Homebuyers

Creating a Budget When You’re Saving Up for Your First Home

Making your first home purchase is a big investment. And if you’re ready to take the next step towards homeownership, you’re not alone.

According to the National Association of Realtors, 32% of homebuyers made their first purchase in 2023. The majority of those buyers were motivated by a desire to have a home of their own. 

So, how do you get from wanting a home to being able to buy one?

One of the biggest questions that will need answering is the financial part of the equation.

“You’re going to be working on your income, your credit, and your assets — three things that we need to buy a home,” said Melyssa Caban, a Branch Manager with New American Funding in Orlando, Florida.

Assess your current financial situation 

The first step to ready yourself for thinking about a home purchase is to get an accurate look at your income and expenses. 

Beyond looking at your salary, you want to have an idea about how much you spend on eating out or food delivery, clothing and retail purchases, and entertainment, as well as utilities. 

Using a budgeting app, such as YNAB or PocketGuard, or a spreadsheet can help track expenses to get a sense of where your money is going each month. 

Outside of income and expenses, you’ll want to review your debt. This might include student loans or credit card debt. 

Looking at income and debt together will also give a sense of your debt-to-income (DTI) ratio. This is something that lenders will definitely consider when determining your creditworthiness.

DTI ratio is equal to the total amount of monthly debt payments divided by gross monthly income. Put more simply, it’s how much debt you carry compared to your income.

There are two types of DTI ratios: the front-end and back-end. 

The front-end DTI is a calculation used to see how much of your gross monthly income goes toward housing expenses. For instance, if your gross monthly income is $6,000 and $1,680 goes toward housing, your front-end DTI is 28%. 

The back-end DTI additionally includes debt liabilities, including car payments, student loans, and credit card or other debts. It’s generally recommended to keep this figure below 36%. 

These ratios are important because they’re used by lenders to see if you can qualify for a loan. There can be some variability depending on if the loan type is Conventional, FHA, other loan types. 

Improve your credit score

After assessing debt, you’ll want a picture of what your credit looks like to see if you’ll qualify for a loan. 

“My best practice is to run an actual application,” said Caban. “That also gives [buyers] a free credit report. You want to see how bad or good your credit looks or if it needs work.”

A credit score of at least 620 is required for most Conventional loans. You can work to improve your credit score by paying down debts, including credit card balances, avoiding any late payments on bills, and refraining from opening new credit accounts. 

Another option is explore a homebuyer assessment, in which a lender will examine your financial situation and help set you on a path to buying your first home.

Set a savings goal

After looking at income and debt, you can see how much money is left over for savings and determine what amount can go toward a down payment. 

A 2023 survey by the National Association of Realtors found that first-time buyers put down 8% as a typical down payment. When a down payment of less than a 20% is used on a Conventional loan, private mortgage insurance is required, another expense to factor in. 

FHA loans have different rules about down payments and mortgage insurance, requiring as little as 3.5% down, but also requiring mortgage insurance for the life of the loan.

As of August 2024, the median average sales price for existing homes in the US was $416,700. At that price, a 20% down payment would be $83,340, while a 10% down payment would be half of that: $41,670. If using an 8% down payment, $33,336 would be needed. 

Determine the timeframe 

According to Caban, it can often take buyers around a year to budget and save. During that time, credit scores can be improved and monthly savings goals can be reached. After tax season, tax refunds can also be included toward savings.  

Find ways to increase income 

Outside of saving, Caban also recommends looking at how income can be increased, whether it’s putting in overtime or asking for a raise. Other funds can also be considered, including gifts, stocks, and 401Ks. It is possible to borrow against your 401K for a purchase of a home, though it may affect your monthly paycheck and retirement contributions. 

Budget beyond buying 

While saving for a home purchase is the goal, setting aside additional funds for furniture, future home repairs or improvements, and even just a rainy day is also a good idea. 

Giving yourself an extra financial cushion in your new home is worth the peace of mind. 

“We always recommend after buying your home that you have at least six months set aside financially,” said Caban.