenders require you to pay your property taxes in installments with your mortgage bill and then the financial institution pays the government directly on your behalf. Your lender can give you an estimate of your tax bill, but keep in mind this will change as your tax assessment and tax rate changes. You can also find the estimated annual property taxes on property listings and divide them by 12 to calculate your monthly outlay.
Your lender typically requires you to pay your homeowner’s insurance in installments along with your mortgage bill in order to make sure the premiums are fully paid and the lender’s investment is protected.
If you have an FHA loan or a conventional loan with a down payment of less than 20 percent, your mortgage bill will also include a mortgage insurance premium. Your lender can estimate your mortgage insurance payments.
In addition to these standard costs, you should include other costs in your housing budget, such as:
Homeowners Association Dues
When you buy a new home it will often be located within a homeowner association which will require dues to be paid monthly, quarterly or annually. When home shopping, don’t forget to compare these fees and what they cover. In some communities, your HOA dues will include membership in a fitness center and access to other facilities such as a swimming pool and tennis courts.
This could actually save money if you can drop a gym membership. Your dues could also cover some other costs of homeownership such as trash and snow removal, maintenance of common grounds and sometimes even your personal lawn care.
If you’ve been living in an older home, you may be surprised that your utility bills are lower when you move into a newly built home, even if it is larger. Newly constructed homes are typically more energy efficient than homes built even a decade ago. You should compare estimated utility costs when house hunting and remember that your utilities include water, gas, electricity, cable, phone and Internet service.
In a newly constructed home, you’re less likely to need to make major repairs, but you should still set aside funds for unexpected maintenance issues. Generally, financial experts suggest you save about one percent of your home’s value (such as $5,000 for a $500,000 home) each year in an account designated for home repairs and improvements.
Most builders provide a one-year warranty on your materials and labor, a two-year warranty on your plumbing, heating, air conditioning and electrical systems and a 10 or 20-year structural warranty. Even so, you may be interested in paying for a contract to maintain your HVAC system or hiring a landscaper to maintain your lawn. Those costs should be considered part of your housing budget.
Written by Michele Lerner, this story originally appeared in the July/August 2017 issue of New Homes Guide. Reserve your free copy of New Homes Guide today for additional stories, area highlights and more.