A NO NONSENSE GUIDE TO BUYING A HOME HOW MUCH YOU CAN AFFORD AND HOW TO FINANCE IT. 1
Buying a home is a major financial commitment that requires a review of your life insurance coverage. I encourage you to speak with your insurance agent or an SBLI representative about how SBLI can help you secure the life insurance you need to protect your loved ones. Best wishes for a wonderful financial future. JONATHAN POND JONATHAN POND is one of America s most trusted and knowledgeable financial experts and a pioneer in bringing low-cost personalized money guidance to American households. His work in educating the public on financial matters has been far-reaching and widely recognized. His 16 prime-time public television specials and 21 books have been critically acclaimed for their effectiveness in providing useful and understandable financial guidance to people of all financial circumstances. The comments and opinions expressed herein are solely those of the author and do not reflect the assent of SBLI or its officers, agents, or employees. SBLI and The No Nonsense Life Insurance Company are registered trademarks of The Savings Bank Life Insurance Company of Massachusetts. NAIC #70435 2013 The Savings Bank Life Insurance Company of Massachusetts, Woburn, MA. All rights reserved. 2
Buying a home is no simple task especially if it s your first home. In fact, many firsttime homebuyers get at least mildly taken, for two reasons: first, they get so attached to the home they want that they can t negotiate effectively. Second, they re uninformed about the many nuances of the real estate market. I can t help you if your emotions get the better of you, but the following information will help you become a more informed buyer. The Down Payment One of the major barriers to buying a house is the down payment. It may be as low as 5 percent of the house value, but usually it s closer to 10 or 20 percent. So, a $200,000 house may require an initial expenditure of as much as $20,000 to $40,000, plus closing costs. Closing costs may be as high as several thousand dollars, including loan origination fees (also known as points) of typically 1 to 3 percent of the mortgage amount. ARE YOU FINANCIALLY PREPARED TO LOOK FOR A HOUSE? Looking for a new home can be exhausting as well as emotionally trying. You re forced to face the financial reality of what you can and cannot afford. Before you begin your search for a new home, it s important to evaluate whether you re in a position to buy. It s also important to remember that the 21 st century family has less home-purchasing power than the generation before it did. Many first-time homebuyers have to settle for a house that s not as nice as the one they grew up in. But the most important thing is to take that first step and own your own home or condominium. You can always trade up in the future. Warning: Don t count on last-minute ways to accumulate a down payment like calling your parents and begging for a loan. In most cases, you ll still need to convince your lending officer that you re financially stable and capable of good personal money management. Figuring Out The the Amount of Of House House You Can Afford The amount you ll need for a down payment and closing costs depends on how much house you can afford in other words, how large a mortgage you can carry given your current income and debt. Here are some guidelines: Your monthly mortgage payment should not exceed more than one and a half weeks worth of your take-home pay. 3
Your monthly mortgage payment should not exceed 28 percent of your net monthly income or 32 percent of your gross monthly income. Your total monthly debt obligations, including the mortgage, should not exceed 35 percent of your gross monthly income. The table below can be used to estimate your monthly mortgage payment. For example: if you re thinking of taking out a $180,000, 30-year mortgage at 7 percent, you would multiply $6.66 by 180 to determine that your monthly principal and interest payment would be approximately $1,199. Remember that this estimate does not include real estate taxes or homeowners insurance. Please note that bank lending guidelines may vary depending on the size of your loan and other criteria. It s smart to check with more than one lender or ask a mortgage broker to help you choose an appropriate mortgage lender. PAYMENT PER $1,000 OF MORTGAGE LOAN INTEREST RATE 15 YEARS 30 YEARS 6.00% $8.44 $6.00 6.25% $8.57 $6.16 6.50% $8.71 $6.32 6.75% $8.85 $6.49 7.00% $8.99 $6.66 7.25% $9.13 $6.83 7.50% $9.28 $7.00 7.75% $9.42 $7.17 8.00% $9.56 $7.34 MORTGAGE CALCULATOR Monthly Payment of Principal & Interest = Interest Rate (from chart) x Length of Mortgage (in months) Example = $6.66 x 180 months = $ 1,199 Your Total = $ x 180 months = $ 4
Let The Banker Work For You One way to determine how big a mortgage you ll qualify for is to contact a bank or mortgage company in your area. Let them know that you re planning to buy your first home and ask for an informational meeting to discuss the mortgage application process, types of mortgages available, and an estimate of what size mortgage will be available to you. Lenders are eager to lend to good customers and may preapprove a loan for you which can enhance your bargaining power when you find the right home. Outstanding Debts Banks look at your whole financial picture, past and present. If you have outstanding debts, the bank will figure in the amount you owe monthly to make sure that your total monthly debt obligations, including your mortgage payment, won t exceed about 35 percent of your gross monthly income. Before you apply for a mortgage, pay off as much of your consumer debt as possible. That includes everything from credit cards to car payments to student loans. The less money you