Step 1: Self -Assessment- Step 2: Getting Pre-Approved
- Step 3: Choosing an Agent
- Step 4: Home Shopping
- Step 5: The Initial Walk Through
- Step 6: Making an Offer
- Step 7: Types of Mortgage Loans
- Step 8: The Appraisal Process
- Step 9: The Home Inspection
- Step 10: Final Walk Through
- Step 11: Closing / Settlement
Step 1: Self -Assessment
Starting a home-shopping / home-buying process means answering a lot of questions. Are you ready to buy a home? How much of a mortgage can you afford? Hows your credit? What size house do you need? What area do you prefer to live in? How are your cash reserves?
The more Q&A, research and soul-searching you do in advance, the smoother the process will be later on. Let's look, then, at some key questions you should ask yourself in the self-assessment phase.
What Can You Afford? Before house hunting, determine how much of a mortgage you can comfortably afford. "Comfortably" means you can pay your mortgage each month and still have money for living expenses, savings, and quality-of-life niceties. In other words, you don't want a mortgage payment that forces you to "squeak by" each month.
To determine your mortgage comfort-zone, you need three things: a budget, a price and a mortgage calculator. For the price, just start with the cost of a house you think you might be interested in buying.
At first, don't worry about whether the price is too high - you'll find that out soon enough when you run the numbers.
Next, run the home price through a mortgage calculator at current interest rates and at a 30-year fixes mortgage. (You might choose a different mortgage type later on; but this exercise is just to get a ballpark mortgage payment based on home price, so choose the 30-year fixed option for the sake of simplicity.)
Mortgage calculators can easily be found on the Internet. Just type "mortgage calculator" into any major search engine, and you'll find several.
Do You Have Cash Reserves? Your lender will also want to see that you have funds in the bank. Lenders know that the home-buying process requires cash reserves for the down payment and closing costs. They also prefer to see some stability with your reserves, meaning the money has been in the bank for a couple months or more (as opposed to being loaned to you by a family member the day before you applied for the loan).
Closing costs usually include the appraisal fee, loan fees, attorney's fees, inspection fees, and the cost of a title search. They can easily add up to $5,000 to $7,000 (or up to five percent of the mortgage amount).
Once you've conducted a self-assessment and determined you're ready to move forward, a logical next step would be to get pre-approved by a mortgage lender.
Step 2: Getting Pre-Approved
First off, let's cover the difference between pre-qualification and pre-approval. Many people think these things are the same, but they're not. Pre-qualification is based on a quick review of your finances and credit. Pre-approval looks at everything regarding your finances, debt and credit. Think of pre-qualification as a "quick review" from the lender and pre-approval as a longer, more detailed review.
Here's a more formal definition of pre-approval, taken from the glossary at the end of this guide: Pre-approval: The process of applying for a loan and obtaining approval for a maximum loan amount before having a purchase agreement.
Being pre-approved also shows sellers you're serious about (and capable of) buying their house. This can be a factor in hot markets where the sellers receive multiple offers. For example, if you bid on a home along with three other prospective buyers, but you're the only one who has been pre-approved by a lender, then you stand the greatest chance of having your offer accepted.
The sellers will be more comfortable with you since a lender has said, in essence, "Yes, this person is worthy of a home loan." The buyers without pre-approval, on the other hand, would be "unknown quantities" to the seller.
Pre-approval also helps identify credit problems early on. If you missed something when reviewing your credit during the self-assessment phase (Part 1 of this guide), the pre-approval process will bring it to light.
Step 3: Choosing an Agent
Why Use an Agent? Even with the wealth of information available on the Internet these days, it's a good idea to have an agent. The fees you'll pay an agent are nominal when you consider what all an agent can do for you. Buying a house is a monumental event that can affect you for years to come - an agent can help you make sure it's a positive event. Among other things, a good agent will act as your home-buying expert, tour guide, negotiator, paperwork administrator, and, most importantly, your trusted advisor.
Additional Benefits of Having an Agent
- They can help you understand the different financing options available to you.
- They can likely refer you to a lender who can help pre-qualify you for a loan.
- They almost always have access to the Multiple Listing System (MLS), an electronic listing of homes for sale by other agents.
