Planning for that First House?

There are many reasons to buy a house: Tired of paying rent, ready to put down roots, upgrading from a starter home, purchasing another rental… the list goes on.While everyone's reasoning and timing is unique, the actual mechanics of making the purchase can look similar. To get you started, we've put together a list of key things to know as you start contemplating a house purchase. Our list includes some of the underlying factors lenders use to qualify you, the difference between "can" and "should" when it comes to mortgages and affordability, how to think about a down payment, and how to save for a down payment.

Home sweet home

We will dive into more specific aspects of the home purchasing process in future blogs - and don't miss our podcast episode on the topic - but for now our goal is to get you the foundational knowledge you need to start browsing the real estate market with a plan.Let's dive in.

Lender Requirements

Debt to Income Balancing

Unless you are paying all cash, your new home purchase is likely to involve a mortgage. Knowing roughly what you qualify for is a helpful first step when you start house shopping. This is not the same as what you can “afford,” but it helps frame the conversation.

Financing and Ratios

There are many, many ratios floating around on the internet. In this context, ratios are simply percentages derived from dividing some subset of your monthly payments by your monthly income.  Before handing you hundreds of thousands of dollars, your lender wants to know that you can probably pay them back. They use a number of tools to make this decision, among which are included the ratios. Often referred to as “rules,” know that you are actually dealing with guidelines. It’s typically smoother sailing inside of the guidelines, but there is room for maneuvering if necessary.

28% Front-End Ratio

Your household should end up spending less than 28% of gross monthly income on housing expenses. Gross monthly income means your income prior to taxes and deductions (e.g. your salary as you think of it). For housing expenses, we use the acronym PITI. PITI refers to monthly principal, interest, property taxes, and insurance. If you will be subject to HOA or condo fees, those fees are included. Not included? Things like cable tv, internet, and utilities.

Front-End Ratio = Monthly PITI / Monthly Salary

Lenders are likely to frown if your PITI will result in a Front-End ratio considerably above 28%.

36% Back-End Ratio

Household monthly debt payments should be less than 36% of gross monthly income.Don’t worry, lenders know that you might have other debt in addition to your soon-to-be acquired housing debt. And yes, they do care. For the back-end ratio, simply add any recurring monthly debt payments to the PITI from above and divide by gross monthly income. One interesting note that you might be able to plan around: Only payments extending more than 10 months are included.

Back-End Ratio = (Monthly PITI + Other Monthly Debt Payments) / Monthly Salary

Lenders will likely be skeptical if your total monthly debt payments lead to a Back-End ratio over 36%.

Remember, Guidelines, not Rules

The number of options available is beyond our scope here, but know that while the rules above tend to hold true for conventional mortgages there are other options. For example, the guidelines for loans through the FHA are in the neighborhood of 31% for the front-end and 43% for the back-end ratios. In other cases, we’ve seen lenders go up to 45% for back-end ratiosAnother caveat is that not all income counts the same. Tech workers who rely on RSU, or commission-based workers often find themselves at odds with the traditional ratios. In fact, in many cases, larger employers will have relationships with banks who understand that employer’s compensation structure and will work with employees to get them financing.


Similarly, it matters who your lender is. Some lenders will work with you and your unique situation, others want your loan to fit inside a box. The former might recognize more of your income or assets, the latter might view you as higher-risk. Shopping around is important.


Lenders Make Money By Lending

As you are reading this on a financial planner’s blog I’m hoping that you are already taking initial steps to be mindful with your money.  If not, I’ll merely mention that you should not accept money just because a lender agrees to lend you said money. Remember that lenders make money by lending money to qualified borrowers. They want you to borrow more.

You are in charge of choosing the amount that you can safely spend on a home. For that, there are no hard and fast rules, and a home purchase in most of the country will look different from a home purchase in the Bay Area, Seattle, NYC, or other high profile locales.

One constant in all of those markets? The size of your down payment plays an outsized role in the final look of your mortgage and monthly housing expense.

Down Payments

Long story short, the traditional approach of paying 20% down tends to offer you the most options when it comes to financing.

downpayment bag

Importantly, if you pay less than 20% down, your loan will require primary mortgage insurance (PMI) which will increase your overall monthly payments. PMI remains in force until your loan drops below 80% of the original home value; and note that appreciation does not count, only the original home value.

