As I begin the process of locating and buying my first home, my mind is loaded with questions. This week, I’m answering the five biggest ones (for me, at least) in detail. Other questions involve a home buying gameplan, hiring an agent, hiring a home inspector, and closing costs.
Whenever I’ve talked to people about the costs of home ownership on a month-by-month basis, I’ve heard some vastly different numbers. Some people claim that it’s incredibly cheap and go on and on about how good of a deal it is; others say they had no idea how expensive it can be.
Cost of Owning a House
I spent some time researching the typical cost of home ownership on a month-over-month basis and I’ve came up with this basic equation for determining the monthly cost:
Monthly cost = mortgage payment(s) + property taxes + insurance + maintenance/improvements – tax benefits
Let’s walk through each of these elements and use an example (who we’ll call Jim) to see how much he can expect to pay each month. Jim wants to buy a $175,000 house in rural Iowa. He has no down payment, but has found a lender who will give him a full mortgage because he has stellar credit. He borrows $175,000 at 6.25% for 30 years.
The reports to us that Jim will be paying $1,077.51 per month to pay off his mortgage. That’s a pretty hefty start.
After doing some research with Google, Jim discovers a calculator for property tax in the area where he will live. The annual property tax on a $175,000 home comes out to $2,391.36, which is basically $200 per month for property taxes.
After calling up an agent recommended by a friend, Jim finds that he can get a homeowner’s insurance policy he’s comfortable with for $950 a year. That comes out to about $79 a month for insurance.
An aside: most lenders, when calculating the “cost of home ownership,” include the mortgage payments, the property taxes, and the insurance. They generally don’t subtract the tax benefit, nor consider the additional cost of maintenance or improvements. They use this number, usually abbreviated PITI (principal, interest, taxes, and insurance), to determine roughly how much to lend to you. Thus, a lender would estimate Jim’s PITI as $1,356.51 per year. The lender would then calculate this as a percentage of Jim’s annual salary ($60,000) to come up with 27%, within a safety area of “lendability.”
This seems to be a big variable based on different living situations, but a fair estimate of an annual investment here is 1% of the cost of the home. So, since Jim is paying $175,000, he should figure $1,750 a year in home maintenance costs, or about $150 a month to keep up his home.
Here’s the good part: the interest on that home loan is tax-deductible. Rather than doing a large calculation here that tries to remove the principal from the home loan as well as figure in the additional state and local tax benefits, we’ll just multiply Jim’s federal tax rate (28%) by his monthly mortgage payment ($1,077.51) to get a rough estimate of how much he’ll save each month in taxes: $301.70. I’ll round that down to $300 to ward off a bit of naysaying.
So, what’s the total damage? If we replace the numbers in the equation above with the numbers we found, Jim will incur an expense of just about $1,500 each month to buy his house, but will make back about $300 each month in income tax savings, leaving him with an average monthly cost of home ownership of about $1,200.
Doing my own calculation with vaguely similar numbers made me feel a lot more comfortable with home ownership. I estimated a bit higher than 1% for monthly home improvement expenses for my own reasons; regular readers of Money360 probably already know that I want a very, very nice kitchen. In the end, though, these numbers made me feel much better about the upcoming purchase, not in that I thought it was cheaper or more expensive, but that I finally had some real numbers to think about.