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Buying a house
Buying a house as a layman (a non real estate professional) can be a very complicated and daunting task. You will have family members, friends, real estate agents, loan officers, and banks all giving you advice, which may or may not be useful in your particular situation. Who can you trust? Whose advice should you take? What advice is right for you? Hopefully, this article will help you come to some answers that will help you.
Why do you want to buy a house?
There are a lot of good reasons to purchase a house for both personal use and as an investment. It is important to examine you reason for wanting to purchase real estate because it affects how you approach the process. The most important thing to determine is whether you are a 'will-buy' buyer, or a 'must-buy' buyer. The will-buy buyer does not have to buy, but will do so if the right property, with the right amenities, at the right price is presented to them. The must-buy buyer is essentially forced to buy because of circumstances.
Many will-buy buyers act like must-buy buyers because they get wrapped up in the experience of looking at real estate, lose their perspective along the way, get attached to a specific house, or are just uninformed about how to approach real estate purchases.
The first step in purchasing real estate responsibly and effectively is to look at your motivation and discuss it with people you trust.
When is the right time to buy a house?
A personal home will very likely be the most expensive thing you purchase in your life. Most people do it more than once, and the mistakes you make in each purchase can follow for a very long time. When asking the questions, 'When is the right time to buy?' there are many factors to consider. Is it a buyers market? Do I have enough cash to purchase? Will my credit rating allow me to get good rates? Are the current rates good? How secure is my income? All of these are good things to consider when exploring the purchase of a personal home.
Since purchasing a personal home will generally put you in debt, and be one of the largest monthly expenditures that you make, it is important to take your time, find answers to all of the questions above, and get good advice from people you can trust. Since you will be getting into debt to make a real estate purchase, it is a good idea to clear up any existing debt that you have, and have a solid handle on your personal budget. If you have not read the article, 'How to get out of debt... Spend less than you make!', you should. If you do not currently have any debt, you should read the article anyway because it has an extensive section on how to create and maintain a personal budget.
The right time to buy a house can have a lot to do with the current market, but should not rely entirely on the current market. A buyers' market occurs when there is more real estate available for purchase than there are available buyers. When this occurs prices drop and the sellers are more negotiable on price and other concessions. While the market can be a big part of your purchase timing, you must also consider whether it is a good time for you personally to make a purchase. Having a strong understanding about how much money you make and how much money you need to live are key factors at arriving at a decision to buy or not to buy real estate. You need a firm grasp of your personal budget.
Sometimes when the market is right, you will not be in a good place personally or financially to make a purchase. No matter how good the market is it just may not be a good time for you to purchase. On the other hand, if you are ready to purchase, but it is a sellers' market (generally a bad market for buyers) , you can still make a purchase, but it will likely take longer to find the right deal for you. No matter what the market is like, there are always plenty of good deals to be found as long as you are willing to be patient.
Bowen Accounting recommends that before you purchase a personal home that you have no debt (credit cards or personal loans), that you have 20% cash to put down, and know what monthly payment you can afford. When you know the monthly payment you can afford, then you can use that to go backwards and figure out what purchase price you can afford.
Make a list
Before you call your real estate agent and start looking at properties you should make a list of what you want. You will likely be living in this house for many years, so it is a good idea to discuss what amenities you would like it to have.
- What area do I want to live in?
- How many square feet do I want and need?
- How many bedrooms and bathrooms?
- Split wing?
- Garage?
- Automatic sprinklers?
- Roof type (composite, shake, or tile)?
- Pool?
- Backyard size?
- Do I you want to live in an association?
List anything you can think of that you would like the property to have. After you have listed them put a mark next to the items that you are not willing to live without.
Now you have a solid list of your needs and wants, and if you have already looked at your budget you know what price range you should be looking at. The next step is to go online to the local multiple listing services (MLS) and see what is available. The previous link is to the Bakersfield CA MLS and on that page if you click 'Find Properties' you will see a wide array of search criteria that you can fill out to get a list of properties that meet your needs. Search for your price range, bed/baths, zip code, and square footage. In a few clicks you will have a list of property details that you can use to fine tune your list.
