Home Buying Guide

Introduction

Buying a home is a terrific way to combine getting a great place to live with a making a good investment. In fact, real estate provides one of the few real tax shelters left, so you’re smart to be thinking about taking advantage of it.

Here’s the thing: when you rent your housing, you pay money every month for the privilege of living in a house or apartment. If your rent is $1,500 a month, you can pay that money every single month for 30 years, and then you’ll have to keep on paying because you don’t own the place.

How do you benefit from buying a house, investment-wise? There are four ways:

1. Principle pay down —this is the portion of your monthly payment that pays down the principle, or balance, of your loan. At the end of the term— usually 15, 20 or 30 years—you own the property and payments end.

2. Appreciation in property value—two years after you buy that $150,000 house, it may be worth $160,000. That means you have $10,000 more equity in the property. Of course, this depends upon market conditions in your area.

3. Depreciation on taxes—each year, you can take depreciation on your home off your federal income taxes. This is allowed because it is recognized that homes age and require repairs.

4. Mortgage interest deductions—the interest that you pay on your mortgage loan is tax deductible. Early on in your mortgage, most of your payment will be interest, since the bank wants to make sure it gets paid. Towards the end, it will be mostly principle.

When you own property, no one can intrude to inspect, perform maintenance, or do repairs without your permission. You have complete privacy. If you get a fixed rate mortgage, your payments will not increase, unlike a lease which tends to bring yearly increases in rent.

To show you how the process goes, we’ll follow Amy and Robert, an engaged couple, as they go through the process of buying a house. Amy is a 27-year-old financial planner and Robert is a 29-year-old software security specialist.

Determine your needs

Before you hire a Realtor, you should determine what you really need and want as far as your new home is concerned. If you’re married, this should involve a discussion with your spouse. If you’re planning to live in the house for a number of years, you need to think about what your needs will be in the future.

Doing this assessment is critical, because otherwise you may end up buying more houses than you need, which is a waste of money. Or you might not buy enough, and it’s a pain to add an addition onto a house.

For instance, are you planning to have children? Do you or your spouse work out of your home, or do you foresee the need for a home office? Then you’ll need either an extra bedroom or a bonus room (also called a “flex” room.)

Home builders have responded to the growing popularity of businesses run out of the home, and many of them now offer floor plans that feature a downstairs office with a separate entrance so that clients don’t have to enter your home.

Do you or your spouse have a parent who may move in with you in the future? If so, you may want to look at homes that offer a “Mother-in-law”, or MIL, floor plan. This floor plan features a separate suite, usually a bedroom and bathroom and perhaps a small living area, for a relative. It may include a separate entrance, too. Do you have dogs? If so, you may need a house with a fenced backyard.

On the other end of the spectrum, if you don’t have dogs or kids and you want the benefits of home ownership without the hassle of having to cut grass, tend a lawn, or maintain the place, you should consider buying a condo. If you have many friends and family members, you may want to have a guest bedroom.

Another thing to consider is what sort of amenities you want in your area. If you want to have access to a community pool, playground, tennis courts, and such, you probably want to be in a neighborhood. Neighborhoods vary widely. Some have little or no restrictions, others have many.

Once you’ve decided how many bedrooms, bonus rooms, and bathrooms you want, you can think about living areas. The formal living room is on its way out, since most people never use it. The trend is toward open spaces, such as a kitchen that overlooks a family room and a dining room.

Other home features that you’ll need to decide if you need are:

1. Laundry room with washer and dryer hook-ups

2. Garage

3. Two -story versus one-story (go for the latter if you have bad knees)

Walk-in closets

1. Island kitchen

2. Oversized bathtub with jets

3. Skylights

4. Fireplace

5. Deck

6. Pool

7. Hot tub (easy to add one, if you have a deck)

Amy wants a fenced backyard and a guest room so her parents and friends can visit. Robert wants a two-car garage. They both want an extra bedroom because they plan to have a child in a few years. So, they’ve decided to look for a three-bedroom, two-bath, two-car garage house with a fenced backyard in a good neighborhood.

Do you need an agent or can you buy a house yourself?

Technically, you can buy a house yourself. You also can do your own brain surgery, defend yourself in a court of law, and do your own electrical wiring, but we don’t recommend it.

There are numerous things to know about buying a house. Some of them are of major importance, others are not. If you do something wrong, you can be sued or the deal may not happen.