So, do you have to put 20% down on a home? No. But again, borrowers typically end up paying more when the lender takes on more risk.(FHA loans fall outside of the scope of this article, but as an example, in 2020 borrowers could finance up to 96.5% of their home value. Similar to PMI, Mortgage Insurance Premium (MIP) will likely apply, of course, and you can probably see how this world can quickly become confusing.) Other examples of creative financing in order to avoid mortgage insurance include taking multiple loans (piggybacking) based on the home value, or taking an intra-family loan with the IRS mandated minimum rates if that is an available option.

Savings and Cash Flow

Putting aside the percentage for a down payment, the final question we’ll address is this: How does one approach saving a significant amount of money for a down payment?

I will “answer” that question with another question: Do you currently have an emergency fund?

If the answer is no, that is the first place to direct your savings. The exact amount will depend on your situation, but six months is typically a healthy target. Once you have an emergency fund in place, your savings can be redirected towards your housing fund.

There are many reasons for an emergency fund, but one of my favorite anecdotal stories (when talking about houses) is that the scale of the first new home project is inversely related to the new owner’s emergency fund. (For factual basis, a 2019 study by found that 30% of homeowners experienced a home emergency that cost $1,200)

With an emergency fund in place, how does one approach the housing fund?

Saving for a Down Payment

Earn more and/or spend less. I know it doesn’t sound revolutionary, but at the end of the day, cash flow matters.


Here are some specific examples:

  1. Track your numbers. If you have never tracked your spending, this is an excellent time to take stock of where your money goes each month. You might be happy with the result, you might see areas for improvement. Either way, this data will help you map out your next steps.
  2. Practice the art of delay. With talented marketers and shipping times down to same-day delivery in some areas, our impulse control has a tough fight ahead. Start small by simply delaying an impulse purchase for a few minutes (eventually maybe whole days). Take that time to think about how the product aligns with your values and your goals. You might still buy it, you might not, but it will be a more conscious decision. We have clients who found they saved hundreds of dollars each month through this practice. Try the mental exercise of picturing the object in your house in six months and see how you feel about it. If you need motivation, look around right now at past purchases and see how you feel about those. I’ll get off my soapbox here, you get the point. You might be surprised at how easy it is to “find” a few extra hundred dollars a month.
  3. Save differently. If I’m honest, I don’t love this point but it is somewhat unavoidable. Saving for retirement is important, but it is one of many goals. A very expensive goal, but still one of many. It could make sense to lower your 401(k), or similar retirement savings account, contributions temporarily. Important points: Avoid giving up any employer match if possible and plan to increase those contributions after hitting your goal. You are temporarily reducing savings, not freeing up money for a higher mortgage payment or shopping budget.
  4. Use stock. We preach the importance of long-term investing, but your money is there to work for you. Is selling stock to fund a house purchase a good investment idea? No one can know for sure. Could it be right for you, your needs, and your goals? Yes. It depends on your situation. If you are sitting on shares - particularly if you are sitting on shares of stock from your employer and refusing to diversify - stock sales should enter the conversation.

To summarize, there is no magic bullet. You need to bring in more money than you spend in order to save for a house. Or anything, really.

Finally, know your situation. General rules and advice only goes so far, at some point it needs to be applied directly to your financial life.

Managing a growing reserve.

Growing savings

In general, if you are looking at a house purchase in the next two years, this fund will be no more aggressive than a certificate of deposit (CD). If you are within six months, the reserve should likely be liquid so that you are ready to move. Why this conservative approach? Because the market can go down. Do you want to find yourself suddenly unable to close on your dream home because [enter negative market event of your choice] occurred and sent markets (or worse yet, your one stock holding) into temporary free-fall? Not likely.  Flexible timing means you can typically take on more risk. Short-term cash needs tend to mean it is time to dial things back.

In general, if you have the time to ride out a market cycle, and the risk tolerance to avoid panicking at a low-point, you can invest. If you have a set time frame and it’s coming up, those funds need to be protected.

As I mentioned, it is not a fun answer, but it is a prudent one.

Wrapping Up

In this piece we covered some general guidelines around mortgages and payment amounts, touched on affordability vs. availability of funds, looked at saving for a down payment - and down payments in general -, and covered a few strategies for socking away funds for that down payment. That feels like a lot, but as those who have spent any time thinking about purchasing a home can attest to, we are just scratching the surface.

We will be revisiting the theme, but in the meantime, if there are areas that you want to explore in more detail, your One Day team is here to help. If you are not yet a client, we offer everyone a 30 minute consultation to make sure you are at least pointed in the right direction.

You don’t need to know everything, but you need to know enough to ask the right questions.

Gain clarity and peace of mind
around your finances

Get Your Free Financial Assessment