Before you step foot into the first home you look at, it’s a good idea to thoughtfully determine your wants and needs, and the difference between the two! By analyzing your needs you will be able to get a clear picture of exactly what you want your new home to look like and how it should function for you. Once you’re in the thick of viewing homes, it’s all too easy to fall in love with someone’s decorating or a home’s outstanding architecture – and to completely overlook that there aren’t enough bedrooms or bathrooms to fit your needs.
First, you should write down why you’re looking for a home. For example, are you currently renting and would like to have a home where you can begin building equity? Maybe you have outgrown your existing home or changed jobs which required you to move to a new city. These factors will all have an impact on how you approach your home search.
It is important to identify what you envision your home to look like and what features it should have. Writing this down helps to avoid ambiguity later in the home search process. You should make at least two lists: one should describe everything you would ideally like and the other should list the features of the home that are an absolute must. It is most likely that you will blend the two lists into one as you progress through the homebuying process. This is a natural and evolutionary process that becomes clearer as you determine what you want and what is available.
First Time Buyers
Approaching the task of buying a home can be overwhelming. It is a complex event during which there is so much to learn and to consider. How much can I afford? Where will the down payment come from? How much will I need and where can I find the best loan? How do I begin the look for a home, what should I expect from my real estate agent and what type of home is right for me?
These questions are just the beginning. Buying a home is one of the largest financial transactions in one’s lifetime, yet most people know very little about it. When embarking on the path to home ownership here are two very important points to remember:
You can and should understand everything that is happening in the homebuying process.
You will need to learn some new terms, apply some new concepts and take the time to learn about purchasing a home.
Always remember that you are the most important person throughout the entire real estate process. It is easy to think that many others may have more expertise or clout, but the truth is that you, the buyer, are the one person in this transaction that makes it all happen. If you decide not to buy, the entire process comes to a complete stop.
If you plan from the beginning to approach the homebuying process intelligently and with confidence, you are much more likely to buy the home you’ve always wanted, and have the confidence that the best decisions were made.
Steps To Buying A Home
- Make a decision to rent or buy.
- Figure out how much you can afford.
- Find the right real estate agent.
- Get pre-approved.
- Decide what kind of home you want.
- Find the right neighborhood.
- Begin the home search.
- Preview the homes.
- Make an offer.
- Apply for a mortgage.
- Have the inspections conducted.
- Close the transaction.
- Move into your new home.
Renting vs. Owning
There’s nothing quite like a home that you can truly call your own. A place where you can have the gleaming hardwood floors you’ve always dreamed of, a space to cultivate your own vine-lined patio, a way to provide a good neighborhood for your kids to grow up in, and a freedom from the whims of your landlord. These are the images that immediately come to mind, for many of us.
Yet some of the biggest advantages of owning a home are less romantic and more practical – in fact, there are financial advantages to owning a home:
Tax Deductibility You can deduct the cost of your mortgage loan interest from your state and federal income taxes. Since interest generally will account for most of your payment during the first half of your mortgage, the savings can be significant. Some of your costs at the time of closing (including prepaid mortgage interest) can be taken as deductions on that year’s income tax return, and points paid up front at the time of closing represent additional mortgage interest and may be taken as a deduction.
Tax Deductibility of Property Taxes You can deduct all of the property taxes you pay.
Appreciation Potential Real estate is considered a good long-term investment because it usually appreciates in value. The effects of borrowing potential can increase as the value of the home appreciates.
Capital Gains Exclusion When it’s time to sell your home the amount of capital gains you have to pay is reduced. A homeowner can exclude up to $500,000 per couple if married and filing jointly, or $250,000 if single or filing separately for homes that have been the taxpayer’s principal residence for the previous two years.
Capital Gain Treatment Congress allows preferential tax treatment on gains from capital assets held for more than one year. This would be important for a homeowner who has gains in excess of the allowable exclusion.
Principal Accumulation Mortgages are designed to pay the interest for the time that the money has been used, as well as to retire the principal debt over a period of time. This payment plan means that part of the payment each month is for principal accumulation.
Personal Enjoyment Pride of ownership is a valid reason for wanting to own a home. You can personalize your home while enjoying the financial benefits.
For the best evaluation of your financial situation, consult your financial advisor. He/she will be the most qualified to discuss the financial consequences of a home purchase decision, as well as help you to establish a plan that will achieve your home ownership goals.
How Much Do I Need
The good news is that there are lots of folks out there who are very interested in lending you as much as 95% of the purchase price of your home, at very favorable interest rates. Furthermore, they are willing to spread out the payments over a long period of time so that you can afford the house you want. Home loans typically are offered in amounts of 80%, 90% and 95% of the price you are paying for the house. You are expected to pay the remaining amount in cash from your own funds.
