Life Events Guides - Buying a Home

Turtles and snails are born with their homes on their backs. You, however, are not so lucky. Unless you plan to live in a cardboard box or can talk someone into letting you live with them for the rest of your life, you will probably need to either buy or rent housing.

Step 1: To Own or Not to Own


Home ownership isn't for everyone. It's definitely a long-term commitment. The prices of homes increase over the years, but usually at a slow rate. With all the financing, closing costs and other expenses associated with owning a home, you'll probably lose money if you sell in less than five years.

You also have to think about the upkeep of a home. Everything from cutting the grass to putting on a new roof is your responsibility. The costs can really add up. Then add taxes, water and sewer bills and other expenses and you can get into some sizable payments.

But when you take full financial and maintenance responsibility for a home, it's yours to do what you please. Paint the walls purple. Add a planetarium. Put in a fireman's pole. You're in charge.

There are also substantial financial advantages to owning a home. The part of your monthly payment that goes towards the principal is all equity and the part that goes towards interest is tax deductible. Compare that with paying rent, which is neither an investment nor a tax write-off.

As your equity increases with time (and payments) it will be a source of financial stability for you, giving you collateral for a loan or producing a large sum of money if you sell.

And if you decide to sell your home, as long as you have lived in it for two of the past five years, you won't have to pay tax on gains of up to $250,000. The limit doubles to $500,000 if you're married and both have lived in the home for two years.

Step 2: Prepare to Qualify


If you think owning a home is for you, start planning for it right now. You need to get your finances in order, save for a down payment and mentally prepare for the responsibility of owning a home.

Down payment
The down payment is usually expressed as a percentage of the purchase price of the house. A $10,000 down payment on a $100,000 house would be a 10% down payment.

How much do you need to save for a down payment? It depends on a lot of variables. Different banks require different amounts, between 3% and 10% depending on the program, and often give better interest rates for down payments larger than 10%. Some programs even let you put 0% down.

Check with your local city or county government for special programs that may offer down payment assistance or reduced down payment requirements. To qualify, your household income will need to be lower than the program's income requirements, or you'll need to buy a home in an area targeted for redevelopment.

No matter how much you need for a down payment, save more. There are a lot of fees included with buying a house and you'll be in much better financial shape when you move in if you've given yourself a little padding.

Unless you're some kind of a financial magician, don't try to pull this down payment out of your finances all at once. Decide how much you want to spend on a house and how much you will need to save for a down payment. Saving a reasonable amount every month, you can compute a target date of when you will have your down payment and when to start your house shopping.

If you're going to be saving money, you might as well have it work for you. Check into short term Certificates of Deposit (CDs) and Money Market Accounts to earn some interest while you're adding more to savings. It won't be a lot of interest but every little bit helps.

PMI - Private Mortgage Insurance
If you put less than 20% down on your home, you'll be charged PMI, Private Mortgage Insurance, as part of your monthly house payment. This insurance protects the lender from loss if you default on your loan and the lender has to sell your home to recover its money.

Once your loan principal drops to 80% of the total value of your home, either through paying loan principal or increasing the value of your home, you will no longer have to pay PMI.

PMI can be a very substantial cost, as much as 20% of your monthly payment, so get rid of it as soon as you can.

Check your credit report
Becoming familiar with your credit report is an important part of financial fitness at all stages in life. It is especially important when you're ready to buy a house. The better your credit rating, the better interest rate you're likely to get. So while you're taking the time to save money for a down payment, take some time to get your credit report in order.

Your first step is to get a copy of your credit report as soon as possible. Contact one of the three major credit bureaus:

• Experian - 1-888-397-3742 - www.experian.com
• Trans Union - 1-800-888-4213 - www.transunion.com
• Equifax - 1-800-997-2493 - www.equifax.com

For more information on what is contained in your credit report, see our credit cards section.

If there are any errors on your credit report, contact the credit agency immediately. For other problems, there are ways to fix them, but it will take some time and effort. Don't trust anyone who claims to be able to fix your credit instantly or erase your credit history. It is illegal to falsify your credit rating. Here are ways to legally fix your credit.

If you have poor debt ratios, meaning too much debt compared to your income, start paying down your debt. That's not an easy thing to do, but it's crucial in repairing your credit and getting favorable interest rates.

If you have insufficient credit history, you're in a good position to build good credit. If you can, get a credit card and be sure not to carry a balance on it. If you don't qualify for a credit card, apply for a department store charge card. Be sure to pay it off every month because those cards can have extraordinarily high interest rates.

