Preparing to Buy a Home

Getting Prepared

Before you step foot into the first home you look at, it's a good idea to thoughtfully determine your wants and needs, and the difference between the two! By analyzing your needs you will be able to get a clear picture of exactly what you want your new home to look like and how it should function for you. Once you're in the thick of viewing homes, it's all too easy to fall in love with someone’s decorating or a home’s outstanding architecture – and to completely overlook other details that may not fit your needs.

It is important to identify what you envision your home to look like and what features it should have. Writing this down and sharing this with me as your agent helps to avoid ambiguity later in the home search process. You might consider making two lists: one should describe everything you would ideally like and the other should list the features of the home that are an absolute must such as the number of bedrooms and bathrooms you need. It is most likely that you will blend the two lists into one as you progress through the homebuying process. This is a natural and evolutionary process that becomes clearer as you determine what you want and what is available.

First Time Buyers

Approaching the task of buying a home can be overwhelming. It is a complex event during which there is so much to learn and to consider. How much can I afford? Where will the down payment come from? How much will I need and where can I find the best loan? How do I begin the look for a home, what should I expect from my real estate agent and what type of home is right for me?

These questions are just the beginning. Buying a home is one of the largest financial transactions in one’s lifetime, yet most people know very little about it. When embarking on the path to home ownership here are two very important points to remember:

You can and should understand everything that is happening in the homebuying process.  Having a knowledgeable real estate agent such as Sal guide you through this process is critical.

There are financial advantages to owning a home:

Tax Deductibility - You can deduct the cost of your mortgage loan interest from your state and federal income taxes. Since interest generally will account for most of your payment during the first half of your mortgage, the savings can be significant. Some of your costs at the time of closing (including prepaid mortgage interest) can be taken as deductions on that year’s income tax return, and points paid up front at the time of closing represent additional mortgage interest and may be taken as a deduction.

Tax Deductibility of Property Taxes - You can deduct all of the property taxes you pay.

Appreciation Potential - Real estate is considered a good long-term investment because it usually appreciates in value. The effects of borrowing potential can increase as the value of the home appreciates.

Capital Gains Exclusion - When it’s time to sell your home the amount of capital gains you have to pay is reduced. A homeowner can exclude up to $500,000 per couple if married and filing jointly, or $250,000 if single or filing separately for homes that have been the taxpayer’s principal residence for the previous two years.

Capital Gain Treatment - Congress allows preferential tax treatment on gains from capital assets held for more than one year. This would be important for a homeowner who has gains in excess of the allowable exclusion.

Principal Accumulation - Mortgages are designed to pay the interest for the time that the money has been used, as well as to retire the principal debt over a period of time. This payment plan means that part of the payment each month is for principal accumulation.

Personal Enjoyment - Pride of ownership is a valid reason for wanting to own a home. You can personalize your home while enjoying the financial benefits.

How Much Do I Need

The good news is that there loan programs that will lend you as much as 100% of the purchase price of your home. Furthermore, they are willing to spread out the payments over a long period of time so that you can afford the house you want.  A USDA loan offers options for no money down, FHA with 3.5% down while conventional loan options usually start with a little as 5% down.  

What Can I Afford?

There is a rule of thumb that says that if you have the capacity to repay the mortgage, you can afford a single-family house that costs up to two and one-half times your annual gross income. (Annual gross income is the amount you make before taxes are deducted.) Like other rules of thumb, this is a general idea of how large a mortgage you can afford. But, because it is so simple, it doesn't take into account all the information that will help you feel comfortable with your mortgage payments.

If you are buying a house with someone else (spouse, parent, adult child, partner/companion, brother or sister or other relative), you should consider your co-purchaser's earnings and existing debts as well. Remember, if you apply for a loan with somebody else, you and your coborrower are both legally responsible for repayment of the mortgage.

Your buying power depends on how much you have available for the down payment and how much a financial institution will agree to lend you.

Private Mortgage Insurance

Depending on the lender and loan type, you may be able to get a mortgage with as little as no money down however, putting less than 20 percent down often means you will be required to purchase private mortgage insurance. Private Mortgage Insurance (PMI) helps protect the lending institution in case you fail to make payments on your mortgage.

Your closing costs

In addition to the down payment, you will also need to consider closing costs. Sometimes, you can negotiate with the seller of a property to pay some of your closing costs, which will reduce the amount of money you will need to bring to closing.

How much a financial institution will lend you

Apart from having available funds for a down payment and closing costs, the other major factor limiting how expensive a house you can buy will be how much you can borrow.

When you apply for a mortgage, the lender will consider both your earnings and your existing debts in determining the size of your loan. Lenders generally use the following two qualifying guidelines to determine what size mortgage you are eligible for:

The amount of money you owe for mortgage payments, property taxes, insurance, and condominium or co-op fee, if applicable, should total no more than 28 percent of your monthly gross (before-tax) income. This is called the Housing Expense Ratio. The amount of money you owe for the above items plus other long-term debts should total no more than 36 percent of your monthly gross income. This is called the total Debt-to-Income Ratio.

Basically, lenders are saying that a household should spend no more than about one-fourth of its income (up to 28 percent) on housing and no more than about one-third of its income (up to 36 percent) on total indebtedness (housing plus other debts). Lenders feel that if they follow these guidelines, homeowners will be able to pay off their mortgages fairly comfortably.

These lender ratios are flexible guidelines. If you have a consistent record of paying rent that is very close in amount to your proposed monthly mortgage payments or if you make a large down payment, you may be able to use somewhat higher ratios. Some lenders offer special loans for low- and moderate-income home buyers that allow them to use as much as 33 percent of their gross monthly income for housing expenses and 38 percent for total debt.

When you go to apply for a mortgage, the lender will use all the relevant data -- your income, your existing debts, the purchase price of the house, your down payment, the interest rate on the loan, and the cost of property taxes and insurance -- and calculate whether you qualify to borrow the amount of money you need to buy the house.

Getting Pre-Approved

Though you may be willing to spend a certain amount, the real determination of how much house you can afford is driven by how much a lender calculates you can afford. So before you begin to search for the perfect house, it is very important to begin the homebuying process by getting preapproved. Getting preapproved for a home mortgage loan will provide you with a preliminary statement on the size of loan for which you can qualify. Knowing this, you can then focus your home search.

In general, lenders allow your total monthly housing costs to go as high as but not more than 30 percent of your gross monthly income. The second requirement is that not more than 36 percent of your gross monthly income can be tied up in the total monthly house payment and payments on long-term debt. In the preapproval process, a lender will examine your finances and will make a preliminary statement on the size of the loan for which you’ll qualify. This is called a preapproval letter and is a valuable tool to have in hand when it comes time to negotiating with a seller. Being preapproved lets the seller know that you have gone through a financial evaluation and there should be no unexpected obstacles to buying the home. It makes your offer much more powerful. Plus it will give clarity on your closing costs.

I am happy to provide referrals to a good knowledgeable lender or you can research lenders yourself.