The smaller the down payment, the greater the requirements are on a buyer’s financial condition. The reason a lender is willing to lend up to 95% of the value of the house is that history has shown real estate to be such an excellent investment. Lenders expect that the home will be worth more in the future than it is today – so their investment in your home is considered very safe.
That’s also why the interest rate you can obtain on a home loan is one of the best around. Consider that America’s largest and strongest corporations borrow at what is called the “prime rate,” and that today you can borrow a home loan – fixed at the same rate for many years – at substantially less than the prime rate. Lenders have found that home loans tend to be excellent investments, and you benefit every month when you make your loan payment.
What if I don’t have enough for the down payment?
Today’s homebuyers have more loan options. A homebuyer may have excellent credit and the ability to make the monthly mortgage payment, but not have the cash for the down payment. For this situation a
nontraditional loan program such as an 80-10-10 may be the best loan. Homebuyers should not despair and assume that a home is out of reach. There are many loan options available for many different financial situations.
What Can I Afford?
There is a rule of thumb that says that if you have the capacity to repay the mortgage, you can afford a single-family house that costs up to two and one-half times your annual gross income. (Annual gross income is the amount you make before taxes are deducted.) Like other rules of thumb, this is a general idea of how large a mortgage you can afford. But, because it is so simple, it doesn’t take into account all the information that will help you feel comfortable with your mortgage payments.
If you are buying a house with someone else (spouse, parent, adult child, partner/companion, brother or sister or other relative), you should consider your co-purchaser’s earnings and existing debts as well. Remember, if you apply for a loan with somebody else, you and your coborrower are both legally responsible for repayment of the mortgage.
Your buying power depends on how much you have available for the down payment and how much a financial institution will agree to lend you.
Your down payment
If you are a first-time home buyer, the price you can afford to pay for a house may well be limited by your ability to come up with the required down payment and closing costs. If you haven’t accumulated much savings, you may want to set aside funds for a down payment on a regular basis from your paycheck. Monies in your checking and savings accounts, mutual funds, stocks and bonds, the cash value of your life insurance policy, and gifts from parents or other relatives may all be suitable sources for a down payment.
Private Mortgage Insurance
Depending on the lender and loan type, you may be able to get a mortgage with as little as 3 percent or 5 percent down. However, putting less than 20 percent down often means you will be required to purchase private mortgage insurance. Private Mortgage Insurance (PMI) helps protect the lending institution in case you fail to make payments on your mortgage.
It is possible to get financing with 0-10% down and not pay PMI (Private Mortgage Insurance). This is why 80-10-10 financing was created. It is called 80-10-10 because a lender provides a traditional 80% first mortgage, a 10% second mortgage, and makes a cash down payment equal to 10% of the home’s purchase price. The same principle applies if the borrower can only afford to make a 5% down payment: 80-15-5 financing is also available.
Your closing costs
In addition to the down payment, you will also need to consider closing costs. The closing is the final step during which ownership of the house is transferred to you. The purpose of the closing is to make sure the property is ready and able to be transferred from the seller to you.
Closing costs generally range from 3 percent to 6 percent of the amount of the mortgage. So, if you were to buy a $100,000 house with a 5 percent ($5,000) down payment, you could expect to pay between $2,850 and $5,700 on your $95,000 mortgage. Sometimes, you can negotiate with the seller of a property to pay some of your closing costs, which will reduce the amount of money you will need to bring to closing.
How much a financial institution will lend you
Apart from having available funds for a down payment and closing costs, the other major factor limiting how expensive a house you can buy will be how much you can borrow.
When you apply for a mortgage, the lender will consider both your earnings and your existing debts in determining the size of your loan. Lenders generally use the following two qualifying guidelines to determine what size mortgage you are eligible for:
The amount of money you owe for mortgage payments, property taxes, insurance, and condominium or co-op fee, if applicable, should total no more than 28 percent of your monthly gross (before-tax) income. This is called the Housing Expense Ratio. The amount of money you owe for the above items plus other long-term debts should total no more than 36 percent of your monthly gross income. This is called the total Debt-to-Income Ratio.
Basically, lenders are saying that a household should spend no more than about one-fourth of its income (up to 28 percent) on housing and no more than about one-third of its income (up to 36 percent) on total indebtedness (housing plus other debts). Lenders feel that if they follow these guidelines, homeowners will be able to pay off their mortgages fairly comfortably.
These lender ratios are flexible guidelines. If you have a consistent record of paying rent that is very close in amount to your proposed monthly mortgage payments or if you make a large down payment,
you may be able to use somewhat higher ratios. Some lenders offer special loans for low- and moderate-income home buyers that allow them to use as much as 33 percent of their gross monthly income for housing expenses and 38 percent for total debt.
