How Much Money Should You Spend When Buying a Home?

How Much Money Should You Spend When Buying a Home?

Older couple standing in front of a house for sale

Buying a home is an exciting time. You have to apply for a mortgage and provide stacks worth of paperwork. You need to find a real estate agent that makes you feel comfortable and shows you the properties you want to see. Another thing you need to do is decide how much money you can spend on a home.

How much money you can spend when buying a home depends on a variety of factors. These factors include things, such as the interest rate you receive and the amount of the down payment you can afford. After you decide on an amount, you have to tour numerous homes to find one that you and that offers you the most home for your money. Here's a closer look at the factors that affect how much you can spend when buying a home.

Interest Rates

In the United States, the Federal Reserve controls how low the interest rates can go. As of March 2020, the Federal Reserve has lowered interest rates to zero to .25 percent in 2020. It's at an all-time low. However, just because the Fed sets the rate that low doesn't mean that's the rate you're going to receive. Your mortgage company will offer you an interest rate based on your credit score, employment history, and the amount of money you make.

If you have the chance, you might consider reviewing your credit six months before applying for a mortgage. This gives you a chance to improve your score. You might be able to pay off a couple of debts to raise your score or find a problem on your credit report that needs to be removed.

The interest rate makes a big difference in how much you can afford when buying a home because it will affect your monthly mortgage payments. You might look at your credit card bills, where you're paying $15 a month in interest, and think it isn't a big deal. With a mortgage, you're dealing with a lot more money as principal.

For example, if you purchase a home for $200,000 with a down payment of $50,000, you owe $150,000. You pay interest on the amount that you owe. Now, if you receive an interest rate of three percent, your monthly payments are around $1,126 per month. If the interest rate rises to five percent, your monthly payment is about $1,356 per month. This is a difference of $230 per month, $2,760 per year, and $82,800 over a 30-year loan. That's a huge difference! You can play with the numbers yourself with a mortgage calculator.

Down Payments

Banks and mortgage companies want home buyers to have a down payment available for several reasons. First, it shows that the buyers have been willing to set money aside and save up to buy their home. It shows financial stability and responsibility. You can't save up a substantial down payment without a solid work history and few outstanding debts.

The second reason that banks prefer large down payment is that it creates instant equity in the property.

For example, if you purchase a home for $250,000, with a $50,000 down payment, you owe $200,000. The home is still worth the original $250,000, so you start with $50,000 worth of equity in the home. There are two ways to increase equity: paying down your principal and rising home values.

Equity is important in a home. If something happens, that causes you to default on the loan the equity reverts to the mortgage holder. The bank can get its investment out of the property if there's enough equity.

You can buy your dream home with a little planning. You can build a solid credit score while setting aside money for a down payment.