So, You Want to Buy a House?

So, You Want to Buy a House?

Part One-of-Many:

Buying a home is one of the most gratifying things you can do.  It is the corner stone of building a personal net worth.  Living in an apartment or a rented house has a temporary feel about it; not unlike moving into your dorm room your freshman year in college.  Home ownership creates a feeling of stability and is a major boost to the psyche.

Like the famous Chinese proverb, the path to home ownership begins with the first step.  In this, and the series of posts that follow, I hope to guide you down that path.

Online Information:

I searched this topic extensively; the results were paltry (including some nationally know “debt free” advisors). Everyone glazes over the topics without offering substance; I’m going to change that.

Search online, “How to Buy a House”, and you’ll see 545,000,000 hits.  Much of it is not great advice.  “Find a good agent”, says one adviser, but gives no direction how to do that.

You’ll find, “Nine-steps to Buy a House”, “10 Steps to Buy a House”, “6 Must-Do’s Before Buying”, “8 Key Steps…”, and the list goes on.  Anyone who attempts to read all those lists would probably close their browser and head out for pizza and beer. (Not altogether a bad idea!).

Not surprisingly, most of the hits are from people/companies who offer a service.  There’s nothing wrong with that of course, as long as you recognize that they hope to sell you something so keep their advice in perspective.

 Real No-Cost, No-Obligation Information:

I am an independent third-party; I don’t have a horse in this race.

I’m Tom Caruthers.  I’ve been involved in California real estate since 1978, when I worked for a commercial developer.  I got my real estate license in 1981.  Beginning with small commercial properties, I shifted to residential and got my broker’s license in 1995.  I no longer list or sell real estate, so I’m not trying to snag you as a client.  We will talk about how to find a good agent, but that won’t be me.

I also spent several years in mortgage lending.  My first loan was for $2 million.  Can you imagine that?  Most lenders would jump up and shout!  I did.  Then the S&L crisis tanked the market in late ‘80s and that was the end of that.

Later, I spent several years in residential lending and found that people buying homes aren’t as patient as investors buying shopping centers.  I don’t do that anymore either, but I am well versed in the industry.  We’ll talk about the different loan programs and the pros and cons of each.  I’ll offer some advice on how to find a good loan officer but, again, that won’t be me.

Okay, what’s the catch?

I’m a general contractor; I specialize in home-improvement programs using FHA and Fannie Mae financing; specifically renovation and energy upgrade loans.  One of the best kept secrets is, you can find a good house in a good neighborhood, that needs some fixing or upgrading, and you can finance the cost of those improvements into your home loan.  You pay less than the average value for the neighborhood and, when you’re done, you have the nicest home on the block!

I will insure you are intimately familiar with these programs.  If you don’t know FHA from Fannie Mae, fear not; you will before we’re through.

My goal is to educate you from a safe perspective.  If, when you are ready to buy, and the service I provide could be a benefit to you, I hope you’ll consider me.  If not, no harm; no foul.  But at least you’ll be prepared.

Okay, let’s begin:

Get into a Home Buying Mindset

A home buying mindset consists of several things:

  • Get your mind, and arms, around your, and your family’s spending habits. When you are ready to apply for a home loan, you may be surprised at how detailed it will be; it’s a far cry from getting a car loan.  The mortgage company will want two-years tax returns, two-months bank statements (all pages, all accounts: checking, savings, IRA, 401k, etc.), and last two paycheck stubs.  And, you must continue to provide those documents as they come available during the escrow process.
  • You are asking the mortgage company to loan you several hundred thousand dollars. They want to know if you are going to make your mortgage payments.  To arrive at that decision, the mortgage company will generate your credit profile.  Including your credit score; they want to see how you manage your money.  Paycheck stubs show how much is coming in and the credit report shows how much is going out to credit cards and installment loans, such as your car payment.  Bank statements show how much you have saved and how much you spend on debit cards.  They put it all together and arrive at a decision.
  • If you have a credit score above 700, and plenty of money* in the bank, you will likely get the lowest interest rate available.  If your credit score is below 700, and you don’t have plenty of money* in the bank, you may likely get a home loan but the interest rate will be higher.
  • *Plenty of Money is a relative term.  The mortgage banks have a condition they call reserves.  Reserves means, you still have an amount equal to at least three-months house payments in your bank accounts after you have made the down payment and paid all the associated closing costs.  Depending on your circumstances, that can add up to a lot of money.

