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How Much House Can You Afford?
There are several ways to gauge how
much you can afford to spend on a house. But, before you go
house-hunting, get pre-qualified for a mortgage so you'll know in what
price range you can shop. It is not unusual for first-time buyers to be
somewhat baffled about how to estimate what mortgage payment they will
be able to handle each month, plus how much money they'll need for a
down payment and closing costs.
That's why it is a good idea to get
pre-qualified through a lender before you even start to look for a
home.
Pre-qualification lets a buyer know exactly how
much a lender is willing to loan them. With pre-qualification in hand,
the buyer can save a lot of time-and frustration.
Pre-qualification does not obligate
buyers to take a loan from the lender, nor should it involve any fees
(until later, when they actually apply for the loan). At the same time,
you must understand that pre-qualification is not pre-approval for a
loan either which is a much more involved formalized process that
results in an actual letter of credit from a lending institution for a
specific loan. Depending on your unique circumstances, you may wish to
consider pre-approval as an option, but it is not necessary-consult
with your real estate professional to decide what's right for you.
The less formal process of
pre-qualifying on the other hand is a tremendous tool for buyers to
have when making an offer. Usually, pre-qualified buyers have an edge
when making a purchase offer because the seller knows that the buyer is
pre-qualified, and that there is at least one lender ready to make it
happen. In addition, it allows you the flexibility to choose the
mortgage that is best for you at the time of actual purchase-which is
sometimes months down the road. That can be important given the
volatility of interest rates. When a lender pre-qualifies, they are
more concerned about the buyer's paying ability than the price of the
property.
For this reason, lenders are interested
in more than just a buyer's income. They also want to know how much
existing debt a buyer has, what their on-going financial obligations
happen to be, and what the buyer's monthly budget looks like.
Lenders use an established
debt-to-income ratio, usually between .28 to 1 and .38 to 1, to
calculate the amount of the loan they are willing to give to a buyer.
For instance, a lender who uses a .3 to 1 debt-to-income ratio has
determined that payments toward debt reduction-including existing debt
plus new debt associated with buying a home-cannot be more than 30% of
they buyer's gross monthly income.
An important factor that may influence
a lender to authorize a loan with a higher debt-to-income ratio -
(where debt payments take a higher percentage of a buyer's income) - is
a larger down payment. Buyers who put a larger percentage of the
purchase price down (5%, 10%, 15%, 20%, etc.) are considered better
"risks," because the theory is that the more a person has actually
invested in the purchase, the less likely they are to default on the
loan.
Buyers usually discover that the
pre-qualification process will produce a home purchase price that is
roughly 2 1/2 to 3 times their gross annual income. The 2 1/2 -to-3
guideline is only a general rule of thumb, however, and it doesn't take
a buyer's full financial situation into consideration. Since the
lender's calculations will also consider a buyer's actual debts and
ongoing expenses, the loan pre-qualification amount may be higher or
lower. Regardless of the price bracket a buyer targets, they should
keep pre-qualification in mind.
How
much
should you budget to own your own home?
Aside from the down payment, the three
largest expenditures involved with the purchase of a home are usually
your monthly mortgage payment, insurance and taxes. Obviously, the
amount of your mortgage payment depends upon your down payment, rate of
interest and the price of the property.
Take, for example, a home that has a
$200,000 mortgage. An 7% fixed mortgage for 30 years, will run
approximately $1330 per month. What about taxes? The rate will often
times vary from city-to-city, but generally you might expect your
yearly tax bill to total around 1.25% of the purchase price. That
means, for a home with a market value of $250,000, yearly taxes might
run around $3125. A local real estate agent can help prospective
homeowners refine these figures.
In addition, it is important to keep in
mind that there are many additional expenses incurred with home
ownership, some of the most obvious are utilities and trash collection.