- They may know of homes for sale in the area that are not yet being marketed.
- They can help you stay on track throughout the buying process, with the many appointments and events the process brings.
- They will handle all the home-buying paperwork... and there's a lot of paperwork.
- They can help you negotiate with sellers.
- They can help you determine the realistic value of homes based on recent sales in the area.
The sellers will be more comfortable with you since a lender has said, in essence, "Yes, this person is worthy of a home loan." The buyers without pre-approval, on the other hand, would be "unknown quantities" to the seller.
Pre-approval also helps identify credit problems early on. If you missed something when reviewing your credit during the self-assessment phase (Part 1 of this guide), the pre-approval process will bring it to light.
Step 4: Home Shopping
Location
Your first step here is to figure out what city (or town) and neighborhood you want to live in. Regardless of whether or not you have school-age children, try to buy in a district with good schools. If you sell the home in the future, a strong school system will be a major advantage in attracting buyers and getting top dollar.
Your real estate agent should be available to give you at least the basic information about schools in the area.
Type of House Next, try to determine what kind of house will fit your wants and needs. This will help you narrow your search, and it will help your agent pull recent sales information on similar types of homes. At a minimum, ask yourself the following questions:
- One story or two?
- How much space do I need now?
- How much space will I need in a year or two, or three?
- What features do I want in a home?
- What architectural styles appeal to me?
Write down as many characteristics as you can think of. Categorize them as either "must have" or "would be nice to have."
Next, get out there and search! Your agent will help you a lot in this regard, but don't stop there. Drive through neighborhoods. Read the "Homes" or "Real Estate" section of your newspaper. Your dream home won't find you... you have to find it.
When you actually start touring homes, take your priority list of size, style, features, etc. Compare each home against the list to see if it offers the things most important to you.
But don't be too quick to reject a house if it doesn't at first measure up. You can always build a deck or update a kitchen. If you find a house that excels in all other areas but lacks one of the items on your list, ask yourself: "Is this something I can add on myself?"
Step 5: The Initial Walk Through
Look beyond the decor! An average house with amazing furniture and artwork is still an average house. Pay attention to the big-picture items:
- How many rooms?
- Will it accommodate your needs?
- Do you like the structural / architectural features?
- How does the house feel?
- Does it need to be fixed up in certain areas, or is it in top shape?
- Any drawbacks?
Don't be afraid to ask for a second walk-through visit. The first walk-through can serve to separate the "definitely not" houses from the "definite maybe" houses. The second walk-through can then separate the "maybe" houses from the "Eureka!" house.
Step 6: Making an Offer
Once you've weeded out all the "maybe" houses and found "the one," the next logical step is to make an offer. This is where you put pen to paper and specify how much you're willing to pay for the home, and under what conditions you will buy (i.e. repairs requested, move-in date, etc.)
Work closely with your agent when making your offer. It's a critical part of the process and not something you want to rush through or handle on your own. On the other hand, if you're in a hot real estate market where houses are selling fast, you'll want to get your offer to the seller as soon as possible. Your agent's expertise will prove invaluable in such circumstances - he or she will help you put your offer together quickly and accurately!
Before making your offer, compare the house to recent sales in the area. Your agent should have this information readily available. If the seller's asking price is above recent sale prices in the area, you should bid lower than their asking price, citing this difference as your reason.
Lastly, be prepared to negotiate and have a plan for doing so. What will you do if the seller turns down your initial offer? What happens if there are offers from multiple buyers and a bidding war develops? Consider these possibilities before making your initial offer. Have a plan in place for each scenario.
And when in doubt, follow your agent's advice!
Step 7: Types of Mortgage Loans
Fixed Rate
A fixed-rate mortgage offers an interest rate that will never change over the life of the loan. The primary benefit is that if interest rates increase during the term of your loan, your rates stay the same.
On the other hand, if interest rates drop during the term of your loan, your rates still stay the same (unless you refinance your home at the lower rate). This is the biggest difference between this loan and variable / adjustable loans (see next item).
The length (or "term") of a fixed-rate mortgage can be 15, 20 or 30 years. Each of these terms has its pluses and minuses:
30-year fixed rate - The 30-year term gives you maximum tax advantage by having the greatest interest deduction. It's also worth noting that the 30-year fixed-rate loan is often the easiest type of loan to qualify for.