Whenever you apply for credit, the inquiry by the potential creditor shows up on your credit history. If you have too many inquiries on your credit history, you need to play the waiting game. Stop applying for credit. These inquiries will become less relevant as time passes and, as long as you don't continue to apply for more credit, this will cease to be a problem fairly quickly.

If you just can't wait to fix your credit and you need to move forward with buying a house, you don't have to live with your mistakes for the next 30 years. Three things determine mortgage interest rates: your credit history, the amount of your down payment and your current income. If your credit rating isn't as positive as you'd like it to be (or as the banks would like it to be, really) try to increase your down payment and income to make up for it. Sure, easier said than done.

If worse comes to worse, you may have to accept a higher interest rate to start with. If you continue to improve your credit rating (which you will do, right?), you may qualify for a lower interest rate in a few years and then you can refinance your mortgage.

Document Soup
When it's time to qualify for a mortgage, you'll need to document a lot of your financial life. That means digging through your files to retrieve documents you probably thought you'd never need again. Your document soup ingredients will probably include the following:

• The past two or three years of tax returns
• Paychecks or pay stubs for the past month that include your social security number
• W-2 forms for the past two to three years
• Recent credit card statements
• Payment records for all other loans
• Bank account statements for the past three months
• Brokerage account statements for the past three months
• Retirement account statement
• Your car title(s)
• Business tax filings if you are self-employed
• If you're selling a house, the sales contract
• Any bankruptcy documents
• Life insurance policies
• Documentation of any other sources of income, including a second job, anticipated overtime, sales commissions, bonuses, interest and dividend income, Social Security payments, alimony, child support, etc.
• If your employer is offering relocation assistance, a documented agreement
• A complete list of creditors, including minimum monthly payments and balances
• Cancelled checks from recent rent payment

Get pre-qualified
Negotiating for a house is a lot easier when you have a check for the full amount in your back pocket. That's the idea behind pre-qualifying for a mortgage. Based on your financial strength, a lender will give you a firm commitment on a loan for a certain amount even though you haven't yet identified a specific property.

You can shop around for houses with confidence, knowing that if you find one within the amount of your pre-approval, you will get financing if you decide to buy it. And when it comes time for negotiations, you're in a much better position because the seller knows you can get the financing.

Step 3: So Many Mortgages!


If you're going to be responsible for paying a mortgage for the next 30 years, you should know exactly what a mortgage is. A mortgage has three basic parts: a down payment, monthly payments and fees. We've already discussed the down payment. The monthly payment is the amount needed to pay off the mortgage over the length of the loan and includes a payment on the principal of the loan as well as interest. The fees are all the costs you have to pay up front to get the loan.

Keeping in mind those basic concepts, we'll look at some of the mortgage variations that are available:

Fixed Rate
A fixed rate mortgage requires a monthly payment that is the same amount throughout the term of the loan. When you sign the loan papers you agree on an interest rate and that rate never changes. This is the best type of loan if interest rates are low when you get a mortgage.

Adjustable Rate
Be careful if you're considering taking an adjustable rate mortgage. An adjustable rate mortgage allows the interest rate on your loan to vary with prevailing interest rates. If rates go up, so will your mortgage rate and monthly payment. If rates increase a lot, you could be in big trouble. If rates go down, your mortgage rate will drop and so will your monthly payment. A good strategy may be to stick with a fixed rate loan to safeguard against raising interest rates. And if rates drop, refinance your mortgage to take advantage of lower rates.

Pledged Asset Mortgages
In a pledged asset mortgage, you can use assets such as stocks, bonds, other property, etc. as collateral on your loan. This eliminates the need for a down payment and also avoids PMI (Private Mortgage Insurance).

Mortgage Help Programs
There are programs that will assist you in obtaining and financing a mortgage. The number and variety of these programs makes it impossible to list and discuss them all here. Check with your bank, city development office or a knowledgeable real estate agent.

Veterans Administration (VA) Loans
The Veterans Administration offers loan benefits to veterans who served in the armed forces on active duty during times of conflict, such as Korea, Vietnam, Desert Storm and Afghanistan, as long as they were not discharged dishonorably. The first step to obtain a VA loan is to obtain a certificate of eligibility, then submit it with your most recent discharge or separation papers to a VA eligibility center.

