Affording a Home
When you feel it’s time to get into a new home, there are lots of factors to
consider. The most important being Can I afford to buy? As simple as that
sounds, it can actually be a very loaded question. You should do some
preliminary research to make sure you know the answer.
Gross Monthly Income ($)
Total Monthly Debt
- Non-Mortgage Debt
Allowable Mortgage Payment
In the formula above, the non-mortgage debt should include any credit card
bills, student loans, car payments, monthly utility bills, and your monthly
entertainment and travel expenditures. Once you’ve discovered how much you can
pay each month in mortgage fees, you can move on to your next set of
Consider that the mortgage payment you calculated does not mean all the money
will be going to the principal and interest of your loan. It will probably
include your yearly property taxes (usually a percentage of your homes worth)
and also private mortgage insurance payments (if your down payment is less than
20% of the loan total.) This might mean that after figuring in the tax and
insurance you may not be able to afford as much house as you thought.
Your calculations so far will be a preliminary figure to find out if and how much
you can afford. When you actually sit down with a mortgage lender, however, he
or she will use a much more specific and complex combination of variables to
decide your ability to pay off a mortgage. Lenders will start by evaluating
your current and future income potential. They will then pull your credit
report and evaluate your history of making payments. (The better your credit
score, the easier it will be to acquire a loan. Try to do everything you can to
clean up your score before applying for a home loan.) Other considerations by
lenders will include how much of a down payment you can contribute, the length
of your proposed loan, your total amount of debt, the interest rate you’ll be
paying on your mortgage, and also the probability that you’ll default on your
loan payments. All of these factors together will determine the size of the
loan you will be able to receive.
However, just because you are offered a certain amount of money doesn’t mean
that it is truly in your best interest to borrow that much. You have to decide
what size payment is within your comfort zone. Don’t forget that there will be
lots of associated costs with buying and owning a new home. Before you actually
get into your home you may have to pay for realtor fees, a down payment, and
closing costs. After the home sale, in addition to the mortgage payment, you
might have to pay for homeowner’s insurance, new furniture or appliances,
maintenance and upkeep of your new place and the cost of any repairs of
remodeling you decide to do.
Buying a home is an exciting and sometimes overwhelming process. Taking a look
at your financial status and all the potential fees before starting the
application process will help you to feel secure in your ability to afford the
Monday, February 15, 2016
Saturday, February 13, 2016
Buying a home is both exciting and demanding.
Homeownership comes with a variety of financial and cultural benefits:
short-term ups and downs in the market, most people who buy homes and live
in them for a long period recoup their investment as the value of the
house, and their proportion of ownership, grows.
- Tax and cash flow advantages. Mortgage interest is currently deductible, which makes it easier to afford a house.
- Self-determination. Your home is yours. You can do what you want with it (within the limitations of zoning, homeowners’ association regulations, and the law, of course).
- Community and personal stability. Homeownership correlates with greater wealth, higher educational achievements of children, and neighborhood quality of life.
The process of buying a home pivots on your financial resources, both current and future. Whether you are buying “by owner” or working with an agent, you’ll need to sort what you need from what you want, and narrow down your options from there.
Before you begin the home buying process, work through these essential considerations:
What are your objectives? Your objectives are the overall goals you are trying to achieve. They might include:
- Accommodating family members, whether in number, disability access or other practicalities of daily living.
- Right-sizing the square footage and cost of your living space to your budget and lifestyle.
- Lifestyle preferences, such as proximity to shopping or entertainment.
- Income –related factors, such as commuting distance or accommodating a home-based business.
Start by prioritizing your needs.
Size & style – What are the practical daily needs of your household, and what type of house can support those needs? Do you need plenty of play space for children? An oversized garage for recreational vehicles? Outdoor entertainment space? One-story living for aging in place? Make a short list of your must-haves so you can quickly zero in on the houses most likely to suit your needs.
Location – The commute to work, schools, neighborhood culture, zoning and access to services and stores that are important to your household.
Monthly housing budget – Typically, no more than a third of your gross income. The monthly budget includes the mortgage, insurance, property taxes, fees, utilities, heating and cooling expenses, and a fund for repair, replacement and maintenance. Condominiums and gated communities also require monthly homeowners’ association fees to cover maintenance of common areas.
