The purpose of this article is to help you to understand the home buying process so that you can approach it from a position of understanding rather than confusion. In this article you will learn about the different types of homes available, the financial limits that banks apply to you when you try to get a home mortgage (and which therefore control the type or size of house you can afford), the extra and often unexpected costs that you will incur during the closing process, and some of the hazards to watch for as you go through the transaction. Once you have finished this article you will prepared to go forth and do battle with the banks, Realtors, lawyers, and loan officers who stand between you and the home of your dreams.
Imagine that you would like to buy a new television. In America just about anyone can drive down to the local discount store, pick out a TV, and purchase it with a credit card in about 10 minutes. The process is easy, well understood, and accepted by everyone.
Now imagine that you want to buy a new car. This transaction is a bit more complicated but still relatively straightforward. If you have the cash for a car in the bank then you can:
You can drive the car off the lot the same day. If you have to get a loan for the car then it might take a day or two to contact a bank and arrange for the loan (provided that your credit history is good), but you can still drive the car away with relative ease.
Now imagine that you want to buy a house. In general the process is going to take at a very minimum a month, and more typically between three and six months. There is also a fairly good probability (perhaps 25%, depending on your situation) that, once you find a home you like and wish to purchase, you will be unable to buy that particular home and will have to start over again. A typical question for the first time buyer to ask at this point is, "What do you mean that I may not be able to buy the house that I pick out?" As you go through this article you will begin to understand that there are a number of things that can go wrong if you are not prepared (and sometimes even if you are ). There are three fundamental things that complicate the home buying process:
Having said all of this, you can expect that any home purchase will involve at least the following steps, provided that everything goes smoothly:
In the following sections we will discuss each of these steps so that you can understand each one.
The decision to purchase a home is not a small one, and involves a number of variables. Some of the considerations that you should keep in mind are listed below:
Keep all three of these considerations in mind as you are deciding whether or not to buy a home. On the other hand, you should also keep the following advantages in mind:
As you can see, home ownership has important advantages and disadvantages, and the decision to purchase a home therefore should not be made lightly.
Before most people can purchase a home, they must get a loan. The most common form of loan used to purchase a home is called a mortgage. In a mortgage, the borrow pledges to repay the loan as specified, and the lender is given the right to seize the property should payments ever be interrupted. A mortgage deed, issued by the lender and recorded at the county tax office, contains an accurate description of the property and the payment terms of the loan.
Because a mortgage is usually for $100,000 or more, banks tend to be fairly particular about the people to whom they grant a mortgage. In general a bank will require you to demonstrate five things before giving a mortgage to you:
It is possible to obtain certain government-backed mortgages that bend some of these rules. For example, an FHA mortgage (a mortgage backed by the Federal Housing Authority) will generally lower the down payment requirement. In general, however, you can expect any mortgage company or bank to follow these rules fairly closely.
You meet the first requirement by saving money over time. There is no other way to do it. If you look back at some of the earlier articles in this series (particularly the article entitled "Incentives"), you may be able to define home ownership as one the things that are important in your life, establish it as a financial priority, and then begin a savings program to accumulate a down payment.
You meet the second requirement by having a steady job with a predictable income. You will need to be able to get confirmation of employment from your employer when it is requested by the bank. You will also have to supply tax returns for three preceding years to show your income history.
You meet the third requirement by looking at your current financial
situation and figuring out the maximum amount of money you can
borrow based on the test.
If you find that you are way off base when you look at the ratios, then you can do two things: 1) you can plan on accumulating a larger down payment or buying a less expensive home, and 2) you can reduce existing debt.
You meet the fourth requirement in two ways. You build a clean credit history by paying your bills on time. You obtain a strong credit history by obtaining and repaying other loans, like credit cards, car loans, etc. If you have never obtained and repaid a loan prior to attempting to get a mortgage, it is likely that the bank will frown on this fact. It is therefore important to build a credit history by obtaining and using credit cards, obtaining and repaying a car loan, etc.
A bank will check your credit history by obtaining a credit report for you from a credit reporting company like TRW. You can and should obtain your own copy of your credit history ahead of time and make sure that the report you receive is accurate and contains no errors. If you know that you have a spotty or poor credit history, you should work to repair the damage. The best way to do this is to talk with a credit counselor. The Fannie Mae Foundation (a private company chartered by Congress) can provide you with help finding credit counselors and other mortgage information. Call 1-800-699-HOME for further information and assistance.
You meet the fifth requirement by presenting to the bank a net worth statement. The bank is primarily interested in your existing assets (to demonstrate financial strength) and your existing debts. You can prepare a net worth statement using the net worth calculator discussed in the article entitled "Understanding your Current Position".
As you are getting your finances in order, you may wish to talk with your bank or a mortgage company and get their opinion on your financial health. This will save you the embarrassment and frustration of applying for a mortgage and being rejected after spending a significant amount of time finding a home you like. Many mortgage companies will pre-approve you for a certain mortgage amount, and going through this process can be very beneficial. Once you are pre-approved, you will know exactly how much money you can spend on a new home, and you will also save yourself the hassle of getting approved once you find a home you like.
There are at least six different types of housing you can purchase in most markets:
You can choose to live in any type of housing, although in general the topics addressed in this article focus on the purchase of a house.
There are two ways for you to search for a house. You can either look in the paper or in magazines advertising houses for sale by owner and you can purchase a house directly from the owner. This route has the potential to be less expensive, because an owner who sells his or her house does not have to pay a 7% Realtor commission. The disadvantage of this approach is the fact that it can be harder to find a home that you like because of a more limited selection, the difficulty in scheduling visits to each home.