owe, the easier it will be for you to qualify for a mortgage. Check Your Credit Score A clean credit report for at least two to three years is an important part of getting the mortgage you want. Before you apply for a mortgage, get a credit report and address any outstanding issues or errors. If you have credit card accounts that you haven t used in years and don t plan to use again, close them. Money In The Bank Many banks will require that, in addition to the required application costs, down payment, and various closing costs, you have at least two months worth of mortgage payments in a savings account. HOW TO SEARCH FOR A HOME The decision to buy a particular home depends on several variables, the most common of which are: Location Is the home convenient to work, shopping, school, and recreation? Is the general neighborhood declining or improving? How heavy are the property taxes? Are there any crime or pollution problems? How good are the local schools, community facilities, and services? Type of Home Are you looking for a traditional single-family house, a condominium, or a multifamily home? An older home or a newer one? Typically, newer houses are more expensive and have more conveniences, but they may also have structural problems or inferior construction compared to older homes. Old houses, however, may be less energyefficient and may require considerable maintenance or repairs. 5
One of the best places to begin your search is to read the real estate section of your local newspaper or its online version. You ll find extensive sale listings by town and may also find articles about specific neighborhoods. If you haven t yet narrowed your search to one or two communities, you ll be able to tell from the asking prices of homes which communities you can and can t afford. You ll Location can play a key role in the appreciation value of your home. also get a sense of what types of homes single family, multifamily, etc. are available in various neighborhoods. Location, Location, Location? Many people think location is all-important, but affordability is just as crucial to consider. A location s advantages have to be weighed against home prices in that area. Keep in mind that one of the benefits of buying as opposed to renting a home is that you re building equity in it. Location can play a key role in the appreciation of the value of your home. One strategy many experienced homeowners use is to buy a less desirable home (smaller, less well-situated, a fixerupper) in the best part of town. about the advantages and disadvantages of the community. You can also ask them to recommend a real estate agency or two; then and make requests for informational interviews with a few local real estate agents. Realtors The first and most important thing to remember about realtors is that they represent the seller, not you (the buyer). Nevertheless, good realtors know the fair market prices for the homes they are selling. The difficulty is that like all salespeople, realtors have their own best interests at heart, and if they can get you to pay a few thousand dollars more than the next guy, so much the better for them. As long as you understand a realtor s position in a sale, you will probably benefit from using one. Buyer s Brokers Some real estate agents have switched camps and work exclusively for buyers. Known as buyer s brokers or buyer s realtors, these real estate professionals negotiate the purchase price on the buyer s behalf. A buyer s broker may also be able to help you determine the areas where affordable housing exists. They charge either an hourly rate or a percentage of the selling price of the home that you purchase. Contact any acquaintances who currently live in or have recently moved from the area that interests you, and ask them Other Important Considerations There are other factors that you must weigh in your decision about what type of house you want. Two of the most important are: 6
Size Determining the optimal size of the house you want requires a projection of your future needs. Is your family likely to grow, or is it likely to shrink as your children leave the nest? The size and the layout of the house may also influence its resale value. Length of Stay If you anticipate staying only four or five years in a neighborhood, you may have different priorities from someone who plans on a permanent stay. If you plan to move within a few years, the house you purchase should be easy to resell and the size and location should fit the demands of the market more than your specifications. MORTGAGES Types Of Mortgages There are almost as many types of mortgages as there are types of homes. The two main types are fixed-rate and adjustable-rate mortgages. A fixed-rate mortgage is a loan whose rate of interest does not change during the life of the mortgage. As a result, your loan payment will be a constant amount. An adjustablerate mortgage is a loan whose interest rate fluctuates throughout the life of the loan. 1. Thirty-Year Fixed-Rate The old-fashioned thirty-year fixed-rate mortgage is still desirable, particularly if you can lock in a low interest rate at a time when interest rates are low. While an adjustable-rate mortgage may offer a lower interest rate at first, the security of knowing that your monthly payments will never change is important to many homebuyers. 2. Fifteen-Year Fixed-Rate With a fifteen-year fixed-rate mortgage, your monthly payments will be higher than with a thirty-year fixed-rate mortgage, but the total interest you pay out over the life of the loan will be substantially lower. A fifteen-year fixed-rate mortgage is a good idea if you can afford the higher payments. If you want to turn your thirty-year mortgage into a fifteen-year mortgage at no cost, just make sufficient additional principal payments each month so it s paid off over a shorter period of time. You can also cut your mortgage-repayment period down by taking out a biweekly mortgage a mortgage structured such that you make payments twice a month instead of once. 3. Two-Step Mortgage A two-step mortgage is a variation of the thirty-year fixed-rate mortgage. There is one fixed rate for the first phase of the loan typically five to seven years with a one-time adjustment for the remaining life of the loan. If you are planning on moving before the first phase expires, consider this option. 7