Current market trends – Are there plenty of good houses currently on the market so you can take your time looking and talk a home owner down on the price? Those are the characteristics typical of a ‘buyer’s market.’ But when house values are steadily increasing, mortgage rates are reasonable and plenty of people are buying, sellers can hold firm and home prices rise. This is considered to be a “seller’s market.” National trends may or may not have a direct effect on the market conditions for the neighborhoods you are considering. Track the home-sale trends in the area to detect the factors relevant for your home purchasing process.
What Can You Afford?
The first thing you need to decide is how much you can afford. Determining this early in the buying process will save you a lot of time and frustration. You will know what is in your price range and what is not.
Establish Your Financial Foundation
Get your credit report – Federal law empowers you to get at least one free credit report annually from each of the three major credit reporting bureaus. (www.transunion.com; www.experian.com; www.equifax.com). Scour the reports for errors and immediately get them corrected. It can take several months for even the best-documented corrections to ripple through the system. If your credit score is below 720, consider talking with a financial advisor to see how you can boost it. That might involve paying down your credit cards, boosting your income, or taking other action.
Save the down payment – Historically, buying a house has required at least 10% down. That threshold was briefly relaxed in the mid-2000’s housing bubble, with disastrous results. Lenders have returned to the time-honored conservative guidelines. The bigger your down payment, the better the terms of the mortgage. If you are counting on a gift or loan from your parents, those funds should be deposited in your savings account months before you apply for a mortgage. Lenders frown on last-minute deposits. You’ll also need to have several thousand dollars on hand for closing costs, moving expenses, and for the inevitable surprises that crop up in the first few months of homeownership.
Get pre-approved for a mortgage – Once you have your credit scores in the best shape possible, and with your down payment securely settled in your savings account, gather your earnings statements and get pre-approved for a mortgage. Not only will this give you a reality check on exactly how much house you can afford, but the pre-approval also gives you a strong platform for negotiating the best price. Sellers want to know you are serious. The pre-approval proves that you are.
What’s the difference between pre-qualification and pre-approval?
Pre-qualification is a "guesstimate" of what a buyer might qualify for prior to actually submitting a mortgage application. Based on the unverified financial information you provide, the lender uses a quick calculation to arrive at a loan amount. Pre-approval means that the lender has verified your financial information and has actually committed money in your name for a specific loan type and amount.
Getting a Loan
Getting a loan to buy a house is a demanding, meticulous process. You will need to document how much money you have, how you got that money, and persuade lenders that money will continue to arrive to cover your mortgage and other financial obligations. Keep copies of all documents you submit for your mortgage application. At the very least, you’ll have a record of the process. And in case parts of your application package go missing, you can quickly supply replacements and keep the loan approval process on track.
What Type of Loan Is Right For You?
Your lender will consider these factors when assessing the types of mortgages appropriate for you. Remember, though, that you need to be conservative in estimating the amount of total debt your household can comfortably carry. Just because you qualify for a ‘stretch’ loan doesn’t mean you should take it.
Key factors in the mortgage include:
- The required down payment
- Both the interest rate and the annual percentage rate (APR)
- Standard closing costs and fees
- Requirements from secondary lenders, such as Fannie Mae and Freddie Mac that might acquire your mortgage. These secondary lenders prefer cookie-cutter, standardized loans so they can assemble portfolios of identical mortgages for investors. If your situation is unusual – for instance, if you are self-employed or have an erratic income – you might not be able to get a loan that conforms to the secondary market. That will significantly complicate your ability to secure a mortgage.
The most common types of mortgages include:
Conventional Mortgages. A conventional mortgage offers a fixed rate, typically for 10, 15 or 30 years. The down payment requirement will likely range from 10% to 20% or even more. If you put less than 20% down, you’ll be asked to carry private mortgage insurance (PMI). If you’re a first-time homebuyer, you might qualify for a loan through a Federal program, such as the FHA, or a state program, geared for first-time or moderate-income buyers. These loans typically require smaller down payments.