The more common way to search for a house is to use a Realtor. Realtors have the following advanages:
Use whichever technique feels more comfortable. If you use a Realtor, take time to shop around and find someone whose style and market niche matches your own. One good way to do this is to seek recommendations from friends at work. Since you have a choice, choose a Realtor with extensive experience, and do not allow the Realtor to rush you.
After searching for a period of time you will presumably find a house that you like in a reasonable location with a price that you can afford. It may take several months of searching to find such a house. At the moment you find it, make an offer immediately. It is not uncommon for a good house at a good price to be purchased by someone else if you hesitate for too long. This is the most common way to lose a house that you really like.
There is a funny thing that happens to many people right after they make the offer. It is commonly known as buyer's remorse. It is the feeling that you have just done something extremely stupid, and often occurs right after you sign your name and hand over the deposit check. Buyer's remorse is a natural human emotion. You can combat it to some extent by making up a written list of advantages and disadvantages for the house as part of your decision-making process. If this list is sound and true, then when buyer's remorse kicks in you can refer to the list and reassure yourself that you did the right thing. Or maybe not. Just be aware that the phenomena is common and be prepared for it.
You make an offer to purchase a home by signing an offer to purchase form and writing a check. The check acts as a deposit and represents your commitment to following through with the purchase should the offer be accepted. This money is normally referred to as earnest money. The check will be cashed, and the money will be placed in escrow. An escrow account is simply a bank account managed by a neutral third party, generally the Realtor or a lawyer. Should you be unable to follow through on your commitment to purchase, you will lose your earnest money. Should the offer not be accepted, the money will be returned to you. The amount of earnest money you will be asked to give varies, but generally is 1% of the purchase price. This money is applied to the purchase price at the closing if the deal is successful.
A standard offer to purchase is a single sheet of paper. On one side are a number of blanks where you fill in your name and address, the offer price, the amount of earnest money, and any conditions or contingencies on the offer. On the back are a number of standard condition paragraphs. For example, many localities require a termite inspection or bond on any house that is sold. There will be a standard paragraph covering this condition. Should the house fail to pass a termite inspection the offer will be nullified and your earnest money will be returned to you.
You can also add your own condition and contingencies. One common condition added by most sellers is "subject to loan approval." That way, if you are denied a mortgage you get your earnest money back. Another common condition is "subject to a satisfactory home inspection by a licensed inspector." You, as the buyer, will have to pay for the inspection ($100 to $500), but you can use the results of the inspection to request repairs to the house prior to purchase. The seller pays for these repairs. You can stipulate that the seller will pay certain closing costs (this is important because it can save you a lot of money - see step 12). You can, in fact, add any conditions that you like (contingent upon sale of an existing home, contingent upon repair of the roof, contingent up removal of dead trees in the yard, etc.), but at the same time the seller has the option of rejecting them.
The most important part of the offer to purchase is the offer price. The seller places the house on the market with an asking price. You have the option to offer the asking price, or more, or less. If you know that you have three competitors and you really love the house, you may have an incentive to offer more than the asking price, but generally you will offer less. The amount that you offer depends on your personality and your negotiating strategy.
The seller will either accept your offer, reject it, or make a counter offer. If you receive a counter offer you have the right to accept it or make a counter counter offer. At this point you negotiate with the seller until you reach a price and terms that are agreeable to both parties. If you do not reach agreement, the offer is eventually rejected, your earnest money is returned to you, and you get to start over again. This is the second way that you can lose a house that you like.
There are a number of good reasons to talk to a mortgage company prior to searching for a home (see Step 2). If you do not then at this point you must start the process. Search for a company that has good rates and that seems to understand you and your financial situation. Ask several different banks or mortgage companies for quotes - the rate differences can be amazing. You local paper will often publish a list of banks with the lowest rates in the area.
There are two different types of mortgages: fixed-rate and adjustable-rate (also known as ARMs). Fixed rate mortgages come in 15-year and 30-year formats. Adjustable rate mortgages come in many different forms, but the most common form starts at some rate and then adjusts itself every six months or year depending on changes to the prime rate.
Adjustable rate mortgages generally start with a interest lower rate, but carry the sometimes-significant risk that your monthly payment will rise if interest rates rise. Fixed rate mortgages are guaranteed to maintain the same monthly payment over the life of the loan.
Once you have chosen a mortgage company and a mortgage type, apply for the loan by filling out the appropriate paperwork and supplying all of the requested information.
Approval may take several days or weeks, depending on the mortgage company. You may be asked to supply additional information during the process.
As discussed in Step 2, much of the nail-biting than accompanies the mortgage-approval process can be eliminated by getting your mortgage pre-approved. See Step 2 for more information and talk to your mortgage company before starting your search for a house..
At the time your offer is accepted by the seller, you and the seller will negotiate a closing date. With the mortgage approved all that you can do is wait for the closing date, prepare to move, and hope that nothing goes wrong.
Finally the closing day arrives. This should be a day of rejoicing because on this day you will become the proud owner of a new home. Unfortunately this day is instead one of frustration and myriad small details unravel. It is not exactly clear why this unraveling is so common, but it is definitely the case.
The closing normally occurs at the office of a lawyer. At the closing you will be required to pay quite a few fees, so bring your check book and make sure you have plenty of money in your account (the lawyer will normally provide you with a total closing cost prior to closing day, but be sure to have at least $1,000 over and above that cost available just in case).
The costs that you may be expected to pay at the closing may include the following, depending on how closing cost payments are negotiated when you make your offer to the seller:
The total figure can add up to thousands of dollars. Some banks will let you roll these fees into the mortgage, but many will not and in that case you will have to have the cash available. You will also sign at least 15 pieces of paper.
Presumably this part is easy, and once you have moved in you can sit down on your couch and you can congratulate yourself. After several months or years of hard work you have successfully bought your part of the American Dream!