Buying Your First Home

Finding the right first home starts with a price range and a short list of desirable neighborhoods. But there are many other factors you’ll need to consider before investing in what may be your biggest asset.

Before You Start:

• Grab your current household budget so you can consider your financial situation and your ability to make mortgage payments.
• Ask family and friends if they can recommend experts, like a lawyer and an inspector, who can help with the home buying process.
• Think about your lifestyle and how it might affect your choice of home and neighborhood.
• Do a little research on current home prices in the neighborhoods you plan to target.

Buying Your First Home

Home ownership is the cornerstone of the American Dream. But before you start looking, there are a number of things you need to consider. First, you should determine what your needs are and whether owning your own home will meet those needs. Do you picture yourself mowing the lawn on Saturday, or leaving your urban condo for the beach? The best advice is to look at buying a home as a lifestyle investment, and only secondly as a financial investment.

Even if housing prices don’t continue to increase at the torrid pace seen in recent years in many areas, buying a home can be a good financial investment. Making mortgage payments forces you to save, and after 15 to 30 years you will own a substantial asset that can be converted into cash to help fund retirement or a child’s education. There are also tax benefits.

Like many other investments, however, real estate prices can fluctuate considerably. If you aren’t ready to settle down in one spot for a few years, you probably should defer buying a home until you are. If you are ready to take the plunge, you’ll need to determine how much you can spend and where you want to live.

How Much Mortgage Can You Afford?

Many mortgages today are being resold in the secondary markets. The Federal National Mortgage Association (Fannie Mae) is a government-sponsored organization that purchases mortgages from lenders and sells them to investors. Mortgages that conform to Fannie Mae’s standards may carry lower interest rates or smaller down payments. To qualify, the mortgage borrower needs to meet two ratio requirements that are industry standards.

The housing expense ratio compares basic monthly housing costs to the buyer’s gross (before taxes and other deductions) monthly income. Basic costs include monthly mortgage, insurance, and property taxes. Income includes any steady cash flow, including salary, self-employment income, pensions, child support, or alimony payments. For a conventional loan, your monthly housing cost should not exceed 28 percent of your monthly gross income.

The total obligations to income ratio is the percentage of all income required to service your total monthly payments. Monthly payments on student loans, installment loans, and credit card balances older than 10 months are added to basic housing costs and then divided by gross income. Your total monthly debt payments, including basic housing costs, should not exceed 36 percent.

Many home buyers choose to arrange financing before shopping for a home and most lenders will “pre-qualify” you for a certain amount. Prequalification helps you focus on homes you can afford. It also makes you a more attractive buyer and can help you negotiate a lower purchase price. Nothing is more disheartening for buyers or sellers than a deal that falls through due to a lack of financing.

In addition to qualifying for a mortgage, you will probably need a down payment. The 28 percent to 36 percent debt ratios assume a 10 percent down payment. In practice, down payment requirements vary from more than 20 percent to as low as 0 percent for some Veterans Administration (VA) loans. Down payments greater than 20 percent generally buy a better rate. Lowering the down payment increases leverage (the opportunity to make a profit using borrowed money) but also increases monthly payments.

How Much Home Can You Afford?

Bob and Janet’s combined income is $50,000 a year, or $4,166 a month. Their housing expense ratio of 28 percent yields a monthly maximum of $1,166 for mortgage, insurance, and taxes ($4,166 x 0.28 = $1,166).

Their total debt ceiling of 36 percent is $1,583 (4,166 x 0.36 = $1,500). Their monthly debt payments include a $200 car payment, credit card payments of $100, and student loan payments of $200. Subtracting this total of $500 from the $1,500 permitted leaves $1,000 in monthly housing payments.

Costs of Buying a Home

Many home buyers are surprised (shocked might be a better word) to find that a down payment is not the only cash requirement. A home inspection can cost $200 or more. Closing costs may include loan origination fees, up-front “points” (prepaid interest), application fees, appraisal fee, survey, title search and title insurance, first month’s homeowners insurance, recording fees and attorney’s fees. In many locales, transfer taxes are assessed. Finally, adjustments for heating oil or property taxes already paid by the sellers will be included in your final costs. All this will probably add up to be between 3 percent and 8 percent of your purchase price.

Ongoing Costs

In addition to mortgage payments, there are other costs associated with home ownership. Utilities, heat, property taxes, repairs, insurance, services such as trash or snow removal, landscaping, assessments, and replacement of appliances are the major costs incurred. Make sure you understand how much you are willing and able to spend on such items.