The are several other amazing sites that you can use to find properties and lots of information about properties in your area. You do not need to rely on just your local MLS system. Some properties, especially investment or flip properties owned and represented by out of town investors/agents may not be listed on the local MLS, so it is a good idea to use other sites (zillow.com, trulia.com, etc...).
You might find that the properties in your price range generally do not include something from your list, so you can remove it from your list or decide not to purchase till you can buy a more expensive property. You may also find items listed that you had not thought to put on your list. Searching the MLS, and other real estate listing sites, on your own is going to get you familiar with the pricing and detail sheets that you will expect to see later when you are actually visiting prospective homes.
Make a list of homes that you think you would like to see and send them over to your real estate agent. Also, be sure to give your agent a copy of your list so they know not to show you properties that do not meet your criteria. You agent can send you lists of properties that you may not have access to, and can also set you up to receive notifications when a property that meets your criteria comes on the market.
Getting pre-approved
You can actually do this step after you decide what your price range is, and while you are making your list. It will take some time, so be ready for a slight delay and have all of your documents ready to be scrutinized. It is a good idea to select your loan officer independently of your real estate agent. This is a matter of separation and control. When you meet with your real estate agent for the first time to look at properties, you want to know what you are pre-approved for in advance, and know what you can afford (these numbers are not synonymous). On Bowen Accountings 'Endorsements' page you will see that Kevin Gonsalves is the person that we recommend. If you tell him that you were referred by use you will get a free appraisal.
Pre-approval is a process where you provide all of the pertinent information to a loan officer so they can find out how much money banks and financiers are willing to loan you. You will fill out an application, provide a few months bank statements and check stubs, and two years worth of tax returns. You will have to sign a lot of documents and disclosures, and in a few days your loan officer will tell you how much money you have been pre-approved to borrow. This number is only important if it is lower than the amount of money you have already determined you can afford.
Loan officers and real estate agents do not know anything about your personal finances accept what you tell them. In general, they are not interested in a full picture of your financial and personal position. You can trust them to process your paperwork accurately, but not to counsel you on your personal budget. You have to know your finances and be able to make a decision about what you can afford on your own. Generally, you will be pre-approved for a loan that will be much more than you can afford in your personal budget. This is because the banks use a formula that will allow your mortgage to be a much higher percentage of your gross pay than you would choose for yourself. Generally, you do not want your mortgage to be more than 25% of your take home pay. It is not abnormal for you to be pre-approved 25%-60% more than what your personal budget should allow.
I cannot stress enough how important it is to make the decision about what loan payment you are comfortable with on your own. When you are making this decision you need to consider that the loan payment (principle and interest) is only one part of the equation as to what your monthly payment will be. If you ask your loan officer for a good faith estimate based on a specific purchase price with a certain amount of money down, they can give you pretty exact numbers. Then make sure those numbers work with your personal budget.
Now that you are pre-approved lets look at some properties.
Let's look at some houses
Most people start the real estate purchasing process on this step. They know someone who knows a real estate agent, they call them up, and 3 hours later they are standing in a property visualizing whether they want to spend the rest of their life there. The steps that lead up to this section are very important and should not be ignored.
When you speak with your agent on the phone or via email you will have told them what your price range is and what amenities you are looking for. They should show you properties that meet these criteria. Sometimes agents will favor properties that have been listed by their brokerage. You will have seen enough properties on the MLS to tell if this is happening. It does not mean that your agent is crooked, it is just the nature of the business.
While you are looking at houses try to remember that 'The Perfect House' does not exist. Rather, there are many houses that will meet all of your needs. In the long run you will be happier with a house that meets all of your needs than a house that aesthetically makes you happy and does not meet all of your needs. A major problem that has to be overcome in the house buying process is that of logic over feeling. Your feelings about a property are to be considered in the process, but they are not first on the list. You should probably look at 5 to 10 properties, even if the first one is amazing. Looking at several properties will help confirm or deny, which one was the best. This process of looking at properties may take several weeks or months. Sometimes you see the first one and love it, and that is fine, but you should still look at other properties that you have appointments for.
