Do you want the good news or the bad news first? Ok, the good news first: there are tax benefits to owning a home. The IRS lets you deduct mortgage interest and real property taxes, within limits, on your annual income tax return. You can contact a real estate or tax attorney for the specifics in your area.
The bad news is that there are many expenses you may not know about that come with buying a home. Here are some of the expenses you should expect when buying your new home:
Closing costs: These include points and other fees charged by the lender, which can add up to 3% of the amount you borrow; title insurance, from a few hundred to over a thousand dollars, depending on the purchase price of your home; inspections, about $200 to $500; and other miscellaneous fees.
Many of these costs are negotiable between the buyer and seller, and are dependent on local customs. You can also negotiate with the lender to reduce, and in some cases completely waive, certain costs.
Down payment: A minimum of 20% of the home’s purchase price is usually required for the best loan terms and to avoid paying private mortgage insurance. However it’s entirely possible to buy a house with a smaller down payment.
Monthly mortgage payments: These include loan principal, interest, and sometimes additional charges for taxes and insurance.
Property taxes: Amounts vary, but the average is around 1.5% to 2% of a home’s purchase price.
Homeowners insurance: Call your insurance company for more information, as rates vary.
Private mortgage insurance (PMI): If your down payment is less than 20% of the purchase price you need PMI. This can tack several hundred dollars each year to your loan costs until the equity in your home reaches 22%. At this point you no longer need the insurance.
Maintenance: You could spend about 1% of the purchase price annually on maintenance and repairs.
Housing expense ratio: Typically, mortgage lenders won’t allow these housing expenses to be more than one-third of your household monthly gross income. In other words, 28% of your monthly gross pay (for example, your annual salary divided by 12) is the usual maximum “housing expense ratio” allowed by lenders. The “housing expense ratio” compares your monthly gross income to “PITI,” an acronym for:
- Principal amount you borrowed, of your mortgage loan
- Interest: on the mortgage loan
- Taxes: property taxes
- Insurance: homeowners and private mortgage insurance (PMI)
Debt-to-income ratio: On top of the 28% lenders allow for monthly housing expenses, they will usually let you spend another 10% for other debt repayments such as student loans, car loans and other similar loans. Added together, your housing expense ratio and monthly recurring debts make up your “debt-to-income ratio,” and should not be higher than 38% of your monthly gross pay.
When considering buying a home, make sure and keep all of these added expenses in mind.