Smart homeowners should also budget for one other item, maintenance and
upkeep of the home. If possible, a small amount should be set aside
each month to pay for those "rainy day" repairs such as painting,
plumbing (hot water heaters, garbage disposals), adding storm windows
(to improve energy usage), insulation (in attics), etc.
But home ownership is not just a one
way street-that is, aside from spending money on repairs and
maintenance, homeowners can profit from their property. The most
significant benefit is the tax deduction. It is no secret that among
the last real income tax deductions available to consumers today are
the interest paid on the home loan, and the property taxes. This can
amount to thousands of dollars in deductions each year. And, of course,
the primary benefit of home ownership is appreciation-equity that
builds every month. A home, aside from being a place that provides
shelter, can be a profitable investment, and the rising value of the
property oftentimes provides another "savings" account.
So, when it comes to buying a new home,
remember one thing ... the purchase of a property requires budgeting
and planning.
How
do
you go about finding a mortgage?
The commotion of house hunting is
finally over. You found just the right house, and your offer has been
accepted. It was a great buy. Now, just one more hurdle-getting a
loan-and you're home free. Often, buyers are so eager to get this
"final detail" behind them, they rush through this portion of the
transaction, and end up with less-than-ideal terms. Borrowers, however,
have something lenders want-their business. This positions them to
negotiate the best possible price (cost of loan), terms and service.
Let's look at price, or the cost of the
loan. The first thing to do is find out what the current rates are,
information readily available on the internet, in your newspaper or
from your real estate agent. When comparing rates, figure the annual
percentage rate (APR), which includes interest, extra fees and costs
amortized over the life of the loan. Also determine the number of
points, if any, that the lender will charge to make the loan.
(A point is equal to one percent of the
loan amount.)
Next, consider what loan options the
lender offers. There are six or seven basic types of loans, which vary
in their duration. Check how rates are calculated (fixed versus
variable), and whether charges are fully amortized over the life of the
loan, or whether you'll have to pay points up front and/or balloon
payments at the end.
Is
there
a prepayment penalty clause?
Which terms are best for you depends on
such factors as what changes you expect in your income and what you
predict will happen in loan rates in the years ahead. For example, if
you only plan to reside in the home for a year or two, starting with a
lower Adjustable Rate Mortgage (ARM) might be the best choice. If you
have no plans to move, and feel that inflation will rise rapidly, a
fixed rate would obviously be better.
Finally, and perhaps most importantly,
consider speed and service. Buyers shouldn't have to wait days for
approval and weeks for closing just because the lender is slow.
Remember, qualified buyers are great prospects for lenders - so give
your business to the lender who demonstrates they not only want it,
they deserve it.
How
difficult is it to qualify for a mortgage if you have a past credit
problem?
Credit problems can make it harder to
qualify, but it's quite possible for buyers with poor credit to obtain
a home loan. Anyone who has had a financial
problem-whether it was a matter of late credit payment, delinquent
taxes, or even a judgment that was filed-should expect this data to be
a factor when applying for a mortgage.
How critical a factor? Minor lapses
will probably have little or no effect. However, buyers with serious
problems may still qualify for a loan, but they may have to pay a
higher rate of interest or provide a larger down payment. There are
three steps that a person with past credit problems should take before
applying for a loan.
First,
request a
credit profile from one of three major credit reporting agencies. To
get copies of your credit report, start at:
Equifax - Credit Reports
Second,
the buyer
should optimize his or her credit profile by citing prompt payment of
rent, utilities, and other bills not reported on the credit profiles.
Finally,
the buyer
should be prepared to provide comprehensive and candid explanations for
any late payments to the loan officer. This is important because
problems not reported by the buyer but discovered by the lender will
reflect unfavorable.
Many lenders are understanding about
one-time problems such as the loss of a job, a medical emergency, etc.
Buyers with patterns of delinquent
payments might want to consider adding six months or a year of flawless
credit to their track record before pursuing their home-buying plans.
