Buying Real Estate
How
Much House Can You Afford?
There are several ways to gauge how much you can afford to spend on a house. But, before
you go house-hunting, get pre-qualified for a mortgage so you'll know in what price range
you can shop. It is not unusual for first-time buyers to be somewhat baffled about how to
estimate what mortgage payment they will be able to handle each month, plus how much money
they'll need for a down payment and closing costs.
That's why it is a good idea
to get pre-qualified through a lender before you even start to look for a home.
Pre-qualification lets a buyer know exactly how much a lender is willing to loan them.
With pre-qualification in hand, the buyer can save a lot of time-and frustration.
Pre-qualification does not
obligate buyers to take a loan from the lender, nor should it involve any fees (until
later, when they actually apply for the loan). At the same time, you must understand that
pre-qualification is not pre-approval for a loan either which is a much more involved
formalized process that results in an actual letter of credit from a lending institution
for a specific loan. Depending on your unique circumstances, you may wish to consider
pre-approval as an option, but it is not necessary-consult with your real estate
professional to decide what's right for you.
The less formal process of
pre-qualifying on the other hand is a tremendous tool for buyers to have when making an
offer. Usually, pre-qualified buyers have an edge when making a purchase offer because the
seller knows that the buyer is pre-qualified, and that there is at least one lender ready
to make it happen. In addition, it allows you the flexibility to choose the mortgage that
is best for you at the time of actual purchase-which is sometimes months down the road.
That can be important given the volatility of interest rates. When a lender pre-qualifies,
they are more concerned about the buyer's paying ability than the price of the property.
For this reason, lenders are
interested in more than just a buyer's income. They also want to know how much existing
debt a buyer has, what their on-going financial obligations happen to be, and what the
buyer's monthly budget looks like.
Lenders use an established debt-to-income ratio, usually between .28 to 1 and .38 to 1, to
calculate the amount of the loan they are willing to give to a buyer. For instance, a
lender who uses a .3 to 1 debt-to-income ratio has determined that payments toward debt
reduction-including existing debt plus new debt associated with buying a home-cannot be
more than 30% of they buyer's gross monthly income.
An important factor that may
influence a lender to authorize a loan with a higher debt-to-income ratio - (where debt
payments take a higher percentage of a buyer's income) - is a larger down payment. Buyers
who put a larger percentage of the purchase price down (5%, 10%, 15%, 20%, etc.) are
considered better "risks," because the theory is that the more a person has
actually invested in the purchase, the less likely they are to default on the loan.
Buyers usually discover that
the pre-qualification process will produce a home purchase price that is roughly 2 1/2 to
3 times their gross annual income. The 2 1/2 -to-3 guideline is only a general rule of
thumb, however, and it doesn't take a buyer's full financial situation into consideration.
Since the lender's calculations will also consider a buyer's actual debts and ongoing
expenses, the loan pre-qualification amount may be higher or lower. Regardless of the
price bracket a buyer targets, they should keep pre-qualification in mind.
How much should you
budget to own your own home?
Aside from the down payment, the three largest expenditures involved with the purchase of
a home are usually your monthly mortgage payment, insurance and taxes. Obviously, the
amount of your mortgage payment depends upon your down payment, rate of interest and the
price of the property.
Take, for example, a home that
has a $200,000 mortgage. An 7% fixed mortgage for 30 years, will run approximately $1330
per month. What about taxes? The rate will often times vary from city-to-city, but
generally you might expect your yearly tax bill to total around 1.25% of the purchase
price.That means, for a home with a market value of $250,000, yearly taxes might run
around $3125. A local real estate agent can help prospective homeowners refine these
figures.
In addition, it is important to keep in mind that there are many additional expenses
incurred with home ownership, some of the most obvious are utilities and trash collection.
Smart homeowners should also budget for one other item, maintenance and upkeep of the
home. If possible, a small amount should be set aside each month to pay for those
"rainy day" repairs such as painting, plumbing (hot water heaters, garbage
disposals), adding storm windows (to improve energy usage), insulation (in attics), etc.
But home ownership is not just
a one way street-that is, aside from spending money on repairs and maintenance, homeowners
can profit from their property. The most significant benefit is the tax deduction. It is
no secret that among the last real income tax deductions available to consumers today are
the interest paid on the home loan, and the property taxes. This can amount to thousands
of dollars in deductions each year. And, of course, the primary benefit of home ownership
is appreciation-equity that builds every month. A home, aside from being a place that
provides shelter, can be a profitable investment, and the rising value of the property
oftentimes provides another "savings" account.
So, when it comes to buying a new home, remember one thing ... the purchase of a property
requires budgeting and planning.
How do you go about
finding a mortgage?
