Buyer's Guide
Why You Should Not Buy a Car
When you get a raise or accumulate some savings, you may find yourself confronted by an innate instinct of modern civilized men and women.
The desire to spend money.
It begins simply, by going out to restaurants, then accelerates to purchasing clothing, electronic gadgets, and since North Americans have a special fondness for the automobile, you may even buy a "brand new car."
If you're married or ambitious, a few months later your thoughts eventually turn toward buying your own home. Or a move-up home, if you are already a homeowner.
Next, you contact a loan officer to get prequalified for a mortgage loan. You state your desired price and how much you can put down. You provide your income and may even supply pay stubs and W2 forms. The loan officer methodically crunches the numbers (by telephone, in person, or even over the internet).
"If only you didn't have this car payment..."
Debt-to-Income Ratios and Car Payments
You see, when determining your ability to qualify for a mortgage, a lender looks at what is called your "debt-to-income" ratio. A debt-to-income ratio is the percentage of your gross monthly income (before taxes) that you spend on debt. This will include your monthly housing costs, including principal, interest, taxes, insurance, and homeowner’s association fees, if any. It will also include your monthly consumer debt, including credit cards, student loans, installment debt, and….
…car payments.
How a New Car Payment Reduces Your Purchase Price
For example, suppose you earn $5000 a month and you have a car payment of $400. At current interest rates (approximately 8% on a thirty-year fixed rate loan), you would qualify for approximately $55,000 less than if you did not have the car payment.
Even if you feel you can afford the car payment, mortgage companies approve your mortgage based on their guidelines, not yours. Do not get discouraged, however. You should still take the time to get pre-qualified by a lender.
However, if you have not already bought a car, remember one thing. Whenever the thought of buying a car enters your mind, think ahead. Think about buying a home first. Buying a home is a much more important purchase when considering your future financial well being.
Do not buy the car. Buy the house first.
Things Not to Do Before Purchasing a Home
Review the article titled, "Don’t Buy a Car," and apply it to any major purchase that would create debt of any kind. This includes furniture, appliances, electronic equipment, jewelry, vacations, expensive weddings…
…and automobiles, of course.
When a lender reviews your loan package for approval, one of the things they are concerned about is the source of funds for your down payment and closing costs. Most likely, you will be asked to provide statements for the last two or three months on any of your liquid assets. This includes checking accounts, savings accounts, money market funds, certificates of deposit, stock statements, mutual funds, and even your company 401K and retirement accounts.
If you have been moving money between accounts during that time, there may be large deposits and withdrawals in some of them.
The mortgage underwriter (the person who actually approves your loan) will probably require a complete paper trail of all the withdrawals and deposits. You may be required to produce cancelled checks, deposit receipts, and other seemingly inconsequential data, which could get quite tedious.
Perhaps you become exasperated at your lender, but they are only doing their job correctly. To ensure quality control and eliminate potential fraud, it is a requirement on most loans to completely document the source of all funds. Moving your money around, even if you are consolidating your funds to make it "easier," could make it more difficult for the lender to properly document.
So leave your money where it is until you talk to a loan officer.
Oh…don’t change banks, either.
For most people, changing employers will not really affect your ability to qualify for a mortgage loan, especially if you are going to be earning more money. For some homebuyers, however, the effects of changing jobs can be disastrous to your loan application.
Why Buying a Home is a Good Idea
As a fairly general rule, homes appreciate about four or five percent a year. Some years will be more, some less. The figure will vary from neighborhood to neighborhood, and region to region.
Five percent may not seem like that much at first. Stocks (at times) appreciate much more, and you could easily earn over the same return with a very safe investment in treasury bills or bonds.
But take a second look…
Presumably, if you bought a $200,000 house, you did not pay cash for the home. You got a mortgage, too. Suppose you put as much as twenty percent down – that would be an investment of $40,000.
At an appreciation rate of 5% annually, a $200,000 home would increase in value $10,000 during the first year. That means you earned $10,000 with an investment of $40,000. Your annual "return on investment" would be a whopping twenty-five percent.
Of course, you are making mortgage payments and paying property taxes, along with a couple of other costs. However, since the interest on your mortgage and your property taxes are both tax deductible, the government is essentially subsidizing your home purchase.
Your rate of return when buying a home is higher than most any other investment you could make.
Why Search for a Realtor, Anyway?
