We recently celebrated our 250th anniversary! 250 articles, that is. I’d like to thank all of the loyal readers and my great staff of writers!
In the spirit of baseball season, I have broken down the process of buying a home into nine innings (technically, ten sections – there is also a post game).
Note: this advice is provided with no warranties. I am not a realtor or a financial advisor. If you have questions about the process, I would suggest that you consult with a professional. This is geared mostly toward the first time home buyer, although other some veteran homeowners might pick up a tip or two.
First inning: Clean up your credit – Your credit history will affect your interest rate. A mere one percent rate hike can add up in a hurry. One percent on an outstanding balance of $200,000 is an extra $2000 per year (this amount would decrease in future years as you pay the balance down). Pay your bills on time, and avoid doing things that could adversely affect your credit score (such as opening 85 new credit cards).
Second Inning: Determine your budget. Some people will go to a bank and ask how much they can get approved for. This is a bad idea, as it may cause you to take on a higher mortgage than you want. Instead, determine what you want your housing budget to be. Once you have determined your overall housing budget, subtract an amount to save toward maintenance and upgrades (a new roof, fixing a furnace, etc.) to leave the amount that you want to put toward the actual monthly payment. Then subtract the amount for insurance, property taxes, and PMI (if necessary) – items that are typically escrowed – to leave the amount of money left for the actual house. Run this number through a mortgage calculator to determine the maximum price of the house.
Sound confusing? Let’s do an example. Let’s say that you want to spend $2000 per month on your overall housing budget. You decide that $350 of this amount should go into a savings account devoted to maintenance and upgrades (to a new homeowner, this might sound like a lot, but a new appliance can quickly wipe this out). This leaves $1650 for the mortgage. You expect to pay $300 per month for property taxes, $100 per month for home insurance, and $50 for per month for PMI. Deduct these amounts from the $1650 and you have $1200 left toward the actual house payments. Assuming a 30 year mortgage at 6%, this means that you can spend $200,000 on a house. (Note: these amounts may not be realistic for you – they are provided simply to show how the math works).
Summary:
- $2000 : Monthly housing budget
- -$350 : Put towards maintenance and upgrades
- -$300 : Property taxes
- -$100 : Homeowner’s insurance
- -$50 : PMI (mortgage insurance)
- = $1200 per month toward the purchase price of the house
Plug $1200 (payment), 6 (annual interest), and 360 (months) into this calculator, and you get a mortgage amount of $200,000.
Third inning: What do you want? OK, you know you want to buy a house – but what sort of house? Ranch? Two story? Two bedrooms? Four bedrooms? Do you need a three car garage or a big back yard? Do you want to live in a particular neighborhood – or avoid certain parts of town? Make a list of things that are “must haves” and things that are nice to have. Look around a bit on realty websites and in your local paper to determine if you can realistically afford the type of home you want, based on your budget. If you can’t realistically afford it, begin to scale back.
Fourth Inning: Get pre-approved – Sellers (and realtors) love buyers you are pre-approved, because it avoids a situation where someone wants to buy a house but can’t get the financing. Get pre-approved for the amount you determine in the second inning – or perhaps a slight bit of wiggle room – but don’t get pre-approved for an amount you don’t want to spend. The availability of the credit might tempt you to buy a more expensive house than you really want or need. At this point, you might want to get an estimate of taxes, insurance, and PMI to get a better grasp on what everything is going to cost.
If you have a choice between a piggyback mortgage (such as an 80-10) and PMI, one thing to keep in mind is that mortgage interest is deductible, but the PMI is not. You will pay more interest with a piggyback (due to a higher rate on the smaller loan) than you will when you use PMI, but your out of pocket cost may still be lower.
Fifth inning: Get a realtor – Ask your family and friends for advice on a realtor. In most cases, you won’t be directly paying the realtor (they split the commission with the seller’s realtor), so get the best possible realtor – money is no object! Find someone who not only is good at his or her job, but also will mesh well with your personality.
Note that your realtor will not help you on homes that are for sale by owner, unless you pay them. Why? Because FSBO homes don’t have a commission to split. Thus it is only fair that you pay them, since they can’t work for free.
If you have rollover minutes on your cell phone plan, you might want to roll some forward, as you’ll chew up a lot of minutes talking to the realtor, spouse, banker, etc.
Sixth inning: Find a house – This is a fairly important part of the whole process, right? You may choose to attend a few open houses, or you might share your list from the third inning and have the realtor find some properties that seem to be a good fit.
