Budgeting For Your House Payment, Down Payment and Beyond


How much money do I need in the bank to buy a house? What payment fits my budget? What is the truth about what I should spend for a mortgage, regardless of what my lender tells me that I qualify for?

Let’s start with understanding down payment and closing costs. They are not the same thing. Your down-payment is an amount the lender requires you to pay up front, based on the type of loan program you are using. For example, FHA loans require a minimum of 3.5% to be paid in cash by the buyer at closing. The bank will only loan 96.5% of the appraised value at closing. If the contract price is higher than the appraised value, the buyer would have to bring extra cash to closing or re-negotiate the contract to match the appraised value.

Closing costs include items like lender processing fees, origination fees, survey, appraisal, inspection and title company fees. These costs average 3% of your contract price. It’s a little higher on homes under $150k and a little lower on homes above $300k. Many of the costs are fixed and become a lower percentage as the sales price rises.

So in the above scenario, you need 3.5% for down payment and 3% in closing costs for a total of 6.5% of the value in cash, up front. While it’s possible to have a seller contribute to your closing costs, they cannot contribute to your down payment.

FHA loans are the easiest for which to qualify, but they are also the most expensive product in terms of closing costs, fees and mortgage insurance. They charge up to a 1.5% funding fee, which they roll into the note (further reducing your ability to build equity) and the PMI (mortgage insurance) is in place for the life of the loan, regardless of how much equity you build. From the perspective of the borrower, mortgage insurance is an absolute waste of money. It brings no return and eats away at your ability to pay your loan off faster.

Conventional loans start at 3% down, but most conventional products have a minimum of 5% down. They do not charge a “funding fee” and have relaxed guidelines on appraisals and inspections. The main thing a conventional lender will be worried about is the roof. Everything else will pass lender inspection most of the time.

VA Loans are available to veterans at 0% down, with very low fees and reasonably low closing costs. This is an awesome benefit given to those who have served in our armed forces and are active duty or have been honorably discharged. While I never encourage anyone to come into a house with no equity, there are scenarios where it’s advisable if you have no alternative.

If interest rates and home prices are rising, it’s better to get into a house now and take advantage of the lower rate and lower sales price than to wait. If you were to wait a year to save 5-10% down, it could literally cost you $50,000 more for the same house between rising rates and rising prices.

To comfortably close on a sale, it is ideal to have at least 10% of the purchase price in cash and reserves. The more money you can put down, the sooner you can pay it off and the sooner you build wealth and equity. Paying off your home is a HUGE step towards retiring and building wealth.

How much payment can I afford? Most banks will qualify you at 35% of your gross income before taxes, deductions, healthcare, etc. The problem with that is, we have to pay healthcare, taxes and other deductions.

A much more conservative and realistic approach is to budget no more than 25% of your NET pay for your total house payment (including taxes and insurance). If you bring home $4000 a month, you should comfortably be able to afford a $1,000 payment, which equates to about a $125,000 home. If you bring home $8000 a month, you should be able to afford $250,000.

These numbers may be lower if you are deeply in credit card or other debt.

If you follow this 25% guideline, you will avoid being “house poor.” You can go out to eat, save money and take a vacation here or there rather than pouring every nickel you make into a house payment – that for the first few years is really only an interest payment.

How can I pay less interest? I’m glad you asked! Put as much money as you can into your down-payment and finance for as short a term as you can afford using the guidelines above.

The savings on a 15 year mortgage term versus a 30 year term are tremendous. Using the example of a $250,000 loan, in 5 years you will have paid down $21,000 on a 30 year note at 5%. You will have paid total principal and interest payments of $1350 x 60 months =  $81,000 in total payments – with a whopping $60k in interest.

If you choose a 15 year mortgage, your payment goes up $500 from $1350 to $1850. That’s the equivalent of staying home for dinner two extra nights a week.

The rate would drop a full point to 4% from 5% and in the same five years, you will have built $68,000 in equity. You will have paid total payments of $1850 x 60 months = $111,000 with only $43k in interest. If you were to move every 5 years and leave your equity in your home, at the end of 15 years you could easily own at $500,000 home outright with no mortgage at all.

When you own a half million dollar home outright, you are so much closer to retiring than you think. Do you realize you could turn that paid off home into 3 rental properties, downsize yourself into a 4th home, pay cash for all of them and earn $50,000 a year for the rest of your life? Or buy 4 rentals and travel for a living. Having equity and cash means having options.

If you choose a 30 year mortgage and move every 5 years while leaving your equity in place, you will still owe well over half or your original $250,000 loan in 15 years. Here’s why: All the interest is front loaded and you pay closing costs each time you buy and sell. Moving every 5 years and taking out a 30 year mortgage means you never pay down the principal balance or build any kind of meaningful equity.

Easy debt is how our economy enslaves us. Many mortgage companies make it easy to borrow more money than you should, for a longer term than you should take to pay it back. That’s how they make money. When you move and constantly churn that 30 year mortgage, debt is your master. If you want to be free, you have to pay it off as quickly as you can.

Even if it means staying home for dinner a couple more nights a week!