Overview

When preparing to purchase a home, establishing a budget for down payment and monthly homeownership costs (mortgage, property tax, HOA, insurance, repairs and maintenance) is crucial so you don’t get in over your head and become house poor. Just because a pre-approval says you can buy up to a certain amount of home, you need to carefully analyze your monthly expense, savings and retirement goals, and what you can realistically afford.

Debt-to-Income Rules to follow

• Your total mortgage generally should not be more than 28% of your total gross income
• Your total debt to income (includes other debt like car payments, personal loan, tax installment agreement, minimum credit card payments) should not exceed 43%

Other Homeownership Expenses

• Other costs of owning a home include homeowners’ insurance, utilities, repairs, and maintenance costs, HOA fees, property tax, and mello-roos, if applicable. Be sure to understand each of these expenses in the respective neighborhoods of interest. New developments tend to have mello-roos, which can quickly increase your average property tax from 1% to 1.5-1.9%.
• Maintenance costs can add up quickly, including routine care such as landscaping, cleaning, and the one-off costs that require bigger investments.

Down Payment Will Drive Your Purchasing Power

• Down payments typically run as low as 3.5% for FHA up to local confirming loan limits and suggested is 20% in order to avoid PMI or private mortgage insurance
• PMI can add 0.5-1% interest cost to your loan and may not be tax deductible based on the phase out of adjusted gross income (talk to your CPA)
• Closing costs need to be added to the down payment, which typically run 2-5% depending on the size and location of the purchase. While these costs can be negotiated with seller, the market will dictate how much you can try and pull this string and still have success at entering into contract and closing on your home

Estimate Your After-Tax Income

• When you rent, you do not receive the benefit of the homeownership tax write-offs of mortgage interest and property tax write-offs
• The additional write-offs you will be able to use between itemizing and your standard deduction should be multiplied by your applicable tax margin and factored into your monthly budget. For example, if your itemized deductions are $7,500 higher than the standard deduction and your marginal tax rate is 35%, your you will have an additional $2,600 per year in take home pay or approximately $220 per month.
• Talk to your CPA to independently verify your after-tax income in a rent versus buy scenario to accurately project your budget.

Financial Tips After Buying Your First Home

• Build a Budget – Once you buy a home, some new financial planning and budgeting tasks need to be done as painful as it may sound. Developing a plan and sticking to it will help you to avoid stressful situations down the road. Build a budget that covers all your home costs and set aside enough spare money for repairs and upgrades.
• Insurance – Consider insurance beyond homeowners’ insurance. Life and disability coverage need to be considered to cover you if you are unable to work or your family if you pass away. There are different options and these should be discussed with your insurance and/or financial advisor.
• Savings and Retirement – Ensure that your budget continues to have savings for retirement, rainy day fund, vacations, and other items that you want as part of your lifestyle. This will help you to avoid becoming a slave to your home. You should have 6-12 months of savings or easily accessible funds in the event something happens. Contributing to your 401K should be a must as this is tax deductible and many employers will match employee contributions, which is free money. Other retirement planning should continue and be discussed with your financial advisor.
• Revisit Your Budget – reviewing your spending habits often and identifying areas where you are being frugal could save in the long-run. Even finding $50 per month yields $600 per year. You should have the mind-set that there is always room for improvement.