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Buying
Real Estate and Getting Mortgage Loans |
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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:
Equifax - 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. Home 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.
Home 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.
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