Adjustable rate mortgages. Adjustable rate mortgages carry an interest rate that changes to reflect current market rates. This is an option for buyers planning to stay in their home for a short time. If you plan to stay in the home for an extended period of time, you may be better off locking in a fixed rate with a conventional loan. When deciding whether an ARM is right for you, determine the following:
- Will I be able to afford higher mortgage payments if interest rates go up?
- Will I be making other sizable purchases in the near future such as a car or college?
- How long do I plan to own this home?
FHA mortgages. Loans through The Federal Housing Administration (FHA) help low-to-moderate income home buyers purchase homes with low down payments (historically, 3%). Rules for FHA loans have been changing, so check with your lender for the latest parameters.
VA mortgages. Veteran Affairs loans may provide the opportunity to buy a home with no down payment. They are offered up to a predetermined loan amount (not more than $200,000) and might be assumable by qualified buyers. Check with your lender to learn the current rules applying to VA loans.
Assumable mortgages. An assumable mortgage is a loan that stays with the property. It is simply transferred to the qualified home buyer. This means considerable savings for the next buyer. It may include no points, no interest rate change and low closing costs. Assumable mortgages are often the most valuable part of a property. An assumable loan can be a marketing advantage when you sell the house because the new owner can take over the loan payments. However, parameters for government-backed loans have been changing, so always check with your lender for the latest rules.
Balloon mortgages. The balloon mortgage has a fixed rate for a certain time frame, typically seven years, followed by a "balloon" payment requiring repayment of the entire home loan balance. Interest rates are generally lower than conventional loans. People may choose this type of loan because they plan on either selling the home, paying it off, or refinancing before the balloon payment is due. Balloon mortgages were in favor during the housing bubble, but have since fallen in popularity because many borrowers could not afford the balloon payments.
Private mortgage insurance. If you put less than 20% down on a loan, you will likely have to pay PMI or Private Mortgage Insurance. PMI protects the lender against a loss in the event of default by the borrower. You can ask your mortgage company to remove the PMI if you’ve paid 20% of the loan. However, you will be asked to provide an appraisal.
Most lenders require you pay real estate taxes and insurance on a monthly basis. This cost is included in your monthly mortgage payment, placed in an escrow account, and paid out by your mortgage company.
Searching for a Home
Most people consider house hunting the most enjoyable part of the home buying process.
If you choose to buy a property directly from the owner, the home seller may reduce the price by the %2-3% commission that would typically be diverted to the listing agent.
Experienced home buyers are likely comfortable with dealing directly with a “by owner” seller, though of course, they will still want to engage a real estate attorney to review the contract and ensure that they are complying with all state laws regarding real estate transactions.
First time buyers may want to engage a buyer’s agent. A buyer’s agent has a fiduciary responsibility to you.
It can be confusing to sort out a real estate agent’s loyalty. If you are simply ‘working with’ an agent who is showing you houses, that agent probably actually is loyal to the seller...even if that agent did not list the seller’s house. To ensure than an agent is completely loyal to your interests, is looking out for your financial wellbeing (that’s the ‘fiduciary responsibility’), and will maintain confidentiality about your finances and buying considerations, you must sign a ‘buyer’s agent’ contract. If you have not contracted specifically with the agent to represent you, it is possible that the agent’s fiduciary responsibility to the listing agent and the home seller.
Beginning your home search
Using your home-search priorities as a guide, start looking for houses you can afford in the neighborhoods that best suit your needs.
Hang out in local coffee shops and parks. Attend neighborhood events. Go to open houses. Talk with friends and co-workers. Look at the neighborhood association and municipal websites.
Keep a log of the houses you are interested in. Take photos and collect listing sheets so you can compare details. This will help you stay organized and remember what you’ve seen.
Where to find listings of homes for sale
ForSaleByOwner.com – This is the largest website for “by owner” sales. These owners are committed to pricing their houses realistically and working with buyers directly to help them capture the best value. These listings typically include extensive details about the houses.
Realtor.com – Operated by the National Association of Realtors, Realtor.com is by far the largest collection of listings in the country. It includes ForSaleByOwner.com listings from sellers who specifically requested that their houses be placed on Realtor.com. By looking at Realtor.com, you are in good company; 93% of house hunters start their home search online, according to the NAR. Listings typically include the basic property data, or more, depending on the effort of the listing agent.
