8 Steps to Homebuying
MOST OF WHAT YOU NEED TO KNOW BOILED DOWN INTO 8 STEPS!
Buying a home today is much more than finding a house you like and then figuring out how to pay for it. Many are naïve to, and often over-whelmed by, the massive number of details that need to be addressed or even the vast number of professionals you will encounter, learn from, and engage to get into your home.
Education, transparency, and communication can be the most important components to reducing your stress and streamlining the process of securing your home. This guide book is designed as a compilation of basic information plus the expertise accumulated through the experience of more than a dozen professionals in a wide range of disciplines that surround the home buying process.
I have broken it all down to eight steps, all of which are crucial in their own way.
STEP ONE: SECURING YOUR FINANCING
As you begin contemplating the prospect of being a homeowner, the first question you need to answer is how much of a payment can you afford. More than merely the sales price of the home, you need to consider the components of your mortgage payment (the Principal & Interest on your mortgage, the Real Estate Taxes, the Homeowners’ Insurance and maybe Flood Insurance based on the location and Mortgage Insurance, depending on your down payment and loan program). Your lender can help you know how much of a payment you will qualify for; however, you will need to consider other factors among which are:
Utility costs for heat, electric, water, etc.
Repair and maintenance costs (home improvements to landscaping)
Family size and ages (food, clothing, medical expenses, etc.)
Personal expenses for cable television, internet access, phone service, etc.
Lifestyle choices (times you go out to dinner or go on vacation, as examples)
So, even before you talk to a lender, you should get comfortable with an amount you can pay every month. Remember, that there are tax benefits to owning a home. It is a good rule of thumb to project that about 20-25% of your mortgage payment will come back to you in lower income taxes. (Of course, consult with an accountant for your personal numbers.)
Since most home buyers will need to borrow money to buy, it’s important to know what a lender looks for in approving your mortgage application. There are four main criteria that will be examined, often referred to as the “Four Legs of the Table”. They are:
Your Income- which represents your ability to repay the loan
Your Credit- which is indicative of your commitment to living up to your responsibilities
Your Assets- which is a combination of your cash invested into the transaction, as well as the reserves you will have after closing
The Appraisal- the collateral upon which the lender will rely on should there be a default
There are two points that need to be made at this juncture.
First, lenders do not require you to be perfect in each of the four legs. Rather, they look at the sturdiness of your “table”- the four legs together. Borrowers with weak credit may need stronger income or more money in the deal, as examples. Be honest with your loan officer and let them help you highlight your strong legs and mitigate the challenges with the weaker ones. Let’s be honest. Your lender is going to find out your challenges. Confronting them early is in everyone’s best interest.
And the second point is that because your income, credit and assets can all be disclosed and verified now, they should be- before the search for a home begins. In that way, you can shop with the confidence that an appraisal and clear title are the only potential pitfalls, after you find your home of choice. This is often referred to as getting pre-approved. A real solid pre-approval is one in which the loan officer analyzes the same documentation that the underwriter will require. While too many loan officers issue pre-approval letters based on what you tell them, as op-posed to what you show them, top-notch loan officers will take a critical look at the actual documents that the underwriter will review for three of your legs:
Income
Pay stubs, W2s, 1099s, and your Federal Tax Returns (all schedules) are universally asked for. For some borrowers, corporate re-turns, K-1s, and Profit & Loss Statements, Divorce Decrees, etc. must be provided.
Fluctuations (overtime, hours worked, bonuses, and such) must be explained and are looked at in the most conservative manner. Additionally, under-stand that if you are declaring Unreimbursed Expenses on your tax returns, often those write-offs will be deducted from your income before qualifying.
Income will be verified via a third-party (your employer, your accountant, and/or directly through the IRS).
Your income is used and compared to both your proposed housing expense
and your total debt picture after you close on your purchase. Lenders refer to these calculations as your “ratios”. The front ratio (your proposed monthly housing cost divided by your monthly income) is considered a strong leg at 30% or lower, while your back ratio (your housing costs plus your minimum credit card payments and installment debt divided by your monthly income) is strong at 40% or lower. Now loans are done at far higher ratios. Just understand that the other legs need to be stronger in those cases, but ratios in the 50% neighborhood are routinely done.
Credit
Lenders will run your credit report. They will obtain three different credit scores from three different credit companies. These scores are a fairly accurate, yet imperfect, predictor of future payment performance.