It is generally a bad idea to go to open houses without your agent. If you do, and you like the house you will be solicited by the listing agent and you want to avoid a double ender whenever possible. The listing agent is the agent that represents the seller of the house, and a double ender is when the listing agent also represents you as the buyer. These deals are very sweet for the agent, but generally not so great for the buyer or seller. Conflicts of interest are inherent in these types of deals, but they exist and you want to avoid them if you can. Generally, when you are looking at property you should be looking with the agent that you have selected and trust. You will have signed an agency agreement with them which means that they are contractually obligated to act in your best interest.
Take a paper and pen with you. Take a copy of your check list. Make notes about each property you look at. Did it meet your list of needs? Is it big enough? Do you like the layout? Does it get enough natural light? Will you have to make minor or major repairs? Does it have updated appliances? It is important to make extensive notes. If you are buying with a spouse, discuss each property in the car while you are on your way to the next property. If you are in the car with your agent it is a good idea to have conversations when they are not around as well. Your agent will give you great details and advice, but in the end it is your decision. After you have selected a property that you think you would like to purchase, rank the other properties that you have seen as well because you may not get the property you picked and you may have to take the next one down.
Do not compromise because you will be living in this property, and have a lot of your finances tied up in the investment. At the same time, be logical and reasonable. Cosmetics, colors, and a lot of things can be changed latter. What is really going to matter to you in 5 years is if the hot water heater refilled fast enough for everyone in the family to take a shower in the morning, and if there is a enough counter space in the kitchen.
Let your agent talk. They know a lot about the property, and have likely seen thousands of properties. A good agent will point out all the things that may cause a problem, and may even give their opinion as to whether they think the house is right for you. They know a lot of terminology, and will probably know a little about the neighborhood and school district as well. You may want to talk to a couple of neighbors, though most people do not usually do this. Good neighbors are a great blessing and bad neighbors can make a great house worthless. Getting off on the right foot and getting some insider information can be very useful.
More research is required after you have looked at properties. Take your top three and then look at the MLS to see what pricing seems reasonable. It may be priced too high for the market (in your opinion). Look up the property taxes on the county's website (if possible). Look at what school district it is in. Google the name of the neighborhood and see if there are any good or troubling news stories about it. After you have more information your rankings of the properties might change. Call or email your agent with other questions you might have.
Throughout this process remember that you are a will-buy buyer, not a must-buy buyer. You don't have to buy anything. If you are looking around and the details make you unhappy, keep looking or just stop. You agent will be there waiting if you decide to wait 3 to 6 months.
Note: It is usually preferable to buy a turn-key property. This means that it is ready to move into and live in. It is usually a bad idea to pick a house you like and expect to renovate it as soon as you move in, or have to do a lot of work before you move in. Some do-it yourselfers like this kind of project, but for the average buyer it is not a good idea.
Now you have looked at several properties, made detailed notes, spoken with your significant other, and made a decision about which house you want to make an offer on. You are not out of the woods yet. You are not choosing which house to buy, but which house to enter into negotiations on.
Make an offer
You have made a selection. In a buyers' market properties don't generally move very fast, but you still have to be mindful of your timing. Even though the house buying process is very long, the timing and details of an offer can make or break the deal. Some properties will only be listed for a certain amount of time, and then the highest offer is taken. Your agent will let you know if you are in a time crunch or not.
Tell your agent which property you want to make an offer on and what you think an appropriate price is. Remember that most listing prices are high to give the sellers wiggle room to negotiate. If you have already expressed interest in a property your agent may have already spoken to the listing agent to feel them out. This is what your agent is the best at. It is what real estate purchases are made of. Remember, you are only going to buy the right house, in the right neighborhood, with the right amenities, at the right price. You are a will-buy buyer. You ability to walk away from a deal is your power.
Your agent will write up an offer, discuss the details with you and have you sign it. This is a very complicated process with a lot of different aspects. The offer that you are making is a contract. If you make it, and the seller agrees and signs it, the deal is essentially done, and you just have to wait for escrow to be completed. This offer is very important, and your agent should go through it in detail with you. Your agent should give you their opinion on the price you have selected. Just remember that you are in charge, but that their input is very valuable. Your agent should discuss who is going to pay closing costs, generally, you want to include in the offer that you want the seller to pay them or at least a percentage depending on what kind of market it is. Your agent will ask you if you want to keep anything you have seen at the property. Generally, you will keep anything that is nailed down or in the ground. Free standing plants and furniture are usually negotiable.
