Buying A House
The following publication is reprinted with permission from Consumer Action.
The Keys to Homeownership
You Can Buy a Home
Buying a home is one of the most important purchases you'll ever make. Owning your own home helps you build wealth, save on taxes and become your own landlord. But you need to be aware of and prepared for the costs of homeownership in time, effort and money.
The cost of owning a home includes more than your monthly mortgage payment. You must pay for property taxes, insurance, maintenance costs and emergency repairs.
Insurance and an emergency savings account are vital to homeownership. Homeowner's insurance covers damage to your house, your possessions, and your liability to other people who've been injured on your property. Many homeowners without insurance have lost everything when disaster strikes.
Buying a home is a big step. It takes time. Start by organizing your finances:
Save. Put money in a savings account each month for a downpayment. You can make a downpayment of 3% to 20% or more if you wish. However, aim to make the largest possible downpayment. If your downpayment is less than 20%, lenders require that you pay extra for private mortgage insurance (PMI) and your monthly payments will be higher.
Housing counseling. Enroll in a HUD certified counseling program that helps buyers get ready for home ownership. To find a local program go to the HUD web site on Buying a Home and click on "Housing Counselor," or call 800-569-4287.
Credit history. You'll get a lower interest rate on your mortgage if you have good credit. The best way to have a good credit record is to pay your bills on time. Get free copies of your credit report at the Annual Credit Report web site or call 877-322-8228. If you find a mistake, follow the directions in the report for disputing errors.
Budget. Track your spending by keeping a list. Can you trim expenses and have more money to save for a home? For more about budgeting, check out the "Manage Your Money Wisely" article on MoneyWi$e.
Income and assets. Add up your income (wages, child support, benefits, etc.) and assets (money in checking, savings and retirement accounts).
Debt. How much do you owe? List all your monthly bills, rent, insurance premiums, payments due on car loans and credit cards, etc.
What Size Loan Can You Qualify For?
Very few buyers can pay cash for a home. Instead, most homebuyers apply for a mortgage.
Many things influence the type and amount of mortgage you will be approved for:
- Your credit history
- Your income and those who will be applying for the mortgage with you
- Your downpayment
- Your debts
- Your savings
- The type of loan you choose, such as fixed rate or adjustable rate
The kind of property you choose to buy, such as a single family home, duplex, condominium or cooperative unit, also figures in the kind of loan you'll get. In general, the smaller the amount you owe, the higher the mortgage you'll qualify for. Pay off any debts you can before you apply.
The higher your downpayment, the less you have to borrow. The downpayment is usually expressed as a percentage of the lower of sale price or appraised value. Sellers and lenders prefer 20% of the sale price as a downpayment, but certain lenders require as little as 3%. Don't pledge all your cash—you'll need money for closing and moving costs. To find downpayment assistance programs visit Local Homebuying Programs online.
When you apply for a mortgage, lenders compare your income to your housing costs and other debts to see how much you can afford to spend each month on mortgage payments and other housing costs. This percentage also helps them determine how much money you can borrow to buy a house. The rule of thumb is that all debts, including housing costs, should total no more than 36% of income.
Who's Who In Real Estate
Real estate agents. A real estate agent can show you homes for sale, negotiate the terms and price on a home purchase. Buyer's agents represent the homebuyer in the sale. Seller's agents may work with buyers, but they are responsible for the seller's best interest. Typically, the seller, not the buyer, pays agent fees.
Mortgage brokers match homebuyers with lenders. A broker may be paid with a loan "origination" fee from the consumer or indirectly by the lender that will be providing the funds—or both. Broker fees are negotiable—ask for a breakdown of how your broker is compensated and question all charges so that you don't pay more than you need to.
Mortgage banks and online lenders. To shop for the best loan, you can meet directly with banks and other mortgage lenders or visit them on the Internet. National online lenders also arrange mortgages.
Appraisers. These professionals determine the current value of the house you want to buy. Appraisers are usually hired by your mortgage lender, but you pay the appraisal fee of $300-$500.
Home inspectors. Hire an inspector to learn if there are any major problems with the house you want. When you sign a contract for a home, ask for a home inspection contingency—then you can walk away if the inspection finds problems you don't want to fix. To find an inspector, ask your buyer's agent for a recommendation or contact The National Association of Certified Home Inspectors, 877-FIND-INS or The American Society of Home Inspectors, 800-743-2744.
Get the Right Home
Check out the neighborhood. If possible, walk around to get a feel for the community. Check out the schools, shops and crime statistics with the local police or town newspaper, or online at the Homefair web site.
Consider your commute. Look at mass transit options and access to major roads.
Check environmental hazards. Order an environmental hazards report to rule out toxic contaminants or natural hazards like floods or forest fires. Ask your real estate agent how to order a report.
Flooding. Damage from flooding is not covered by homeowner's insurance, but a federal government program offers flood insurance. Check your flood risk at the FloodSmart web site.
The most common mortgages last for 15 or 30 years. Several types of mortgages are available:
Fixed rate mortgages carry the same interest rate during the life of the loan. Your basic mortgage payment is always the same. (If your lender collects monthly property tax and insurance payments for you, your fixed payment may vary from year to year.) Fifteen-year mortgages have much higher monthly payments.
Variable rate mortgages often allow you to qualify for a smaller payment and lower introductory rate, but this does not make them a good choice. Your monthly payment can increase if interest rates rise. Learn how high the interest rate can go, how often the interest rate may change and be sure you can afford a higher payment.
Federal Housing Administration (FHA) loans. If you have damaged credit, FHA loans are easier to qualify for and usually have lower downpayment requirements. You may even be able to get a loan if you've been through bankruptcy. To find out more, visit the FHA web page.
