How to Budget for a House

A man’s accomplishments in life are the cumulative effect of his attention to detail.

— John Foster Dulles

Start with Principal and Interest

This is your purchase price spread out over the length of the loan along with the finance cost of delaying the payments from the date of purchase. For example, if you buy a €200,000 house with a 10% down payment, and you borrow with a 30 year fixed rate mortgage at 4% interest, then your monthly PI (principal + interest) = €859.35. This is the one part of your housing cost that is constant and predictable, but unfortunately there are many other costs.

Add Taxes and Insurance

Next, you must budget for property taxes and insurance. The property taxes you pay will depend on where you live and your homeowner insurance costs will depend on a variety of factors. Using national averages, that €200,000 house will cost you €230/month for property taxes and €65/month for homeowners insurance. Note that unlike your fixed rate mortgage, your property taxes and insurance will gradually go up over time due to inflation. The other thing to consider is that you will always have these costs as long as you own the property – even after your mortgage is paid off! After 30 years, your mortgage will be paid off and you will no longer be paying your €859.35 (principal + interest). However, if inflation averages 4%/year, then after 30 years, you will still be paying €745.98/month in taxes and €210.82/month in insurance. Notice that your monthly cost for taxes and insurance may equal (or exceed) your original monthly cost for principal and interest by the time your mortgage is paid off.

Add Repairs and Replacements

Another big (and unpredictable) cost is repairs and replacements. A house has many things to wear out over time – appliances, roof, siding, driveway, sidewalk, chimney, carpet, plumbing, etc. All of these items will need to be repaired and eventually replaced. Even though these costs are large, most people do not budget for them. This is a huge budgeting mistake.

If you do not think these costs will be material, just try the following 10 minute exercise. Go around your house and make a list of all your major appliances: furnace, hot water heater, refrigerator, washer, dryer, water pump, sump pump, oven, whatever. Then take a quick guess at a realistic lifespan and a replacement cost for each item. Divide the replacement cost by the number of years and total everything up. Over time, that is roughly how much you will spend each year just on appliance replacements. You can do the same exercise for exterior items (e.g. roof, chimney, gutters, etc) or for plumbing or carpet or most anything. It is not difficult to see this will be a large number, and that is just replacement costs. Most people also want to eventually upgrade items such as fixtures, cabinets, windows, and doors.

Finally, there are numerous repairs to be done, and most of us need to be cautious of overconfidence when considering our skills. Most people already know (or can easily learn) how to fix a toilet or faucet, paint a wall, repair a light switch, or patch a sidewalk. These are good skills to have and will save you money. However, unless you are highly skilled, there will still be many jobs where you will need to pay a professional. It is unlikely you will handle issues like a main sewer backup, a leak in a second floor roof, or the removal of a large tree growing too close to your house.

Add Furnishings and Landscaping

If you have previously been renting or you have moved to a larger house, you should expect that you will probably spend additional money on furnishings or landscaping. One of the joys of owning a home is being able to do exactly what you want with the house and the yard. However, this opportunity comes with a cost. Furniture, pictures, lamps, playsets, shrubs, trees – these all cost significant sums of money. Only you can decide how much you will spend, but do not kid yourself – it will not be zero. For many people, decorating costs will be substantial, if for no other reason than the new owners will want to undo many of the decisions made by the former owners of the property.

Add Risk

Lastly, there is a hidden cost to home ownership: risk. When you rent, the landlord bears nearly all of the risk. When you own, the risk becomes yours. We see at least five specific risks:

1. Borrowing Risk. When you borrow anything, you agree to pay something back later. If you borrow a lawnmower from a neighbor, you agree to return it the next day. When you agree to borrow money via a mortgage, you agree to the payment schedule. Despite the best of intentions, one can never entirely predict the future, and mortgages are a very long term commitment.

2. Collateral Risk. Although your homeowner policy will protect you from many things, it will not protect you from everything. For example, most policies do not cover floods or termite damage. You might also find undisclosed environmental issues with lead or asbestos.

3. Location Risk. The general real estate market might do well, but your particular neighborhood – or your particular house – might still have issues. Your house might decline in value due to foreclosures on your street, increased crime in your neighborhood, the loss of nearby employment, or the planning of a bordering highway.

4. Liquidity Risk. Even if the property does not decline in value, you may not always be able to sell it in the time frame you desire. This may limit your future options. For example, you might not be able to move to another city to take a more desirable job.

5. Diversification Risk. For many people, the cost of a house is very large compared with their total assets. This has the effect of concentrating household wealth in one asset.

Consider the Positives

We do not want this article to come across as entirely negative. Homeownership has many positive aspects. There is a certain pride to homeownership that cannot be discounted. It also provides stability. If you are the owner of the property, you can stay there as long as you like (provided you pay the financing costs and there are no imminent domain issues). A renter may be forced to move because the landlord has other ideas. Additionally, if you desire to live in a particular neighborhood, or a particular school district, or even a particular lot, there may simply be no rental available. Buying may be your only choice if you want to live in that exact location. Lastly, despite the uncertainties of repairs and other items, ownership may be cheaper than renting if you are disciplined and stay in one location for a long period of time.

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