20-year fixed rate - If you shorten your mortgage, you usually get a lower interest rate. The 20-year mortgage is not as common as the 30-year, so you'll have to shop around to go this route.
15-year fixed rate - Same benefits as the 20-year term (quicker payoff, lower rates), but will increase the monthly amount you pay.
Adjustable rate (ARM)
The adjustable rate mortgage (or "ARM") offers a fixed initial interest rate with a fixed initial monthly payment. "Initial" is the key word here, because after some predetermined initial period, the loan is subject to changes in market conditions.
The initial interest rate you pay will probably be lower than a fixed-rate mortgage; but the uncertainty, of course, comes after the initial period. This type of loan is usually a good option for buyers who only plan to stay in a home for a short while.
In other words, if you turn around and sell the house before the initial fixed-rate period expires, you'll benefit from the lower rate and be out before the uncertainty sets in.
How often the interest rate adjusts with an ARM depends on the terms of the loan. Take the 5/1 ARM as an example. 5/1 means your interest rate would stay the same for the first five years and then adjust each year starting at the sixth year. A 3/3 ARM would offer an initial fixed rate for three years and would then adjust every three years starting at the fourth year.
Balloon Loan The balloon loan is a short-term, fixed-rate loan that lets you make small payments for an introductory period of time. After the introductory period - usually five, seven or ten years - you must refinance or pay off the remaining balance with one lump-sum ("balloon") payment.
Government Loans (FHA, VA, RHS)
FHA Loan - A loan insured by the Federal Housing Administration, open to all qualified homebuyers. There are limits to the size of FHA loans, but they are usually enough to cover most moderately priced homes. FHA loans also offer low down payments (usually 3-5 percent).
VA Loan - A long-term, low or no-down-payment loan guaranteed by the Department of Veterans Affairs. Because this loan is insured by the VA, it has the added benefit of zero down payment. This type of loan is only available to qualified military veterans who have obtained a certificate of eligibility from the Department of Veterans Affairs.
RHS Loan - The Rural Housing Service (RHS) loan offers low interest rates with no down payment. It is available to households with low to moderate income located in rural areas or small towns.
How large of a down payment do I need? Some mortgages only require a down payment of 5% of the purchase price. Of course, the more you put down, the less you'll have to borrow, and the more equity you'll have (not to mention a smaller mortgage payment each month).
If you put less than 20% down, you'll most likely have to pay mortgage insurance to secure the loan. Lastly, when figuring out how much you want to put down, remember that you'll also need money for closing costs, moving expenses, decorating, etc.
Step 8: The Appraisal Process
What is a home appraisal? A home appraisal is a survey of a home by a professional for their opinion of the property market value. In most cases an appraisal is done for a bank when a home is being approved for a loan for the home buyer. The home appraisal is a detailed report that looks at such items as the condition of the home, the neighborhood, what similar homes are selling for, and how quickly similar homes sell (to name a few). The appraisal may be a sales comparison or a cost/replacement opinion of value. There is also an income appraisal, but this is done primarily with commercial properties. The sales comparison will look at other properties in your neighborhood and what they are selling for and then figure how they compare to your home. With a cost/replacement opinion of value the appraiser is looking at what it would cost to replace the home if destroyed; this is more commonly used for new homes. Important Note: An appraisal is not a home inspection! Appraisers only look for major concerns, they do not examine the home's full condition (i.e. examine the roof, appliances, etc.). For this reason a home inspection should still be requested by the home buyer before purchasing the home.
Who is an appraiser? Appraisers are licensed by individual states and are held to strict ethical standards. Appraisers are the third party whose purpose is to give their opinion of the market value of a home. Ideally the appraiser should not be connected with anyone involved with the home transaction.
Who picks the appraiser? When an offer is made on the house the appraiser will normally be determined by the lender. The lender may have their own appraiser or contract with an independent party. Sometimes the bank will allow the seller to choose an appraiser, but only when that appraiser is already well known to them.