The commotion of house hunting is finally over. You found just the right house, and your
offer has been accepted. It was a great buy. Now, just one more hurdle-getting a loan-and
you're home free. Often, buyers are so eager to get this "final detail" behind
them, they rush through this portion of the transaction, and end up with less-than-ideal
terms. Borrowers, however, have something lenders want-their business. This positions them
to negotiate the best possible price (cost of loan), terms and service.
Let's look at price, or the
cost of the loan. The first thing to do is find out what the current rates are,
information readily available on the internet, in your newspaper or from your real estate
agent. When comparing rates, figure the annual percentage rate (APR), which includes
interest, extra fees and costs amortized over the life of the loan. Also determine the
number of points, if any, that the lender will charge to make the loan.
(A point is equal to one
percent of the loan amount.)
Next, consider what loan options the lender offers. There are six or seven basic types of
loans, which vary in their duration. Check how rates are calculated (fixed versus
variable), and whether charges are fully amortized over the life of the loan, or whether
you'll have to pay points up front and/or balloon payments at the end.
Is there a prepayment
penalty clause?
Which terms are best for you depends on such factors as what changes you expect in your
income and what you predict will happen in loan rates in the years ahead. For example, if
you only plan to reside in the home for a year or two, starting with a lower Adjustable
Rate Mortgage (ARM) might be the best choice. If you have no plans to move, and feel that
inflation will rise rapidly, a fixed rate would obviously be better.
Finally, and perhaps most
importantly, consider speed and service. Buyers shouldn't have to wait days for approval
and weeks for closing just because the lender is slow. Remember, qualified buyers are
great prospects for lenders - so give your business to the lender who demonstrates they
not only want it, they deserve it.
How difficult is it to
qualify for a mortgage if you have a past credit problem?
Credit problems can make it harder to qualify, but it's quite possible for buyers with
poor credit to obtain a home loan.
Anyone who has had a financial problem-whether it was a matter of late credit payment,
delinquent taxes, or even a judgment that was filed-should expect this data to be a factor
when applying for a mortgage.
How critical a factor? Minor lapses will probably have little or no effect. However,
buyers with serious problems may still qualify for a loan, but they may have to pay a
higher rate of interest or provide a larger down payment. There are three steps that a
person with past credit problems should take before applying for a loan.
First, request a credit
profile from one of three major credit reporting agencies. To get copies of your credit
report, start at: CreditNow - Credit Reports
Second, the buyer should optimize his or her credit profile by citing prompt payment of
rent, utilities, and other bills not reported on the credit profiles.
Finally, the buyer should be prepared to provide comprehensive and candid explanations for
any late payments to the loan officer. This is important because problems not reported by
the buyer but discovered by the lender will reflect unfavorable.
Many lenders are understanding about one-time problems such as the loss of a job, a
medical emergency, etc.
Buyers with patterns of
delinquent payments might want to consider adding six months or a year of flawless credit
to their track record before pursuing their home-buying plans. So remember-if you are
thinking about purchasing a home, but are worried about your past financial record-don't
give up. There are solutions, lenders and agents who are in business to help.
What are the five most
common mistakes made by first-time buyers-and how can you avoid them?
A good home-buying decision is one that fits your lifestyle and your budget-a house you'll
be able to resell when the time is right. Sound simple? Not always.
Five common mistakes
frequently made by first-time buyers.
1. Looking outside your price range. To avoid disappointment, contact a
real estate agent who can help you pre-qualify before you start looking for a home. The
agent can also provide valuable insight on taxes and other expenses associated with a home
(utility bills, etc.)
2. Buying on impulse. Buyers-especially first-timers-may be impressed by
the first two or three homes they view. Look at a good selection. List the positives and
negatives. Narrow the prospects to three or four, and then return for a closer look.
Evaluate more than just the property. Look at the surrounding area and community
amenities. Is this what you-and your family-want and need?
3. Not planning ahead. Think seriously about any personal changes you are
planning in the next five to seven years.
For instance, if you are planning on having children, consider how the home will meet both
your current and future needs. If a double-income is necessary to qualify for
financing-and make your payments-do your plans foresee an income sufficient to continue
making payments?
4. Failure to focus on location. Don't just focus on the house, examine
the neighborhood. Is the area safe, well maintained, moderately quiet and close to work,
stores, and schools?
Find out about zoning and what new construction is planned on any vacant land in the
immediate neighborhood.
Will the property be easy to market when you are prepared to sell it?
5. Failure to understand the home buying process. Once you select a home,
get involved. Find a real estate agent willing to spend time with you, and don't hesitate
to ask questions. Have them explain the negotiation, financing and escrow processes and
other elements involved in the transaction.
Home-buying involves knowing
the price, and what's inside and around the property.Consider all your options carefully.
This may be the most important financial transaction of your life.
What's the real
difference between a new home and an old one?
