# The SCOOP! Blog by ChangeMyRate.com®

## How to Calculate the Costs of Buying a New Home

December 23rd, 2016 5:08 AM by Jackie A. Graves, President

In my last post, we looked at the maximum amount of money a home buyer should spend to acquire a new house or apartment. But there's more to the home buying equation than that one figure. (For the first article, see: Calculating How Much You Should Spend to Buy a Home)

Let's take a look at many of the other costs that come with buying a home.

## The Down Payment

People who purchase homes usually put 20% down. So if you are looking at a \$400,000 purchase, you need at least \$80,000 for the down payment. If you only have \$50,000, you should probably buy a house that costs no more than \$250,000. Some people borrow money from friends and family in order to come up with a higher down payment, but this tactic can backfire. Here’s why.

First, this maneuver often gets people into a house they can’t afford. Since they have an artificially higher down payment, it allows them to take on a bigger mortgage. Besides the higher monthly payments, people who go this route still have to come up with the money to pay back their friends and family. The bottom line? Take your down payment and work backward to determine how large a mortgage might be conceivable for you. Then, do the numbers to make sure you can afford those payments.

## Other Set-Up Costs

While we’re on the topic of mortgages, remember that banks charge you fees and points to arrange loans. The good news is the bank has to give you a good faith estimate of what those costs might be before the loan is set up. It’s smart to get this one-page document before you even identify the house you want to buy—just to get an idea of what you are looking at. Go over this document carefully and ask lots of questions. You might determine that it makes sense to shop elsewhere for a loan if your bank is particularly expensive. (For more, see: First-Time Home Buyers Guide.)

## Ongoing Payments

Your down payment will tell you how large a mortgage you might qualify for. Once you have that number, it’s time to figure out how much your monthly payments will be. You can shop the internet to get a sense of the current rate and then plug that number into a mortgage calculator to estimate what your monthly payments might be.

Keep in mind that if you build your estimate using an adjustable loan, your payments will be lower at first. But don’t fall into the trap of buying the largest home you can afford based on an adjustable rate. If rates rise, your  monthly payments will go up and you may find yourself in a house you can’t afford. To make matters worse, if rates do rise and housing prices drop, you may not be able to sell the home either. This is exactly what happened in 2007 to 2010 and caused many people to lose their homes.

My suggestion is to use the 30-year rate as an approximation when you are estimating your monthly mortgage payment. Having said that, remember that under current tax law, you may receive a tax deduction for the interest you pay on your mortgage. That means that your mortgage payment may not be as painful as you might otherwise think. For example, if you are in the 40% marginal tax bracket and you pay \$30,000 in annual interest on your mortgage, you will save roughly \$12,000 in taxes each year. This is one of the most important financial incentives available to home owners and one you should certainly consider. (For related reading, see: 5 Tips for Recession House Hunters.)

## Other Costs

When you move into a new home, you may want to do landscaping, remodeling or purchase new furniture. Carefully consider the costs of these expenses and make an objective measurement of what they will cost and when you plan on spending this money. Owning a home can be expensive. You’ll have to deal with property tax, insurance and maintenance. As a good rule of thumb, I suggest you budget two months extra mortgage payments for annual upkeep. This is for unforeseen fixes and it’s on top of utilities, gardening, etc.

Now that you have your numbers, it’s time to put this all together to see if you can really afford your home or not.

Open up a spreadsheet and input the following numbers:

1. Net take home pay. Your after-tax family income.
2. Cost of living. How much you spend to support your family now, on average, per month other than for housing.
3. After-tax savings. This is the amount you set aside each month outside of your IRAs, 401(k), etc. in order to achieve your long-term goals. I like to treat this as any other expense because that's what it actually is.
4. Estimated costs to own your home. This is the monthly total from the steps above.
5. Homeowner tax deductions. Add back your after-tax savings benefit that results from the mortgage deduction.

If you run through this exercise and come up with a negative number, you can’t afford to buy the home in question. If you end up with a surplus, you might have a winner.

Buying the right home takes time and patience. Make sure you know what you are looking for before you begin your search. Once you identify where you want to live and know how large the house you need must be, it’s time to analyze some numbers. Make sure the price of the home is no more than four times your gross family income. And make sure that your debt-to-income ratio will be less than 40 after the purchase is complete. These broad steps will tell you if you are on the right path or not.

Next, take your down payment and reverse engineer to determine the maximum amount the bank might be willing to lend you and what your payments might be. When you have that number, add up your other housing costs, your other living costs (including savings) and subtract that from your net income. If the result is a surplus, the house might be a candidate. But if the result is negative, it’s time to reconsider your parameters and find a lower-cost housing alternative. (For related reading, see: Top 8 House Hunting Mistakes.)