Assuming you are following along with this series, you’ve read or listened through the buy or rent discussion and leverage and you’ve decided buying a home is a good decision for your financial future. Now what? Start looking for a home! Not quite yet, but I’m guessing that you’ve already done that and you might even have a few places in mind already. Beginning the search is important and looking through a lot of homes on Zillow is a good idea to you get a sense of what you like and the area you want to live in, but we need to cover the financial preparation before you start taking tours.
Step 1 – Credit Score:
You will want to do everything you can to improve your credit score with the goal of 760. If you have been renting you can use companies like RentalKarma to help increase your credit score because of your rental payment history. All of the credit score companies also offer options to increase your credit score for payments made for utilities and phone bills. I can’t stress the importance of your credit score but the math speaks for itself. For every 1% point of interest, you lose about 10% buying power. For example, if you were buying a $250,000 house and you have a 4% interest rate the total payments over 30 years will be $429,000. But if you have a 5% interest rate, total payments will be $483,141. That’s $52,468 (12%) more just because of your credit score.
Hopefully you start your credit score improvement process months before you start looking for your home so you have time to make sure you get the lowest interest rate available.
Step 2 – Choose Your Mortgage Lender:
Determine who you will use to provide you with your initial mortgage and get pre-approved. I recommend your local credit union, but you can also use sites like www.bankrate.com to show you the different rate offers from lenders and sometimes these are lowest rates available and they are lower than your local credit union. If you have a great credit, they all want to work with you. If you are a veteran, know you have additional programs available to you and you should take advantage of them.
Go through the pre-approval process to ensure you know what your budget is for your home. All of us always want bigger and nicer than we can afford, but knowing what you can get approved for gives you a ceiling and hopefully you choose to not go with maximum loan as you will need money for some other things you haven’t thought of yet.
Understand the mortgage products and which one is best for you. With rates so low, it is typically recommended that you go with a traditional 30-year fixed rate mortgage. This give you the best long-term solution because you don’t have worry about rates going up
Step 3 – Figure out your Down Payment:
As part of the pre-approval process the lender will usually discuss down payment requirements with you and where the money will come from for the down payment. If you are considered a first time home buyer there may be state grants to help or you may be eligible for a 3.5% down payment instead of the 20% down typically required. Typically the lender also wants this money to be “seasoned”, which is a fancy way of saying that the money has been in your bank account for at least 3 months and is designated for the down payment.
If you are going to get money from your parents or other relatives they will want to know the “form” of the money. Is it a loan or a gift? If it is a loan then that will affect the amount they will allow you to borrow as you would need to make a payment on the loan for your down payment loan as well as the mortgage payment.
If you are choosing to put down less than 20% then you will also have Private Mortgage Insurance (PMI). This is a required insurance policy and the cost of this policy will reduce the amount you can be lent. This is effectively just another cost, treated the same as home owner’s insurance and property taxes that are part of the payment you will have to make each month. The total payment will be limited to a percentage of your income.
Step 4 – Budget for the Home after Purchase
Remember, buying the home is only one step in your process of home ownership. Once you move into the home you will likely want to paint, buy new furniture, new drapes or other window coverings, new appliances and you may need some maintenance equipment including tools, a lawn mower, edger, etc. You might want to change the yard or update a bathroom.
Figure out your budget for the other items that will turn your house into a home. You don’t need to have the money up front to do everything, and in fact, very few us ever get to do all the improvements we want because it is expensive. Try to stick to your budget and have a category for miscellaneous for things you may not have thought about yet.
Step 5 – Find a Real Estate Agent
While you can do a lot of your searching on-line, finding an agent who is familiar with the neighborhood can be a big advantage. They can give you inside information to whether a particular neighborhood is on the rise or the decline, what schools are like in the area and typically they know how similar properties to what you are looking at are selling for and they can help you with the negotiation and getting to closing.
There is no single way to find a good real estate agent but a referral is always the best option. Most agents advertise with Zillow and Facebook, but ask around. You want someone familiar with the area you are looking to purchase.
Another word of advice when looking for an agent, make sure you get what you want. As buyer, you are the customer that every agent wants because you can make the transaction happen. As a pre-approved buyer, you are in the best position. What I mean by “you can make the transaction happen” is that agents are typically paid by the buyer at closing. What do you need to get to closing? A BUYER!!
You are the customer they want the most. They like representing the seller, but every seller NEEDS a buyer. No buyer, no transaction. That said, in a hot property market there are lots of buyers but in a normal or down market, the buyer is in demand.
Important Side Note on Real Estate Agents:
Understand that Real Estate Agents do not have the same incentives as you do. This doesn’t mean that an agent will not advise you as they should, it just means that incentives are not aligned. If you are the buyer, your incentive is to get the best deal that you can, ensure the home is worth what you are paying for it and that it is in good condition so you don’t have a lot of unexpected repair bills. A real estate agent only gets paid if the home closes, so their incentive is to get to close. If the home isn’t worth as much as the selling price or needs additional repairs, none of that will come of out of their commissions.
So how could this issue come up in the real world? Suppose you have looked at 20 homes, made an offer of $300,000 on the home you like, completed appraisal and inspection and you are at the final negotiation after inspection. The home appraised for $295,000, $5,000 less than your offer and you were going to put 20% down. To maintain the offer and get financing you will now have to put $65,000 down instead of $60,000. The inspection also found a few things that need to be fixed, but one of them is the roof and total costs are expected to be an additional $10,000. In total, this is $15,000 more than you were expected to spend.
Initially, your agent may discuss with the selling agent and see what discounts the seller’s are willing to give. The seller agrees to credit $5,000 for the repairs. Your agent tells you this is a good compromise, you’ve gone this far in the process, can you compromise a little and get the house you want?
In a very hot real estate market this could be good advice. If there are multiple offers and others are willing to pay the full $300,000 without discounts, then maybe the home is worth it. It will be hard to evaluate all of the information, but if you are now over your budget by $10,000 on your home purchase, then is it the right deal for you?
If you start over then you may be looking at another 20 homes again. This will take up a lot more of the agent’s time and is an incentive for them to try to get every offer made to close.
From the agent’s perspective, if you walk away, they get $0, until you find a home you want. And because they are paid a commission percentage, a lower home price actually means they make less, which always sounds weird because if incentives were aligned and they got you a better deal they would make more, but it doesn’t work that way. This is also true for the seller’s agent, who just wants to get a deal done as well.
I do not mean to imply that all agents are giving you advice on what is best for them, instead I’m just pointing out how incentives are not aligned and you need to know that so that you can weigh the opinion of your agent accordingly. If the deal is not what you want, walk away!
Step 6 – Find your Home
Now that you know how much you are approved to borrow, you have your down payment ready, you have a budget for after you move in and you have a real estate agent, you are now ready to start looking at homes. There is no magic advice for this part except be patient and trust your intuition. If any part of the deal doesn’t feel right to you, walk away. Let your agent do a lot of ground work for you, with the information on what you are approved to borrow they should be able to show you everything available. If your agent tries to get you to look at homes that are more expensive that what you are approved for, get a new agent. Remember, they are supposed to work for you and means not showing you things you cannot afford.
Watch my Youtube video on this!
I’m also open to answering your questions via email! Hit me up at dave@keepyours.org.