VA loans offer some very helpful benefits including:

• 100% financing - That means no down payment
• An origination fee of no more than 1% of the loan
• Low interest rates
• A loan guarantee from the VA

Federal Housing Administration (FHA) Loans
The FHA was created to aid people in obtaining affordable housing. FHA loans are actually made by a lending institution, such as a bank, but the federal government insures the loan. This is often the least expensive loan that non-veterans can get.

To qualify for an FHA loan, you must be a permanent resident of the United States (although not necessarily a citizen), you must live in the home you purchase with the loan and the dollar amount of the loan must fall below a maximum set by the government. This amount is raised for those purchasing a home in designated "high cost" areas of the country. You also have to be "credit worthy," meaning you need to have your credit report in order. You know how to do that, right?

The benefits of an FHA loan include:

• A choice of many different loan programs
• Low down payment (as low as 5%)
• Low closing costs
• A higher qualifying debt ratio than other loans, meaning you can have more debt or less income

Borrowing against your 401(k) plan
If you contribute to a 401(k) plan at work, you might be able to borrow money from your plan to buy your house. You can borrow up to half of the money you have accumulated (up to $50,000). Even though it is your money you will have to pay it back as you would any other loan or you will be penalized. Usually it's paid back through monthly deductions from your paycheck.

This strategy does have its drawbacks, however. Borrowing may slow the growth of your 401(k) investment. Also, you may decide to decrease the amount of your monthly 401(k) contributions to compensate for the repayment deductions. This will keep the amount of your check the same but will also hinder the growth of your retirement savings.

If you leave your job, any outstanding 401(k) loan balance will be considered a withdrawal and you will be assessed a 10% penalty if you are under 59 ½ and you will also be taxed on that money.

Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac are two federal agencies that can assist you in finding approved lenders. They do not, however, make loans themselves.

Foreclosure Homes
A foreclosed home is one that has been "repossessed" by the lender. A lender will usually repossess a home after several attempts to collect money from a borrower in default of a loan. These homes are then resold quickly and sometimes for much less than market value. If you can find one of these homes, chances are you can get a great deal.

For Sale By Owner (FSBO)
You may be in luck if a house you are interested in is being sold by the owner, without the assistance of a real estate agent. Since the seller does not have to pay a standard agent fee, as much as 8% of the selling price, the seller can actually sell the house for less and make more.

It is harder to find a FSBO home since they aren't listed with real estate agencies. But you can find them in the newspaper or simply by driving down the street looking for a "For Sale" sign. You may want to hire an attorney to help you through the paperwork aspect of the sale, since no real estate agent is involved to guide you.

Step 4: Meeting the Mortgage Broker


A mortgage broker is like a mall for mortgage loans. Mortgage brokers have a great selection of loan programs and they can help you sift through the many varieties to find exactly the right one for you. But, just as in any profession, there are good brokers and bad ones. Research interest rates carefully before you visit a mortgage broker to make sure you're getting a good deal.

A mortgage broker makes money by adding a small commission to each loan. The broker will issue the loan at a slightly higher interest rate, then sell the mortgage to another bank for a profit. You may still get a better rate by using a mortgage broker, since the broker gets rate sheets from all the lenders in your geographical area, and can choose the lowest rates.

Step 5: The Right House for You


When deciding what type of home is right for you, it's best to consider both your current and future needs. Will your family be growing? Are you going to need an office at home? Are you going to be able to keep up with the maintenance? You don't want to buy a home and then find out three years later that you have outgrown it.

Types of properties

Homes
If you like privacy and independence, buying a single-family residence might be the right choice for you. Decide whether you want a new home, a previously-owned home or a fixer-upper. If you buy a newly built home, be sure to figure in the cost of upgrades and landscaping, which aren't usually included in the base price. You might be better off with a previously owned home in good repair. A fixer-upper, on the other hand, may allow you to purchase more home for your money. Your house will quickly increase in value as you put work into it - as long as you're willing to invest the time and money required to do the job right.

Condominiums
A condominium is halfway between an apartment and a house. You still own the building and the property, but you pay maintenance fees every month that pay for amenities such as landscaping and general building maintenance. You're still responsible for interior repairs and maintenance. Be sure to read the homeowners agreement before you decide to buy a condominium. These documents dictate the policies and procedures of living in the community and can include anything from how many and what types of vehicles can be parked in your driveway to how many pets you can own.

Co-ops
Co-ops are more frequent in larger cities and they're becoming increasingly popular. In a co-op, you're a renter, but you're also part of a group that serves as a landlord. You buy into the association.