What other aspects of the appraisal can hurt the loan? By in far, the appraisers opinion of the home's value being lower than the asking price is the most detrimental. However, other factors may cause the lender to refuse the loan or require further contract negotiations. These concerns would result from property conditions that may require the home buyer to do more investing in the property to keep it valuable, such as upkeep on a private road. Your REALTOR(r) can help you with these types of objections and altering the contract to meet the lenders concerns.
Step 9: The Home Inspection
What Does a Home Inspector Do? In short, an inspector checks the safety and functionality of your potential home. Inspectors focus primarily on the structural and mechanical aspects of the home.
Get a home inspection as soon as possible after the sellers accept your offer. Make the contract contingent upon the home inspection. That way, if the inspection uncovers a major flaw that you're unwilling to accept, you have a legal way out of the contract.
Don't confuse the home inspection with the home appraisal. The home appraisal protects the lender's financial interests. The home inspection protects you, the buyer. The appraisal is the bank's way of determining whether or not the house is worth the price you've agreed to pay. The inspection is your way of identifying structural or mechanical problems with the house. How to find a home inspector:
- Ask a friend or coworker who has recently bought a home in the area.
- Ask your agent if he or she can recommend a qualified inspector.
- Visit the American Society of Home Inspectors website: www.ashi.org.
- Visit the National Association of Home Inspectors website: www.nahi.org.
Is a Home Inspection Worth the Price? Consider this. Home inspections usually run between $200 and $400. Weigh that small cost against the comfort of moving into a known situation, and the answer is obvious... get a home inspection!
The List Your home inspector will go through your home with a fine-toothed comb. So be present for the inspection - you'll learn a lot. Afterward, the inspector will make a list of discrepancies. Some items won't be a big deal to you, but it's still the inspector's job to point them out. But other items will be more serious, and these are the items you should discuss with your agent.
Who's Fixing What? When you review the inspector's list with your agent, you'll have to decide which items (if any) you want the sellers to repair. Like nearly everything else in the home-buying process, the fix-it list is negotiable. When you submit your list of requested repairs to the sellers, you face one of several outcomes:
1. The seller will agree to fix all of the items.
2. The seller will agree to fix some of the items.
3. The seller won't agree to fix any of the items.
4. The seller will reduce the price in lieu of certain repairs.
How you proceed in light of the seller's response is up to you and your agent. A good rule of thumb - don't ever turn a blind eye to a major repair issue just because you're excited about getting in the house. If you're an experienced investor and you're buying the house specifically to fix it up, that's one thing. But if you're buying your first home, be conservative and carefully consider each item on the inspector's list. It will benefit you in the long run.
Summary:
Hire an inspector to review your prospective new home for potential problems. The peace of mind you'll get is well worth the cost you'll pay. Review the inspector's list with your agent and carefully consider each item on the list. Consider your ability (or inability) to make the repairs yourself, vice having the sellers repair them.
Step 10: Final Walk Through
The final walk-through normally takes place a day or two before closing / settlement. The purpose of this walk-through is to ensure that any repairs agreed upon in advance have been made, and that no other issues have arisen.
Who is an appraiser? Appraisers are licensed by individual states and are held to strict ethical standards. Appraisers are the third party whose purpose is to give their opinion of the market value of a home. Ideally the appraiser should not be connected with anyone involved with the home transaction.
In most cases, the final walk-through is your first opportunity to see the house without furniture. Examine the walls and ceilings carefully. You have two objectives: First, you want to make sure nothing has changed since you last saw the house. Secondly, you want to inspect all repairs the seller agreed to do in response to the inspection.
Uncorrected items should be brought up prior to closing. It is the seller's responsibility to fix them.
Step 11: Closing / Settlement
A day or two before the actual closing, you should receive a final HUD settlement statement from your lender. This statement will list all the charges you'll have to pay at closing. Review it carefully with your agent.
What Happens on Closing Day? In a nutshell - a lot of paperwork, and all of it important. The closing agent, generally an escrow company representative, will list all remaining monies that you owe the seller (remainder of the down payment, prepaid taxes, etc.), as well as any money the seller owes you (unpaid taxes and prepaid rent, if applicable).
When you're comfortable that you understand all the documentation, you'll sign the mortgage. You'll pay all remaining closing costs. The deed will be recorded in the state's Registry of Deeds.
Congratulations! You're now a homeowner!
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