Purchasing your first home is an exciting milestone, but before you dive into the house-hunting process, it’s crucial to establish a clear budget.
Whether you’re looking to buy a home in Phoenix or a condo in Baltimore, having a solid understanding of how to calculate your first home budget is essential for making informed decisions, avoiding financial strain, and presenting competitive offers. This comprehensive guide from Redfin will walk you through the process of determining what you can realistically afford.
The Importance of Calculating Your Home Budget
Your home budget not only dictates your price range but also impacts:
- The types of homes you should consider
- The amount of upfront cash required
- Whether your monthly payments will be manageable
- The competitiveness of your offer
Without a well-defined budget, buyers often face financial surprises, delays in closing, or exhaustion from viewing properties outside their financial comfort zone.
Step 1: Calculate Your Gross Monthly Income
Begin by determining your gross monthly income, which is your earnings before taxes and deductions.
Include:
- Salary or wages
- Bonuses or commissions
- Additional income sources
If your income varies, calculate an average over the past one to two years.
Step 2: Understand Your Debt-to-Income Ratio
Lenders utilize your debt-to-income ratio (DTI) to determine your borrowing capacity.
There are two types:
Front-end DTI – Includes housing expenses only.
Back-end DTI – Encompasses housing costs and other debts like student loans and credit card payments.
Most lenders prefer:
- Front-end DTI below 28%
- Back-end DTI between 36%-43%
For instance, if your gross monthly income is $6,000, your total monthly debts, including your future mortgage payment, should ideally not exceed $2,160 to $2,580, depending on the loan program. Some programs permit higher DTIs based on credit score and other factors.
Step 3: Adhere to the 28/36 Rule as a Starting Point
A common guideline is the 28/36 rule.
- Allocate a maximum of 28% of gross income towards housing
- Limit total debt payments to 36% of gross income
For example, if you earn $5,500 per month, 28% would amount to $1,540, which should encompass your entire housing payment, covering principal, interest, property taxes, homeowners insurance, and any applicable HOA fees.
Remember, this is a guideline, not a strict rule. Your comfort level is more crucial than hitting a specific percentage.
Step 4: Estimate Your Total Monthly Housing Expenses
Your mortgage payment is not just about principal and interest. Factor in the complete monthly housing cost, known as PITI:
- Principal
- Interest
- Property taxes
- Homeowners insurance
Additionally, consider:
- Private mortgage insurance for down payments under 20%
- HOA dues
- Flood insurance in specific regions
Affordability is determined by this total amount, not just the loan figure.
Step 5: Calculate Your Upfront Expenses
Your initial home budget should encompass upfront costs, not solely monthly payments.
Down Payment
First-time buyers commonly put down between 3% – 10%, depending on the loan type. Certain programs necessitate as little as 3% down, while others like VA loans may require no down payment.
Closing Costs
Closing costs typically range from 2% – 5% of the purchase price and may include:
- Loan origination fees
- Appraisal
- Title insurance
- Escrow fees
- Prepaid taxes and insurance
On a $350,000 home, closing costs could vary from $7,000 to $17,500.
Moving and Setup Expenses
Include:
- Moving costs
- Utility deposits
- Initial repairs
- Furniture or appliance purchases
These expenses accumulate rapidly and should be factored into your overall savings target.
Step 6: Evaluate Your Monthly Budget Honestly
Before committing to a home price, assess your current spending habits.
Ask yourself:
- How much do I save monthly?
- Will I still be able to build an emergency fund?
- Do I anticipate significant life changes like starting a business or changing careers?
Just because a lender approves you for a specific amount doesn’t mean you should spend that much.
Zach Buchenau from Be The Budget advises first-time buyers to view the lender’s approval as a starting point and tailor their budget to their actual lifestyle. He emphasizes the importance of aligning your budget with your life goals, such as having children, taking annual vacations, or planning for early retirement.
Step 7: Allocate for Homeownership Costs
According to Zach, homeowners often overlook recurring expenses that accumulate over time, such as lawn maintenance, HOA fees, or unexpected repairs. He suggests budgeting 1% – 2% of the home’s value annually for maintenance alone.
Include provisions for:
- Maintenance and repairs
- Landscaping
- Pest control
- Appliance replacements
- Increased utility bills
A common rule of thumb is to set aside 1% of the home’s value annually for maintenance purposes. For instance, a $400,000 home would require approximately $4,000 per year.
Step 8: Obtain Pre-Approval to Confirm Your Range
Once you’ve determined your comfort zone, consult with a lender and get pre-approved. Pre-approval:
- Verifies your qualification amount
- Offers an estimated interest rate
- Strengthens your offer during home selection
This step transforms your estimated budget into a practical purchasing range.
Illustrative Example: Calculating a First Home Budget
Let’s assume you earn $6,000 monthly before taxes and have a $400 monthly debt.
Following the 36% rule:
- 36% of $6,000 equals $2,160
- Subtract the $400 debt
- Leaving $1,760 for housing
If current rates estimate your mortgage payment at $1,750 monthly, inclusive of taxes and insurance, that figure may align with your target range.
Subsequently, calculate the home price corresponding to that payment based on interest rates and your down payment amount.