Why take a chance? A licensed Realtor will…

1. Listen to what you want, then show you with homes in your price range.

2. Advise you on what repairs and upgrades to ask for.

3. Negotiate with the seller so you don’t have to.

4. Guide you through the process of presenting an offer that protects you legally.

5. Make sure you are all set for closing.

6. Be present at the closing so that things go smoothly.

Amy and Robert have picked a Realtor who was referred to them by one of Robert’s friends. Amy was impressed by how much listening the Realtor did.

Line up your financing in advance

How much can you afford? If you’ll need a loan to buy the house, your bank or credit union will need to get some information on your income, assets, debts, and job or business history before they can tell you how much they will loan you.

After you’ve decided what to look for, you should immediately contact your lending institution to see how much you can qualify for. They will give you a pre-qualification letter that you can present to a seller along with an offer. This lets the seller know that you are serious and you have the ability to buy that house.

Generally, lenders will qualify you for an amount somewhere between two and three-and-a-half times your annual household income, depending on your credit score, your assets, and how much debt you have.

One of the best steps to take before you start the home-buying process is to pay down or pay off debt and get a copy of your credit record from all three credit reporting agencies: Equifax, Trans-Union, and Experian. You can do this online, just google “credit report.” Most people find things on their credit reports that are inaccurate or outdated, and you can ask to have them corrected or removed.

Understand, though, that pre-qualification is not a guarantee and that you will still have to go through the whole process of qualifying, which involves some paperwork. And it is possible that even if you’ve been pre-qualified, your mortgage application could still be denied. This happens rarely but it does happen, particularly when people go out and make major purchases after being pre-qualified.

The biggest thing to understand is that debt hurts you when you are qualifying for a mortgage. If you’re about to buy a new car, wait until at least a month after you’ve closed on buying your new home. And don’t take out a bunch of new credit cards before you close in anticipation of fixing up your new home. Instead, strive to pay down and pay off debt and don’t open new accounts or buy new things.

Once you get pre-qualified, your lender will tell you the amount that they will loan you for a mortgage. That, plus however much cash you have to put down, is how much you can spend.

Be prepared to provide your lender with:

1. Verification of income if you work at a job

2. Two years worth of bank statements if you work for yourself

3. Three months worth of bank statements

4. A detailed mortgage loan application, including a listing of all debts and assets (the blue book value of your car is an asset, what you owe on it is a debt)

5. Proper identification such as a driver’s license (a Patriot Act requirement)

6. A gift letter if any portion of the down payment is a gift from family

Be aware that lenders typically don’t like to see borrowed money used as a down payment. If the money you will use for the down payment hasn’t been in your bank account for a minimum length of time (usually three to six months), the lender will want to know where it is coming from. If a family member gave it to you, they will probably need to write a gift letter stating that the money is a gift.

If you put down less than 20% cash on your new home, lenders will require you to pay a monthly Private Mortgage Insurance (PMI) premium. PMI is insurance that protects the lender in case you default on the property. If you can’t put down 20% cash, one way to get around the PMI requirement is to get an 80% mortgage loan from one lender and another loan of 10 to 15% from another lender, and then put down 5 to 10% cash. Not all lenders allow this.

Financing options

Most mortgage loans fall into two broad categories: conventional loans and government loans. Any loan other than an FHA, VA, or RHS loan is a conventional loan. FHA (Federal Housing Administration) is a loan for low-income borrowers with a low down payment. It’s also called a HUD loan.

VA (Veterans Administration) is a loan for military veterans. The current limit is $203,000. The VA doesn’t make loans—it guarantees loans that other institutions make. RHS (Rural Housing Service) makes loans in rural communities. Assuming your income is not considered low and you aren’t buying rural agriculture land, you’re looking at a conventional loan.

Currently, there is a virtual smorgasbord of mortgage options. Fixed rate mortgages let you lock in one rate for the lifetime of the loan—a good bet if interest rates are headed upwards. A new addition to fixed rates is the bi-weekly mortgage, in which you pay ½ month’s payment every two weeks. This means that several times a year you make the equivalent of an extra ½ month’s payment. This strategy will pay off a 30-year mortgage in 18-19 years.

Variable interest rate loans, such as the popular Adjustable Rate Mortgage (ARM), offer lower initial payments, usually with a period of a year or two during which the rate cannot increase, but then the rate is tied to the prime rate.

The danger of an ARM is that if interest rates continue to rise, so do your payments. Granted, there is usually a clause that ties any increases to increases in the prime rate, and limits such increases to 1% per year, but you’re still looking at significant increases if interest rates rise. The advantage of an ARM is that you can get into a higher-priced home if you expect your salary to continue rising.

