Step 2: Learn How Much Money You Need to Buy a Home

What will your dream home look like? Will it have three bedrooms and a garage? Maybe it has a big yard or kitchen-one big enough for family meals, and . . . hold on a second! It's fun to picture your dream home, but you need to put a frame around that picture. Before you start looking at homes, you'll want to figure out how much home you can afford. That way you can focus your search on homes you like that are within your price range and that fit your monthly budget. To complete the calculations, do the following:

• Review your monthly budget [link to budget worksheet]
• Gather information about your annual income, assets (items you own), and debts (how much money you owe). You can estimate these figures, but it is best to take a little time to gather accurate information. You can get this information from paycheck stubs or W-2 forms, bank statements, credit card bills, and loan statements.
  

You can then enter this information using the "How Much Can I Afford" calculator. [Link to Fannie Mae Calculator] This calculator will give you a good feel for the loan amount you can afford and your monthly mortgage payment.

• Your monthly mortgage payment is not the only cost involved in buying a home. Depending on your situation, you may need cash for a down payment as well as earnest money deposit, loan fees, and closing costs.
  

Cash You Need to Buy a Home
Now that you have an idea of how much house you can afford and you'll want to be aware of the cash you'll need to complete the home buying process. Generally you'll need cash for the down payment, earnest money deposit, loan fees, and closing costs.

Down Payment
If you think you need a 20 percent down payment to buy a home, think again. There are many loan programs, especially for first-time home buyers, that require little or no money down. However, it's important to note that if you put less than 20 percent down, most lenders will require you to purchase private mortgage insurance (PMI). Many factors affect whether you will be required to get PMI and different rules may apply. If PMI is required, ask your lender about the monthly cost and how long you must maintain it.

Earnest Money Deposit
A seller wants to be sure that you are a serious buyer. So you'll be asked to put up some money-called earnest money-as a show of good faith. Your earnest money deposit may vary between 1% and 10% of your purchase offer. If the seller accepts your purchase offer, your earnest money deposit is held in escrow-a special account-until the home purchase is completed. Your deposit is then applied to your down payment or closing costs.

Loan Fees
Loan fees may be collected during the loan application process (upfront fees) or at closing (closing costs). Note that the names given for the fees may vary from state to state. You should carefully review all fees and ask your lender about any that are not clear to you.

Upfront Fees
You will need cash, a check, or money order to cover upfront fees, such as

• Appraisal Fee: An appraisal is an estimate of the home's value done by a licensed appraiser. The estimate is based on the size, age, and condition of the home, improvements to the property, and recent sales of nearby, similar homes. The appraised value may not be the same as the selling price, but it will show if the home has enough value to support the loan.
• Credit Report: The lender orders a copy of your credit report to determine your credit history and to check the information that you provide on your loan application. The lender will not use a credit report you ordered for your own use.
• Application Fee: This fee may be charged upfront or it may be added to your closing costs.
• Points: You might pay points to reduce your interest rate. One point is equal to 1% of your loan amount. For example, on a loan of $100,000 one point is $1,000 ($100,000 x .01 = $1,000). Each point reduces your interest payment by about ¼ percent. You might want to pay points if you plan to stay in your home for several years and must lower your monthly payments. But if you plan to move or refinance your loan in a couple of years, it may be better to pay fewer or no points.
• Loan Origination Fee: This fee is typically a percentage of the loan amount and covers the lenders administrative costs in processing the loan.
  

Closing Costs
Closing costs can vary between 3% and 6% of the value of the home. Lenders are required to give you a good faith estimate of your closing costs within three days of receiving your loan application. The good faith estimate will give you an idea of costs you can expect to pay at closing. Step 8 explores closing costs in more detail.