Danger: Non-Traditional Loans
Beware of risky "exotic" mortgages. These nontraditional loans are not appropriate for the majority of borrowers:
Interest-only loans seem attractive because they let you make a lower interest-only payment during a temporary introductory period. Unfortunately, this doesn't repay the original loan amount (principal) and your payments will shoot up dramatically when the intro period ends.
Zero-down loans don't require a downpayment, which means that when you sell or refinance you may lose money if your home has not increased (appreciated) in value. Many homebuyers have actually ended up owing money when they sell because the value of their homes has gone down.
2/28 or 3/27 loans. For 2 or 3 years, these loans start with a low interest rate that jumps to a much higher rate, which may adjust every six months. The higher-and-higher payments can put you at risk of losing your home.
Subprime loans. Subprime lenders charge higher rates and fees to people with damaged credit, and often target lower income, senior or minority borrowers. These loans often contain unfair or deceptive (predatory) terms, such as pre-payment penalties (hefty fees for paying the loan off early).
Qualifying for a Mortgage
Get pre-approved. Lenders "pre-approve" you for a loan only after a thorough review of your credit history and income. If you are pre-approved, you will get a letter from the lender. Some sellers or real estate agents require a pre-approval letter. Pre-qualified is not the same as pre-approval. Pre-qualification is only a general estimate of the loan amount you might qualify for.
You can get a mortgage through a bank, credit union, finance or mortgage company or online lender. Contact a few lenders to compare rates, fees and points (an optional charge to get a lower rate). A point is 1% of the loan amount.
To prepare to meet with lenders or mortgage brokers:
- Copy your most recent tax returns, pay stubs, and bank account statements.
- Know your credit score—a number that measures the quality of your credit history. You can buy your score at Myfico, Experian, Equifax or Transunion.
- Don't apply for other loans (auto, credit card) near the time you apply for a mortgage as it will show on your credit report and perhaps lower your credit score.
- If rates are heading up, consider paying extra to lock-in (guarantee) your interest rate. If you apply with several different lenders, do it within 60 days to maintain a good credit score and improve your chances of getting a good loan. The better your credit, the lower the interest rate will be on your loan.
- Participation in first-time homebuyer programs can reduce your interest rate, limit fees or help with a downpayment. Check with a housing counselor, or with your city, county and state government to learn about these programs.
Private mortgage insurance (PMI). If you put down less than 20%, lenders require you to pay PMI to protect them if you don't pay your mortgage. This is an added cost to you. Per $100,000, monthly PMI premiums range from $25 to $65. Many lenders will stop charging PMI when your home's value increases by at least 20%. To avoid PMI, you can take a second mortgage called a "piggyback" loan to use as a downpayment. PMI premiums and the interest on most piggyback loans are tax deductible.
Appraisals. Lenders hire appraisers to estimate the home's value. An appraiser assesses the condition of the house and compares it to similar homes in the area. You're entitled to a copy of the appraisal before closing.
Truth in Lending statement. Within three days of submitting your application, the lender is required to give you this statement containing information on the annual percentage rate, the finance charge, the amount financed, and the total payments required. This document will also provide information about prepayment penalties (if any), whether the loan is assumable, the payment schedule of the loan, and any late payment charges.
Good faith estimate. Also within three days of submitting your application, the lender will also give you a "good faith estimate of settlement costs." Expect closing costs of 3%-6% of the mortgage. This document should include your total estimated monthly payment, including principal, interest, taxes, and insurance but may be several hundred dollars less that your final costs because all prorated charges may not be known so early in the process. Ask for an explanation of all fees.
Title insurance. Lenders require that you pay this charge to ensure that the property is free of forged titles, liens and errors. Consider buying additional owner's title coverage to protect you from title problems that were not found during the title search and to cover any legal fees needed to defend claims against your title. To compare title insurance costs in your state, check the American Land Title Association web site.
Making an Offer
If you offer to buy a house and the seller accepts, you've got a deal—and it's binding.
Contingencies. Make sure your offer gives you a way out by including a home inspection or financing contingency. If you find a serious structural problem or can't get a mortgage, you'll be able to walk away without legal consequences.
Earnest money. Most sellers want you to make an earnest money deposit. When the seller accepts your offer, your deposit is held by a third party—an escrow or title company—until the day the sale is final (your closing).
Negotiations. Be prepared to make a counter-offer if the seller rejects your first bid. Know your limits and stick to them.
At Your Closing
The final step in the home purchase is closing (settlement). Your sales contract sets the number of days until you close, typically 30-90 days on existing homes. (New construction contracts may be much longer.) Before closing, take a final walk through to make sure the house is in the same condition it was when you agreed to buy it.
A day or so before closing, your lender will give you a HUD-1 settlement statement listing all closing costs. Review the buyer's costs and payments carefully. Call your lender if you see major differences between the good faith estimate and the HUD-1 statement.
Go to closing with a certified check in the amount called for on your HUD-1 form, a photo ID and extra personal checks. You'll be asked to sign many papers. Review each document carefully before you sign'mistakes can be costly. If necessary, ask someone you trust to go with you to the closing.
At closing, you'll pay a pro-rated portion of the property taxes and utilities such as electric, gas or fuel oil. The lender may also require you to pay for homeowner's insurance and interest from the date of closing until your first mortgage payment is due.
When all the papers are signed, you'll get the keys to your new home.
Consumer Action's Housing Information Project created this brochure in partnership with Capital One Services, Inc. © 2007 Consumer Action. Rights Reserved.