Home size does matter
The drawbacks to a small house are obvious - not enough space. But there are drawbacks to a large home as well. Upkeep is considerably more work with a large home. The spaciousness that once brought you such happiness may lead to the frustration of never-ending cleaning and maintenance. Consider how much space you need, how many rooms you need and how much furniture you want to have. Limit your home size to meet these requirements unless you're willing to put in a lot of time or hire maintenance and cleaning professionals.

Neighborhood
Urban, suburban, rural, young, old, high-traffic, low-traffic. You have many different options when it comes to choosing a neighborhood - too many to cover here. But here are some neighborhood variables to think about.

How long are you willing to commute? This will give you a geographical boundary to look within.

Do you have children? If so, investigate the school system that your children will be attending carefully. See what learning opportunities are available to them. Even if you don't have kids or your children attend private school, the quality of the schools in your community will have an impact on the resale value of your home.

Do you like high-energy environments or peace and quiet? When some people go home, they want to leave the world behind and relax in the peace and quiet of their personal retreat. Others would be bored to death by that environment and need more interaction and energy.

What aspects of a community are important to you? Envision the perfect neighborhood in your head. Ask yourself what makes it perfect? Then seek out that neighborhood.

When looking at homes, try to get a feel for the neighborhood to see if it's right for you. Talk to the neighbors and ask them what it's like. Be nosy. After all, you might live there for quite some time.

Step 6: Real Estate Agents - For You or Against You?


Real estate agents can be valuable resources when looking for a home. About 85% of all homes sold are listed with a real estate agent. But it's important to know whose side they're on.

A seller's agent
Someone selling a home usually does so through a real estate agent. An agent contracted by the seller is known as a seller's agent, meaning the agent is working for the seller. Real estate agents are obligated to do whatever they can to get the best deal for their clients. You are not their client. When they show you a home, they are obligated to tell the seller anything you say. So if you tell the agent, "I'm going to offer $90,000 for this home but I'm willing to pay $100,000," the seller will soon know that you're willing to pay $100,000.

A buyer's agent
You can hire your own real estate agent to help you through the home buying process. Since you engaged them, they are obligated to work for you, to get the best deal on a home for you. And even though you won't have to pay your real estate agent anything, they still work for you, not the seller.

How agents make money
Real estate agents make a commission on the homes the sell, usually around 6-7% of the selling price. For example, an agent that sells a $100,000 home, would receive a $6,000-$7,000 commission. If the buyer also has an agent, the buyer's agent and seller's agent split the commission. In the earlier example, both agents would get $3,000-$3,500 in commission. That commission is paid out of the money the seller receives from the sale. Even though the buyer's agent works exclusively for the buyer, the buyer doesn't have to pay them one cent.

Step 7: Closing Time


It's time for the end game. All the financing, house hunting and negotiating comes together into one final step - the closing. This can be a confusing and anxious time, especially if you're not familiar with the process. If you're pre-approved and you've saved enough money to handle the extra costs, you've done everything you can do, so try to relax as you go through the closing process.

The contract
Once you've found a home, made an offer and the seller has accepted your offer, the seller or their agent draws up a contract specifying the terms and a closing date. When you sign this contract, you have officially agreed to purchase the home. Have a real estate attorney, or the real estate agent representing you, look over your contract. There are many small details that could make the difference between a good deal and a bad deal. An experienced professional can help ensure you're getting a good deal.

Good faith deposit
When you make an offer on a house, you'll have to put down a good-faith deposit. This is to discourage you from putting a bid in on a lot of different houses with the intention of buying only one. This good faith deposit is usually several thousand dollars. If the deal falls through, you will get this money back unless you failed to perform as you contracted. If the deal goes through, the deposit goes toward your down payment and your share of closing costs.

Contingencies
The contract almost always specifies contingencies. That means the contract is only valid if certain requirements are met. For example, if your financing doesn't come through, you still aren't required to purchase the home. Contingencies also cover home inspection (defined later), termite inspection, title search and several other possibilities that would nullify the deal.

Inspection
Don't skip the home inspection. It is one of the most important parts of the home buying process. There are many big problems with a home that can't be detected with an untrained eye. A home inspector will go through the entire home to make sure there are no problems that may affect the value of the home or cause major problems in the future. If the home inspector finds any major problems not disclosed before you signed the sales contract, you can use the inspection contingency to walk away from the deal, or to renegotiate the price.

