The Basics

You don't pay cash when you buy a home. If you had to do that then nobody could afford to buy a house. Instead you get a loan from a bank called a mortgage. You make payments on this loan every month for 15 or 30 years, and then you get to stop making payments.

Most homebuyers also make a cash down payment of 3 to 20% of the sale price. A down payment is usually between 3% and 20% of the total cost of the home. The amount of the down payment depends on your credit history, income, the cost of the home, and the type of mortgage you choose. Some lenders also have loan options that allow for no down payment at all.

If your down payment is less than 20%, you will need private mortgage insurance (PMI). This is insurance you pay to protect the bank if you don't repay your loan in full. PMI is added to your closing and monthly mortgage costs. When you apply for a home loan, many mortgages require you to also have at least two month's worth of mortgage payments saved, called reserves. However, there are mortgages that do not require reserves.

Most lenders want to know the source of your down payment and have restrictions about how much can come from gifts from your relatives. In most cases, these gifts will need to be documented. Ask your lender for more information.

The higher the down payment you can make, the easier it is to get a loan, and the lower the interest rate is, and the lower the monthly payment is. But if you can't afford to make a down payment (or don't want to), banks are increasingly offering "zero-down" loans. In fact, 43% of first-time homebuyers put no money down. (USA Today, 2006)

In most cases it makes more financial sense to buy instead of rent, and to buy as soon as you can afford to do so. Most people think the benefit in buying is to "stop throwing your money away on rent," but in fact the equity you build from buying is offset by the money you will "throw way" on taxes, insurance, and maintenance, which renters don't pay. The real benefit from buying is that you freeze your monthly payment for 15 to 30 years, and then you stop paying it altogether.

What kind of home can I afford?

In general you can afford a home worth about three times your annual household income. If your combined income is $50,000, you could afford a $150,000 house.

If it looks like you can't afford a home then consider getting a bigger home than you need and renting out part of it. This is especially applicable to single people, where the smallest home they can find might be too big for their needs. For example:

House Size

Total Cost

Rent out...

Your Net Cost

2 bedroom


1 room for $300/mo.

$500/mo. for 1 room

4 bedroom


2 rooms for $300/mo.

$600/mo. for 2 rooms

Duplex (2 rooms each side)


One side for $800/mo.

$400/mo. for 2 rooms


In 2006 a friend of mine was paying $600 to live in a tiny 1-bedroom apartment. She bought a 4-bedroom house that cost her $1100/mo., and rented out two of the rooms for $600/mo. total. So her net cost per month is only $500. She's spending $100/mo. less, and she has twice as much room, a yard for her dog, and she owns her own house.

Earlier I said you can afford a home worth three times your income. Here are factors that could allow you to buy a home worth more or less than that.

your buying power

your buying power

No debt

Debt, esp. big debt

Large down payment

Small down payment

Good credit

Bad credit

Duplex where you can get rental income

Single-family home, no bedrooms rented out

How much a home costs

The median price for a home was $225,000 in U.S. metro areas in late 2006. (Natl. Assoc. of Realtors) Of course the price varies according to the part of town, and even the state you're in. Homes in California cost lots more than homes in West Virginia and Arkansas. And naturally if the median (middle) price is $225,000, there are houses available for much less. In 2004 I bought two houses on the same lot for $86,000 total, or $43,000 per house.

How much will my monthly payments be?

  • Your monthly payments will probably be 0.75% to 1.15% of the purchase price. On a $150,000 home that's $1125 to $1725/mo. This includes taxes and insurance. We'll cover how to estimate your monthly payment more accurately on the next page.
  • The bigger your down payment, the lower the monthly payments.
  • The lower the interest rate, the lower the monthly payments.
  • The longer the loan, the lower your monthly payments. But it's better to get a shorter loan so you pay it off quicker and save on interest, if you can afford the higher payments.
  • Don't forget that you can lower your monthly obligation by renting out a room or two (or a whole side, if you buy a duplex).

To afford a house you'll need the up-front money as well as money for the monthly payments

Here's a summary:

Money you need up front

• Down Payment (probably)
• Closing Costs
• Misc. Costs


Monthly costs

• Mortgage Payment
  (inc. taxes & insurance)

Money you'll need up front

·         3 to 20% of the purchase price for a down payment. The actual amount depends on what kind of loan you get and how good your credit is. Your bank might offer a zero-down loan, but if you can afford to make a down payment, you should do so, because you'll get a lower interest rate and because your monthly payments will be lower.

·         1 to 8% of the purchase price for closing costs. You might not have to pay this up front. The bank might be willing to add it to your mortgage. (Add them to the mortgage if you need the cash, but pay the closing costs up front if you don't.) The actual amount of closing costs depends on how good a deal your lender is willing to give you, and the price of the house. The more expensive the home, the less the closing costs are as a percentage of the total price.

·         $250 to $800 in Miscellaneous Costs. These are things like the application fee for the loan, the fee for the bank to run your credit report, professional inspection of the home, and an appraisal (if you can't get the appraisal added to the closing costs).

·         Putting these three things together, on a $150,000 house you'll need

o        $4500 to $30,000 for the down payment (unless you get a 0% down loan)

o        $0 to $12,000 for the closing costs

o        $250 to $800 for miscellaneous costs

Total: $4750 to $42,800. Yes, that's quite a difference. You'll learn more about estimating the costs for your own situation as you go through this guide.

How to get a mortgage

You generally need four things to qualify for a mortgage:

1.      Money to make the down payment.

2.      Income that's 2 to 3 times higher than your mortgage payment. (more on figuring mortgage payments in a minute)

3.      Two years of solid employment history (same job or field).

4.      Decent (not perfect) credit.

There are sometimes ways around this if you lack one or two of those, but usually not if you lack three or four. More on this later.

All the costs involved in buying a home

Closing, or settlement, costs are fees you pay when you actually get your loan from your financial institution. These include points, taxes, title insurance, financing costs, items that must be prepaid or escrowed, and other settlement costs. You might be able to have the closing costs added to the mortgage so you don't have to pay them up front.

Closing costs generally range between 2-7% of the loan value. You'll receive an estimate from your lender, called a “Good Faith Estimate” based upon your anticipated loan amount. You can then use this estimate to shop lenders and mortgage brokers to look for the best rates and least fees associated with obtaining your loan. You must pay these costs at the time you close on your loan.

Where the money comes from

Sale Price

Down Payment


Closing Costs

Cash, or added to mortgage

Misc. costs







Here's a summary of what you've learned -- to buy a house you make a down payment in cash, get a bank loan for the rest, and pay the closing costs in cash. Remember that you might be able to have the closing costs added to your loan instead of paying them in cash. Remember also that the amount of money you have to put down varies depending on the type of loan you get and what the bank requires, and the closing costs vary too.

Mortgage Calculator


Today's Rates

Mtg Loan Rate APR
30-yr Fixed 3.75% 3.79%
15-yr Fixed 3.22% 3.29%
1-yr Adj 3.46% 3.49%
* national averages
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