Other facts which are important when preparing to apply for a mortgage loan:

  • Know what’s on your credit report: There are three credit reporting bureaus: Equifax, Experian, and Trans Union. You should see all three reports; they will be similar but not identical. Your lender will order a “merged” report which is one report with information from all three bureaus. You don’t want any surprises.  If you see inaccuracies, you have the time to write a letter of explanation including your proof of the inaccuracy before you ever get in front of a mortgage loan officer. This is especially important if you have a common name; the Jim Smiths of the world are constantly writing letters to correct inaccurate information. Getting erroneous information removed from your credit report takes time. Better to do it now while there is no clock ticking.
  • Don’t pay off any debts yet and, certainly, don’t incur any new debts. There is a science to managing debt. The oldest current account carries more weight than the newest. Also, it’s a good idea to carry revolving debt balances at or below 30% of the credit line.  If you want to chip away at an account, start with the one with the lowest balance and get that at or below the 30% line and keep it there.
  • A Note about credit repair agencies: Technically, they are a shell game.  They can’t get any legitimate information removed but they can get the credit bureau to remove it for a rule violation.  If you dispute information on your loan file, in writing, the credit bureau has 30-days to investigate the matter.  If bureau can’t prove the information is accurate within that time period, they must stop reporting it.  The scam is, credit repair agencies urge you to write letters to the credit bureaus on the Friday after Thanksgiving, when America starts the Christmas shopping season, whether the information on your credit report is legit or not; this is not about ethics.  The credit agencies are swamped with new credit applications because of the holidays and often don’t have the resources to investigate challenges to existing reports.  If the bureaus have not investigated the challenge within 30-days, they must remove the item from your report.
  • The federal government requires the three bureaus to offer a free credit report to you once a year.  The three bureaus launched a website, www.AnnualCreditReport.com.  You can get a copy of all three bureau reports there.  NOTE: This is not an endorsement of this website.  An online review search gives it low scores.  I personally tried it and was only able to retrieve an Equifax report; TU had technical difficulties and Experian couldn’t confirm my identification but gave me a letter to print and mail for a hard copy.
  • Two-years on the job or history in your industry: If you are just out of college and got a great job in Silicon Valley, with a starting salary of $150,000 a year, hurrah for you.  You probably can’t get a home loan for two years; the mortgage bank needs to see stability. If you’ve been working at Facebook as a programmer for three years and got a better job at Google six-months ago, you shouldn’t have a problem because you show stability in your profession.  Besides, who wouldn’t leave Facebook if you had a chance to jump to Google?
  • Know you Debt Ratios: Mortgage banks use two ratios as guidelines; the front-end ratio and the back-end ratio. The front-end ratio is your total housing expense divided by your monthly gross income (before taxes). Housing expenses are principle and interest payment, property taxes, homeowner’s insurance, mortgage insurance and association dues if applicable.  If your total monthly housing expenses are $1,000 and your gross monthly pay is $3,000, then your front-end ratio is 33.3%; get it?

    The back-end ratio is your total consumer debt (credit cards, car payments, student loans, child support, and anything else that shows a monthly payment on your credit report), plus your housing expense, divided by your monthly gross income (before taxes). If you have a $200 car loan, $50 student loan, and $100 in credit card bills, that will total $1,350 including your housing expense.  Based on your monthly income of $3,000 your back-end ratio is 45%, get it?

    Here is an exercise for you: First, add up your total monthly consumer debt (minimum payment required as reflected on your credit report).  Second, calculate 42%* of your gross pay and subtract your consumer debt number to arrive at a housing expense number.  Divide this number by 6.50 x 1,000.  That is a very rough estimate of the price you can pay for a home.

Copy of Backend Ratio Example

    
Example:
Monthly Gross Pay$7,500
x42%$3,150
Monthly Debts:
(2) Car Payments900
MasterCard/Visa75
Student Loan250
Misc.150
Total$1,375
Difference$1775
Divide $1,775 by 6.5, multiply by 1000 to arrive at estimated purchase price: $273,077

 

This is a great example of how consumer debt drives the deal.  In this example, if a family could pay-off some of that consumer debt, the amount they could borrow increases dramatically.

Few people are mortgage ready at the moment they decide to buy a house; most take some time to get their finances in order.

My best advice is to learn to budget your money.  That topic is too broad to cover it here, but Amazon sells the book, Managing Your Money, All-in-One for Dummies.  http://tinyurl.com/z9tk7au.   It’s a good place to start and you need to start managing your money if you want to buy a house.

Next week we’ll talk about neighborhoods and mortgage lenders.

See you next Tuesday…

About Tom

Tom Caruthers holds a California General Contractor’s license, a California Real Estate Broker’s license, and a Private Pilot’s license with an Instrument Rating. Tom has worked in residential and commercial real estate, residential mortgage lending, and residential home improvements since 1978. Please leave a comment in the section below.

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