So remember-if you are thinking about purchasing a home, but are
worried about your past financial record-don't give up. There are
solutions, lenders and agents who are in business to help.
What
are
the five most common mistakes made by first-time buyers-and how can you
avoid them?
A good home-buying
decision is one that fits your lifestyle and your budget-a house you'll
be able to resell when the time is right. Sound simple? Not always.
Five
common mistakes frequently made by first-time buyers.
1.
Looking
outside your price range. To avoid
disappointment, contact a real estate agent who can help you
pre-qualify before you start looking for a home. The agent can also
provide valuable insight on taxes and other expenses associated with a
home (utility bills, etc.)
2.
Buying
on impulse. Buyers-especially
first-timers-may be impressed by the first two or three homes they
view. Look at a good selection. List the positives and negatives.
Narrow the prospects to three or four, and then return for a closer
look. Evaluate more than just the property. Look at the surrounding
area and community amenities. Is this what you-and your family-want and
need?
3.
Not
planning ahead. Think seriously about any
personal changes you are planning in the next five to seven years.
For instance, if you are planning on
having children, consider how the home will meet both your current and
future needs. If a double-income is necessary to qualify for
financing-and make your payments-do your plans foresee an income
sufficient to continue making payments?
4.
Failure to focus on location. Don't just
focus on the house, examine the neighborhood. Is the area safe, well
maintained, moderately quiet and close to work, stores, and schools?
Find out about zoning and what new
construction is planned on any vacant land in the immediate
neighborhood.
Will the property be easy to market
when you are prepared to sell it?
5.
Failure to understand the home buying process.
Once you select a home, get involved. Find a real estate agent willing
to spend time with you, and don't hesitate to ask questions. Have them
explain the negotiation, financing and escrow processes and other
elements involved in the transaction.
Home-buying involves knowing the price,
and what's inside and around the property. Consider all your options
carefully. This may be the most important financial transaction of your
life.
What's
the real difference between a new home and an old one?
While each offers its own style and
charm, the difference usually boils down to two things:
1. How
the home fits into the buyer's lifestyle.
2. The
condition of the property.
Homes that are 10 years old or
less are generally better insulated - or have dual-glazed windows or
thermal panes - which translate into lower heating and cooling bills.
And, in today's rising energy cost environment, these considerations
are significant. Although there are some exceptions, homes that have
been built with all-electric systems, generally have higher utility
bills.
Homes that range between 15 and
20 years old may be in need of new water pipes, especially if the old
ones were galvanized and if a water softener was used. Water softeners
and galvanized pipe can be deadly and, after 15-20 years, re- plumbing
is usually required. Have a plumber or general contractor inspect the
pipes. Needless to say, it can be expensive to re-plumb an entire
system. Check the built-in fixtures and appliances for any signs of
damage. Flush toilets, test all the water
taps and the electrical sockets, open and shut the windows, and try all
the lights.
A window that will not open may be a
sign of a more significant problem-for example, a wall may have
shifted, or worse yet, it could indicate a problem with the foundation
itself. It is also a good idea to ask the seller for copies of past
utility bills. Examine them for some insight into what you can expect
monthly gas and electric costs to be. Although newer homes may be free
of significant physical or structural problems, there are other things
to consider in making your decision.
Generally, room size and yard size tend
to be smaller in some newer homes. While, on the other hand, they
usually offer the benefit of the latest building and design technology.
Many new homes also have more windows and natural light incorporated
into their design plan, allowing for a more spacious feel and efficient
energy usage.
Should
a
buyer get a professional inspection for the home they are buying?
Definitely. Hiring a professional home
inspector can save a great deal of grief for buyers. The one exception
would be when the home is new and carries a written warranty by the
builder. Many buyers mistakenly believe that the only reason to have a
home inspection is to make sure that the house they're buying doesn't
have defects serious enough to warrant backing out of the transaction.
But there's more to it than that.