Finding Your Realtor by "Accident"
When someone decides it is time to sell their home, they interview several Realtors from different companies to determine which one is best for them. They want someone who will represent them and someone they feel will do an effective job at marketing their home. However, when someone decides to buy a home, they usually end up with their Realtor through sheer accident.
Why don’t homebuyers search for a Realtor the same way that homesellers do?
Instead, homebuyers usually end up with a Realtor as a result of answering an advertisement. The advertisement will give a brief summary of a home available for sale along with the price, but it says nothing at all about the Realtor.
Listing Agents and Selling Agents
You see, there are two "sides" to every sale. The seller's side is represented by the listing agent. The buyer's side is represented by the selling agent. The selling agent can also be referred to as the buyer's agent. Selling agents (buyer’s agents) do not usually list very many homes for sale. They deal mostly with homebuyers. Selling agents "sell" the homes that are placed in the Multiple Listing Service by the listing agents.
Most agents concentrate primarily on one side or the other. This is not a "hard and fast" rule. There are also agents who split their time equally between buyers and sellers. Often, these are the very best Realtors. The fact of the matter is, if you are buying a home who do you want on your side? A Realtor who deals primarily with sellers? Or one who deals mostly with buyers?
If you call on a single classified advertisement in a newspaper, an ad in one of those home selling magazines, or a listing on the internet, you are most likely calling the listing agent.
Should You Call the Listing Agent?
First, very few people actually buy the house they call about.
For argument's sake, suppose that you call the Realtor who is listing the property you "might" be interested in. It turns out that the house is absolutely perfect and affordable and you want to make an offer. Do you want the same agent who represents the seller to also represent you?
When you make an offer to buy a house, you are entering a negotiation. The seller wants as high a price as possible and the buyer wants the lowest price possible. Plus, there is more to buying a house than just settling on a price. If a Realtor represents both sides, there is a potential conflict of interest, although an ethical Realtor can often equally represent both sides. In such a case, however, the agent becomes more of a transaction facilitator than an agent working actively on behalf of either the buyer or seller.
You must keep in mind that there are times when it might not work out, too. The listing agent may choose to represent only the seller and that would leave you without your own advocate.
The Crux of the Matter
Most real estate transactions go fine, but almost every one has a challenge or two. These challenges are often routine, but sometimes not. Because the agent has divided loyalties, one side or another may doubt where those loyalties truly lie. Mistrust develops. This can take a small problem and blow it way out of proportion. At that point it becomes a crisis.
Having an agent on your side as your advocate removes the mistrust and helps keep things on an even keel. If a challenge develops, you know where your agent stands.
Plus, the seller pays for it -- you don't.
Actually, the best thing for you to do when you see an advertisement in the paper is to call your own Realtor and tell them about the ad. Since addresses usually do not appear in advertisements, your Realtor will call the listing agent and find out the MLS number for the property. If the listing is on the internet, it probably already provides the MLS number.
The house may turn out to be a great home for you, but it may also be a property the Realtor has already disregarded because it backed up to a busy noisy street and you have told your Realtor you wanted a quiet neighborhood.
First you have to have a Realtor you can call. How do you find one?
Referrals are always a good way to go. Perhaps a friend, co-worker, or family member recently bought a house in the same community and had a good experience. However, if they bought a house twenty miles from where you want to move, it may not be a good idea to use the same Realtor.
You want an agent who knows the area in detail and has already previewed many of the homes available for sale in that community. Community knowledge should be important to you because you are not just buying a house. You are buying a home in a local neighborhood in a specific community.
Every Realtor can show you every property available for sale in the Multiple Listing Service. Since that is true, you can call any real estate office and find a Realtor willing to show you houses for sale. The problem is that you do not know if you are talking to an excellent Realtor or a lazy inactive one.
When you prepare an offer to purchase a home, you already know the seller’s asking price. But what price are you going to offer and how do you come up with that figure?
Determining your offer price is a three-step process.
First, you look at recent sales of similar properties to come up with a price range. Then, you analyze additional data, such as the condition of the home, improvements made to the property, current market conditions, and the circumstances of the seller. This will help you settle on a price you think would be fair to pay for the home. Finally, depending on your negotiating style, you adjust your "fair" price and come up with what you want to put in your offer.
The first step in determining the price you are willing to offer is to look at the recent sales of similar homes. These are called "comparable sales." Comparable sales are recent sales of homes that compare closely to the one you are looking to purchase. Specifically, you want to compare prices of homes that are similar in square footage, number of bedrooms and bathrooms, garage space, lot size, and type of construction.
