How to budget for a house: A home buyer’s guide to housing costs

Understanding how to buy a home is an important step toward getting there. And the first step is to know what it costs to buy and own a home so you can budget your time and money to make it happen. Here’s more about how to set a budget to buy a home.

Key takeaways:

• Review your income and your expenses to understand how much you can afford to budget for buying and owning a home.
• Review and take steps to improve your credit score and debt-to-income ratio, including paying your bills on time and reducing your debt.
• Make sure you understand how much you need to save for a down payment and closing costs, as well as ongoing costs such as property taxes, homeowners insurance, homeowners association fees, maintenance, and repairs.

Factors that determine how much house you can afford

Budgeting for a home starts with understanding your income and expenses. You might not know where to begin if you’re a first-time home buyer.

One common rule of thumb is multiplying your annual income before taxes by 2.5 to estimate how much home you can afford. While this calculation can give you a rough starting point, your income is only one piece of the puzzle.

Here are some other factors that determine your home buying budget:

Credit history

When  you apply for a mortgage, lenders consider several factors when deciding your interest rate and loan terms. Your credit score and credit report are among the most important. Home buyers with excellent credit typically get the best interest rates and the best deal on their loans. Buyers with average credit scores still may qualify for a loan but pay more interest.

Before you start house hunting, check your credit history and score. Your credit score is a three-digit number that ranges from 300 to 850. According to Experian®, borrowers with credit scores of 760 or higher tend to qualify for the best interest rates. To see where you land, visit AnnualCreditReport.com for a free copy of your credit report from all three major credit bureaus.

If your credit score needs a boost, focus on making on-time payments and paying your debts.

Debt-to-income ratio

Another important factor lenders  is your debt-to-income ratio, which shows how much of your monthly income goes toward debt payments like credit cards, auto loans, and student loans. Most lenders prefer a DTI ratio below 43%, though some may require it to be under 36%.

To calculate your DTI ratio, divide your debt payments by your income. For example, if you earn $6,000 a month before taxes and have $1,800 in monthly debt payments, your DTI ratio is 30%.

Borrowers with a higher DTI ratio may pay a higher interest rate, making your mortgage more expensive. Reviewing your current debts and paying down balances may improve your chances of getting a better rate and free up enough room in your budget for a home loan.

Mortgage rates

Market conditions, inflation, and bond rates can also influence mortgage interest rates, directly affecting your buying power.

According to the Consumer Financial Protection Bureau, mortgage rates jumped from 2.65% in early 2021 to a peak of 7.79% in late 2023. While the percentage increase may not seem like a big deal, it adds up. On a $400,000 loan, it would mean paying more than $1,200 more each month.

Rates have come down since then, but home prices are still rising. If rates continue to drop, buyers may be able to borrow more and afford higher-priced homes.

While you can’t control the market, you can decide what works best for you – whether that means waiting for rates to drop or buying now and refinancing later. Just keep in mind that refinancing means you’ll need to qualify again and pay closing costs.

How to budget for a home

Now that you know what impacts how much home you can afford, it’s time to create a budget that works for your financial and life goals.

1. Know your gross monthly income

The first step to figuring out how much house you can afford is to review your monthly cash flow and spending habits. Start by looking at your gross income, which is how much you earn before taxes and other deductions like retirement contributions or health insurance.

This includes your salary, wages, bonuses, and other income streams. Knowing your gross income gives you a solid starting point for estimating a home price that fits comfortably within your budget.

2. Itemize your monthly expenses

After calculating your gross monthly income, the next step is categorizing your expenses. Divide them into fixed costs (like rent or car payments) and variable expenses (like groceries or entertainment). This can help you spot spending habits you may be able to cut back on.

For example, groceries are a variable expense, which means they can change every month. By doing things like meal planning, couponing, and comparing prices from different brands, it’s possible to reduce your grocery bill.

Also, remember to include expenses that come up less often, like annual subscriptions or car maintenance. You can divide those totals over 12 months to work them into your monthly budget.

Lastly, it might help to group your spending into “needs” and “wants.” This can give you a better idea of where there’s some flexibility in your budget and where you may want to prioritize your spending.

Be careful not to build a home buying budget that depends too much on cutting back on essential expenses. It’s important to leave some flexibility in your budget.

3. Budget for your down payment

Your down payment requirement for buying a home can range from zero percent to 20% of the home’s purchase price. The exact amount you’ll need to put down depends on the type of loan you choose and your financial situation, including your credit score. For example, a fixed-rate conforming conventional loan requires a 3% down payment. FHA loans require a minimum of 3.5%, while VA loans and USDA loans have no down payment requirement.

You must pay for private mortgage insurance if you put down less than 20% on a conventional loan. Although PMI costs vary, you can typically expect to pay around $30 to $70 per month for every $100,000 of your mortgage amount. Once you have at least 20% equity in your home, you can stop paying for PMI.