Your agent is very important in this process, and making offers is the most important function that they perform for you. While you generally should not put the fate of your budget in their hands, you really have to trust them in the process of writing up and presenting your offer. If during this process you feel like you cannot trust them for some reason. It is not too late to get another one. This is their job, and how they earn their commission. They should be very good at it, represent you like you are their children, go over all of the details and different ways you can write the offer, write a concise and complete offer, and get you the best deal possible.
Once the offer is written your agent will have you sign it, write a check as a good faith deposit, then send it to the listing agent, who is supposed to present it to the sellers. Generally, the sellers have three days to accept your offer. Even if the three days has passed, they can still accept it, but it will not be valid unless you agree to the terms again. If the owners like parts of your offer but not other parts, they will make a counter-offer. When it is received your agent will go over the terms of the counter and you will have to make a decision. You will be held to the same three day deadline with the same rules in reverse. The deadline can be changed, but three days is pretty standard.
Remember, that you must always be willing to walk away. Even if you have put 200 hours of work into selecting a property and making an offer, if you do not like the counter you should either re-counter or walk away. Often times I have seen people who walk away from a deal get called back a month later with an offer to do the original deal again. No matter what type of market it is or how much you love the house, you must be willing to walk away. If you do a bad deal you will likely be paying for your mistakes for the rest of your life.
After you have an accepted offer, or have accepted a counter you will enter into escrow.
Inspection, appraisal and escrow
Escrow is a fancy word that means you have to wait a set period of time (defined in the offer, usually about 30 days) for the title companies and banks to get all the paperwork straight before you can move in. If you have done the proper groundwork by getting pre-approved, and have saved enough money for the down payment and closing costs escrow will generally be pretty easy.
Escrow can fall through for a number of reasons. When escrow falls through it means that the deal is off and unless some problem is corrected either you cannot buy the house, the bank will not finance the house, or the seller is unable to sell the house. There are certain specific clauses written into standard offers that will cancel the escrow; If major problems are found during the inspections, if the house does not appraise for a high enough value, if the buyers cannot secure financing (should not be a problem because you are pre- approved), if the owners cannot provide clear title to the property.
You MUST get an inspection. The bank that is lending you the money generally, will require that you get an inspection. They want to be sure that the property they are lending money on is not going to fall down. Remember that the inspector has been hired by and works for you. When the inspection is scheduled you want to be there. Follow the inspector around and ask a lot of questions. Most inspectors jump at the chance to tell you everything that is wrong with the property. When they issue their final report, read the whole thing. Ask your agent questions about things you do not understand. The inspection should reveal any major or minor problems. Major problems can stop a deal if the sellers do not agree to fix them (generally at their cost, but more negotiation may be required), and minor problems should be noted by you so you can arrange to fix them after you own the property. You can even have some things fixed during escrow.
The bank will almost always require an appraisal, and just like the inspector, they work for you. Even though you will not be the one to call the appraiser, order the appraisal, or the first person the report will be delivered to, they work for you. Arrange to show up when they are scheduled to do the appraisal, ask them about the process, ask them what things they are looking at, ask if they need more information. You will get a report from the appraiser after your bank and agent looks at it. Do not be afraid to tell the appraiser the purchase price. It may not affect their assessment, but it never hurts to tell them. While you can generally pick your own inspector, you cannot pick your appraiser. The property usually needs to appraise for the same or more than you are buying it for. If it does not appraise for enough money you generally have to go back to the negotiating table with the sellers. This is one of the items listed in the original offer that can stop the deal. Even if it is a deal stopper and the sellers will not lower the price to meet the appraisal, you have the option of coming up with more cash to make up the difference. It is either that or walk away. Generally, if it does not appraise for the purchase price, it is not a good idea to pay the difference out of your pocket.
The last deal stopper has to do with the title to the property. The title has to do with who owns the property and who has an interest in the property due to financing placed against it. During escrow a title company, will be researching the title, clearing off old liens and preparing new liens and title for you. If they come across something that cannot be cleared off, like the seller is not the only person listed on the title, an old second mortgage was not cleared off, or the owners had a lien placed against the property due to a lawsuit, the title would be clouded. If the clouded title cannot be fixed, then the deal will stop.
