how to budget for a house

For many Americans, purchasing a single family home or condominium seems out of reach. One recent study concluded that median home prices are unaffordable in 70 percent of America’s counties. According to the study, an average wage is not enough to cover a monthly house payment in 335 counties.

Prospective real estate buyers read these analyses and are gripped with uncertainty and doubt. However, the truth is that these studies are skewed towards major cities. Included in the negative analysis are counties home to San Diego, Los Angeles, and Miami.

By understanding how to budget for a house, the average person in Oregon or Washington state overcome this national trend. Read on for a comprehensive guide on home budgeting. Learn how to craft a detailed budget to ensure you are making an affordable selection.

What Is My Monthly Take Home Pay?

Many people do not differentiate between gross and take home pay. This is a major mistake for those sticking to a budget.

For starters, it does not account for standard payroll deductions. Right off the top, Social Security and Medicare withhold 7.65 percent of your gross wages.

Next, both federal and state income taxes make a sizable dent to wages. There are other standard payroll deductions for disability, unemployment, and family leave as well.

The payroll deductions do not stop there. The deductions above are just the government’s cut.

If you are an employee of a business, then you likely have some benefits. These benefits may include health insurance or a retirement savings account. In most cases, they are taken directly from gross wages as a payroll deduction.

For a family health insurance plan, the average monthly premium is over $800. Depending on your employer’s contribution and quality of the plan, it is possible for that number to be even higher.

Some employers offer 401(k) savings accounts for retirement. They entice you to save by matching your contribution up to a fixed amount such as 5 percent. Health insurance and retirement savings take a significant chunk out of gross earnings.

Given these deductions and the potential for variance, the best strategy is to avoid using gross earnings. Instead, we recommend using take-home pay when figuring out how to budget for a house.

What Are My Fixed Expenses?

After you determine your take-home pay, the next step is to start reducing expenses. The easiest expenses to collect are your fixed monthly expenses.

This includes all recurring monthly expenses that do not vary in amount. Some good examples are your mobile phone or cable bill. Another significant monthly expense is your automobile and its insurance policy.

Some utilities also come in the form of fixed monthly payments. While energy and water usage vary by month, some providers spread the cost out evenly over 12 months. Keep in mind, these numbers will fluctuate if you buy a house, so while it’s good to tally these numbers now, you’ll need to have an idea of future expenses when budgeting for a new home.

Other fixed expenses can also weigh on your purchasing power. These include student loan payments, childcare, child support or alimony and other monthly obligations.

What Are My Variable Expenses?

The next step to figuring out how to budget for a house is calculating variable expenses. This is a little harder to do because the amount varies by month.

A few examples of variable expenses include transportation, groceries, and entertainment. When estimating how much they can afford for a new house, many people think they can short-change these areas.

However, this leads to a scenario in which you are house poor and cannot afford to go to the movies or on vacation. A better strategy is to closely monitor your variable expenses over a multi-month period. Then, take a conservative estimate for how much you will spend each month.

There are other variable expenses, as well. Some prospective buyers pay monthly interest on credit card debt. Another example is medical bills, which vary depending on how often you get sick and the severity.

Also, it is highly recommended to build a buffer in your expenses. Put away a percentage of your income for savings or unexpected expenses.

How Much Can I Afford?

To recap, you have now determined your monthly take-home pay and expenses. The next step is calculating the delta between the two.

This value tells you how much spending power you have. Let us consider a simple example to illustrate this concept.

After doing your homework, you discover that your take-home pay is $6,000 and your expenses are $4,000, respectively. This leaves you with $2,000 for a housing allowance.

With this amount defined, you can now start diving into the makeup of a monthly mortgage payment.

What Type of Mortgage Are You Seeking?

Most shoppers want to skip right to the home’s price, but there are still more factors to consider. One of those variables is the type of mortgage.

The most significant variable is the mortgage term. Are you planning to apply for a 30-year mortgage?

With this option, you can spread the home’s price out over a longer time and drive down the monthly payment. On the other hand, you can eliminate a monthly payment from your budget by selecting a shorter term. In general, mortgage brokers offer 10, 15, and 30-year terms.

How Much Money Do You Have for a Down Payment?

The down payment lowers the principal amount on the mortgage. This means putting more money down drives down the monthly payment.

The vast majority of mortgages require a minimum down payment. This percentage typically ranges from 3.5 to 20 percent. The United States Federal Housing Administration (FHA) requires a minimum of 3.5 percent down payment. Conventional mortgage types, on the other hand, require between a 5 and 20 percent down payment.

For those learning how to budget for a house, it is important to note the existence of private mortgage insurance (PMI). This is something that lenders charge to mitigate the risk of mortgage default.

PMI costs are calculated by applying a 0.5 to 1 percent annual factor on the loan value. If you cannot make a 20 percent down payment, PMI costs will add several hundred dollars to your monthly payment.

What Is the Interest Rate on the Mortgage?

Interest rates are another cost driver to a monthly mortgage payment. They are set based on various economic factors. Your lender will notify you what the current interest rates are.

There are both fixed and variable interest rate mortgages. On a fixed interest mortgage, the rate remains the same throughout the loan term.

Variable rate mortgages fluctuate with market conditions. Selecting a variable rate poses a long-term risk as your monthly payment can rise beyond your budget.

How Much Are Property Taxes and Home Insurance?

Two other cost drivers are property taxes and home insurance. Of the two, home insurance has a lesser impact on how to budget for a house.

Once a prospective home is identified, shoppers should obtain an insurance quote. For the median home, home insurance will cost you less than $60 per month.

Property taxes are a more significant expense. In Oregon, for example, property tax collections are $1,404 per capita. This ranks Oregon in the middle of the pack for property tax ratings in the United States.

The amount you pay depends on the county that you move to. Each county has an effective tax rate that is multiplied by every $1000 assessed. This calculation will add a considerable amount to the monthly payment.

What Financial Incentives Are There to Buying?

While much of the focus here has been about budgeting, there are also many financial advantages to home ownership. For starters, the federal government subsidizes homeownership.

One such example is the state and local tax deduction. Here you can write off up to $10,000 of property taxes from your federal income tax.

Another popular deduction is the mortgage interest deduction. With it, you can deduct annualized interest on your mortgage. This further decreases your federal tax liability.

Most importantly, home ownership allows you to build equity and net worth. As the principal owed on the mortgage declines, you own an increasing share of the asset.

What Is My Monthly Mortgage Payment?

Experts disagree on a rule of thumb for how to budget for a house. The government uses 30 percent of gross income calculation in its evaluation of mortgage applicants.

As we cautioned earlier, this rule of thumb is based on the flawed concept of gross earnings. Instead, what we have outlined here is a much more thorough approach.

Taking a bottom-up approach to estimate total expenses is the best method. By carefully considering both fixed and variable expenses, you will have a better understanding of affordability.

It is also important to highlight the importance of risk planning in how to budget for a house. There certainly will be unexpected expenses like a failed appliance or vehicle repair. In addition to fixed and variable expenses, it is important to set aside a percentage of income for savings.

A Recap of How to Budget for a House

Now that you know how to budget for a house, you are ready to start shopping. Using take-home pay as the starting point will set you on a strong foundation.

Also, by considering costs of your mortgage interest rate and property taxes, you are less likely to be caught off guard. If you want to learn more about how to budget for a house, contact us to schedule an appointment today.

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