Convertible ARMS start out adjustable, but then give you the option of changing to a fixed rate if interest rates start rising. Usually, you can switch during the first five years or on the adjustment date.

Interest-only loans are a new product on the market. With this type of mortgage, you pay only the interest on the loan. The upside is a lower payment. The downside is that you never build any equity and never, in fact, have a hope of owning your home unless you choose to make payments to principle.

Balloon mortgages are also increasingly common. With these, you make the same payments as you would on a 30-year mortgage, but you only make them for a period of 5-7 years, then the balance must be paid off or refinanced. The advantage here is a lower interest rate. If you meet certain conditions, you can convert the balloon to a fixed-rate without qualifying or having the property reappraised.

Two-step mortgages give you a fixed rate mortgage for a certain period of time— such as 5 years—but then change to market rate, where they remain. Graduated Payment Mortgages (GPM) work on a negative amortization scheme. Payments start out low, then rise.

Buydown mortgages give you an upfront discounted interest rate that slowly goes up to an agreed-upon fixed rate within one to three years. This lets you to qualify for more house with the same income and gives you the advantage of lower initial monthly payments for the first years of the loan when extra money may be needed for furnishings or home improvements.

To reduce your monthly payments during the first few years of a mortgage you make an initial lump sum payment to the lender. If you do not have the cash to pay for the buydown, the lender can pay this fee if you agree on a little higher interest rate.

Seller-assisted financing is growing in popularity as the population ages, since it guarantees the seller a monthly check for decades. Seller financing can be very creative and there is no one approach.

Another aspect of financing is the term of the loan. If your goal is to build up as much equity and become mortgage-free as soon as possible, bite the bullet and go for a 15-year term. You will save a significant amount of money in interest. The downside is that you won’t be able to qualify for as expensive a house as you would if you went with a 30-year term.

A little-known secret is that you can always make extra payments to principle. Thus, you can get a 30-year mortgage and treat it like a 15-year by making extra payments to principle each month. If you fall on hard times, you can skip the extra payment. For this reason, a 30-year fixed-rate mortgage is the best choice if you plan to live in your home for more than seven years.

One word about the new 40-year mortgages: don’t do it. The new 40-year mortgages were invented to allow buyers to afford more home than they could with a 30-year mortgage. Don’t fall for it—you’re overbuying.

Amy and Robert’s combined incomes are $80,000 per year, and they found out that they qualify for a loan of up to $200,000. Robert’s parents gave them $25,000 as a wedding present, and they plan to put down $20,000, so they will start looking at homes in the $200,000 to $230,000 range.

Summary of mortgage loans:

Searching for your new home

Once you’ve determined what you want and what sort of financing you can get, it’s time to look for your home. With the advent of the internet, home buying has evolved. We live in the age of the educated, empowered consumer. Increasingly, buyers are doing their own home-buying research online.

If you pre-shop houses online, you can forego driving around all day looking at dozens of potential homes by spending an hour online looking at photos and virtual home tours. In this way, you can pre-screen the houses you’d like to see. Once you’ve narrowed your list down to two or three homes, your Realtor can show them to you.

Amy has been looking forward to this weekend for months—the Realtor has found ten 3-2-2 homes with fenced backyards and is taking her and Robert to look at them. They will only have to look at three houses, because they pre-screened them by taking virtual tours online.

Making an offer

An offer to purchase real estate is a legal contract, so it takes some thought and preparation. Your Realtor will talk to you about what kind of offer to make and what things to ask for. An offer includes:

Price, including how much of it is cash and how much is financed.

1. How much earnest money you will put down—this is part of the sales price, and it is only refundable under certain circumstances.

2. A possible option period in which you have the right to inspect the home and cancel the offer with a refund of earnest money. In Texas, option fees are typically $100 and non-refundable.

3. The date by which the sale is to be completed (closing date).

4. Various things, such as:

5. Who pays for a new survey if required

6. Who pays for certain repairs

7. Who pays for maintenance that needs done

8. What appliances come with the property

9. Any conditions or qualifications. The most common one is that the offer is contingent upon your bank approving you for a certain amount of financing at a certain interest rate or better.

10. A deadline for how long the offer is valid.

Home appraisal, mortgage, escrow, and closing

Once you’ve found a home you like and are serious about buying, you’ll make an offer. An offer is a binding agreement to buy the property if it passes inspection and you get your financing. Of course, you can always add a weasel clause if you wish that allows you to bail out for most any reason.

The seller will probably come back with a higher number—below his asking price, but still higher than your number—and then you can make a counter-offer. Eventually you will come to an agreement on price, or not. If not, walk away and make an offer on another place.