During escrow the title company is going to issue an insurance policy, which will protect you in the event that they failed to discover something that had clouded the title of the property you are buying. Basically, you are paying a one time fee to ensure that no one else comes and takes your property away from you later.
Escrows fall through all the time. This is another reason not to get emotionally invested in a specific property. However, if the inspection, appraisal, and title review goes well then you are just about done. Escrow will generally not close until the day specified in the offer, but that can be changed if there are no problems encountered and everyone agrees to it. You will not be allowed to move into the property until escrow is closed.
There are a few other things you will need to do while you are in escrow. You will need to speak to your insurance broker and have them setup a policy for the property you are buying and have that information delivered to your loan officer. If you did not previously own a home you can get significant insurance savings by using a 'preferred' insurance company and bundling your auto and home insurance together. On Bowen Accounting's 'Endorsements' page you will see that we recommend Einhorn Insurance.
At the end of escrow you will have to sit down at the loan or title company (or both) and sign a lot of documents and disclosures. This process should be taken very seriously. No matter how much time it takes, have them explain all of the documents to you. Review them, ask questions. Once you have signed the documents the deal is complete, so it is important that you know what you are agreeing to. Most of the forms are standard and will only take a short explanation. You will probably only go through this process a few times in your life, and it is important to do it right. Never sign anything you do not understand.
Government and Conventional financing
First you must decide what type of loan you want. In many cases you will not have a choice, but when you do have one, you want to make the right decision. The two basic types of loans are government backed loans and conventional loans. Government backed loans include FHA and VA loans and have a lot of strings and costs attached to them. Conventional loans are loans issued directly by a bank to you with no government interference. Both types of loans operate the same way from your perspective but the costs and other options might be different.
If your loan officer tells you that you only qualify for an FHA loan, this is usually because you do not have good credit, have very little credit history, or do not have enough money to put down on the loan. Your loan officer might tell you that you qualify for either type but an FHA loan will allow you to get into the house with less money down. Just remember that less money down always means you pay more in the long run. Most people don't care, and as long as the monthly payment is manageable, why should they care how much they pay over the life of the loan. Well, when you are making a major life decision like buying a house, you should look at it from a lifetime perspective. In this case you should attempt to get a conventional loan because it will cost you the least over the life of the loan.
Generally, you want to put at least 20% down on your purchase. That is a lot of money! In fact, that down payment is the reason that a lot of people did not buy houses prior to the creation of FHA and VA loans. FHA and VA loans allow people to buy houses with only a few thousand dollars down. The magic 20% number has to do with what is called mortgage insurance. If you qualify for a conventional loan and do not have 20% equity in the property you will be required to pay a monthly fee on top of your mortgage till you get to the 20% mark. That fee is roughly .75% per year of the financed amount. example: if you purchase a 185,000 property and only put 5% down your monthly mortgage insurance will be about $110 per month. You want to avoid paying this, and the only way to do it is to either get a conventional loan with less than 20% down and pay extra on the loan till you get the 20%, or just pay 20% down upfront. If you get an FHA loan you will have to pay the mortgage insurance for the first 5 years of the loan regardless of whether you pay the loan down to below 80%.
Government backed loans have a an extra fee included in the financing that is part of the mortgage insurance. This amount will be charged to you as part of your loan, and you will pay interest on it for the life of the loan. VA, FHA and all government backed loans have a lot of extra requirements attached to them and are more likely to fall out of escrow than a conventional loan. There are a lot of reasons that conventional loans are better than government loans, but your loan officer will generally just do what is easiest based on the amount of money you have to put down. Basically, if you don't' have enough money to get a conventional loan, your loan officer is rarely going to tell you to wait till you have enough money. They are usually going to tell you that you qualify for an government backed loan, which you will pay for dearly.
It is a bad idea to get a loan expecting to refinance in a couple of years. Refinancing is time consuming and expensive so don't accept the advice that it is a responsible game plan.