Condominiums may not have the same costs as a house, but they do have association fees. Older homes are often less expensive to buy, but repairs may be greater than those in a newer home. When looking for a home, be sure to check the actual expenses of the previous owners, or expenses for a comparable home in the neighborhood.

Choosing a Neighborhood

Before you start looking at homes, look at neighborhoods. Schools and other services play a large part in making a neighborhood attractive. Even if you don’t have children, your future buyer may. Crime rates, taxes, transportation, and town services are other things to look at. Finally, learn the local zoning laws. A new pizza shop next door might alter your property’s future value. On the other hand, you may want to run a business out of your home.

Look for a neighborhood where prices are increasing. As the prices of the better homes increase, values of the lesser homes may rise as well. If you find a less expensive home in a good neighborhood, make sure you factor in the cost of repairs or upgrades that such a house may need.

Finding a Broker

If you are a first-time home buyer, you will probably want to work with a broker. Brokers know the market and can be a valuable source of information concerning the home buying process. Ask lots of questions, but remember that most brokers are working for the seller, and in the end, their primary obligation is to the seller and not to you. An alternative is a so-called buyer’s broker. This individual does work for you, and therefore is paid by you. Seller’s brokers are paid by the seller.

Make sure that the broker has access to the Multiple Listing Service (MLS). This service lists all the properties for sale by most major brokers across the country. Brokerage commissions average 5 percent to 7 percent and are split between the listing broker and the broker that eventually sells the home. Don’t be surprised if your broker is eager to sell you their own listing since they would then earn the entire commission.

Home Buying Costs

Down Payment	0% – 20% of purchase price
Home Inspection	$200 – $500
Points	$1,000 and up for 1% – 3%
Adjustments	3% – 8% of purchase price

Once you’ve determined a price range and location, you’re ready to look at individual homes. Remember that much of a home’s value is derived from the values of those surrounding it. Since the average residency in a house is seven years, consider the qualities that will be attractive to future buyers as well as those attractive to you.

Although it can be difficult, try to remember that you will probably want to sell this home someday. The more research you do today, the better your decision will look in the years to come.

Summary:

• Buying a home can mean building significant value through the years.
• Think carefully about how much you can afford to spend and consider borrowing guidelines like those used by Fannie Mae.
• Pre-qualifying with your lender is a good way to determine how much house you can afford.
• You will need cash for a down payment and closing costs. Generally speaking, the higher the down payment, the lower the interest rate and monthly mortgage payment.
• In addition to your mortgage payments, you will also need to consider the other costs of home ownership.
• Schools, taxes, services, crime rates, transportation, and zoning are important considerations when selecting a neighborhood.
• Brokers usually represent the seller, but they can be valuable sources of information for buyers as well. A broker that belongs to the Multiple Listing Service will be able to offer a wider variety of homes to choose from.
• Remember to consider resale value when buying your home.

Best Times to Buy

A Conventional wisdom says that you need to stay in a home a minimum of five years to ensure that you recoup your purchasing costs. But with some markets soaring, this advice doesn’t always apply.

It’s All About the Market

Market conditions play a huge part in any decision about when to buy. Housing market values have varied widely from region to region in recent years. While the Florida market has seen meteoric rises in home values, Ohio has seen its real estate prices go into negative territory in the last year.

Do not buy high and sell low – if your market is softening or has hit its peak and is heading south, you may want to wait on your purchase.

The magazine Smart Money has created a worksheet to compare the costs of renting vs. buying using market appreciation calculations to determine at what point you come out ahead. Plugging in the price, down payment, your income bracket, interest rate, and current market appreciation rates, the worksheet will break out what you will gain.

For example, say you were to buy a $400,000 house in Boulder, Colorado and you estimate the market will soften from the current 11% appreciation to about 9 percent annually. If you stayed in the house three years, you would recover $88,750 in equity at the end of that period; if you stayed five years, you’d realize $120,360.

It’s All About You

The top three reasons people file for bankruptcy are change of job status, divorce, and unforeseen health expenses. If you face any of these challenges and don’t have a financial cushion, this may negatively impact your ability to pay a mortgage. Big life events dictate your readiness to buy now or to wait for a little more stability.

Signs you should not buy right now:

• Will you be moving within the next five years?
• Will you be having kids soon?
• Will you be making a job change?
• Have you recently filed for bankruptcy or is your credit score below 630?

If you answered yes to any of these questions, or you are experiencing other life-changing events like illness, marriage, divorce, or breakup, you may want to wait.

Your Financial Future

Aside from life events contributing to your decision, getting your financial house in order before you begin your home search is key. Even with all the programs available for buyers with a low-or-no down payment, if your debts are growing steadily and you don’t foresee an increase in your income, you are putting yourself in greater financial risk by taking on a mortgage.