Identifying how much you can afford to put down will help you estimate how much you can borrow. While a smaller down payment reduces the upfront cost of buying a home, putting more down can save you money on interest.

4. Determine how much house you can afford

Once you’ve calculated your available income and expenses, and estimated your down payment, the next step is figuring out how much you can reasonably afford to spend on housing each month. A common starting point is the 28% rule, which suggests keeping your monthly housing costs at or below 28% of your gross income. While this can be a helpful guideline, it may not work for every financial situation.

Here’s what to include when building your housing budget:

• Mortgage principal and interest: This typically makes up the largest portion of your monthly mortgage payment. The principal is the amount you borrow, and the interest is what the lender charges you to borrow it. A mortgage calculator can help you estimate this payment.
• Property taxes: Make sure to include your property taxes in your budget since they can vary depending on where you live. Many lenders establish an escrow account to collect a pro-rated monthly estimate of your annual tax bill. Your lender will pay the bill on your behalf when it’s due.
• Homeowners insurance: This covers your home in case of damage or disaster, such as fire or hail damage. According to Forbes Advisor, a homeowners insurance policy with $350,000 in coverage costs about $1,678 per year. Many homeowners also pay this annual fee with an escrow account.
• PMI: If your down payment is less than 20%, you may be required to pay PMI. This adds to your monthly cost. On average, PMI ranges from 0.2% to 2% of your mortgage amount annually.
• Homeowners association fees: Depending on where you live, you may need to pay annual or monthly homeowners association fees. These typically cover services like landscaping, trash pickup, community facilities, and maintenance costs.

5. Factor in closing costs

Closing costs are another major upfront expense to plan for when buying a home. They include a range of fees and services, such as:

• Application fees
• Appraisal costs
• Home inspection fees
• Title insurance
• Government recording fees
• Attorney fees
• Survey fees

Closing costs usually range from 3% to 6% of the total home loan amount. For example, on a $400,000 home, you can expect to pay between $12,000 and $24,000.

In some cases, you may be able to negotiate who pays these costs with the seller – especially if you’re buying a home during a buyer’s market. Sellers may be more willing to cover a portion of the closing costs to help move the deal along. This could lower your upfront expenses and make the home more affordable at closing.

6. Budget for home maintenance costs

Budgeting for a home doesn’t stop when you sign your closing papers. You also need to plan for ongoing home maintenance and repairs.

Most experts suggest setting aside 1% to 4% of your home’s value each year for upkeep. On a $400,000 home, that could mean putting away between $4,000 and $16,000 annually. You may need to set aside more if your home is older or larger.

Here are some typical home maintenance costs to budget for:

• Lawn care
• Pool upkeep (if applicable)
• Pest control
• Appliance maintenance
• Exterior repairs (like roofing or siding)
• Minor interior fixes (like leaky faucets or drywall patches)

You also may want to build an emergency fund to cover unexpected repairs or larger issues, such as replacing your roof. This way, if something comes up, you won’t have to dip into your regular savings or retirement funds unless necessary.

Avoid falling into the ‘house poor’ trap

While it might be tempting to stretch your budget and buy the most expensive home you qualify for, it can leave you financially strained.

“House poor” is when too much of your income goes toward your mortgage or other housing costs, leaving little money for other expenses or savings. It’s best to live within your means and make choices that support both your current lifestyle and long-term goals.

How to budget for a house FAQs

Here are a few frequently asked questions and answers to keep in mind as you go through the home budgeting process.

What should I do if I can’t afford to buy a house?

If you determine you can’t afford a home right now, you can take steps to improve your financial situation to make it possible in the future. Work on improving your DTI ratio and identify areas that allow you to cut costs. You also may be eligible for grants and assistance programs to help with the initial costs of buying a house.

What’s the 50/30/20 rule?

The 50/30/20 rule is a guideline for creating a budget. The rule states you should allocate 50% of your net income toward necessities, 30% for your wants, and the remaining 20% for paying off debts and building your savings.

How much should I put down on a house?

The right down payment amount depends on your financial situation and long-term goals. Think about what you can reasonably afford – not just today, but in the months and years to come. Putting down at least 20% can help you avoid PMI. On the other hand, if a smaller down payment gets you into a home sooner and leaves room in your budget for savings or repairs, that may be the better fit.

The bottom line: Set a budget to prepare to buy a home

Budgeting for a home requires factoring in upfront and ongoing expenses – not just your loan amount. It also means preparing for upfront costs, ongoing expenses, and long-term financial planning. Taking time to estimate these costs and understanding what fits within your current budget can help you avoid financial stress down the road. With a clear picture of your income, spending habits, and savings goals, you can make confident, well-informed decisions about which home is right for you.

At Rocket Mortgage®, we’re here to help you make smart financial moves and guide you every step of the way. Start your mortgage application online today and move one step closer to your dream home.