This week I received a question from a reader asking how much to save up before buying a house. Here is Alicia’s question:
How much money do my husband and I have to save up before buying our first home?
Thank you for asking such an important question Alicia. This is a question many people should ask but don’t.
Working out how much the down payment would be is only half the answer – you’ll also need to work out what is affordable on your budget once you’ve factored outgoings and debts into the bargain. Certain loans are available to make it easier for first time buyers in North America to own their own home and you may be able to qualify for one of these.
What Can You Afford?
How much of your income would be used to pay down your house-related debts? The TD Canada Trust recommends two calculations that can help you to assess exactly what you can afford to buy:
The Gross Debt Service (GDS) ratio – This approach looks at the cost of your house purchases, including mortgage payments, taxes and heating costs. Ideally, you should not be spending more than 32 per cent of your gross monthly income on your home. Any figure above this is considered to be on the wrong side of affordable.
Total Debt Service (TDS) ratio – This approach looks at your debt levels, including housing debts, loans, car payments and credit card repayments. Ideally, you should not be spending above 40 per cent of your gross monthly income on debt.
Both of these figures are the higher end of the scale and where possible, it’s advisable to be aiming for lower.
What Is an Affordable Mortgage?
Work out the household gross annual income and multiply by 3.4. For example, if you earn $50k, you could afford a house worth $170k. This is considered to be the absolute maximum that you can realistically afford. Aim for a house worth more than this figure and you’re unlikely to be able to afford to take it on.
Other Related Expenses
Purchase prices and mortgages aren’t the only expenses associated with buying a home. Closing costs can be as much as 20 per cent of the purchase price, for example. Don’t forget about living expenses too. After all, there’s no point moving into your dream home if you can’t afford to pay the bills or put food on the table! It’s also a good idea to know that you’ve got an emergency fund buffer in reserve for those unexpected expenses that will inevitably crop up.
What Are The Options for First Time Buyers?
Here’s some good news though – there are some loans available to help first time buyers to get on the property market in the USA and Canada. Here are some of them:
USA – FHA Loan
These loans are insured by the Federal Housing Administration (FHA) and typically have lower down payments and closing costs. Down payments can be as little as 3.5 per cent of the purchase price. Closing costs can be negotiated into the loans too.
USA – No Down Payment USDA Loan
These loans don’t require any down payment at all but you need to meet eligibility criteria. The main one is that the house must be deemed to be in a rural area according to the USDA definitions.
Canada – RSP Home Buyers’ Plan
Do you have a Registered Retirement Savings Plan (RRSP)? The RSP Home Buyers’ Plan may be an option as a first time buyer in Canada. This allows you to withdraw up to $25k from your RRSP to buy a home. This must be repaid year-on-year within the next 15 years.
High ratio mortgages
Down payments can often be anything from 5 per cent to over 20 per cent of the purchase price. To get a conventional mortgage, you’ll often need a down payment of at least 20 per cent. What if this is just too steep to be achievable for you? You may prefer a high ratio mortgage instead. These don’t require such a sizeable down payment. However, be aware that a bigger down payment means lesser mortgage expenses and lower interest payments.
Want to avoid the prospect of falling in love with a dream home only to realize that it’s way out of your price range? You might want to look at a pre-approved mortgage. This will enable you to see options that are within your budget. When we bought our house a few years ago we went through this exact process. It made searching for a home a lot easier because we knew what we could look at or consider and what was out of our price range.
As you can see, buying a home is a complex process. Hopefully this guide will help you to estimate your price range so you don’t fall in love with a home that is too expensive, which you later regret. If you ask me, it pays to take the time to do this upfront research. A house is one of the most expensive purchases you are going to make in your life so give the decision the time and consideration it deserves.
So readers, do you own a home? What process did you go through to buy your house and why? Do you have any other tips to share with Alicia?
Our first step was getting preapproved. Like you said, we didn’t want to fall in love with something only to find out that we couldn’t have it. Our whole process took less than a month.
Ours was pretty quick too. We were preapproved in a couple of weeks.
