How Much Money Do You Need to Buy a House?

Source: Flickr user Nikcname.

Buying your own home is a part of the classic American Dream, and saving up for a down payment is something millions of Americans are doing. As you embark on your quest to become a property owner, there's a key question to answer: How much money do you need to buy a house?

A simplistic way to answer that question might be to simply look at median home values across the country. According to the National Association of Realtors, here are the median home sale prices for a single-family home in various metropolitan regions during the second quarter of 2015:

While these figures are interesting, they're just the median prices -- smack-dab in the middle of local price ranges. In each region, you'll find homes that are far cheaper and homes that are way more expensive. What really matters is how much house you can afford to buy.

The answer varies from person to person, and it depends on several factors. However, it's important that you pinpoint this figure as precisely as you can. Many home owners find out the hard way that they've bitten off more than they can chew. They may struggle to keep up with their payments, and even worse, they may lose their homes.

So let's review how much money you need to buy a house and how to avoid being dragged under by debt.

Source: Flickr user Woodleywonderworks.

The basics
First off, you want to make sure the mortgage payments you end up with are manageable. Naturally, lenders want you to make the payments too, so they assess two ratios when considering whether to lend to you. The "front-end ratio" checks what portion of your pre-tax income would go toward your monthly housing payment (think mortgage, taxes, insurance, etc.). You generally want a ratio of 28% or less. The "back-end ratio" checks what portion of your income goes to all your debt, including your mortgage, credit card debt, student loans, car loans, and so on. A ratio of 36% or less is generally preferred.

So, for example, if you aren't saddled with too much debt and your pre-tax income is $50,000, you should aim for an annual overall housing tab of $14,000 or less, which comes to $1,167 per month.

You're also generally expected to put at least 20% down on a home loan, borrowing no more than 80% of the home's value. You can put down less and borrow more, but it will cost you more -- in private mortgage insurance (PMI). You'll be at greater risk of ending up with an "underwater mortgage" -- that is, owing more than the home is actually worth -- and therefore having trouble selling it. You'll also be more likely to default on your loan because you've overextended yourself.

Pick the right mortgage
Making smart moves when buying a house also involves getting the right kind of mortgage. For example, you need to decide whether you want a 15-year or 30-year loan, as well as whether you want a fixed-rate mortgage or an adjustable-rate mortgage (ARM). If you choose a longer term, you'll have lower monthly payments, but over the life of the loan you'll pay much more in interest. If you're not comfortable with the payments a 15-year loan would demand, then consider getting a 30-year loan that allows prepayments and then aim to pay significantly more than necessary each month in order to shorten the life of the loan.

Meanwhile, if you're not planning to be in the home for long, an ARM could serve you best in today's low-interest rate environment, as it can lock in low rates for a few years. ARMs lock you into an appealing low rate for the first few years -- typically three, five, or seven. After that, the rates adjust to more closely track prevailing interest rates. An ARM is a risky choice if you expect to stay in the home for many years, as the rate can rise significantly over time. If you think you'll be in the home for decades, it's often better to lock in a low rate for the expected life of the loan. Fixed-rate mortgages, as their name implies, set your interest rate in stone when you take out the loan. With current interest rates so low these days, fixed-rate mortgages are particularly attractive.

Buying more house than you can really afford is a recipe for disaster. Source: Flickr user Kory Twaites.

Strategies
If you're now thinking that you don't quite have enough money to buy the house you want, fear not, because there are many paths to home ownership:

• Delay buying. While you wait, house prices may rise or fall, but you have no control over that, and you cannot predict it, so don't try to time the market and buy a house before you're ready. In the meantime, you can sock away more money for your down payment so you won't need PMI. And if your credit score is less than stellar, then a few years is plenty of time to boost it substantially by paying bills on time, reducing your debt load, etc. The higher your score, the lower the mortgage interest rates you'll be offered -- and that can save you tens of thousands of dollars over the long run.
• Buy less house. You may have your heart set on a four-bedroom home in a nice part of town, but it could make more financial sense to buy a fixer-upper or perhaps a three-bedroom home in a blue-collar neighborhood. You might even consider buying a home in a different part of the country if your work allows you to do so. This strategy could leave you with much more money to save for retirement, pay off debts, put your kids through college, and more.

The amount of money you need to buy a house depends many factors, so grab a calculator, crunch some numbers, and consider different scenarios. If you do your homework, you'll arrive at a number that makes sense.