Craigslist.com – This popular online classified service is rich with listings, both by agents and ‘by owner.’ Craigslist is organized by geography, and can be difficult to search. You will need to scroll through it daily to see the latest listings.
Newspapers – Sunday papers are a rich trove of listings, news and analysis about the local real estate market. Many newspaper web sites offer handy email services that can update you when new listings that fit your specifications become available.
Multiple Listing Service – If you are working with a buyer’s broker, your broker will scan listings posted by other agents to this commonly owned and operated database of houses for sale. In the past, MLS listings have been for agents’ eyes only. But now it is common for agencies to put all MLS listings on their websites. Don’t hesitate to look at MLS listings on brokers’ sites, but be wary of the fiduciary responsibility of any agent who offers to show you a house you inquire about. If you are in doubt, specifically ask the agent about any legal obligations that you might incur before you go to see a house. In some states, simply being shown a house by an agent means that the agent is owed a 3% commission — even if you thought you were buying the house directly from the owner.
Yard Signs – Even in the internet age, yard signs are still important. If you are getting familiar with a new neighborhood, you will notice new “for sale” yard signs.
Making an Offer
Once you’ve found a house that looks promising, you will want to research the price parameters of recently sold, similar houses. This will ensure that you are making an offer consistent with recently completed sales – and it increases the chance that your offer will be confirmed by the appraiser your lender will assign to confirm the validity of the deal.
A comparable market analysis (CMA) lists the recent sale information of nearby homes, including how long each home stayed on the market, how close the asking price was to the actual sale price and other factors. It then compares the information regarding these houses with the one in question. If you’re using an agent, she will do this for you to help you determine a realistic price. There are several online appraisal services that can provide you the same information as a CMA. Zillow.com offers a popular service. You can also check local property tax records to find recently sold houses within a short radius of the house you are considering.
As you go through this buying process, remember that everything is negotiable, and everything should be in writing. You should be very specific when you prepare your purchase offer, and the sellers should be equally specific when they issue their counter offer.
Here are tips for smart negotiating:
- Work with an experienced local real estate lawyer.
- Don’t make a verbal offer.
- Don’t offer full price unless the home is a real steal. You need room to negotiate.
- Include a home inspection contingency. This enables you to cancel the deal if you inspector unearths major problems that can’t be fixed efficiently or economically.
- Make sure the contract includes an "out" in the event you cannot secure financing.
Earnest money proves to house sellers that you’re serious. After all, they’re going to take their home off the market on your behalf. Earnest money is typically between 1% - 5 % of the purchase price. The money should be held by an attorney or title company in escrow. Never give the money directly to the house seller. Such a deposit does not mean you’re bound to the contract. Your full deposit is credited toward the down payment and closing costs.
Once your offer is accepted, it becomes a binding contract, so be sure to include the necessary contingencies. Contingencies are clauses that, if not met, will render the contract null and void. Common contingencies are the sale being subject to approved financing, the sale of an existing home and/or a satisfactory home inspection.
You’ve made your offer. Now you need to have an expert verify exactly what you are purchasing.
A formal inspection determines if anything needs to be repaired or replaced. Be sure the purchase contract spells out who pays for the inspection and how you will work out with the seller who covers any necessary repairs. The contract should also include a contingency in case the inspection reveals flaws that cannot be resolved with the seller.
Licensed home inspectors inspect homes to determine what, if anything needs repairing or replacing. Typical inspections may include.
- Termites – signs of termites in the home or foundation.
- Plumbing – checks for leaks, dripping faucets, toilet tank leaks, etc.
- Electrical – does it meet the local building code? Do all outlets and switches work properly? Can the electric service handle the current?
- Exterior – settling cracks, paint peeling, structural problems, likely flooding.
- Interior – signs of leaks in walls or ceilings, structure and general condition.
- The roof – leaks or damage.
- Windows – condition and age.
- Insulation – is it in good enough shape to buffer the interior from extreme heat and cold?
- Appliances, and heating and cooling systems – do they work efficiently? Are breakdowns likely?
