Maybe not even what your lender tells you …
Like many potential home buyers you may have found a mortgage calculator on the web. You eagerly entered in the estimated price of your dream home, the interest rate for which you have been told you may qualify (or you hope to qualify), and with the click of the mouse you get a magical number! Be wary! This is NOT all you need to consider before purchasing a home.
There are more costs to home ownership than just that magic number. Your lender may even approve you for a lot larger monthly mortgage payment. Would you believe that once you add in all home ownership costs, you might not feel comfortable with either number? It can and does happen.
This page will cover five monthly home ownership costs. It will also briefly describe closing costs. You should know each of these costs PRIOR to determining what home price you feel you can comfortably afford.
DISCLAIMER **(This is not a substitute for obtaining professional advice and calculations from lenders. Costs and standards vary across regions of the country. This is only to be used as a tool to educate and provide a way for a potential buyer to understand and ESTIMATE for potential costs)**
MONTHLY EXPENSES
There are five basic monthly home ownership expenses: (1) principal loan payment, (2) loan interest payment, (3) monthly property tax payment, (4) monthly home owner’s insurance payment, and (5) monthly home maintenance expense.
There is a 6th portion if your down payment is less than 20%. This sixth part is Private Mortgage Insurance or (PMI). Private Mortgage Insurance varies in cost based on what type of mortgage loan (conventional versus First Home Buyers versus Veterans Administration Loan, etc.), and what type of home purchased (single family home, townhouse, or condominium). Click here for information on PMI from the Federal Reserve Bureau. Click here for an article which walks you through the FHA PMI calculation. If you are putting less than 20% down, don’t forget to add PMI to your monthly expenses.
LOAN & INTEREST PAYMENT
The mortgage principal or loan payment reduces your loan amount (principal refers to the total amount of money you borrow). The interest payment is the fee you pay to the bank in return for them lending you money. These two payments make up what is called the principal and interest (p&i) payment. This payment is usually the magic number you receive when you use mortgage calculators. These payments relate solely to the mortgage.
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PROPERTY TAXES AND HOME OWNERS INSURANCE
Taxes and Insurance (t&i) costs make up part of the check you will write each month. The t&i portion of the payment is deposited into what banks call an escrow account (think of it as a depository). The t&i payments are accumulated in this account until the property taxes and home owner’s insurance is due, usually a one-time payment each year. The bank makes the payments on your behalf to the local and county governments and home owner’s insurance company.
Property Taxes Property taxes are assessed on the land and building which you are purchasing. These taxes are to support the community services provided by those governments.
To determine property taxes for a potential home, check on your local real estate listing service. Property taxes are often noted as an annual expense. So make sure to clarify how the property tax is listed, if you see annual taxes = $1,200, you would divide this number by 12 to get the monthly expense.
Homeowner’s Insurance Home Owner’s Insurance is required by the mortgage company. This insurance is to protect your ability to pay your loan should certain damages occur to your property. Some properties will require additional insurance such as flood insurance.
Per the Federal Reserve Bureau, a general estimate of homeowner’s insurance may be calculated by dividing the purchase price of the house by $1,000, and then multiply the result by $3.50. Note, the Federal Reserve states the average home owner policy costs around $480 a year. You could use this average figure in place of calculating an estimate if you want to be more conservative. If additional insurance such as flood insurance is required, this cost would be in addition to the insurance cost calculated here.
Add up all four of the costs described above to get the total ‘mortgage’ payment (‘piti’). The total of these four costs provide you an estimate of the check you will be required to write out each month. Don’t forget to add in flood insurance or private mortgage insurance if you will be required to have those!
HOME MAINTENANCE
The fifth cost, home maintenance, is often overlooked by some home buyers. These are real costs, and, if you were a renter prior to home ownership, these will be entirely new and additional costs to you.
There can be two parts to home maintenance expense: Home Owners Association Fees you may be required to pay, and the monthly costs you will incur to maintain your personal residence.
HOA Fees (home owner association fees) Monthly HOA fees for a single family home generally contribute to maintaining common areas within a development. Common areas include the green space, pool, club house, etc. Your Realtor can tell you if the property you desire has HOA fees.
Note for purchasers of Townhouses or Condominiums - The HOA fees for these homes MAY include Home Owners insurance in the HOA fee. If the HOA fee includes an insurance policy for the building and land, then the monthly home owner’s insurance payment as calculated above would not be relevant as it would be included here in the HOA fee instead.
The unit owner may or may not need to obtain a policy to cover the contents of the home (similar to a renter’s policy). Check the HOA Covenants and By Laws to determine if a policy such as this is required. You will want to add the cost for that policy to your monthly expense if you determine to purchase it.
Monthly Maintenance Costs To maintain your home you will incur expenses each year such as, lawn maintenance, sealing the driveway, irrigation, repair AC, fix dishwasher, fix leaky plumbing, etc. This cost can vary and you need to make your best estimate – is it an additional $100 a month or $500 a month?
This figure would be less if you own a town home where grounds and exterior maintenance are included in HOA fees. It would also be less if you purchase a home in a development where lawn maintenance is included in the HOA.
Not very handy with tools? Hiring help usually costs more than a good do-it-yourselfer (but less than a bad one!).
CLOSING COSTS
Buyer closing costs in a real estate transaction are to pay for services from lenders for your loan, to attorneys to verify and legally complete contracts, to a loan originator to perform loan application processes, and many other services. Rather than enter into a detailed discussion, note that for most areas of the country, the Federal Reserve Bureau suggests estimating closing costs as 3% of purchase price. That 3% is the amount of cash the buyer needs to have on hand, in addition to the down payment. To reduce the amount of closing costs you must pay, you and your REALTOR can consider asking the seller to pay some of the costs as part of your negotiation.
SO WHAT IS YOUR PURCHASING POWER?
Start with how much money you have as a down payment and subtract that from the price of home you want to be able to afford. Plug the amount you would have to borrow into a mortgage calculator. Enter in the current average interest rateand see what the monthly principal and interest payment will be. Use this as your starting point.
Using the information provided about taxes and insurance above, calculate an estimate of the monthly property tax payment, and an estimate of the home owner insurance. Add these two costs to the monthly mortgage costs you just calculated for a starting point.
Finally, add on an estimate for monthly home maintenance costs. Is the result an amount you are willing to afford? Can you pay this amount, every month, comfortably?
Now you’ll have a good idea of YOUR purchasing power! From here you can adjust the price of your dream home up or down to get to YOUR monthly happy number!
Don’t forget to make sure you have the estimated 3% for cash toward closing in addition to your down payment!
Feeling a little shaky about all of this? Don't worry! This is why you work with a Professional REALTOR. If your REALTOR can’t or won’t help you walk through this information along with your lender, you may not have the right REALTOR.
Want some immediate help? Contact me - I assist my clients with worksheets which automate this process and help you as you move through your search!Making sure you know a good estimate of these costs prior to your home search will help you and your REALTOR reduce the stresses of finding the right home!
Happy House Hunting!
A purchasing power calculator at Realtor.com.
Kristen Richardson, REALTOR® Keller Williams Realty-Franklin
TN lic# 325119
615-243-8073
FromHereToClose.com
Kristen is a former professional accountant. She is located in Middle Tennessee.
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