With only a few exceptions, many loans for people who are still repairing their credit or recovering from bankruptcy carry higher rates than those available once your credit is in better shape. So the question comes down to this: Do you buy now, before prices appreciate higher than you can afford, but do so with an expensive loan? Or do you wait and repair your credit, then get a favorable loan, and pay more for your home?

That’s the sort of analysis you need to go over with a financial counselor or mortgage broker before you start hitting open houses.

Ways to Cushion the Blow

On the other hand, if you are willing to buy a home that needs a bit of work and, over time, you can afford to get it done, your home could appreciate faster, strengthening your financial position. If you are willing to take on a roommate or renter, you can also soften the expense of a mortgage, which almost always costs more than rent. Buying a home is a risk, and it’s worth asking yourself hard questions about what you’re willing to do to protect yourself from getting in over your head.

If you answered “no” the life-change questions, and have the down payment or equity from your current home, you still need to look at interest rates and at how buying affects your taxes. You can’t time the stock market, but you can time interest rate hikes, as they are a little easier to predict. If they are going up fast, you can jump in before they rise too far; if they are already high, you will have to calculate how refinancing in the future affects your budget.

What to Do First

If you are anxious to get moving, be patient. You have a few things to do first:

• Go to open houses – get the lay of the land
• Talk to a mortgage broker to get pre-approved
• Interview agents (You may want to find an agent at the same time as you look for a mortgage broker – a good agent can recommend reputable brokers and help you make sense of the terms of the loan)
• Review credit report and scores with mortgage broker to determine if any repairs are needed
• Use Zillow.com to find info on neighborhoods that interest you and then use the Home QandA feature to ask current homeowners

Home Ownership Rate Falls to 13-Year Low

Tighter lending standards by banks are disqualifying potential home buyers and preventing them from buying homes, at least according to analysts who point to that reason behind the second-quarter home ownership rate falling to its lowest level since 1998. The home ownership rate stood at 65.9 percent in June, its lowest in 13 years, the U.S. Census Bureau reports.

“Tight underwriting standards and the lack of a down payment are keeping a big chunk of buyers out of the market and other people are being displaced by foreclosures,” Wayne Yamano, director of research at John Burns Real Estate Consulting in Irvine, Calif., told Bloomberg News. He predicts that the home ownership rate may fall to about 62 percent by 2015.

The home ownership rate reached a record high of 69.2 percent in the second and fourth quarters of 2004.

“A home ownership rate of 69 percent is not sustainable,” William Wheaton, an economist and co-founder of the Center for Real Estate at the Massachusetts Institute of Technology, told the Investor’s Business Daily. “The notion that it comes down to 64 percent or 63 percent is completely logical, reasonable and likely to happen. … You have a generation of first-time buyers that went overboard into the market in 2000-2007. You’re going to have to wait for the next generation to come in and gobble up houses (and) that’s going to mean a little scarcity of first-time buyers for the next 5 to 10 years.”

But many economists are banking that the younger generation, particularly Generation Y, will drive the housing market in the next decade.

“It may take them a little longer to get a home” due to weak hiring and pay, says Stan Ross, chairman of the University of Southern California’s Lusk Center for Real Estate.  But, “I really believe that the American dream [of home ownership] still exists.”

Source: “U.S. Homeownership Falls to Lowest Since 1998 on Tight Lending,” Bloomberg News (July 29, 2011) and “Home Ownership Plunges to 13-Year Low, Bust,” Investor’s Business Daily (July 28. 2011)

Are Too Many Real Estate Deals Falling Apart?

One of every six real estate professionals reported in June having signed contracts canceled before closing — which is up from one in 25 the month prior, according to the National Association of REALTORS®.

The average cancellation rate for the past 16 months has been between 8 percent and 10 percent.

Lawrence Yun, NAR’s chief economist of NAR, says possible culprits could be lowball appraisals and tightened mortgage underwriting rules. Some real estate professionals also point to lawmakers’ indecision on the national debt ceiling the last few weeks and an increase in short sales-related cancellations due to buyer frustration at the lengthy process or banks not approving the short sales.

And some real estate professionals say that buyers simply have just gotten more picky.

Home inspections often turn up some problems in homes, but “lately buyers seem to be holding out for perfection,” Jessika Mayer, manager of professional development at Coldwell Banker Plaza Real Estate in Wichita, Kan., told The Real Deal. She says that minor problems surfaced by inspections that buyers once let pass are now derailing deals, with buyers’ increasing demands for replacements, repairs, and price discounts.