When you walk through a house with your realtor, give them feedback. Don’t simply say that you don’t like the house; instead, tell them what you don’t like. This allows them to focus on houses that are more suitable for you.
When it is time to make an offer on the house, your realtor can advise you on a good place to start the negotiations. You don’t want to insult the sellers, but you also want to leave some room for negotiations.
As a tactic to gain leverage, you may want to point out some of the less desirable qualities of the house – such as saying “we really like the house, although the yard seems a bit small.” In our case, we actually looked at both sides of a zero lot line home (referred to as a duplex in some areas). The homes were basically the mirror image of each other, with some small differences. Thus, we had some leverage based on the fact that a very similar house was for sale just a few feet away. If one of the sellers wouldn’t negotiate, we could just go next door and make an offer on the other house. Do not, however, turn this into an all out attack on the house. You won’t fool anyone, and you’ll make the sellers angry.
Seventh inning: Get inspections – While some people may be tempted to avoid the expense of inspections, you will want to strongly considering getting them done. They could find big problems that you might not have found on your own. Our inspector found a rotting window frame on the upper level – it is unlikely we would have caught this on our own. We were able to get the sellers to pay the estimated cost of replacement – this more than paid for the cost of the inspector.
Seventh inning stretch: OK, time to stretch your legs and get ready for the big finish.
Eighth inning: Closing – Finally, the day that you have been waiting for! First of all, you should have an estimate of closing costs from your lender. Make sure you have the funds available (and a bit more, just in case there are some “surprises” on closing day). Verify whether you can pay with a personal check, or whether a bank check is required.
If you have questions during the closing, make sure you ask them. Once you have signed the paperwork, it is too late to begin asking questions.
Make sure you know when the first mortgage payment is due, and where to send the payments. A lot of lenders allow you to pay online, which I have found to be very nice.
Ninth inning: Moving day – If someone gave me the choice of being hit in the head with a shovel or moving, I’d take the hit with the shovel. Moving sucks.
Having said that, there are things that you can do to make the process a little easier. This is a great time to get rid of things you no longer need. You can also work on packing a few things every day, to avoid a big rush to pack everything right before the move. Make sure that everything is completely ready to be moved when your moving crew arrives. They are your moving crew, not your packing crew. I have heard stories of people having laundry in the washer and dryer – that’s not good.
If you are renting a truck for the move, reserve it ahead of time, and pick it up the previous night, if possible. The rental places often get a big rush of traffic in the mornings.
If you have friends who are helping you move, remember to thank them. Multiple times, if your have a lot of heavy items.
Post game: After the move – Within a month or so, you’ll realize that you don’t like your house quite as much as you did when you agreed to buy it. This is buyer’s remorse, and it’s a very common feeling. Trying to focus on the positive aspects of the house.
Make sure to stock up on items you will need, such as furnace filters, salt for a water softener, and bulbs to fit the various light fixtures (wow – there is an incredible variety of light bulbs). Put new batteries in the smoke detector, carbon monoxide detector, and thermostat.
When tax time rolls around, make sure to have records of the mortgage interest and property taxes you paid during the year. These are itemized deductions – if you have used the standard deduction in the past, it might make more sense to itemize because of these deductions.
If you have two mortgages – such as an 80% at a lower rate and a 10% at a higher rate, any extra payments should go to the loan that is at the higher rate.
If you have PMI, make sure to notify your lender when your loan balance is less than 80% of the home’s value. They don’t always drop the PMI automatically.
When it is too early to refinance? Never. Refinancing is not a question of time, but rather a question of cost savings. There’s also a rule of thumb that you should not refinance unless you can cut your rate by 1%. In the past, this might have made some sense. However, with the increase in housing costs over the past few decades, this rule of thumb is obsolete. For example, if you have a $500,000 house, a half point drop in your interest rate can save you $2500 the first year (and slightly lesser amounts each year, as you pay down the mortgage).
The best way to determine whether or not to finance is to figure your break-even point. First, figure out the costs of refinancing. Do not include prepayments on the new mortgage or re-establishment of escrow, as these are not true closing costs (prepayments are simply a mortgage cost, and re-establishment of escrow is offset when your previous lender returns the existing escrow balance to you). Take the refinance costs and divide by the monthly savings – this is your rough break even point. Actual break even will be slightly more, due to the fact that interests costs decline each month. However, this is typically a very small difference.
What did you miss over the weekend?
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