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Millions of people dream of buying their own homes, rather than renting. You’ll get the advantage of your monthly payments going toward equity, rather than rent for someone else’s property, and will have far more flexibility and rights for what you do with the property.
However, the process of applying for a home loan can be confusing, even given how easy it is to apply for a home loan online. And the price of a home can be both intimidating and misleading.
So what exactly do you need to be able to afford a home?
The true costs of a home
Let’s start by delving into the true costs of owning a home. When you look at houses in your area, you’ll see a top-level price that may make it seem like you’ll never be able to afford a home. But these prices can be misleading in a few different ways.
First, the asking price may not be the price you end up paying. The majority of homes in today’s market will actually sell below asking price, though there are exceptions to this rule, usually by neighborhood. If a house is going for $245,000, you may be able to get it for $230,000, or even less, depending on your local market conditions.
Second, the rate you’ll pay per month is a composite of several key components. If you’re like most homeowners, you won’t be able to afford a home outright. Instead, you’ll make an initial down payment, building some equity in the property, and will get a mortgage or home loan for the remaining costs. Then, each month for the term of your loan (usually 15 or 30 years), you’ll pay into an escrow account that will cover the following costs:
- Principal. Each month, you’ll pay a few hundred to a few thousand dollars toward the principal of your loan.
- Interest. You’ll also pay a chunk of interest each month, based on the annual interest rate of your mortgage.
- Home insurance. Your home insurance, which may be required by your lender, may also be rolled into this account.
- Property taxes. In most areas, you’ll owe annual property taxes, which will be converted into a monthly rate.
- PMI. If you can’t afford a significant down payment, you may be required to pay private mortgage insurance (PMI), an additional fee for your mortgage.
In many cases, even all these costs combined will be less than what you’re paying in rent for a similar property in the same area.
Of course, you’ll have to consider some additional costs when you’re working up a budget, including:
- Extra costs when buying. There are some extra fees and costs you’ll encounter when buying a home. For example, you may need to cover the closing costs, and pay for a home inspection before you finalize the deal.
- Utilities. You’ll need to pay for utilities, like electricity, natural gas, water, and sewer separately. This can add hundreds of dollars a month to your total expenses.
- Repairs and maintenance. Even new homes will require some ongoing maintenance and periodic repairs. Save a few thousand dollars a year, at minimum, to cover these costs.
Qualifying for a Loan
This all assumes that you’ll be able to qualify for a home loan, and that your interest rate will be reasonable. Your ability to qualify will depend on several factors, including your current credit score, the down payment you’re able to offer, your income, and your current assets.
As long as you can afford the monthly payments and have credit in decent standing, you shouldn’t have a problem.
However, you may face a higher interest rate if your credit situation isn’t ideal.
Saving a Down Payment
The biggest chunk of money you’ll need to have to buy a home is your down payment. As a rule, most financial institutions require you to have 5 percent of the sale price of the home. In some cases, you may qualify for a program that allows you to put as little as 3 percent of the sale price toward your home.
However, in many cases, it’s better to save at least 20 percent, which will reduce your monthly costs and prevent the need for PMI.
The Bottom Line
So how much do you really need to purchase a home? There are too many variables for a single answer, but in general, you’ll want to research home prices in your surrounding areas and save up for a 5 percent down payment of that kind of property.
If you want a lower interest rate (and lower monthly payments) a 20 percent interest rate is even better. Assuming properties are reasonably priced in your area, this approach can help you buy a house while making monthly payments lower than what you’re currently paying in rent.