Home insurance premiums could double in five years under bill

Homeowners, some already hit with double-digit property insurance rate hikes in recent years, could see premiums more than double in five years. They also could lose their right to file claims for late-surfacing damage or suffer more home damage while they save up to make repairs.

Those are possible outcomes predicted by some homeowners, local leaders and a major home builders group from the sweeping property insurance bill that hit Gov. Rick Scott’s desk Wednesday. The governor has until May 26 to decide whether to sign it into law or veto it.

Supporters of the bill, including insurers, say the bill could strengthen the state’s property insurance market and draw more private insurers to Florida — a key goal for Scott and other state leaders who want policyholders to have more insurance options. Many homeowners in South Florida have only the option of insuring their homes with state-backed Citizens Property Insurance.

Insurers report premiums are not keeping pace with their costs, including expenses for sinkhole claims.

Opponents say the bill reverses changes that were made when problems surfaced after the 2004 and 2005 hurricanes: Premiums doubled and tripled in some cases, and homeowners had trouble finding contractors willing to repair their homes if they could not pay the costs upfront.

Rate hikes

One provision allows insurers to increase premiums up to 15 percent a year for costs and profits related to reinsurance, insurance for insurers. That means a $1,000 premium could double after five years to $2,011, as the increases compound. The provision drew the most fire before the Senate approved the bill last week.

Another provision allows insurers to charge customers for advertising costs and agent commissions — without direct or indirect interference from regulators.

Those parts of the bill are meant to ease the burden on insurers, allowing them to get rate increases for expenses including those they may not control. The less regulation, the more likely insurers are to stay in or come to Florida, say lawmakers who support the bill.

Mickey Berk, a retired business owner in Coral Springs, said he’d like more insurance companies to choose from, but not if it means another rate hike. His annual homeowners insurance premium went up 20 percent in March, to $6,000.

“Somehow it seems if we have a hurricane, we get hit. When we don’t have hurricanes, we get hit anyway. I don’t know where it stops,” he said. It has been more than five years since Florida suffered a direct strike from a hurricane.

Arnold Ruskin, a retired accountant in Margate, said he managed to lower the premium for his condominium unit insurance last year to $550 by getting less coverage and increasing the deductible. But his insurer informed him a few weeks ago the premium will increase to $715 when it’s up for renewal.

“I don’t think the state understands the problems [facing people] living on fixed incomes. Gasoline is high, food is high, and they keep giving these insurance companies new” benefits, he said.

Claims payments

Critics also worry that if the bill becomes law, some policyholders won’t receive claims payments for home repairs. The bill would shorten the time policyholders have to file or reopen claims to two years for sinkhole claims and three years for hurricane claims — from five years currently.

Supporters of the bill say homeowners should know whether their property is damaged within a few years of a disaster.

Thousands of homeowners who filed claims for Hurricane Wilma did so years after the storm. Some said they did not know they could challenge their insurers’ decision to deny claims or pay less than the contractors’ estimate. Others said they did not know how extensive the damage was until years later.

Some policyholders avoid filing sinkhole claims when they first notice cracks in their homes’ walls and foundation because they don’t know how serious the damage is. They know if they file a claim, insurers are required to report the problem to county officials, diminishing the home’s value.

Under the bill, if the ground under policyholders’ homes continues to settle and the damage worsens after two years, homeowners would be out of luck.

Less up-front money

Another provision would require insurers to pay upfront only part of a claim to repair damage to a home. Insurers initially would pay what they estimate as the depreciated value of the home, less the deductible. As repairs are made and expenses incurred, they would pay the rest.

Lawmakers say the measure is aimed to ensure repairs are made, rather than homeowners pocketing the money.

That could make it difficult, and in some cases impossible, for policyholders to repair the home.

As it is, many contractors are reluctant to take on construction jobs that involve an insurer because it usually takes longer to get paid — if the insurer approves the claims, said Doug Buck, director of legislative affairs for the Florida Home Builders Association.

The bill would make the work even less appealing. “The homeowner will probably be asked by a contractor to cover it out of his or her own savings,” Buck said. That means the damage to the policyholder’s home could get worse while he or she saves up for the repair or waits for a contractor.

Harry Dressler, a Tamarac city commissioner and a former senior vice president of financial services firm Morgan Stanley, said this change could be hard on homeowners who are underwater, or owe more than their homes are worth. “You could be contributing to a major increase in defaults [as people say], ‘Why am I paying the mortgage or why am I going to borrow money to pay for repairs? I’ll pass,’” he said.

Consumers who want to weigh in on the bill, SB408, can contact the governor’s office at 850-488-7146 or at flgov.com/contact.