Things to know before buying a home | Housing | Financial Literacy | Khan Academy

Let's say you're interested in buying a home, and you have found the house that you want, and it costs $300,000. Let's think about whether you are ready to purchase that and other things that you might have to consider.

A lot of folks realize that if you want to get a loan to buy this house, most banks aren't going to give you the full amount as a loan. There might be some special circumstances depending on your background, depending on whether you are a veteran or things like that, but in most cases, banks are going to expect you to put a 20% down payment. That protects the bank in case the value of that property goes up or down, or especially if it goes down. It also makes you invested in the property so that you don't just walk away.

So, if we take 20% of $300,000, that is going to be $60,000 that you're going to have to put as a down payment. Now, you might say, "Okay, is that the cash that I need to save in order to buy the house?" My answer to you is, it is almost the cash that you need to save to buy that house. Because when you buy a house, there's also something called closing costs. Depending on where you are, some of the closing costs might be paid for by the seller; sometimes it is the buyer. You are the buyer in this situation, but you could reasonably expect.

Some of the closing costs are all of the legal and the paperwork that you have to do when you buy a house. Sometimes there are costs associated with the mortgage itself, but it's reasonable to assume that that's going to be another 2% to 5% of the purchase price of the house. So, once again, let's say, let's be a little conservative here. If we took 5% of $300,000, that's another $15,000. Hopefully, it would be less than that, but let's be conservative.

So in this situation, you are going to be looking at a total of $775,000 at least. Well, depending on what we assume about the closing costs, but around this that you would have to come up with in order to feel good about going through the entire transaction. But we aren't done with our considerations because it's not just about the amount of money that you can bring as a down payment; it's also what can you afford in terms of a mortgage.

As we will see, there are other monthly costs other than a mortgage. So if you have $60,000 down, this means that you're going to have to borrow the remainder, $240,000. I recommend you go to a mortgage calculator. I looked it up right over here; if we're buying a $240,000 30-year fixed mortgage at this interest rate—interest rates are constantly changing, so look it up wherever you are—this is a monthly payment of $1,742.00.

And even to get this mortgage, it's not just that a bank will say, "Oh, you have the money; I'm going to give it to you." They're going to do things like a credit check. They are going to verify your employment, and not just that you are employed, but how much money you are actually making. As a general rule of thumb, they're going to want to see that your housing costs are no more than 30% of your gross income. And by the way, that's a pretty good rule for yourself so that you don't overspend and you don't break your budget.

The more your income relative to how much you're going to have to pay every month, the better it's going to look when a bank considers whether to give you a loan. Now, I keep saying housing costs as opposed to mortgage because the mortgage is part of it, but there are other things that you're going to have to consider when you buy a house.

First of all, there are going to be property taxes. Property taxes can be significant depending on where you live; they can be anywhere from 1% to 3% of the value of the house every year. So if we were to go with, say, 2% property taxes in this example—and I encourage you to look it up wherever you are—2% of the value of the house, and they'll go up if the value of the house goes up; in most places, that's going to be $6,000 a year. Six thousand per year, which is another $500 a month.

So now our total monthly costs are $1,742 plus $500, and we are not done. If this is a condominium or even if it's a house in a development, sometimes there's a homeowners association, and they charge for the grounds, upkeeping, the gardening. If there's a shared pool, sometimes it includes things like some of the utilities or picking up the trash or other types of maintenance.

So that could easily be, depending on the size of the house, where you live, etc., it could be anywhere from $400, $500, $600, sometimes a lot more than that. But let's throw another $500 right over here. Let's remind ourselves what this is: this is the mortgage, this over here was property tax, and this over here is the homeowners association.

There are other costs if you don't put 20% down; some lenders may force you to get private mortgage insurance. You could pay that on a regular basis; sometimes all of this could be rolled into the loan, and it all gets rolled into your mortgage. But you're going to pay it one way or another. So if you even add up all of this, you are at $2,742, and even this does not factor in all of your housing costs.

Because above and beyond this, you might have to pay for your own gardening, your own upkeep. Things are always breaking; you have to replace appliances every 15 to 20 years; you have to replace a roof. You should ask around and figure out what you're likely to spend there and factor all of that in. Let's say once you factor all of that in, your total costs are, say, $3,000.

Based on these numbers, it would probably even be a little bit more than that when you factor in utilities and upkeep and maintenance and broken appliances and other types of homeowners insurance that you might need. But let's say that all of that stuff, when you factor in, is about $3,000 a month. Then, if we go to that 30% rule of thumb—that you shouldn't spend more than 30% of your gross income on housing costs—that would imply that you need a gross income of at least $10,000 a month or $120,000 a year.

Once again, that's not a hard and fast rule, but the bank is probably going to look for something like that as well. But it gives you a sense of what you're likely to afford. It's good to go into buying a house; everyone dreams of owning a house, and it's not a bad dream. But it's very important to go into it with eyes wide open.