Your score (often referred to as a FICO Score) can range from 400 to about 850 with 680 considered average. A strong Credit Leg can get you better terms on your loan. Conversely, lower scores make you appear riskier, and a lender is likely to charge you more or require stronger income and asset legs to compensate for that risk.
The scores are composed of:
Your payment history (concentrating on the past 24 months)- 35% of the score
Your balances (as a ratio of your available credit)- 30%
Your length of credit history- 15%
The types of credit you have (mortgages vs. installment debt vs. bank credit cards vs. store credit cards)- 10%
The number and type of inquiries made to your credit report over the past 120 days- 10%
There are many “secrets” to optimize your credit score. Discuss them with your loan officer, and ask them for a link to our 45 minute online workshop that goes deeper into the subject.
Assets
You will need monies for four different buckets, when you buy a home:
The down payment is the difference be-tween the purchase price and the mortgage amount- which can be very different than the money deposited at contract signing.
Closing costs do vary by lender and by loan product, but not as much as you might think. Many closing costs are third party fees paid to the title company, governmental agencies, the appraiser, the lawyers and alike. Discuss these items in detail with your loan officer.
Pre-paids are the items you will pay for homeowner’s and flood insurance, establishing your escrow account for real estate taxes, and short interest.
Reserves are the monies left in your ac-count after closing. Some loan programs insist on reserves. Some do not.
As a general rule lenders will look for the funds to be in your account for two months prior to contract.
All large deposits (anything over $1000 other than obvious payroll) must be sourced.
The strength of your Asset Leg is a factor of the amount of your down payment, the amount of your reserves, and the source of all this money. Gifts and sellers’ con-cessions are methods of reducing the cash you may need. Structuring transactions in this way should be done by seasoned professionals because a misstep in how you source and shift monies can kill a transaction.
We just scratched the surface of what goes into your mortgage application. For more in-depth information, ask your loan officer how to check out our online workshop which is free and available 24/7 from the comfort of your own computer. Mostly, you should see the value of a Real Pre-Approval. Understand the confidence it gives you as you negotiate. Further, your loan officer can become an advocate for you, putting the seller at ease. Today, more than 30% of mortgage applications are denied, largely over items that should have been uncovered during the pre-approval. Don’t be on the wrong side of that statistic!
STEP TWO: LOCATING THE PROPERTY
Before you begin your search… all interested parties, who will have a say in the final choice, need to discuss the non-negotiable needs and wants. Decide, of course, on the number of bedrooms and baths you require, as well as the number of stories, the size of the backyard. But then, assemble a list of other features (a basement, a formal dining room, garage size, a fire-place, and so on). Organize them into “must-haves” and “like-to-haves”. Preparing this way will cut your search time significantly (and likely make the process less stressful and argumentative). A good real estate agent is likely to have a form for you to work off of that will organize your thoughts.
Similarly, a neighborhood analysis is worthwhile. Talk to an agent about the neighborhood’s features- shopping, public transportation, houses of worship, school and crime statistics- whatever may be important to learn ahead of time. Drive around the neighborhood at different times of the day to get a more comprehensive feel. Scout out your potential neighbors, their pride of ownership, age, family size and so on.
Property searching these days can be done via the computer, but it is best done in conjunction with a real estate professional. Hiring an agent to work for you has many advantages which will be explained in more detail in Step Three, but do not overlook the time they can save you by narrowing your search. The internet is a tremendous tool for previewing homes and eliminating them from contention, but you really need to visit a home, before you fall in love with (or dismiss) it. Pictures can be deceiving- positively or negatively. If a home has all your “must-haves” and some of your “like-to-haves”, schedule a showing with your agent.
Visiting the home- What should you look for? First, look beyond the decorations and furnishings. They will more than likely be leaving before you move in. Look instead for layout of the rooms, the flow, how your stuff might fit in. Then, keep an eye out for the condition of the home- water stained ceilings, cracked foundations and dated kitchens are obvious. But, check out other things like water pres-sure in the shower, the age of the oil burner, the musty smell in the basement and the integrity of the roof. Giving an unemotional opinion as to the condition of the property, may be another reason to consider hiring an agent to work for you. Sure, you are likely to have a home inspection from an engineer later, but that is an expense you may be able to avoid, if your eyes are open.
STEP THREE: MAKING AN OFFER
Many home buyers develop a rapport with an agent that shows them properties. They even become friends. They confide in them things like “offer X dollars to the seller, but we’d go up another x dollars, if we need to”. What they do not know is that unless they have signed an agreement to formally hire that agent to represent them, that agent- their friend they confided in- is legally compelled to disclose the entire conversation to the seller.