Locking in your rate is the other key factor you need to understand when approaching financing. Once you are approved to get a loan you can lock in your rate. The interest rate changes daily. Some days it is up and some days it is down. The daily changes usually fluctuate about a 1/4 of a point, and while that does not sound like a lot, it is. Getting the lowest rate is very important. So talk to your loan officer about their expectations as to whether the rates are expected to go up or down in the next few days or weeks. Once you lock in your rate, it is only good for 30 to 45 days, so you do no usually want to lock in till you have an accepted offer. If the escrow takes longer than expected and the rates have changed, you may have to pay a fee to keep the rate you have.
Getting the best rate possible is tied to many factors, such as your credit score, credit history, amount down, your loan term, and the points you pay. When dealing with a personal home purchase you generally choose a 30 years (360 month) or 15 year (180 month) mortgage. Choosing the 15 year mortgage will get you a better rate. Bowen Accounting recommends that home buyers get a 15 year loan with 20% down to minimize the lifetime cost of the loan. Your rate is also affected by special deals that the banks make with the loan brokers. If the broker gives you a slightly higher rate, then the bank pays them a fee after the loan is closed. You have the option of paying the fee to this broker directly to get the lowest rate. This is called paying or buying points. It is generally a good idea to pay your points. It will save you a lot of money in the long run. The scenario I just described is very troubling and seems to be fraught with conflicts of interest. The loan broker is working for you but also working for the bank. They generally should not care if you pay them or if the bank pays them, but be very wary if the loan officer does not offer you the option to pay your points.
Welcome home
Congratulations! You are a home owner. You have bought the right to enjoy your property. You do actually 'own' the property, but there is a lien against it for the amount of money that you have borrowed to purchase it. You will usually get one month where you do not have to pay your mortgage while it is being setup with the bank. Also, your loan will likely be sold to another company in the next 6 to 12 months. So even though you are paying so and so bank now, that will probably change to one of the big banks.
Now it is time to consider how you are going to make the place exactly the way you want it. You have been responsible thus far, do not change the game plan now. Look at the list you made while talking to the inspector, add to it all of the things you would like to change, and then set a budget for the amount of money these repairs and changes should cost. Save up the money and then do it. I have seen a lot of people buy a new house, and then in the first year spend so much on repairs and remodeling that they are forced to use credit. With some good planning up front and throughout the process you should be able to make the list and the budget prior to the close of escrow, and adjust your savings accordingly. Take the time to avoid using credit cards or home equity loans to do repairs. In the end those items will end up costing you a lot more than you had originally planned to spend.
Last but not least, let talk about how long you would like to have a mortgage. If you are interested in paying your mortgage off early please take a look at our amortization schedule creator on our 'Tools' page. This will show you how much time and money you can save by making extra payments. Paying a little extra money every month can shave years off of your mortgage, and that translates into a lot of lifetime savings on finance charges.
Who can you trust?
Throughout this article I have stated that you should 'get good advice' from 'people you trust'. I say this with the caveat that you should know who to trust. Real estate agents and loan officers/brokers get paid a commission on your transaction. Usually, their entire income is based on helping people complete real estate purchases so that they can be paid. While many of them have integrity and want to help you through the process you have to ask yourself how much you can trust their opinions on sensitive matters. They will be very useful throughout the process in giving you factual information like; what types of loans exist, understanding your disclosures, how to get better rates, giving factual information about the properties you view, writing offers, and walking you through the process of the transaction. However, they will be less likely to be helpful in deciding what your price rage should be, and if this is the right time for you personally to by a home.
I have met a lot of real estate agents and loan officers/brokers, most of which have been very smart people with a lot of integrity. You must always be mindful that their end goal is to get you to buy real estate, which will earn them a commission. This is a problem that is inherent in buying property. It is important to trust your loan officer/broker and your real estate agent with the right things. They are there to help you complete the transaction, but you must be informed enough to actually make the decisions about how much to spend, what you want, how much your payment should be, and what terms are acceptable to you.
Any good loan officer or real estate agent will guide you through the process no matter what your knowledge level is. They will generally, help you answer questions, and really good ones will tell you what questions you are not asking. The process of buying a house responsibly will require a little study and a lot of diligence on your part. Ask any question, review all documents for errors, read all of the documents you are signing, ask for more clarification on things you do not understand. If it is too overwhelming to you ask your lawyer or CPA to represent you in the transaction. For a nominal flat fee most professionals will do this for you.