4. Adjustable-Rate Mortgage (ARM) If you re thinking of staying in your home for only a few years, an adjustable-rate mortgage is probably a good idea for you. Adjustable rate mortgages (ARMs) are most beneficial when interest rates are low and are expected to stay low. With an ARM, the interest rate and, therefore, the monthly payment changes based on a financial index, which means that payments can and will change. The frequency of the interest rate change is spelled out when you take out the mortgage, but typically varies from six months to three years. The initial interest rate of an ARM is typically lower than those of fixed-rate mortgages. While this is attractive, payments can increase, sometimes sharply, if the index on which the adjustable rate is based increases. If the initial ARM rate is superlow, you can rest assured that it will rise when the loan rate is first adjusted. Many adjustable-rate mortgages have rate-of-payment caps, which means that your monthly payments won t go through the roof all of a sudden. However, you ll need to keep an eye on changes in the financial index or you may be caught unaware by a substantial increase in your monthly payments from one year to the next. Coming To Terms With Points Comparing mortgage terms is one of the most perplexing tasks for the homebuyer, due in large part to the impact of points on total carrying costs. Each point equals one percent of the loan amount. When comparing mortgages, one general rule of thumb is to equate each point with about 0.25 percent on the interest rate. For example, an 8.5 percent loan with two points is roughly equivalent to an 8.75 loan with one point. The significance of points diminishes as the period of time you own the home increases. Difficulty Obtaining Mortgages Due to the increasing number of foreclosures and the frequent practice of reselling mortgages on the secondary market, lenders are following strict guidelines in approving mortgage applications. In some areas housing prices are so high that people can t get large enough mortgages and are shut out of the housing market altogether. In other areas, depressed home prices may make lenders wary. Bottom line: It s more important than ever to know your credit score and have a good credit history before you begin your home search. Getting The Mortgage You Want You have a much better chance of arranging for a favorable mortgage if you have a good working relationship with a bank and if you have a clean credit history. You should get to know a personal banker or mortgage broker and keep that person informed of your 8
financial status. Even if you are not currently interested in purchasing a specific house, your banker should be able to gauge whether you are capable of carrying a substantial mortgage and may even be able to bend a few rules if you re a good customer. Nevertheless, you should check with as many other local lending institutions as possible. Mortgage Shopping In addition to scrutinizing lenders fees, you should compare mortgage rates. Ask your realtor, buyer s broker, or mortgage broker to search for a suitable mortgage not just locally, but beyond your local area. You may be able to get a better deal from an out-oftown lender. Be sure that your agreement doesn t include a mortgage prepayment penalty... Lending institutions vary both in the interest rates they charge and in mortgage terms and closing costs. Be sure that your agreement doesn t include a mortgage prepayment penalty, so you have the option to repay your mortgage early, either with a lump sum or with periodic additional payments. If you have good credit, don t hesitate to try to negotiate concessions on the loan terms. THE PURCHASE AND SALE AGREEMENT A purchase and sale agreement (P&S) is the contract between a buyer and a seller that specifies the terms and price of the sale. Of course, the negotiation between buyer and seller occurs before the purchase and sale agreement is prepared. Negotiations are the time to hold your emotions in check. You obviously want the home, but until you have bought it, it s just a house. If this is the first time you have purchased a home, be sure to enlist the assistance of family members or friends who have purchased houses in the past, who may be able to provide more objective advice. Prior to signing the P&S and forking over the deposit, you should probably ask an attorney to review it. You will want to include some contingencies in the agreement, typically including obtaining the financing (which will require the lender to appraise the property), a satisfactory home inspection, and a clear title. These are discussed on the next page. 9