Because the agent is paid by the seller, their loyalty must be to the seller- in information they disclose and in the negotiations. It’s almost like going to court and confiding in your adversary’s attorney.
To protect yourself, you should explore Buyer’s Agency, wherein you hire an agent you like and trust, to represent you as you search, visit and negotiate on your behalf. Understand that it will not, in a vast majority of cases, cost you a dollar because the seller when they listed the home for sale has already offered a commission to the agent who brings a buyer. Your Buyer’s Agent will include their commission due them from you in the offer to the seller (as a replacement to the commission they had already agreed to).
With Buyer’s Agency you get experienced, professional guidance in your home search, neighborhood inquiries, the condition of the property, and above all, structuring your offer to the sell-er and negotiation for the best price and terms for you….at virtually no additional cost! Make sure you understand who your agent is working for. Listen. Since the seller is paying the real estate agent out of the sales price of the home you are buying, aren’t you really paying the real estate commission with your money? Shouldn’t you be represented?
STEP FOUR: YOUR ATTORNEY, THE CONTRACT & TITLE INSURANCE
Within the legal profession, too often lawyers themselves see real estate law as “easy”- like riding a bike. But too often we see lawyers with thirty years experience in other types of law look like a three year old just taking off the training wheels. They might be the best criminal lawyer, or patent lawyer, or bankruptcy lawyer, but real estate law has its own nuances that are only learned by doing real estate law. A big word of caution, do not pick an attorney because they are a family member or because the union you belong to can get you a discount or be-cause they are inexpensive. Take the referral of your real estate agent or a friend/family member/co-worker that has done a real estate transaction with them.
After you have successfully negotiated your deal with the seller though the agents, the binder is signed and sent to the lawyers. Typically, the seller’s lawyer draws up the contract based on the terms you negotiated (price, closing date, mortgage obtainment, etc) and put into the Binder. The contract is sent to the buyer’s attorney who makes any revisions you want, and you sign the contract. The contract goes back to the seller’s attorney. The seller reviews your changes, and if they are acceptable, they sign. Once both sides have executed, you are in contract.
Some items we recommend you discuss with your attorney for your contract:
Sales Price
Your Earnest Money Deposit
Closing Date (a firm date or “on and about date”)
Mortgage Contingency
Seller’s Concessions
Transfer Taxes
Real Estate Agents involved
Any repairs the seller may have agreed to
Certificates of Occupancy
In our market, the buyer’s attorney customarily orders Title Insurance. Title insurance guarantees to the buyer that the seller is authorized to convey the property and that it will be free and clear of any liens (mortgages, judgments, prior real estate taxes, etc.). The title company does numerous searches of the property and the individual people in a multitude of online and paper records in the various municipalities. Beyond negotiating and enforcing the contract, making sure your title is clean is an important function for the lawyers. When issues arise, the lawyers (and often the real estate agents) work in tandem with the lender to make sure all sides are happy and protected. Some of the more common issues are: a satisfied lien that has not been recorded, clearing of a foreclosure, and while the title company does not insure the Certificates of Occupancy, they do provide them from the town or municipality’s Building Department to the parties for everyone to examine.
STEP FIVE: THE HOME INSPECTION
ENGINEER’S INSPECTION / MOLD TESTING & TERMITE / PEST REPORTS
Many people enter into Step Five prior to Step Four. Others do both at the same time. Still others choose to wait for contracts to be signed because this step is the first where you will likely be writing a check. The inspectors looking for structural problems or mold issues or damage resulting from termites and other pests get paid for the work performed with no requirement that you close or even go to contract. For that reason, it is best if you can identify the big issues yourself…..to save time, money and disappointment.
Realize we live on an island. The dampness and climate virtually assures us of mold and termite issues. Next, the earth moves and homes shift over time, so cracks in the foundation are inevitable. Lastly, things wear out. Over time, roofs leak, heating systems need replacing, an so on. Your home is not likely to be without issues. Look to the professional inspectors to make you aware of problems and the costs associated with them. Remember, they are likely to point out even minor issues to “cover their behinds”, and be realistic about a home’s condition.
When looking for a home inspector, first ask your agent (especially if you have executed a Buyer’s Agency Agreement), as they know the experienced people. Ask for the Inspector’s credentials.
Are they licensed? What designations do they hold? What organizations do they belong to?
