First-Time Homebuyer Guide + Free Budget Worksheet

TL;DR

• Use my home buying budget worksheet to assess how much house you can afford!
• Understand what goes into your monthly payment
• Factor in 1% of the home’s cost for maintenance
• Keep total housing costs (including phantom costs!) to 28-33% of your gross income
• Find a house you’re willing to stay in for 5-10 years to help ride out market volatility
• Note that selling costs are about ~10% of the home’s value. They can eat up any returns if you sell over a short time-frame.
• Calculate how much you’ll pay in interest to understand the total cost of the house
• Remember that renting is paying for a service, not throwing your money away. Use calculators to help you determine whether buying truly is the smarter financial choice

No One Will Tell You Your “True” Numbers As a First-Time Homebuyer

I know I’m not alone in feeling like I’m not adulting until I buy a home. If you’re a renter, you probably hear frequently that you’re throwing away money on rent and becoming a first-time homebuyer is a great investment.

The funny thing is, if you wait long enough in a conversation with a homeowner, you’ll inevitably hear how pricey owning a home actually is. Property taxes increased, the plumber needed to be called last weekend, wouldn’t you know it, we have rats!

Not going to lie, I dream of buying my first home one day. Not having to listen to our downstairs neighbor’s bass at night, being able to own a dog, having more storage… The idea of owning a home gets me daydreaming pretty quickly.

Despite how much I want a new home, the process of looking for a condo last year illuminated how costly owning a home actually is. It also showed how important it is to understand what you can comfortably afford. For more info on our homebuying journey, see this post. 

The problem is that no one actually tells you what you can comfortably afford. Sure, your mortgage lender will tell you what price of home you qualify for. However, I found that amount was far higher than what I was comfortable with.

Redfin and Zillow’s payment calculators will also not tell you what you can comfortably afford. You have to figure it out yourself. Luckily, it’s pretty easy with a few numbers and some online calculators, including the free budget worksheet I include below.

Understand Your Monthly Payment

With home prices falling over the past year, it is tempting to feel like the time is approaching to jump into the housing market. If you’re sitting on hundreds of thousands of dollars, then maybe the answer is “yes.” If you’re going to slum it and get a mortgage with the rest of us plebeians, then the first thing you’ll want to evaluate is your monthly home payment.

Principal and Interest

Your monthly housing payment is arguably more important than the worth of your home. This is because it affects how you can live your life. A very high monthly payment means that you’ll likely have to be very frugal everywhere else in your life. Not a whole lotta fun.

Your monthly payment consists of the interest and principal you pay on your house. Let’s say you purchase a $500,000 home. Average mortgage rates as of the time of this writing are 8.16%. If you put 20% down, your monthly principal and interest payment will be about $2,981. Over the course of 10 years, an average of $582 of that payment will go towards the principal (the OG loan amount). The other 80% goes to interest *crying emoji.* If you put less money on your house than the amount going towards the principal is even less.

Credit Score

Moreover, the interest you pay depends on your credit score. Having a higher credit score corresponds to a lower interest rate payment. For example, someone with an 800 credit score would pay, on average, a 7.96% interest rate. In contrast, someone with a 650 credit score would pay, on average, an 8.75% interest rate. The person with the lower credit score would pay $223 more per month for interest than the person with the higher credit score.

You can check your credit report for free once a year from Equifax, Experian or TransUnion. If you are looking to increase you credit score, check out my guide on boosting your credit score.

Let’s say you wait until interest rates are lower. For example, many financial experts expect that we will not go lower than a 5% interest rate in the coming years and even decades. At a 5% interst rate, only 25% of your monthly payment will go towards the principal for the first 10 years. You can play with your own calculations at this amortization calculator.

Calculate How Much You’ll Pay In Interest

Even though your monthly payment is the most important number for your day-to-day living situation, it’s good to go into a home purchase with your eyes open. That means understanding how much you’ll pay in interest over the lifetime of your house. Of course, the reality is that most of us will have to pay a ton of interest if we want a house at any point. 

