Making the Buying Decision
Assuming you plan to own your home for several years and can afford the payments, you'll likely be better off owning versus renting. Here are some points to consider:
|You might receive a state income tax renter's credit, but nothing more.
|Payments towards interest, taxes and points are tax deductible.
|None, unless your rent payment is lower than the cost of owning a home, and you invest the difference in a CD, stock or mutual funds.
|Even if your home value remains constant, your loan balance should decrease. This results in increasing equity your property.
|Most leases are less than 1 year in duration. It's easy to move at the end of a lease. Also, your landlord usually won't have to renew your lease, and you could be forced to move out at the end of your lease.
|Selling a house can take time and may cost 6% to 8% of the sales price. If you have to sell quickly, it could cost even more. If you don't have to sell, yet must move, consider renting your house. You'll probably receive additional benefits by depreciating your home for income tax purposes. Remember, buying a home makes sense if you plan to hold it for several years.
|Your rent payments generally increase every year. Rent increases are often tied to inflation.
|Mortgage payments on a fixed-rate loan will not change. Adjustable-rate loan payments vary according to the terms of the note and economic conditions.
|Renting makes sense if your time frame is less than 2 to 3 years.
|The longer you plan to own your home, the more sense it makes to buy. Some buyers with plans to move relatively soon may buy if they expect the market to appreciate significantly.
Additional points to consider in your decision include:
- What are my reasons of owning a home?
Do you need a bigger home? Do you need a better neighborhood? Are you speculating that prices will increase? Whatever your reasons, it helps to write them down. Seeing your reasons on paper helps create objectivity, and will help you follow through in the event you get the "jitters" later on.
- Do I have enough cash for the down payment?
While this is certainly an important consideration, many lenders today offer zero-down and low down payment loans. However, you may still have to come up with cash for closing costs and moving expenses.
- Can I afford to make house payments in addition to making payments on my other debts?
This is probably the single, most important question to answer accurately. Spend adequate time creating a realistic budget. If you fall too far behind in your mortgage payments or property taxes, you'll probably lose your home and any equity you might have had in it. Generally, you should spend less than a third of your gross income on your total housing expense, including principal, interest, taxes and insurance.
An important step in purchasing is home is determining how much of a down payment you'll make, and from what sources the down payment and other costs will come. For accurate answers to these questions, a current inventory of your assets is crucial.
Begin by gathering all financial statements for all your assets. You may not plan to liquidate all assets, but a complete accounting is important. The assets you keep can serve as collateral for a loan and as reserves which may be required by your lender. If you're going to receive a gift from a relative, try to obtain a letter stating the amount of the gift.
You may be able to borrower from your 401(k) without any tax penalties. If you liquidate your 401(k) or IRA, there may be tax implications. Consult with your tax advisor before liquidating any assets.
If you own stock you want to keep, consider borrowing against it with a margin loan. Consult with your stock broker regarding this option.
This worksheet may help you inventory your assets.
|Retirement Funds (401K, IRA, etc):
|Gifts from relatives:
|Total Cash Available:
Determine the total cash needed to close:
|Closing costs including points:
(taxes, prepaid interest, insurance, pmi):
|Cost of repairs, if any:
|Total Cash Needed:
Calculating the total cash needed can be challenging, especially if you're doing this for the first time. Consider getting help from a real estate or mortgage professional. They're usually quite generous with assistance and advice in anticipation of helping you with your transaction. Ask your mortgage company to provide a Good Faith Estimate of closing costs--including prepaid expenses.
If you're short on cash, consider asking the seller to pay your closing costs. Discuss this with your Realtor prior to making your offer.
Ideally, you'll want make a 20 percent cash down payment to avoid Private Mortgage Insurance (PMI) and get the best rate. If you are unable to put 20 percent down, there are many programs available. Here are some of them:
- Zero Down Programs There are many zero down payment programs available. If you qualify for a VA loan, you can get a zero down program. Even if you're not a vet, several lenders offer zero down loan programs. Your mortgage broker can help you find the best one for you.
- Low Down Payment Programs There are numerous FHA and conventional programs that allow you to put as little as 2 to 5 percent down.
- Piggy Back Loans By getting a piggy back loan, you can generally avoid paying PMI, even though you are putting less than 20 percent down. The most common piggy back loans are:
- In the case of an 80-10-10, you put down 10 percent and get two loans--a first loan for 80 percent of the purchase price, and a second loan for 10 percent of the purchase price. Even though the second loan rate may be higher than the first loan rate, you generally come out ahead since you don't have to pay PMI.
- Eighty percent first loan, 15 percent second loan, 5 percent down.
- Eighty percent first loan, 20 percent second loan, no cash down.
Take advantage of our Qualification Calculator to begin the process of determining the home value for which you qualify. You'll also need to discuss your particular financial details with a mortgage company. Like most industries, the mortgage industry uses its own jargon. Understanding the terminology of the industry will serve you well in understanding the process of buying and financing your home. Here is some terminology you will need to understand:
- Application: The loan application is a comprehensive document representing the borrowers income, expenses, assets, liabilities and net worth. It can be considered both an Income Statement and Balance Sheet of the borrower. The application helps the lender determine the borrower's credit-worthiness.
- PITI: An acronym for Principal, Interest, Taxes and Insurance. Principal and interest refer to your monthly mortgage payment. Taxes and insurance refer to 1/12 of the annual property taxes and insurance premium. PITI is designed to represent the monthly cost of home ownership (total housing expense ) for qualification purposes. (Total housing expense can include PMI and association dues if applicable.)