While each offers its own style and charm, the difference usually boils down to two
things:
1. How the home fits into the buyer's lifestyle.
2. The condition of the property.
Homes that are 10 years old or less are generally better insulated - or have dual-glazed
windows or thermal panes - which translate into lower heating and cooling bills. And, in
today's rising energy cost environment, these considerations are significant. Although
there are some exceptions, homes that have been built with all-electric systems, generally
have higher utility bills.
Homes that range between 15 and 20 years old may be in need of new water pipes, especially
if the old ones were galvanized and if a water softener was used. Water softeners and
galvanized pipe can be deadly and, after 15-20 years, re- plumbing is usually required.
Have a plumber or general contractor inspect the pipes. Needless to say, it can be
expensive to re-plumb an entire system. Check the built-in fixtures and appliances for any
signs of damage.
Flush toilets, test all the water taps and the electrical sockets, open and shut the
windows, and try all the lights.
A window that will not open
may be a sign of a more significant problem-for example, a wall may have shifted, or worse
yet, it could indicate a problem with the foundation itself. It is also a good idea to ask
the seller for copies of past utility bills. Examine them for some insight into what you
can expect monthly gas and electric costs to be. Although newer homes may be free of
significant physical or structural problems, there are other things to consider in making
your decision.
Generally, room size and yard
size tend to be smaller in some newer homes. While, on the other hand, they usually offer
the benefit of the latest building and design technology. Many new homes also have more
windows and natural light incorporated into their design plan, allowing for a more
spacious feel and efficient energy usage.
Should a buyer get a
professional inspection for the home they are buying?
Definitely. Hiring a professional home inspector can save a great deal of grief for
buyers. The one exception would be when the home is new and carries a written warranty by
the builder. Many buyers mistakenly believe that the only reason to have a home inspection
is to make sure that the house they're buying doesn't have defects serious enough to
warrant backing out of the transaction. But there's more to it than that.
Certainly, an inspection will
usually reveal major problems that may even surprise the seller. The obvious ones are
corroded plumbing, antiquated and unsafe electrical systems, or structural and foundation
problems. And, the discovery of such problems may cause the buyer to re- think his or her
offer. Although a competent inspector can uncover deal-crushing defects, these problems
are usually not commonplace. Typically, the seller will already have told the buyer about
anything major. More often, inspections reveal less serious problems; problems that may
not be serious but can be aggravating.
For instance, there could be a
minor electrical defect, or inferior ventilation of a heating system or fireplace. If so,
the buyer is usually in the position of having the purchase price reduced, or the defect
corrected. More important, it also prevents the minor problem from developing into a major
disaster a year or two down the road.
There is, of course, the possibility that the home inspection will produce another
outcome: everything is fine. In this case, they buyer gains piece of mind, confident about
the major investment he or she is about to make. That, too, is an enormous benefit for the
cost of the inspection.
Now, how does a buyer
find a home inspection?
By asking their real estate agent, friends, or lender. Inspectors are also listed in the
Yellow Pages under "Home Inspection Services." But, a word of advice, don't hire
a contractor. Contractors earn their living doing repair and renovation work, so their
recommendations aren't likely to be as objective as those of a professional inspector.
Is real estate a wise
investment?
There are fewer investments that have shown a better return. However, the key to investing
wisely in real estate is understanding how the industry differs from others.
For example, when the defense
industry dips, it usually shows a national decline and the stock prices of
defense-oriented firms drop across the board. The same is true of most industries. They
are impacted nationally. That is not the case with real estate, which is actually an
industry and investment driven by local conditions. One community may suddenly lose a
manufacturing facility, and almost overnight the market is flooded with properties for
sale.
Obviously, the key to
successful real estate investing, like stocks and bonds, is to buy low and sell high. But,
how do you know when the "low" has been reached? Or, for that matter, how can
you judge when you property may be peaking in value? Some investors rely partially on the
media. They read the daily newspaper, watch television and follow the trends. Although the
media provides a good deal of information, remember that by the time things are printed or
broadcast, the news may be old.
For instance, you will find
statistics frequently quoted in the media that have been supplied by the National
Association of REALTORS (NAR). But, NAR statistics-like most- tell you where things have
been, not where they are going.
So what can you do? First, check local economic indicators. Also, the local chamber of
commerce can frequently help. They usually have information on which companies are moving
in and out of an area.
Logically, the relocation of a
firm into a community generally indicates that demand for real estate in that marketplace
will increase-while if firms are moving out of the area, housing demand will often shrink.
Aside from economic indicators, check real estate trends and cycles. Talk to a real estate
agent. They can provide statistics on how quickly homes have sold, how prices have
fluctuated in the past six to 12 months, and projections of future home sales. They can
show you how today's market compares to last year's. Are sales headed up? Down? The same?