APPRAISALS Appraised values are what bankers, realtors, buyers, and sellers use as their standard to determine acceptable and unacceptable bids. If you are a potential buyer but are uncertain whether the asking price on the home that interests you is reasonable, spend some money and get an independent appraisal of the property from a qualified appraiser. 1. The Foundation A solid foundation is a must. Be sure your inspector knows his or her masonry. Ask when the foundation was made and whether and to what extent repairs have been required. Also, is the basement above or below the water table? You don t want to spend the rest of your days listening to the rhythm of a sump pump or dealing with serious flooding during storms. Don t confuse appraisals with assessed value. The assessed value of a home is the value that the town or city places on the property to determine its property taxes. Assessed values are almost always lower than appraised values, except in areas where real estate values have declined dramatically and suddenly. There is also a valuation known as fair market value. This valuation is based on recent sales prices of similar homes selling in the same vicinity. INSPECTION You need to hire a professional home inspector to give the home you want to buy a thorough physical exam. Some of the items your inspector should report to you include: 2. The Roof The cost of roof repairs can run from a minor patch for $1,000 to a complete reroofing for $10,000 to $20,000. You can t determine the quality of a roof from the ground or from a ladder. The inspector needs to get up on it and get into the attic to track watermarks, damp rot, and more. 3. Windows Replacement windows can be very expensive. Consider the cost of replacement if the windows aren t insulated, for example, or are over fifteen years old the age when glass can become brittle. 4. Plumbing The inspector you hire should be qualified to examine the plumbing. If he or she isn t, hire a plumber to check all the pipes and waterworks. When were they installed? What repairs have been made? Are the pipe joints soldered with lead? It s expensive to replace or repair 10
pipes, and you should know the extent and cost of the damage before you commit to a purchase. The same goes for the electrical work and the heating and/ or air-conditioning system. 5. Environmental Concerns You can be held financially liable for lead paint and other hazardous or toxic materials on the property you purchase. In some states there are no disclosure laws that require the seller of a property to tell the buyer whether there are hazardous or toxic materials on the premises. Fortunately, most states do have disclosure laws to protect prospective buyers from unscrupulous sellers. But be careful don t discover a problem only when it s too late. TITLE SEARCH 1. Title Examination Once you have signed a purchase and sale agreement, you or the lender can conduct a title examination of the property. A title search is a routine investigation to prove that the seller indeed has the right to transfer title of the property to you. Usually, a professional abstractor examines the transfer-of-property records for the house, often tracing the chain of ownership back sixty years or more. If no irregularities in previous titles appear, the sale can be concluded. 2. Title Insurance In many areas, the lender requires buyers to purchase title insurance. This protects the lender against any defects that might appear in the transfer records, such as illegal transference or liens that supersede the transfer. Title insurance can be purchased from a number of insurance companies or through most attorneys. Usually, the buyer pays for it, although this item is sometimes negotiable. CLOSING THE HOME PURCHASE The closing, or settlement, is the legal closing of the property transaction. The buyer, the seller, the attorneys for both, the real estate broker, and a representative of the lender usually attend the closing. Here all legal documents (abstract of title and deed to property drawn up by the attorneys) are signed, and all fees are paid, including the broker s commission. 11
Closing costs add up. The fees you ll need to pay typically include: Mortgage Application Fee Depending on the lender, this can run from nothing to several hundred dollars. Origination Fee This is the fee that a mortgage department or company charges to process your loan. Mortgage Insurance Fee If you don t have a 20 percent down payment but you re still a candidate for a mortgage, you may be required to insure the difference between your down payment and the 20 percent figure. Appraisal Fee You pay a professional to assess the market value of your desired home for the bank. This starts at $150, with no ceiling. Home Inspection Fee This fee at least $150 is what you pay a professional to inspect the house for defects. Credit Report Fee You pay the bank to run a credit check that tells them how creditworthy you are. These checks start at $30. Bank Attorney Fees You pay the cost of the bank s legal work. Points These are paid at closing to the lender: one percent to three percent of the loan amount if the loan requires points. Many loans do not. (Two points on a $125,000 mortgage, for example, would be $2,500.) The following is a list of fees, categorized according to who usually pays them (although most of them are negotiable). Seller s Responsibility Buyer s Responsibility Negotiable Broker s commission Seller s attorney fees Seller s percentage of property taxes, insurance, and utilities Income tax from profit of sale State transfer fees Survey Buyer s attorney fees Owner s title insurance policy Title examination fee Financing fees Recording fees Appraisal fee Loan origination fee (commonly known as points, which are taxdeductible if paid by the purchaser) 12
A Final Suggestion Buying a home may be one of the best investments you ever make, but it also comes with financial obligations, including securing sufficient life insurance coverage to help surviving family members meet their housing obligations in the event you die early. I encourage you to speak with an SBLI representative about how SBLI can meet your life insurance needs. You can talk to an SBLI representative at 888.438.7254 or chat online at SBLI.com. Jonathan Pond NNG-Home813 13