Home Buying in the US
Buying a home is typically the largest single purchase an American makes. The median US home price in 2024 is ~$420,000. Understanding the process, the costs, and the mortgage system prevents expensive mistakes.
The Rent vs. Buy Decision
Buying is not always better than renting — the decision depends on your financial situation, local market, and time horizon.
Buy when:
- You plan to stay in the area for at least 5–7 years (needed to recover transaction costs)
- You have a stable income and emergency fund
- You can afford a down payment without depleting savings
- Owning makes financial sense in your local market (use the price-to-rent ratio — if a home costs more than 20× annual rent, renting often makes more sense)
Rent when:
- You might move within 3–5 years
- Your local market is extremely overpriced
- You're still building credit or savings
- You want flexibility
The 5% rule: David Bach's rough comparison — estimate the annual unrecoverable costs of owning (property taxes ~1.2% of value + maintenance ~1% + cost of capital ~2.5–3%) ≈ 5% of home value. If 5% of the home value > annual rent, renting may be the better financial choice.
How Mortgages Work
A mortgage is a loan secured by real property. If you stop paying, the lender can foreclose (take the property). Mortgages amortise over time — your monthly payment is split between interest and principal, with interest front-loaded.
Types of Mortgages
| Type | Rate | Best For |
|---|---|---|
| 30-year fixed | Higher rate; fixed for 30 years | Stability; planning to stay long-term |
| 15-year fixed | Lower rate; paid off in 15 years | Faster equity; significant total interest savings |
| 5/1 ARM | Lower initial rate; adjusts after 5 years | Selling/refinancing within 5–7 years |
| FHA loan | Requires 3.5% down; lower credit score OK | First-time buyers with limited down payment |
| VA loan | 0% down; no PMI; excellent terms | Veterans and active military |
| USDA loan | 0% down; rural areas | Buying in USDA-eligible rural/suburban areas |
| Conventional | Requires 620+ credit; 3–20% down | Most buyers with decent credit |
Key Mortgage Terms
| Term | Meaning |
|---|---|
| Principal | The loan amount |
| Interest rate / APR | APR includes fees; use APR to compare loans |
| Amortisation | Paying down the loan over time through scheduled payments |
| PMI (Private Mortgage Insurance) | Required if down payment < 20%; costs 0.5–1.5% of loan/year; can cancel when you reach 20% equity |
| Escrow | Lender holds money for property taxes and insurance, pays them on your behalf |
| Points | Upfront fee paid to lower the interest rate; 1 point = 1% of loan amount |
The Down Payment
The down payment is the portion of the purchase price you pay in cash. The remainder is financed via mortgage.
| Down Payment | Effect |
|---|---|
| Less than 3% | FHA / VA / USDA programs only |
| 3–5% | Conventional loans available; PMI required |
| 10–19% | PMI required; mortgage insurance reduces |
| 20% | No PMI; best rates; strongest offer |
20% rule: On a $400,000 home, 20% = $80,000 cash. This is a significant barrier. Programs exist to help:
- First-time homebuyer programs: State Housing Finance Agencies offer down payment assistance (grants or low-interest second loans)
- FHA loans: 3.5% down with a 580+ credit score
- Fannie Mae HomeReady / Freddie Mac Home Possible: 3% down for qualifying income levels
Closing Costs
Closing costs are fees paid at closing in addition to the down payment. They typically run 2–5% of the loan amount:
| Cost | Who Pays | Typical Amount |
|---|---|---|
| Loan origination fee | Buyer | 0.5–1% of loan |
| Appraisal | Buyer | $300–$600 |
| Title insurance | Buyer (lender's policy) + Seller (owner's policy) | $700–$2,000 |
| Home inspection | Buyer | $300–$500 |
| Attorney fee (where required) | Buyer or Seller | $500–$1,500 |
| Property taxes (prepaid to escrow) | Buyer | 2–6 months |
| Homeowner's insurance (first year + escrow) | Buyer | $1,000–$2,500 |
| Recording fees | Buyer | $25–$250 |
Example: On a $400,000 home with 20% down ($80,000), closing costs might add $6,000–$16,000 — total cash needed: $86,000–$96,000.
Seller concessions: You can negotiate for the seller to pay some closing costs, especially in a buyer's market.
Step-by-Step Home Buying Process
- Check your finances: Credit score (aim for 740+), debt-to-income ratio (under 36% recommended), savings for down payment + closing costs + 3–6 month emergency fund
- Get pre-approved: A lender reviews your financials and commits to a loan amount. Pre-approval letter is required to make a credible offer.
- Find a buyer's agent: A buyer's agent is typically free to you — paid by the seller's commission (though this is changing post-2024 NAR settlement)
- Search for homes: Use Zillow, Redfin, Realtor.com, and your agent
- Make an offer: Include purchase price, earnest money (1–3%), contingencies (inspection, financing, appraisal)
- Negotiate and go under contract: Seller may counter; you negotiate final terms
- Home inspection: Hire a licensed inspector (~$400); negotiate repairs or credits for issues found
- Appraisal: Your lender orders an appraisal to confirm the home is worth the purchase price
- Clear to close: Lender finalises underwriting; get final loan disclosure
- Closing: Sign documents, pay closing costs + down payment, receive keys
The True Cost of Homeownership
The mortgage payment is only one cost. Budget for:
| Ongoing Cost | Typical Amount |
|---|---|
| Property taxes | 0.5–2.5% of assessed value/year; varies heavily by state and locality |
| Homeowner's insurance | $1,000–$3,000/year |
| HOA fees (if applicable) | $100–$500+/month |
| Maintenance and repairs | Budget 1–2% of home value/year (~$4,000–$8,000 on a $400k home) |
| Utilities | Increase vs. apartment (larger space, maintain everything yourself) |
A $400,000 mortgage at 7% for 30 years = $2,661/month in principal + interest. Add $600 property tax + $150 insurance + $250 maintenance = ~$3,661/month total — not including HOA.
Tax Benefits of Homeownership
- Mortgage interest deduction: Deduct interest on up to $750,000 of mortgage debt (if you itemize)
- Property tax deduction: Up to $10,000 SALT cap (combined with state income taxes)
- Capital gains exclusion: When you sell your primary residence, exclude up to $250,000 of capital gains (single) / $500,000 (married) — if you've lived there 2 of the past 5 years
Note: After the 2017 Tax Cuts and Jobs Act doubled the standard deduction, most homeowners no longer have enough to itemize.
Study Snapshot
Home Buying — rent vs. buy (5% rule, 5–7 year horizon), mortgage types (30yr fixed, 15yr fixed, FHA, VA), down payment (20% to avoid PMI), closing costs (2–5%), 10-step buying process, and true cost of ownership.
Concept Flow
Check Your Understanding
- What is PMI, when is it required, and when can it be removed?
- What is the difference between an interest rate and an APR when comparing mortgages?
- Why do you need to plan to stay in a home at least 5–7 years to justify buying over renting?
- What ongoing costs beyond the mortgage payment must you budget for as a homeowner?