Certainly, an inspection will usually
reveal major problems that may even surprise the seller. The obvious
ones are corroded plumbing, antiquated and unsafe electrical systems,
or structural and foundation problems. And, the discovery of such
problems may cause the buyer to re- think his or her offer. Although a
competent inspector can uncover deal-crushing defects, these problems
are usually not commonplace. Typically, the seller will already have
told the buyer about anything major. More often, inspections reveal
less serious problems; problems that may not be serious but can be
aggravating.
For instance, there could be a minor
electrical defect, or inferior ventilation of a heating system or
fireplace. If so, the buyer is usually in the position of having the
purchase price reduced, or the defect corrected. More important, it
also prevents the minor problem from developing into a major disaster a
year or two down the road.
There is, of course, the possibility
that the home inspection will produce another outcome: everything is
fine. In this case, they buyer gains piece of mind, confident about the
major investment he or she is about to make. That, too, is an enormous
benefit for the cost of the inspection.
Now,
how
does a buyer find a home inspection?
By asking their real estate agent,
friends, or lender. Home Inspectors are also listed in the Yellow Pages
under "Home Inspection Services." But, a word of advice, don't hire a
contractor. Contractors earn their living doing repair and renovation
work, so their recommendations aren't likely to be as objective as
those of a professional inspector.
Is
real
estate a wise investment?
There are fewer investments that have
shown a better return. However, the key to investing wisely in real
estate is understanding how the industry differs from others.
For example, when the defense industry
dips, it usually shows a national decline and the stock prices of
defense-oriented firms drop across the board. The same is true of most
industries. They are impacted nationally. That is not the case with
real estate, which is actually an industry and investment driven by
local conditions. One community may suddenly lose a manufacturing
facility, and almost overnight the market is flooded with properties
for sale.
Obviously, the key to successful
real
estate
investing, like
stocks and bonds, is to buy low and sell high. But, how do you know
when the "low" has been reached? Or, for that matter, how can you judge
when you property may be peaking in value? Some investors rely
partially on the media. They read the daily newspaper, watch television
and follow the trends. Although the media provides a good deal of
information, remember that by the time things are printed or broadcast,
the news may be old.
For instance, you will find statistics
frequently quoted in the media that have been supplied by the National
Association of REALTORS (NAR). But, NAR statistics-like most- tell you
where things have been, not where they are going. So what can you do? First, check local
economic
indicators. Also, the local chamber of commerce can frequently help.
They usually have information on which companies are moving in and out
of an area.
Logically, the relocation of a firm
into a community generally indicates that demand for real estate in
that marketplace will increase-while if firms are moving out of the
area, housing demand will often shrink. Aside from economic indicators,
check real estate trends and cycles.
Talk to a real estate agent. They can provide statistics on how quickly
homes have sold, how prices have fluctuated in the past six to 12
months, and projections of future home sales. They can show you how
today's market compares to last year's. Are sales headed up? Down? The
same? The answers will not only help you determine what the market is
like in your area, but they will also be critically important in
helping you determine when and where to make your real estate
investment.
Does
a
home warranty protect a buyer in the event something goes wrong after
they have purchased a property?
Sometimes. That's because home
warranties are often times misunderstood and not every warranty
provides the same protection. All warranty companies are not equal,
either.
Home
warranties, of course, were
designed to protect buyers from
problems that emerged after they moved into a dwelling. For example, if
a major appliance breaks or the roof leaks, the ideal warranty kicks in
and pays for the repairs. On the surface, this sounds simple and
straight-forward. But, most of the time it is not.
First, all warranties differ. Aside
form the obvious differences, the amount of deductible required, they
may also vary as what is covered and what is not. For instance, with
some warranties if the hot water heater works on the day of closing,
but suddenly does not work six months later, then it may be covered.
And, with other policies if the water heater was not in good working
condition when the home was purchased, and it breaks a week or two
later, there is no coverage.
