The Art of Buying a Home
I heard my most memorable quote regarding home ownership a few years ago, and it came from our company's CEO. Having come from modest means, our CEO, who hails from Meridian, Mississippi was raised by a single mother. He recalls the day as a twelve-year-old boy, when his family moved into their first home: "Immediately, we felt differently about ourselves."
I can say that this also applies to my wife and me. Trust me when I tell you that I've never suffered from low self-esteem at any point in my life. However, that first night as a brand-new homeowner, I underwent a great sense of accomplishment and gratitude I will never forget.
Home ownership is the proverbial "American Dream", and indeed over two-thirds of Americans own their home (or at least are mortgaged to hilt for it.) Owning one's home has several benefits (in addition to the intangible incremental self-worth noted above):
In the interest of disclosure, there are certainly down sides and risks to home ownership:
Clearly, home ownership is not for everyone. In my humble opinion, however, if carefully studied and analyzed in advance, home ownership's benefits will far outweigh the risks for those who are interested in it.
The following are some tips in performing due diligence on a home purchase that will help any first-time homebuyer. A lot of these are from my personal experience as a first-time homeowner, including mistakes I made and wished someone had told me in advance, like I'm relating to you.
There are 5 key items that one has to focus on in the home buying process:
1. Determine How Much You Can Afford
The first step in finding a home is figuring out how much you can afford to spend. Unless you just hit your state's lottery, this will probably mean that you're going to need to borrow money, otherwise known as getting a mortgage.
Taking out a mortgage is probably the biggest obstacle facing prospective homeowners. There are several key questions involved in this process:
Do you make enough to pay the lender back?
As a general rule most lenders prefer that you to come up with at least 20% of the value of your new home for a down payment before they will give you a mortgage. However, there are special financing arrangements for which most of us qualify that will enable you to get your new home for as little as 3% of the asking price. I'll address mortgage loan types and those special programs a bit later.
Additionally, the lender, through the use of various formulas, will figure out your ability to take on the additional monthly mortgage payments to your existing debts and monthly expenses. Without boring you with the details of the various formulas, let me tell you the basics of what you need to know: Minimize your monthly debt payments by either paying off those credit card balances, car loans, student loans and other miscellaneous loans, or at least substantially pay them down prior to applying for the mortgage.
What is your credit rating?
Like most Ethiopians (and I would imagine most immigrants to this country) my wife and I did not fully comprehend the value of our credit rating. To be very direct, every loan, every loan application, every inquiry into your credit by prospective employers and landlords everything is recorded on your credit history. Of course, in addition to your applications and original amounts, the timeliness of your monthly payments and current balances, along with your monthly payment amounts, is recorded month by month. Any debt collection efforts, any bankruptcy declarations, any debt "work-out" is recorded for the prospective lender to see.
Your credit report is one of the most sacred personal data sources that you should protect. Easily, it can make or break your aspirations of home ownership. The "Big Three" credit reporting agencies are Experian, Equifax, and Trans Union. For about $8 each (less in some states) you can order reports directly from their websites. These reports will indicate your history of paying your bills on time. The best advice I can give you here is to quickly obtain your report and see what's on it. To be sure, errors sometimes do happen, where as an example, a former creditor mistakenly recorded that you made a payment 30 days late, or a fraudulent account was opened in your name, etc. You should clear these up in advance of letting the lender take a peek at your credit report. My added tip is to review your credit report at least annually to ensure that nothing untoward is being recorded about you.
Do you have something to use as collateral?
2. Obtain a Mortgage Loan
What exactly is a mortgage? It's a loan from a financial institution to you. In return, you pay interest on the amount loaned. The lender also has first dibs on your house in case you are unable to pay back the loan.
A loan has three facets: 1) size (how many dollars you need to borrow); 2) percentage rate (how much you pay in interest on the loan); and 3) term (how long it will take to pay off the loan). The first of these is self-explanatory
The other two are more complicated. Let's look first at the interest rate.
This is the primary reason that the lender will lend you his money. This rate can and will vary from institution to institution, from day to day (sometimes several times a day) and from borrower to borrower. One thing remains constant, however, those applicants with the best credit get the lower rates. This stands to reason, as most lenders want those with a proven track record in debt repayment, and will provide the added incentive of a slightly lower rate to attract those borrowers.