- Radon gas – an odorless and colorless gas that is sometimes found in the earth’s rock and soil.
- Lead-based paint – some older homes may still have lead-based paint that can be hazardous if ingested by children.
- Asbestos – homes built in the early 1970s and before often had asbestos tile floors and asbestos ceiling tiles. This substance poses a health risk and must be removed.
The home inspector will write up an inspection report with all minor and major defects itemized. Good inspectors will find minor flaws in nearly any home. It’s up to you to decide if these flaws are deal-killers. It’s also important to tour the house with your inspector so you can get an introduction to its mechanics and condition.
When the inspection is done, it’s time to move into the title and closing phase.
Title Insurance, Appraisal and Homeowner’s Insurance
Some people can get confused about this stage of the real estate transaction, but with a little knowledge and guidance, it’s easy to understand. We’ll break down the basics for you.
When you buy a home, a title company examines the chain of titles (previous owners) to insure that there are no problems with obtaining clear title to the property. Parties other than the current owner of the home may have rights to it for things such as mortgages, liens due to unpaid taxes, lien claims to those who the owner owes money for home improvement projects and so on. As a new owner, you may know nothing about these risks, but you are still vulnerable to such claims on your property. A deed is not sufficient protection. That’s why title insurance is necessary.
It is very common for title companies to also handle the escrow portion of the transaction, meaning they serve as a neutral party to exchange funds and make sure both parties adhere to the agreed upon terms of the contract. To find a title/escrow
Some real estate agencies have partnerships, or own, title insurance companies so they can keep this lucrative stream of fees in–house. If an agent recommends a title insurer to you, ask if the insurer is owned or affiliated with the real estate agency. Keep shopping around to find the best rate for the title search and closing services.
Lenders require appraisals to confirm that the home for which they’re providing you a loan is in fact worth what you intend to pay. From 2008 to 2010, appraisal regulations shifted abruptly and often. Be sure to be aware of the current regulations that set parameters for what appraisers can and cannot do.
However, you are allowed – even encouraged – to work with the seller to furnish the appraiser with documentation that supports the purchase price. This documentation can include receipts and permits for home improvements and upgrades; listing sheets and tax records for comparable, recently sold properties; and evidence that some recently sold neighborhood properties were foreclosures or distress sales and thus not appropriate comparisons for your sale. The fees appraisers charge vary and are typically built into your loan costs.
Your lender may also require a location survey that certifies the house is within the boundaries of the lot. The lender often selects the surveyor, but you may have a choice.
If you are not assuming the seller’s homeowner’s policy, you will need to buy your own. Title will not be transferred until you can prove you have the home covered by insurance. This protects you and the lender from the unforeseen, such as fire, flood, tornados, or any other damage to the home. You may also consider additional levels of insurance to cover natural disasters that are more prevalent in your area.
Escrow and Closing
When the closing is schedule, you are getting close to the finish line. At the closing, your seller officially signs over the title to the house. Your lender releases the purchase funds to the buyer, and of course, you sign reams of documents pledging to pay back your lender.
The escrow agent conducts the closing and is often affiliated with the title insurance company. Their job is to ensure the buyer obtains a clean title, the lender obtains a good mortgage, that the costs of the transaction are paid, that the seller’s mortgage is paid off, and that the seller receives their proceeds.
The escrow agent prepares a closing statement that outlines what the required funds are, who’s paying and where the funds are to be deposited. The agent will not disburse funds until they can guarantee that the above noted items have been taken care of.
Utilities – Water, gas and electric meters will be read on the day of closing and the seller will owe for the utility usage up until that day. You may also need to make deposits with both the water and electric companies.
Service Contracts – If you are taking over any service contracts from the home seller, you will owe the seller for the unused portion of those contracts that have been pre-paid. These could include pest control, pool and/or lawn services, home maintenance contracts, etc.
The check – The title/escrow company you are using will tell you how much you need to bring to closing. Personal checks are not accepted, so bring a cashier’s check.
Home Warranty – You might want to purchase a home warranty, especially if the heating and cooling systems and major appliances are not new. The warranty will cover the repair or replacement costs in case items such as appliances break down after you purchase the home.