However, understanding how much interest we’ll need to pay could make it more clear whether you are financially ready to buy or whether you perhaps want to save a larger down payment.

Remember that $500,000 house from the earlier example? Assuming we put 20% down, over the course of that 30-year-loan we would pay $840,908 in interest, for a total of $1,340,908 for that $500,000 home. 

Taxes, Insurance, and Possible HOA fees

In addition, taxes are often rolled into the monthly payment. You can specifically choose whether to pay them twice a year or monthly through your mortgage lender. Homeowner’s insurance and mortgage insurance (if you pay less than 20% down) are also included in the monthly payment.

If you are buying a condo, your monthly payment will also include HOA fees which sure start to feel like rent. They are hundreds of dollars and go towards maintenance and services like pools or gyms. However, the accumulated HOA fees are rarely enough to cover big maintenance problems. So make sure you understand assessment fees (which I’ll discuss below).

 Given all that, be wary when people tell you that buying a home is a great investment. I found that for the first 10 years we’d own a condo, we would be paying hundreds of dollars MORE in HOA fees, interest, and taxes than our current rent for just a 1-2 bedroom condo–and that’s not even including phantom costs. I’ll discuss those below.

Factor in 1% of Your Home’s Worth For Housing Expenses

When mortgage lenders calculate how much home you can afford, they do not account for the cost of home improvements like home repairs, the higher cost of utilities presuming you are buying a bigger space and/or a place that is less energy efficient than your little apartment, and the cost of furnishing a new space.

These costs are called phantom costs because they are largely invisible. They are also underappreciated in the home buying process. However, financial advisors recommend that you budget 1% of the cost of your home each year for maintenance costs. That may sound like a lot, but that reflects the average amount people pay year-to-year.

If you are thinking of buying a condo, it is very important you understand assessment costs.

Assessment costs cover maintenance projects that are shared by multiple (or all) tenants. They could include a new roof, painting the exterior, or new carpets for the hallways. Assessments happen periodically. And if they find an important repair, you have to pay your share to have that thing repaired. 

Many of the condos Andrew and I looked at were being sold by people who didn’t want to or couldn’t pay $20,000 assessment fees because of projects like these. Note that that’s $20,000 per unit, not total.

Aim to Keep Your Total Housing Costs to 28-33% of Your Gross Income

The rule of thumb is that your total housing costs, including your mortgage/rent, maintenance costs, any HOA fees, etc. should amount to 28-33% of your gross income. 

In high cost-of-living areas, that is probably an unrealistic target for most people. However, it’s good to be aware that if you spend more than 30% of your income on housing, you are considered cost-burdened. Being cost-burdened puts you in a more tenuous financial position because it will be harder to weather financial difficulties with less available income.

It’s important to keep this in mind because when I went through the mortgage process, I qualified for an amount that blew my monthly budget out of the water. When you qualify for a mortgage, the amount will reflect what you can technically afford. However, it may not reflect what you can comfortably afford. 

Assess How Housing Fits Into Your Monthly Budget

How do you assess what you can comfortably afford? First, reflect on your monthly expenses. What percentage of your income do you currently pay for housing? How financially comfortable are you with that amount? If you pay more will it derail your long-term financial health, including your ability to pay off debt, contribute to savings, and invest for your retirement? Or do you expect to pay more and can either still comfortably afford that difference or can make small changes to your budget to adjust the rest of your living style?

The amount of mortgage you qualify for will also be based on your debt-to-income ratio. In other words, if you have more debt, you’ll qualify for less house. Make sure if you have debt that you have cash reserves after buying your home so that you do not get into more debt. After all, your your mortgage lender is not accounting for you taking on more debt when they are assessing how much you can afford.

You can use my home budget calculator below to figure out how much home you can afford.

Understand the Homebuying Process

The conventional recommendation (and the recommendation of many financial advisors) is to only buy a home if you’ll live in it for 5-10 years. Why? Because the housing market always goes up… until it doesn’t. If you’re a millennial you know this super well, right? We came of age during the Great Recession, the latest slide in housing prices is happening just as many of us are starting families.