There are several ways by which you can research prevailing interest rates in your market. One such resource is Bankrate Monitor. Of course, you can also your local newspaper's weekly real estate edition as well.
Clearly, though a 30-year mortgage gives you the flexibility of paying back the loan in smaller monthly payments, you will pay much more interest over the "life" of the loan (in most cases double) on a 30-year mortgage. Once again, the concept of 30 years to pay off a mortgage may be a foreign one to most of us Ethiopians, as our parents had only 7 10 years to pay off theirs back in the Home Land.
Types of Mortgages
Although these are the most common types of mortgages, several other creative financing deals can be struck with your lender that can be derivations of the some or all of the above with fixed or variable terms, "amortization" and interest rates.
My recommendation on the kind of mortgage to take out will vary by the interest rate environment. In the current (June 2000) rate market, where interest rates are very high, I certainly would not recommend a fixed rate loan as the way to go. However, in a lower-rate environment (like the late '90s) one would do well to obtain a fixed rate, in anticipation of rates increasing. As an example, one may take out a hybrid (e.g. 7-year fixed) with the hopes that interest rates will decline and enable the borrower to "re-finance" his loan, even before the 7 years are up.
The Lender: Bank or Mortgage Broker?
Mortgage brokers normally originate the loan, process it, and pass it along to a lender, who sells it to an investor. These investors range from state pension funds to government and quasi-government companies such as the Federal National Mortgage Association (FNMA), or "Fannie Mae"; the Federal Home Loan Mortgage Corporation (FHLMC), or "Freddie Mac"; and the Government National Mortgage Association (GNMA), or "Ginnie Mae." A mortgage broker can in many cases speed up your closing time, do all the processing, and get you a better rate.
The mortgage broker is compensated on commission, and he is going to have higher closing fees and is allowed by law to charge whatever he wants for loan processing.
A good rule of thumb: Ask what the broker's fee will be. You can then make an informed decision as to whether paying that fee will be worth it over time if you get a better deal on a loan.
Banks and Mortgage Bankers
Which Should You Use? In short, whichever gives you the best deal. That's why you should shop around first and find out all you can. It shouldn't matter to you as to who will ultimately own or service the loan, in comparison to your monthly expenditure.
Where can you get a mortgage?
One of the first places to check is your local bank. This can result in a reasonably good deal for the qualified customer. In many other cases, the bank will not have a program that fits your needs, or you may fall outside the guidelines of its lending ability.
Once you have visited your bank, look in the real estate section of your local newspaper for the rates at other banks. It's a good idea to start the research on your own, before bringing in a mortgage broker, so that you'll 1) avoid the "hard sell" from the get-go, and 2) have a better idea of what you could find on your own.
When should I shop for a mortgage?
What information should I get from the mortgage company?
One of the worst scenarios I can think of goes as follows: You've spent a lot of time researching and finding the perfect neighborhood you want to live in, the cutest little house with the best backyard, and you think you can even afford it. It has everything you ever wanted. You've spent a couple hundred hours finding your new treasure, you've spent a couple hundred dollars on fees and property inspections, and you have mustered up your courage to make an offer. Your heart is so set on it that you've even started telling your friends your new address.
And then the bank calls.
Your mortgage application has been denied. Woyew!
How could you have saved yourself from this heartache? With a pre-approval for a mortgage. In fact, I strongly recommend you get one before you go any further in the home-finding process.
What is pre-approval? It's basically a quick look from a lending institution at your creditworthiness. With a pre-approval letter in your hand, you're immediately in a stronger negotiating position with any seller. Note that this is different from another "pre" the Pre-qualification letter. The former is a much more serious commitment to you by the lender, whereas the latter, while not quite worthless, is more of an "informal agreement", where the lender hasn't verified the information you've provided (income, credit, job, finances, etc.)
Both will give you a feel for how much you can borrow in advance.
One situation in which such financing is available occurs when the seller has had difficulty selling the house. If that's the case, you'll naturally want to know why. Also, sellers are not in the lending business. They tend to want a short-term mortgage -- usually not longer than three years. After that time, you will have to get a mortgage from a regular lender and pay the seller in full.