Here in the US it’s ideal to be able to put 20% down on your home as you avoid PMI (private mortgage insurance). It’s basically a waste of money and something you no longer have to pay once you have 20% equity in the house (depending on the value of the home it could run anywhere between an extra $50-200/month).
Due to where we live we actually used the USDA loan. Another great benefit to that government program is that you don’t have to pay PMI (regardless of how much you put down)! We put more than 0% down, but we weren’t able to make it to the full 20, so having that PMI forgiven has been a huge help.
Glad to hear the USDA loan option worked good for you. We have similar rules here in Canada as far as PMI goes. You have to pay it here too if you don’t put down 20%.
I highly suggest putting the full 20% down because then you are not such with that PMI payment every month. Like Jason said its a big waste of money.
Agreed. Any extra payment you can avoid is good.
Thanks for this article! We’re not going to buy for a few years but it helps to have that reference point for income. We might be buying a veeeery small house in a very expensive city. 🙂
Remember, size doesn’t matter. You just need a safe, warm dry place.
I live in the US and had 20% down plus closing costs in cash prior to buying. I also had some money for unexpected expenses and to cover some cosmetic renovations we wanted to do before we moved in. We knew we would have to replace the AC unit and saved up for it as soon as we got the house. There are a ton of expenses over the mortgage so try to think of everything.
You are a super star Lance. It sounds like you were really prepared which is great. I am sure the preparation paid off in a reduction of stress and bills. Good for you.
Great point about thinking of renos or upgrades too. This is something many people don’t put into the equation and they pay big for that. We had a couple small things to do when we moved into our house and we planned for them. It made things a lot easier.
Good thinking. We did the same thing when we got preapproved. We could have bought a more expensive house but we didn’t. We didn’t want to be house poor.
Thanks for the helpful tips and loan options! My sister is beginning the process to buying a house and I’ve sent her a link to this article.
Great. I hope it helps. Let me know how things work out for her.
You can also get seller concessions on down payment, PMI and closing costs in the US. For FHA’s I believe you can get as much as 3% of the home value in concessions.
I don’t know too much about these but I know they exist which is why I mentioned them. They sound kind of neat.
My first step will be to get $40K or so in down payment. I don’t want to end up owing so much money that my financial position gets worse!
That is a commendable goal. 40K is a lot but worth saving up for for a smaller mortgage. Hope it works out for you.
Very informative post!
Awesome resource. I agree with getting pre-approved to set properly set your expectations. If you’re going new construction and go with their preferred lender, they usually have incentives like money back or no closing costs!
Good point. I forgot to mention that one. We are looking to do an addition on our house and we are hoping to link it with the mortgage company when we renew.
Miss T, this is good formula, put in details. I am working towards my first home with 100% down payment. I sincerely feel people should pay down as much as they can with the saving they have.
100%. You are amazing. If we could all set that goal, debt ratios would look much different. Best of luck with that. I am so proud of you for saving before buying.
My personal guideline is that carrying costs shouldn’t be more than 33% of net income. So, if you’re making $50,000 you’re probably keeping about 60% after income taxes. That’s $2500 a month, so if you take 1/3rd of that you shouldn’t be spending more than $825 a month on your mortgage, insurance, property taxes, and maintenance for the house. Spending more than that means you can get more easily into trouble.
If you’re a couple, each making $50,000, then that means $1650 a month or about enough to afford a decent home or condo.
I like that rule. Very simple and easy to calculate. Thanks for sharing.
Now I just have to see where we measure out using this formula.
My wife and I bought our starter home 17 years ago, and we’re still in it! At the time, we had no kids, and now we have five. We paid 5% down on the home. Sadly, with the housing crash in Michigan, our house values have declined greatly over the last few years. Our home is now worth just about what we paid for it in 1995. It’s a sad reminder that there are no guarantees in life, and you’d better not over-extend yourself with debt.
It is sad but true. Life is unpredictable. All of that money people initially made on their house is now gone. I am glad to hear you didn’t sink yourself into a hole. At least now you are no worse off. You at least still have the value you paid for. I know some people who paid over inflated prices and are now in real trouble.