Warranties can be critically important
when it comes to new construction, too. Obviously, the reputation of
the builder is an important consideration. However, problems with new
homes can be enormously expensive if they are not covered by a warranty.
There are two types of defects when it
comes to new homes - patent or latent. Patent are those problems which
can be seen. Cracked plaster, a fence that is off level, etc. Latent
problems develop later, and may not show up for five or six months.
Ground shifting, for example. Latent problems are usually more
expensive than patent problems.
Thus, the warranty for a new home can
be one of the most important documents executed during the buying
process. Whether you're purchasing a new home or a resale, remember
that warranties definitely have a place when it comes to protection and
peace or mind in the real estate transaction, but make sure that you
check them out carefully.
Is a final walk through, an inspection
of the property by the buyer before they move in -- really important?
Yes, it is. The intent of a pre-closing inspection is to give the buyer
one last opportunity to verify that they are getting all that was
promised in the sales contract. Although buyers still have legal
recourse if they discover-even after closing-that the condition of the
home is not as it should be.
The best time to identify problems is
before closing, when the seller will be motivated to correct any
deficiencies in order to close the transaction. Typically, a buyer
takes possession of a property one to three months after signing the
sales agreement. But, a lot can happen before the actual move-in.
Appliances and fixtures can break down, and walls, carpets and doors
can be damaged during the seller's move-out. Sometimes the seller will
simply have forgotten that he or she had agreed to leave the
refrigerator or window coverings with the house. Whatever the reason,
problems identified before closing have the best chance of being
remedied.
If possible, schedule the inspection
right before the closing, such as the day before. Ask your real estate
agent to attend the inspection with you. What should you be inspecting?
Using a copy of the sales contract as a checklist, first make sure that
all items that should be in place (appliances, built-in furniture,
window coverings, fixtures, etc.) are there.
Test each appliance to make sure they
work properly. Test all electrical switches and the garage door opener,
if there is one. Run the garbage disposal and turn on every water
faucet, checking under the sinks for leaks. Flush the toilets. Inspect
the floors, carpets, walls and doors for recent damage. If you discover
that something is damaged or missing, make a note of it and inform your
agent immediately.
In most cases, the seller is usually
able to take care of small problems immediately, either by making a
needed repair or offering compensation to handle it. And, if there are
major problems the seller can even sign a statement acknowledging the
deficiency and agree to correct it. Although pre-closing inspections
take time and may be inconvenient, they are important and well worth
the buyer's time.
What
are
"contingencies" and why are they important?
A "contingency," is an escape-clause
that is added in-writing to a contract which allows a buyer to back out
of the transaction if certain conditions aren't met. Some
contingencies, often called `riders'-like attorney approval of the
contract, or the passing of a home inspection-are obviously designed to
protect buyers from a poorly written contract or a defective home.
Other purchase contingencies may hinge
on the buyer's current living situation, or his or her cash-flow. For
example, when it comes to contingencies many first-time buyers can be
better prospects for a seller's home than move-up buyers. Why? Because
offers from homeowners usually are contingent upon the sale of their
present home. And, even if a move-up buyer has an offer for their home
in-hand, their buyer's offer may be contingent on another contingency
(or sale) and so on down the line. If one transaction in the chain
falls through, they all might. Cash offers can also be more attractive
to sellers.
Why? After all, the seller will get
their money at closing whether or not the buyer has cash or takes out a
loan. True, but cash offers don't require lender approval, and loan
approval is never a certainty and may delay or prevent closing.
(Incidentally, for this reason, buyers who get pre-qualified for a loan
have an edge over other buyers. A pre-qualified buyer is the same as a
cash buyer.)
Buyers offering a larger-than-customary
amount of "earnest money", (a deposit that accompanies an offer) can be
more appealing too. More money deposited with the signed contract often
demonstrates greater sincerity and motivation to close the transaction.
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