The answers will not only help you determine what the market is like in your area, but
they will also be critically important in helping you determine when and where to make
your real estate investment.
Does a home warranty protect a
buyer in the event something goes wrong after they have purchased a property?
Sometimes. That's because home warranties are often times misunderstood and not every
warranty provides the same protection. All warranty companies are not equal, either.
Warranties, of course, were
designed to protect buyers from problems that emerged after they moved into a dwelling.
For example, if a major appliance breaks or the roof leaks, the ideal warranty kicks in
and pays for the repairs.
On the surface, this sounds simple and straight-forward. But, most of the time it is not.
First, all warranties differ.
Aside form the obvious differences, the amount of deductible required, they may also vary
as what is covered and what is not. For instance, with some warranties if the hot water
heater works on the day of closing, but suddenly does not work six months later, then it
may be covered. And, with other policies if the water heater was not in good working
condition when the home was purchased, and it breaks a week or two later, there is no
coverage.
Warranties can be critically important when it comes to new construction, too. Obviously,
the reputation of the builder is an important consideration. However, problems with new
homes can be enormously expensive if they are not covered by a warranty.
There are two types of defects
when it comes to new homes - patent or latent. Patent are those problems which can be
seen. Cracked plaster, a fence that is off level, etc. Latent problems develop later, and
may not show up for five or six months. Ground shifting, for example. Latent problems are
usually more expensive than patent problems.
Thus, the warranty for a new
home can be one of the most important documents executed during the buying process.
Whether you're purchasing a new home or a resale, remember that warranties definitely have
a place when it comes to protection and peace or mind in the real estate transaction, but
make sure that you check them out carefully.
Is a final walk through, an
inspection of the property by the buyer before they move in -- really important? Yes, it
is. The intent of a pre-closing inspection is to give the buyer one last opportunity to
verify that they are getting all that was promised in the sales contract. Although buyers
still have legal recourse if they discover-even after closing-that the condition of the
home is not as it should be.
The best time to identify
problems is before closing, when the seller will be motivated to correct any deficiencies
in order to close the transaction. Typically, a buyer takes possession of a property one
to three months after signing the sales agreement. But, a lot can happen before the actual
move-in. Appliances and fixtures can break down, and walls, carpets and doors can be
damaged during the seller's move-out. Sometimes the seller will simply have forgotten that
he or she had agreed to leave the refrigerator or window coverings with the house.
Whatever the reason, problems identified before closing have the best chance of being
remedied.
If possible, schedule the
inspection right before the closing, such as the day before. Ask your real estate agent to
attend the inspection with you. What should you be inspecting? Using a copy of the sales
contract as a checklist, first make sure that all items that should be in place
(appliances, built-in furniture, window coverings, fixtures, etc.) are there.
Test each appliance to make sure they work properly. Test all electrical switches and the
garage door opener, if there is one. Run the garbage disposal and turn on every water
faucet, checking under the sinks for leaks. Flush the toilets. Inspect the floors,
carpets, walls and doors for recent damage. If you discover that something is damaged or
missing, make a note of it and inform your agent immediately.
In most cases, the seller is
usually able to take care of small problems immediately, either by making a needed repair
or offering compensation to handle it. And, if there are major problems the seller can
even sign a statement acknowledging the deficiency and agree to correct it. Although
pre-closing inspections take time and may be inconvenient, they are important and well
worth the buyer's time.
What are
"contingencies" and why are they important?
A "contingency," is an escape-clause that is added in-writing to a contract
which allows a buyer to back out of the transaction if certain conditions aren't met. Some
contingencies, often called `riders'-like attorney approval of the contract, or the
passing of a home inspection-are obviously designed to protect buyers from a poorly
written contract or a defective home.
Other purchase contingencies
may hinge on the buyer's current living situation, or his or her cash-flow. For example,
when it comes to contingencies many first-time buyers can be better prospects for a
seller's home than move-up buyers. Why? Because offers from homeowners usually are
contingent upon the sale of their present home. And, even if a move-up buyer has an offer
for their home in-hand, their buyer's offer may be contingent on another contingency (or
sale) and so on down the line. If one transaction in the chain falls through, they all
might. Cash offers can also be more attractive to sellers.
Why? After all, the seller
will get their money at closing whether or not the buyer has cash or takes out a loan.
True, but cash offers don't require lender approval, and loan approval is never a
certainty and may delay or prevent closing. (Incidentally, for this reason, buyers who get
pre-qualified for a loan have an edge over other buyers. A pre-qualified buyer is the same
as a cash buyer.)
Buyers offering a
larger-than-customary amount of "earnest money", (a deposit that accompanies an
offer) can be more appealing too. More money deposited with the signed contract often
demonstrates greater sincerity and motivation to close the transaction.