How many inspections do they do annually?
Do they have past clients you can contact?
What kind of guarantee do they offer? Do they carry Errors &Omissions Insurance?
What will the report cost and what will it cover?
Most inspectors will be looking for the structural integrity of the home, watching for health and safety issues (like mold), and projecting the future for heating and cooling systems and the roof, among other items. Be wary of inspectors who also want to do any corrective work. You want to be sure their recommendations do not have an impure motive.
Termites have been known to travel as much as two miles for food…..two miles! As you take a more critical look at a home you want to make an offer on, check around the front and back stoops, as well as around the boiler, as they are the most frequent points of entry, but also, keep an eye out for:
In the early days of spring, termites swarm and fly in groups of 300-500. They find a place to land (near a food source) and mate. While they mate, they lose their wings, so look for wings on the ground near stops and boilers.
Look for signs of prior treatment of termites…..like holes drilled in foundations or in the stoops.
Check for decks that are built over stoops as these are tough to examine, but common places for infestation.
Be wary of any place where there is direct wood to soil contact.
Ask your termite inspector for tips to prevent future problems (like making sure your gutters aren’t clogged and the water is easily being transported away from the home).
STEP SIX: THE MORTGAGE PROCESS & APPRAISAL
Many of the people you will work with during your home buying journey will professionally “disappear” after closing because they got their check. Not the case with your lender. The closing is the beginning of your up-to thirty year relation-ship. Lenders just want to lend you money and have you pay them back at the agreed to terms in a timely fashion. They are not in the real estate business. They are in the money business. So the seemingly crazy things they may ask for, are not intended to torture you. They are purely designed to give the lender comfort that you will repay the loan, and give them protection should you not.
Because you were so diligent in providing your income, credit and asset documents for your pre-approval, much of your work is already complete. After signing the contract, you will bring your updated pay stubs and bank statements to your loan officer and fill out the formal application. While your pre-approval was general in nature because there was no defined house yet, this application will be more precise, in terms of numbers.
Literally dozens of disclosures and a Good Faith Estimate of Closing Costs will be generated. Don’t be intimidated by the amount of paperwork. But, make sure your loan officer can explain these things they are asking you to sign. Too many people just sign. That’s not to say you should be overly analyzing either. You should have picked your loan officer (like your agent and your attorney) because your trust that they have your best interest at heart. Too many see a mortgage as a commodity that they should shop for the lowest price. Smart people quickly learn the cost of cheap advice, and instead choose to work with experts over the lowest costs provider.
Your loan application is accepted by the lender and given to a Loan Processor. Their primary function is to verify the provided information in terms of your income, credit and assets. And to anticipate the questions the underwriter will have (and sufficiently answer them). Good processors are technically strong and proficient. They assemble a clean file for submission. Great processors are also great communicators, taking the time to explain the “why?” behind some seemingly illogical requests. Great processors are putting together a complete story that makes the under-writer comfortable with you as a borrower. Sometimes taking an extra day, getting another sup-porting document, can save you time and aggravation. Work with your processor, they are on your side (despite the way it may feel sometimes).
During processing, we introduce the fourth leg of your table- the appraisal. The appraiser is an independent third-party who is there to protect both you and the lender. The appraiser will give his educated opinion of the home’s value by comparing it to other home sales (making adjustments for different home sizes, condition, and location), by determining the costs to rebuild the home, and even potential rental income the home could generate. Overall, a home’s value should be “the price a reasonable buyer would pay a reasonable seller”. The appraiser is not an engineer, they will point out areas of concern from a health and safety standpoint, as well as a guesstimate as when things may need to be repaired or replaced. The appraisal will insure that you are paying a fair price and that the lender’s collateral is credible.
After the processor, your loan is sent to underwriting. We look at under-writing as the “speed bump” in the process- a time to slow down and take some caution to make sure we should proceed. The underwriter evaluates the legs of your table and can either:
Approve the loan as submitted
Conditionally approve the loan, subject to more information or documentation
Suspend the loan until more information or documentation is provided
Reject the loan
If there is more work to do, the loan processor and the loan officer will work with you to satisfy any requests from the underwriter. When the underwriter’s questions are answered to their satisfaction, they will issue a “Clear-To-Close”.