It’s impossible to predict what the market will do, and a property ties up a heck of a lot of your money. It’s not like the stock market where you can change how much you’re contributing or sell some and keep some in. There aren’t a lot of half measures if you’re buying a primary property and viewing it as an investment.

Understand the Cost of Selling

Plus, we often think that if someone bought a home at, let’s say, $750,000 5 years ago and now it’s worth $900,000, that they’ll make $150,000 if they sell it. However, that calculation doesn’t account for any of the phantom costs mentioned above. Nor does it account for the additional expenses of selling a house, which usually amounts to about 10% of the purchase price. So if you sell a house for $900,000, be prepared to say goodbye to $90,000 of that in selling costs.

Sure, you still make a profit (unless you had to do hella remodels), but that’s a much smaller payday. Plus, we’re also totally ignoring the headache of buying and selling places, the likelihood you will have to pay more for the next house, and the opportunity cost that you could have put the money for a house into a different investment and earned returns on it. And that’s an example where the housing market is doing super well and the cost of your house went up 20%!

If you have to sell a house for the same price you bought it for, then you’re actually losing a bunch of money. And I don’t even need to talk about what happens if the market goes. So even if you’re a first-time home buyer, make sure you understand the costs of selling. Factor that into the risk of buying something as an investment or shorter-term living situation.

Use My First Time Home Buyer Budget Worksheet

Confused about how this all fits together? Or not sure about the actual costs of buying a house? Try using the Excel template below which will provide a clearer picture of how much money you can actually spend on a home using a few key inputs. The first step is to download the Excel file to your computer. Note that there are two sheets. In the first, you can include your own information. In the second, I provide an example with notes so that you can see what this looks like in completed form and figure out where to get information on things like homeowners insurance and PMI.

Step-by-Step Instructions for Using the Household Budget Worksheet

The next step is to input your total income for the year. This is your pre-tax income and is usually the number that most comes to our mind when we think about our income. You’ll then input your monthly take-home pay (after taxes). And below that you’ll include any debt payments like child support or credit card payments. You don’t want to spend more than 36% of your total gross income on debt payments, including home loans. The spreadsheet template will do the calculations for you to assess what you can afford to pay for a home based on your income and current debt.

The Excel template also calculates your monthly mortgage payment for you, including phantom costs for ongoing expenses like maintenance. You just have to input the purchase price of the home and a few other numbers you can find through a little Google search or perusal of Redfin or Zillow. I provide information on how to find those numbers in the “Example” sheet.

The budget spreadsheet does have a few limitations to note. First, it can only calculate monthly payments for fixed rate mortgages (usually lasting 15 or 30 years). Second, it does not include additional, optional buying costs for things like home inspection or warranties. It also does not include the tax benefits of owning a home.

You can add those in if you would like to include that information. The monthly payment will also be an estimate, given that you will be inputting estimated data for things like taxes and insurance and that it’s estimating maintenance data as 1% of the home’s value. Nevertheless, it should provide you a clearer picture of the amount of home you can afford.

Compare the Cost of Rentals To Ensure You Get a Good Deal as a First-Time Homebuyer

The alternate title of this post could have been, renting isn’t all that bad. Indeed, you are not throwing money away when you rent. You are paying for a service. You get a roof over your head, flexibility, almost no responsibility for maintenance or paying taxes, and more. 

So never let someone make you feel like you’re not adulting for renting. Often it is the best choice. In fact, at the moment, there are only 4 metro areas where it’s cheaper to buy than to rent. You can assess whether it’s cheaper for you to buy or rent using Nerdwallet’s or the New York Times’ helpful calculators.

If, after all that, you find yourself in the enviable position of finding the right house that costs 30% of your gross monthly income (including phantom costs) that you’ll stay in for at least ~7ish years and you feel comfortable with the amount of interest you’ll pay and the level of maintenance it needs, then go for it! And rest comfortably knowing that you’ve done your homework and made the most responsible choice you can. 

Invite me over too. I love living vicariously through other people until I too can afford a home.

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