- Gross Monthly Income: Gross monthly income is your monthly income before income taxes. You are usually given full credit for your base salary. Overtime, commissions and bonuses are usually averaged over the previous 24 months. If you are self-employed, the income reported on your tax return will usually be averaged over the previous 2 years.
- Front-Debt Ratio (top ratio): Your front debt ratio is your PITI divided by your Gross Monthly Income. This qualifying ratio is used by the lender in making a decision to grant or deny your loan request.
- Back-Debt Ratio (back-end, bottom, total expense, total debt ratio): Your back-debt ratio is PITI + Other Monthly Debt Expenses divided by your Gross Monthly Income. Other monthly debts include auto loans, credit cards, person loans, student loans, etc. Your phone and electric bills are NOT considered part of your debt expenses. This qualifying ratio is used by the lender in making a decision to grant or deny your loan request.
- Loan to Value (LTV): LTV = loan amount divided by the property value.
Here is an example of how the above information is used:
- Monthly base income: $5,000
- PITI: $1,000
- Other monthly debt (credit cards and student loans): $600
- Home purchase price: $100,000
- Down payment: $20,000
With this information, qualifying ratios and the LTV can be calculated:
- Front-debt ratio: $1,000 / $5,000 = .20 or 20%
- Back-debt ratio: $1,600 / $5,000 = .32 or 32%
- LTV: $80,000 / $100,000 = .80 or 80%.
Mortgage companies and lenders like to see qualifying ratios at or below acceptable levels set by the industry. Acceptable qualifying ratios denote a borrower's ability to repay the debt. A low LTV is also desirable. The lower the LTV, the greater the equity the borrower has in the home, and the more secure the lender's investment. As the LTV increases, acceptable qualifying ratios decrease.
Here is a table of LTV and maximum qualifying ratios used in the industry. These ratios are general guidelines only. In practice, lenders make their own decisions based on a number of additional factors such as your credit history, length of employment, etc. Please check with your mortgage company regarding your particular situation.
|At or Below 90%
Tips and Tricks: You may be able to increase your purchasing power by:
- Paying off debt:This would reduce your back-debt ratio. Many lenders do not count the monthly payment on your installment loans if you have fewer than 10 payments left. If you have a car payment with 12 payments left, you may want to consider making additional payments to reduce your total payments left to under 10.
- Making a larger down payment: This reduces your LTV, total housing expense and provides for higher qualifying ratios. If you make a down payment of 20% or more, you won't have to pay PMI.
- Borrowing against your 401(k): You can sometimes increase your purchasing power by using the proceeds of your 401(k) loan to pay down your other debt, or to use it towards the down payment. This can be a little tricky, so please consult with a mortgage professional.
- Obtaining a margin loan: If you own stocks and do not want to sell them, your stockbroker may be able to arrange a margin loan, using your stock as collateral. Since a margin loan has no monthly payments, this generally does not affect your debt ratios. You may use the proceeds towards the down payment or to pay off debt.
As a potential buyer competing for a property, you'll have a better chance of getting your offer accepted by being as prepared as possible. Consider this hierarchy of preparedness:
- 1. Neither pre-qualified nor pre-approved
- 2. Pre-qualified
- 3. Pre-approved
The benefits available at each level can be easily understood when viewed from the seller's perspective. Imagine you're a seller in receipt of multiple offers to purchase your property. A complete stranger (buyer) is asking you to take your property off the market for at least the next two to three weeks while they apply for a loan. As the seller, let's consider the type of buyer you'd prefer to deal with.
- 1. Neither pre-qualified nor pre-approved
- This buyer provides no evidence that they can afford to purchase your property. You may wonder how serious they are since they're not at least pre-qualified.
- 2. Pre-qualified
- This buyer met with a mortgage broker (or lender) and discussed their situation. The buyer informed the broker regarding their income, expenses, assets and liabilities. The broker may also have seen their credit report. The buyer provided you with a letter from the broker stating an opinion of what the buyer can afford.
- 3. Pre-approved
- This buyer provided a broker or lender written evidence of income, expenses, assets, liabilities and credit. All information was verified by a lender. As a result, much of the paperwork for this buyer's loan has been completed. This buyer will probably be able to close quickly. They provided you with a letter (pre-approval certificate) from the lender. You're as certain as possible that this buyer can close.
As a potential buyer, you can see that being pre-approved will give you the best chance of getting your offer accepted. This is critical in a competitive situation.
Start Looking for a Home
You're prepared and ready to purchase a home. Now it's time to go out into the market place and find it. Will you use a real estate agent to help you look, or will you look on your own?
For practically everyone, it's worthwhile to use a real estate agent. The benefits of using an agent are numerous.
Advantages of using a real estate agent
A good agent builds a career by creating repeat customers and earning referrals. To that end, she does everything possible to make your home-buying experience as pleasant as possible. An agent is expert in her market. She knows (or can find) everything you want and need to know about the community.
An agent will:
- Arrange access to homes for you to preview
- Accompany you on your tour of homes
- Research the neighborhood, including market values
- Draft the offer to purchase
- Negotiate with the seller
- Arrange inspections
- Abide by all local, state and federal laws
- Help you obtain financing
- Review all closing documents for correctness
- Follow up after closing to make sure you're move-in is accomplished smoothly
Finding and keeping a good agent
Finding a Real Estate Agent whom you can trust and enjoy working with may require some effort. When you find the right person, stick with them. Give them the same respect and consideration you would expect. When an agent knows that they have your loyalty, they will do their best job for you.