Requirement for closing
Be ready for closing so the process can move quickly. A settlement agent will handle most of the process. This may be your lawyer, a mortgage broker or an escrow company. You will be given an estimate of the closing costs and fees up front.

Before you can close on a house, you need the following:

• Title Search - This ensures the seller is clearly the owner of the house and there are no liens against the property.
• Title Insurance - If there is a problem with ownership, including fraud and forgery, the costs of dealing with those problems will be covered.
• Survey - In some locales a surveyor will be employed to make sure the dimensions of the lot are accurate.
• Homeowner's Insurance - Since the home is the collateral for the loan, a lender will not give you a loan unless you have fire and casualty insurance. If you carry auto insurance, ask that agent for rates on home insurance. Insurance companies often give you better rates if you have more than one type of policy with them.

Closing costs
The cost of closing a home can be thousands of dollars. You should have some money set aside for these costs. But before you sign the contract, see if you can negotiate to have the seller pay for more of the closing costs. They are receiving a large amount of cash and will more easily be able to afford a few thousand dollars in closing costs. You may not be able to negotiate more than is customary in your area, but it doesn't hurt to try.

Step 8: Home Sweet Home Equity


One of the biggest advantages of home ownership is the equity you build in your home. The faster you pay your mortgage and build this equity, the better financial shape you'll be in. Equity can be a powerful tool to manage your finances.

Paying off your mortgage
During the first few years you make payments on your mortgage, most of your payment goes toward interest and not very much goes toward paying down the principal. The more you owe on the mortgage, the more interest you'll pay. If you increase the amount you pay, more of the principal will be paid and less interest will be charged. You could retire your mortgage several years ahead of schedule if you just make one extra mortgage payment per year.

Home equity credit lines
A home equity line of credit is a form of revolving credit in which your home serves as collateral. With a home equity line, you will be approved for a specific amount of credit that represents the maximum amount you can borrow. You pay a variable interest rate and have a minimum payment due each month based on the amount of the credit line you have used.

Once approved for the home equity plan, you may borrow up to your credit limit at any time. You can draw on your line of credit by writing checks against it. You may be charged for a property appraisal, application fee and possibly other costs when obtaining a home equity credit line.

When you sell your home, you will be required to pay off your home equity line in full. If you are likely to sell your house in the near future, consider whether it makes sense to pay the up-front costs of setting up an equity credit line. Also keep in mind that leasing your home may be prohibited under the terms of your home equity agreement.

Home equity loans
Similar to a home equity line of credit, a home equity loan is backed by your home as collateral. Since lenders consider these loans to be more secure than unsecured debt such as credit cards, home equity loans offer more attractive interest rates than unsecured loans

A home equity loan is best utilized for a specific expense, such as paying college expenses, which you will be able to pay off over a shorter time period than your primary mortgage. If you're carrying a great amount of high-interest, unsecured debt, transferring it to a home equity loan can help you pay it off sooner, as well as provide tax advantages. The interest on up to $100,000 of a home equity credit line or home equity loan is tax-deductible.

Just remember that you've used your home as collateral. If you can't keep up with the payments, you may lose your home. The costs of a home equity loan are similar to a home equity line of credit.

Step 9: Fun with Refinancing


If interest rates have dropped since you took out your mortgage, you may want to consider refinancing your home - that is, getting a new mortgage with a better interest rate to replace the old one. As a general rule, if you can cut your rate by 2% or more, it is worth investigating. Depending on how much the new bank charges in closing costs and how long you plan to stay in your home, you could end up saving a significant amount of money this way. Refinancing may slash $100 to $300 or more off your monthly payment. Interest on the entire amount borrowed is tax-deductible, unless you increase the amount of the loan by more than $100,000. Consult your tax advisor to discuss the particulars of your situation.

You do not have to refinance with the same mortgage broker that you originally used. It's wise to try them first, as they may offer you an attractive package in order to keep your business, but shop around and compare rates as you did the first time around.

Costs vs. Benefits
To make sure you're going to save money by refinancing, take all the costs into consideration.

Closing Costs
Remember these? You will have to pay them again when you refinance. Depending on how high they are, they may overshadow the savings you will get from your new interest rate and it may not be worth it to refinance.

Pre-payment Penalties
Your current mortgage may have a significant penalty for pre-payment that could overshadow the savings that result from refinancing. Check your mortgage papers. If a pre-payment penalty exists, it will be in your agreement.