If the home you are interested in is part of a tract of homes, then you will most likely find some exact model matches to compare against one another.
There are three main sources of information on comparable sales, all of which are easily accessed by a real estate agent. It is somewhat more difficult for the general public to access this data, and in some cases impossible. Two of the most obvious information sources are the public record and the Multiple Listing Service.
Earnest Money Deposit in an Offer to Purchase Real Estate
After you have come up with an offer price, the next step is to determine how large a deposit you want to make with your offer. You want the "earnest money deposit" to be large enough to show the seller you are serious, but not so large you are placing significant funds at risk.
One recommendation is to make sure your deposit is less than two percent of your offered price. The reason for this is that if your deposit is larger than that, the lender will pay particular attention to how you came up with the funds. You might have to provide a copy of a canceled check along with a bank statement showing you had the money to begin with. Normally, this is not a problem, but if you have a short escrow period or are barely coming up with your down payment, it could pose an inconvenience.
Another reason to limit your deposit is "just in case." Although significant problems are the exception and not the rule, they do occur. "Just in case" there is a nasty or prolonged dispute between you and the seller, the less money you have tied up in a deposit, the fewer funds you have placed at risk.
As with practically everything in real estate, there are exceptions to this rule, too. During a hot market there may be multiple offers on the property that interests you. A large deposit may impress a seller enough so they will accept your offer instead of someone else’s, even when your unknown competitor is offering the same price or slightly higher.
Since large deposits do impress sellers, you may also find that by making a large deposit you can convince the seller to accept a lower offer. More money up front may save you money later.
How Financing Details Affect Your Offer
Most buyers do not have enough cash available to buy a home, so they need to obtain a mortgage to finance the purchase. Since you will probably make your purchase contingent upon obtaining a mortgage, the seller has the right to be informed of your financing plans in order to evaluate them. That is one of the major reasons that financing details are included in your offer.
As part of your offer, you will need to disclose the size of your down payment. Once again, this allows the seller to evaluate your likelihood of obtaining a home loan. It is easier to get approved for a mortgage when you make a larger down payment. The underwriting guidelines are less strict.
Another reason for including financing information in your offer is to protect yourself. If interest rates suddenly become volatile and rise quickly, as sometimes happens, you may looking at a mortgage payment much higher than you anticipated. By putting a maximum acceptable interest rate in the offer, you are protecting yourself from such an occurrence.
At the same time, the seller will probably want to see that you have some flexibility in the financing terms you are willing to accept. If interest rates are currently at eight percent and you indicate this is the highest rate you will accept, you would be able to cancel the contract without penalty if interest rates rose past that point. The seller would suffer because they have lost valuable marketing time and may have made their own plans based on successfully closing the transaction.
Asking for Closing Costs and Financing Incentives
There may be times when, as part of your offer, you request the seller to pay all or a portion of your closing costs, or provide some other financial incentive. One common request is asking the seller to provide funds to temporarily buy down your interest rate for the first year or two. Such incentives can be especially effective if a buyer is tight on money or pushing their qualifying ratios to the limit.
Whenever you ask for incentives such as these, you will probably find the seller less willing to negotiate on price. After all, what you are really asking for is have the seller to give you some money to help you buy their house. The end result is that, for a little relief in the beginning, you are willing to pay a little more in the long run.
Another occasional request is to have the seller "carry back" a second mortgage to help facilitate your purchase of their home. In cases when the seller does not need all the proceeds from their sale in order to purchase their next home, this is an option. The advantage to the buyer is that by combining your down payment and the second mortgage from the seller, you may be able to avoid paying mortgage insurance and save yourself some money.
If such a carry-back is part of your offer, you should include the terms you wish to pay on such a second mortgage. Keep in mind that your first trust deed lender needs to know this information so they can underwrite your loan, and they have certain minimum requirements. The minimum term of the second mortgage can be five years. The minimum payment can be "interest only." Longer mortgage terms and payments that also include principle are also acceptable.
If you are one of those rare individuals making a cash offer to buy a home, it makes sense to provide some documentation with your offer that shows you have the funds available. A bank statement would be fine. If you have to liquidate stock or some other asset, your offer should give a timetable on when you will provide proof you have converted the asset to cash.
Other Financing Details in Your Offer
Your offer should also contain information on whether you are obtaining a fixed rate or an adjustable rate mortgage. It should also state whether you are obtaining conventional financing or obtaining a VA or FHA loan.