There are other reasons why a seller might want to provide financing. It gives him a steady stream of income and return without having to pay capital gains tax. The seller also has collateral -- the house. If the buyer defaults, then the seller can take the house back.
Should you put down less than 20%? Well, if you've got the money, there are advantages to putting 20% down. For one thing, you immediately have substantial equity in your home. This may be important to you psychologically. In addition, you'll avoid having to pay private mortgage insurance. The best word of advice I can offer in terms of accumulating enough money for your downpayment is: Live below your means and sacrifice. There is no better feeling than reaping the benefits of self-discipline through home ownership.
If you simply haven't got the money, some last-ditch ways are to borrow from friends and relative, play the lotto, or go to Vegas and take your chances.
Thanks to several innovative programs sponsored by the US government, it's possible for a lot of us to own a piece of the American Dream. The programs have been successful in spurring home ownership.
Home owners with FHA-insured loans usually only have to make a small down payment (about 3% of the value of the home). They also enjoy a lower interest rate, between 0.5% and 1% below the interest rates on other mortgages. The down side is that they do indeed have to purchase private mortgage insurance, or -- as it's called under these loans -- mortgage insurance premium (MIP).
3. Select a Real Estate Agent
The real estate agent/broker plays a very important role in not only locating the right home for you, but in providing you with vital information that will come in handy in the negotiation phase of your home purchase. That's why it's very important that you spend the necessary amount of time up front selecting the right agent.
The traditional real estate agent is required to have a fiduciary relationship to the seller. Therefore, it is imperative that you select a buyer's agent to represent you. This person expressly works for you, but is typically paid his/her commission by the seller a somewhat contradictory term, I realize, but welcome to the world of real estate!
The first rule of thumb I'd offer (once again, based on personal experience) is to shy away as much as possible from engaging a personal acquaintance (your friend Bob who moonlights in real estate, your cousin Tamrat's girlfriend Lemlem, who just got her real estate license, etc.) Times will be a little tense while you look for a home, and personal relationships take away from the effectiveness of your agent trust me on this.
In selecting your real estate agent, I recommend the following up-front research:
Once you decide on a realtor, the next step will be to sign a contract with that person. You need to make clear who pays the realtor's commission prior to signing the contract, and make sure it's noted as such on your contract. Most of your better agents will want you to sign an exclusive agreement.
I'm personally not crazy about this arrangement, as it contractually prevents you from employing another agent the same time that you're working with this agent concede this point. However, I concede this point (refer to "welcome to real estate above"), but strongly advise against signing a long-term exclusive with anyone, especially the first time around. I recommend a 90-day term. This will give you enough time to gauge the effectiveness of the agent, and to make a change if you deem that you're not getting anywhere with your first agent.
4. Select the "Right" Home For You
The best advice I received from a mentor of mine when we were searching for our home was: "Choose the worst/cheapest house in the best neighborhood."
There are several reasons for adopting this strategy. The key reason is that you want to be the beneficiary of value appreciation by the "better" homes, without paying the exorbitant prices your neighbors did.
In selecting your home, you will run the gamut of choices between new homes, re-sales, bank or government foreclosures and so-called "fixer-uppers". You can find nice deals in any of the above categories of homes, however, to economize on your time, I would advise you (especially as a first-time homebuyer) to stay away from new construction (you building your own home) and fixer-uppers. These can be laden with land mines that you will not be able to appreciate as a rookie. It may prove to be an interesting experiment for your second or third home something to look forward to.
5. Negotiate and Close the Purchase
The Asking Price
This is where your buyer's agent really comes in handy. He or she should be able to guide you through the process of making an offer that is within your range. I will quickly hasten to underscore the theme to this whole essay in taking control of your destiny and not handing it over to your realtor just wisely using their counsel. Here are some helpful steps you should take in evaluating an offer price on the property:
Once you take the above steps, you will be ready to "take the plunge" and make an offer. This was a very nervous process for us as first-timers, and there's a part of you that just wants to bail out of the whole thing tight there and then. Any offer you make should have at least two contingencies: 1) You're ability to obtain adequate financing, and 2) The property passing an independent inspection. This is a very important "insurance policy" for you and will enable you to have an expert identify major problems before you own the home. See section below for details on your home inspection.