Don’t Despair, There is a Loan For You
When you go to apply for a mortgage, the lender will use all the relevant data — your income, your existing debts, the purchase price of the house, your down payment, the interest rate on the loan, and the cost of property taxes and insurance — and calculate whether you qualify to borrow the amount of money you need to buy the house.
Income vs. Debt Ratios
As you think about applying for a home loan, you need to consider your personal finances. How much you earn versus how much you owe will likely determine how much a lender will allow you to borrow.
First, determine your gross monthly income. This will include any regular and recurring income that you can document. It is the average income of a 2 year time period. Unfortunately, if you can’t document the income or it doesn’t show up on your tax return, then you can’t use it to qualify for a loan. However, you can use unearned sources of income such as alimony or lottery payoffs. And if you own income-producing assets such as real estate or stocks, the income from those can be estimated and used in this calculation. If you have questions about your specific situation, any good loan officer can review your documents.
Next, calculate your monthly debt load. This includes all monthly debt obligations like credit cards, installment loans, car loans, personal debts or any other ongoing monthly obligation like alimony or child support. If it is revolving debt like a credit card, use the minimum monthly payment for this calculation. If it is installment debt, use the current monthly payment to calculate your debt load. And you don’t have to consider a debt at all if it is scheduled to be paid off in less than ten months. Add all this up and it is a figure we’ll call your monthly debt service.
In a nutshell, most lenders don’t want you to take out a loan that will overload your ability to repay everybody you owe. Although every lender has slightly different formulas, here is a rough idea of how they look at the numbers. Typically, your monthly proposed housing expense, including monthly payments for taxes and insurance, should not exceed about 28% of your gross monthly income. If you don’t know what your tax and insurance expense will be, you can estimate that about 15% of your payment will go toward this expense. The remainder can be used for principal and interest repayment.
In addition, your proposed monthly housing expense and your total monthly debt service combined cannot exceed about 36% of your gross monthly income. If it does, your application may exceed the lender’s underwriting guidelines and your loan may not be approved.
There are a number of factors within your control that affect your monthly payment. For example, you might choose to apply for an adjustable rate loan that has a lower initial payment than a fixed rate program. Likewise, a larger down payment has the effect of lowering your projected monthly payment.
A lender takes into account many factors that reflect the financial condition of a homebuyer. With a variety of loan programs, buying a home is possible.
Though you may be willing to spend a certain amount, the real determination of how much house you can afford is driven by how much a lender calculates you can afford. So before you begin to search for the perfect house, it is very important to begin the homebuying process by getting preapproved. Getting preapproved for a home mortgage loan will provide you with a preliminary statement on the size of loan for which you can qualify. Knowing this, you can then focus your home search.
In general, lenders allow your total monthly housing costs to go as high as but not more than 30 percent of your gross monthly income. The second requirement is that not more than 36 percent of your gross monthly income can be tied up in the total monthly house payment and payments on long-term debt.
Lenders use slightly different formulas for determining the “total monthly house payment.” These costs generally include the mortgage principal and interest payment, property taxes as a monthly sum, and hazard insurance as a monthly sum. These four items are referred to as PITI (principal, interest, taxes and insurance). Other costs may be included in this calculation if your down payment is less than 20 percent or if you are responsible for homeowner’s association dues. The calculations may vary from lender to lender, but will provide you with a gauge.
The Preapproval Letter
Your friends and family may know you to be reliable, dependable and someone who pays bills on time, but all others in a real estate transaction will require you to prove it. That’s where preapproval comes in. A preapproval letter is more reliable than a pre-qualification letter. In the preapproval process, a lender will examine your finances and will make a preliminary statement on the size of the loan for which you’ll qualify.
Preapproval is an involved process. The lender will take all pertinent information regarding your finances and perform an extensive check on your current financial status. This procedure will ultimately give you the exact loan amount that you will be eligible for (depending on what type of loan you decide to select.) Being preapproved lets the seller know that you have gone through an extensive financial evaluation and there should be no unexpected obstacles to buying the home. It makes your offer much more powerful.
Preapproval gives you a very good indication of:
How much down payment you’ll need
Your closing costs
Your monthly payment (including PITI: principal, interest, taxes and insurance)
The type of loan for which you qualify and which best suits your needs; and,
Special programs for which you may be qualified, including those for veterans, first-time buyers, teachers, etc.
To become preapproved you will need to provide a lender with the following:
Your employment and income history (including recent pay stubs)
Your monthly debts
The amount and source of cash available for the down payment and closing costs
Preapproval letters are not binding on the lender, they are subject to an appraisal of the home you want to purchase and are time sensitive. If your financial situation changes, interest rates rise or a pre-determined date passes, the lender will review your situation and recalculate your maximum mortgage amount accordingly. You can research lenders yourself and ask them to preapprove you.
I will help to provide you with additional information on areas that are attractive to you, as well as schedule times for you to preview any properties that may be of interest.