Now you need to show the contract to your lender. Your lender will line up a title company to prepare the title deed documents and set up an escrow account. The deed documents are very important because they show that the sellers have clear title to the property they’re selling and that they do, in fact, own it.

You will also want title insurance, so that if there is a problem later with the title to your new property, the title company will pay to have the problem fixed. The escrow account will hold your pre-paid items such as taxes, insurance, and other items.

Your lender will require a market-value appraisal to be done on the property. This is important because the loan and its terms are predicated upon the loan-to-value ratio. This is the ratio of the mortgage loan to the value of the property. On a conventional loan, most lenders don’t like LTV to exceed 80%.

For example, if you and the seller agree on a price of $250,000, and you are planning to finance $200,000, you really need for the property to appraise at $200,000 or better so that the ratio of the loan to the property value is 80% or less.

Your lender will also require a property inspection and a termite inspection. The termite inspection is simple—it should say that there is no evidence of termites. The property inspection is more complex. It will usually result in a lot of little things that you may or may not be able to get the seller to fix.

Usually, anything that represents a health or safety hazard will cause your lender to insist that the defect is fixed before you buy the property.

Other defects, such as a missing doorknob or a broken kitchen cabinet door, are up to you and the seller to negotiate. If the seller doesn’t want to fix them, he or she may offer you a discount or allowance on the price so that you can get them fixed.

Amy and Robert have found their dream house. The Realtor has prepared an offer of $210,000, which includes $20,000 down and a loan for $190,000 at 6.5% interest. They are also offering $1,500 in earnest money and $100 for a seven-day inspection period, and requesting that the seller replace the eight-year-old carpet and the deck, which has some rotting timbers.

What to do before closing

There are many things you’ll want to line up before you close on the property. Bear in mind that you do not own this property before you close on it, and that anything can happen, so do not pay money to have anything fixed and don’t move any of your stuff into the new house before you close.

What you will want to do is to line up your utilities and insurance to take effect the moment you close on the property. Believe it or not, houses have burned down right after they were bought. Your lender will require insurance, so make sure you line it up. Even if you buy with cash, arrange for insurance to take effect the second you buy the property.

Other things to line up are:

Utilities—contactthe electric, gas, and water companies and arrange to have service either begun or transferred to you the day you close on the property.

1. Trash disposal

2. Phone

3. Cable TV

4. Internet

5. Post office—arrange to have mail forwarded.

The sellers have countered Amy and Robert’s offer, and Amy and Robert have come back with a new offer: $214,000 and a $4,000 allowance for new carpet and deck repairs. This brings the price down to $210,000. The seller has accepted the offer and they’ve scheduled a closing. They are excited!

Closing the deal

Now you’re ready to buy the property. Be prepared to sign a thick stack of paperwork. But it’s a good feeling, knowing that now a portion of your housing payments will actually go to an investment—equity in your very own home.

After you close, you’ll want to:

1. Meet neighbors

2. Change your driver’s license address

3. Get new mailing labels

4. Have a housewarming party!

Robert has sent out an email to their friends, inviting them over a week after move-in. Amy has called the utilities and arranged to have service transferred over to them the day of closing. They go to the closing and Amy smiles the whole time. Afterwards, they celebrate by eating take-out Chinese food while sitting on the fireplace hearth in their new home.

Moving in

There are many ways to prep for a move that will make it much more stress-free. Here are some:

Get quotes from several moving companies weeks before your move.

Don’t pay movers a deposit. Standard practice is payment upon completion.

1. Consider your pets and where you will put them during the move. If doors will be open and movers are used, buy a pet carrier or board you animals during the move.

2. Start packing earlier than you think you need to—it always takes longer than you think. If you’re short on time, ask your Realtor to refer you to packers you can contract with.

3. Pack a week’s worth of clothes and toiletries in a suitcase, and have one or two boxes for things you will need to find immediately, such as prescriptions, the coffeepot, and a few dishes and silverware.

4. If you are moving more than an hour away, taper down grocery shopping a week before the move. For short moves, transport food in ice chests.

Don’t water plants for a few days before a move—they will leak in the truck.

Conclusion

Buying a home is not a simple process, but it is one of the most rewarding things you can do, both in terms of personal pride and satisfaction and in terms of investing. With easy terms and a wide variety of mortgage loans on the market, almost anyone can qualify. So go ahead—get a Realtor, find your dream home, take the plunge, and become a proud homeowner. You’ll be glad you did.