Once you make your offer, one of three things will happen: 1) It will be accepted, 2) it will be rejected, or 3) you will receive a counteroffer. If it's accepted, skip to the next section. If it's rejected, you can still come back with a higher offer if you're really interested in the house. And if there's a counteroffer, you're now in a negotiation.
Offer And Counteroffer
Since you should have done your homework on how much you can afford and the relative value of the house in comparison to the local market, you should have an easier time with the counter-offer than you think. If the seller made you a counter-offer of their own, remember that you don't have to accept that, but can offer your own counter-offer to theirs. Once you settle on an offer amount, communicate is to your agent (the protocol is that your agent communicates all offers to the seller's agent.)
You can specify to your agent that the offer you've made is good for 24 hours. This lets the seller know that it's serious, and that you don't want this to drag on indefinitely. It also motivates the seller's agent to get in touch with the owner right away. This doesn't mean that they must accept the offer within 24 hours; it means that the ball will be back in your court within 24 hours (assuming that they don't reject the offer outright). It's smart from a psychological standpoint:
One final tip in negotiations: Keep your emotions in check (this will be very hard) and avoid "falling in love" with the house. If you find yourself in a state of high anxiety, step back. This may seem like your dream house, but there are going to be others. Really. Your agent should help you with this -- if he or she feels that the seller is just asking too much, they're probably right. There are many houses in which you can be happy, so stand firm when you've decided that you've reached your upper limit.
The Home Inspection
No matter how many times you've toured your new house, there will always be something that you're going to miss. Why kick yourself later when you can hire someone to make sure that everything's up to snuff?
You need to find a good home inspector. He's going to give you information that will either add to your comfort level, send you back to the negotiating table, or send you back to your home search. In any event, it's critical information.
Here are some helpful tips on finding the best inspector:
If the place passes the inspection, and you obtain your financing, you're ready to close on the house. That means you're actually going to buy this property. And that means you've got to be ready for closing costs.
Closing costs are the many fees and taxes associated with purchasing a home. They include searches, clearances, and reports to process the transaction. Depending on where you live, they can easily add up to thousands of dollars. They're generally around 3% to 6% of the purchase price of the home.
Your lender is required to give you a written, good-faith estimate of all your closing costs within three days of your applying for a loan. However, don't go into the process of buying a home without knowing about them.
Once your offer has been accepted, your financing is in place, and your home inspector has given the thumbs up, you're ready to do the deal, that is, to close.
On the day of closing, or the day before, the purchaser is allowed a walk-through of the property. All plumbing, electrical, heating, air conditioning -- all the major systems of the house -- have to be "in working order." Otherwise it is the seller's responsibility to get them up to scratch. You've already had the home inspection, of course, so there should be no major surprises here. However, that doesn't mean that there won't be. So take your time on your walk-through, even though you'll feel a natural urge to get this thing out of the way so that you can take possession of your house.
The big day is here: the day on which, officially, you become a homeowner. You're going off to "settle" the deal, to "close" on your new home. What's going to happen? What should you expect, and what do you need to bring?
The length of time the closing takes depends on how smoothly things go. It's likely to take about one hour for you to sign all the paperwork. If there are surprises (see below) at closing, it will take longer.
Your buyers agent will be helpful at the closing. You'll need to have in hand your new homeowner's insurance policy showing that you have, indeed, insured the house, and a cashiers check for the down payment. The settlement sheet is a document that lists all of the closing costs and the particulars of your loan. Once you review and sign the settlement form, you are ready to "take possession" of your new home. This means the house is yours. It means that, after you've signed all these documents, the hands over the keys to the house to you. Congratulations! Elell-ellel!!
At this point, the seller gives you whatever package of information he may have on equipment at the house. This includes things like the instruction booklet for the washing machine; information on how that timer-light above the front door works; how you re-code the automatic garage door opener; how-to manuals for the refrigerator and the food disposal, etc., etc.
Your hard work has paid off enjoy your new home!
Helpful Web resources:
Resources on Mortgage Shopping