During Step Six, you should be in regular contact with your loan officer for status of your file, and in determining the optimal time to lock in your inter-est rate. Rate lock discussions should take into consideration:
Your anticipated closing date, your contractual closing date, and your worst-case closing date
Your ratios, as higher rates lead to higher ratios, and potentially could put your approval in jeopardy
Current market conditions an likely future movements are important. Many loan officers are hesitant to discuss the future, but you should ask for their opinion because they should have an educated one. Loan officers who can’t discuss the markets and current geopolitical events are not advisors. They are order takers. Search out the informed. Now, no one will be 100% accurate in their predictions, but common sense says knowledgeable people are more accurate.
STEP SEVEN: INSURING YOUR ASSET
Most of us hate the idea of insurance on any level. You make payments with the hope of never needing it. We pay health insurance and pray not to get sick. We pay auto insurance and hope to never get into an accident. But, at the same time, we have all heard the horror stories of people who got sick or crashed their car, only to not be insured. And because it’s something we don’t really want, people too often look for the cheapest solutions, rather than the proper ones. Like in most financial choices, finding the cheapest (or paying for the most expensive option) is usually not the best decision. Instead, with insurance, you need to ask questions (because it is not a “one size fits all” situation) and find a balance of cost and cover-age.
When purchasing a home, there are three basic choices you need to consider:
Insuring the asset (your home) against fire, weather, flood, etc.
Insuring the contents inside that home from damage or theft
Insuring the payments of the mortgage should there be a death or disability
Honestly, your lender only cares about the first one. They will require you to have homeowner’s insurance in force to protect the collateral. Most lenders like your coverage to be sufficient to pay off the mortgage, but will settle for language in the policy that calls for “full replacement costs”. If you are in a Federally-designated Flood Zone, your lender will insist on you having flood insurance, as well. A good insurance agent will discuss the difference between “full replacement costs” and “actual cash value”. They may even suggest Flood Insurance even if you are not in a Flood Zone, because it is inexpensive. Paying a few bucks more might become a very wise choice.
Because your mortgage does not cover your furniture, electronics, jewelry and other valuables,
coverage is technically optional. However, as you will quickly learn, should you ever make a claim, coverage and your documentation of items are crucial. Receipts, even photos and video) stored securely can both streamline your time and maximize the monies you will receive. Carefully, discuss your assets and review the amount of your coverage and deductibles every couple of years, as things change.
Lastly, life and disability insurance is a good idea, yet one rarely discussed prior to buying a home. Life insurance, disability insurance and a will are unpleasant to think about and stressful to pay for, but the best protection you can have…..and you should have it.
STEP EIGHT: THE CLOSING
A day or two before closing, you will do a final Walk-Through of the property. Generally, you are looking to see that the condition of the property is what you and the seller had agreed to in the beginning. This is not a point to try and renegotiate the deal (unless there is a major problem). Things to keep an eye out for: Have any repairs required been made? Have any items (like appliances or fixtures) been removed that were supposed to stay? Did the removal of furniture and personal property result in any damage? Test each faucet for hot and cold water. Check for any leaks under sinks and tubs. Flush the toilets. Are windows and doors opening, closing and locking properly? Appliances working? Cabinets and drawers functioning properly?
The scheduling of the closing is typically coordinated by the attorneys, once your mortgage application is cleared to close and any title issues are resolved. If everyone has done their job, your closing should be a stress-free event where you sign a pile of papers and write a lot of checks. You will literally be overwhelmed by paperwork. In the end there are four main documents you and your attorney will focus on:
The Note is your personal promise to repay the lender. Check the names of the people guaranteeing payment, the interest rate and the terms (15 or 30 years, for example).
The Mortgage is your pledge of the home as collateral for the loan. Check the names as they will have to be identical to the names on the deed, as well as the address and legal description of the property.
The Deed is the document that transfers ownership from the seller to you. Check the names and legal description. The original deed and mortgage will be taken by the title company for prompt recordation at the County Clerk.
The HUD-1 is a summary of the monies as they move around the closing table. It reflects the sales price received and the expenses of the seller, in addition to the funds and expenses for the buyer.
Most of the people you have worked with (your agent, your lawyer, the inspectors, appraisers, processors, loan officers, and such) will grab their checks at closing, wish you well and move onto their next deal. The best of these professionals will continue to go deeper with your relationship. They understand that helping you physically get into the home, get up-and-running and become part of the community is truly what they get paid for and earn referrals from.
So, look to your real estate agent and your loan officer for referrals to even more professionals you may need after closing!
THIS CAN BE YOU NEXT!
CLOSING DAYS ARE THE BEST DAY!
#HAPPYHOMEOWNERS
