Even in the current low interest rate environment, the cost of purchasing a home is growing. The cost of financing a home continues to increase, as is the complexity of the mortgage market. It can be the biggest financial decision an individual makes over the course of their lifetime.
The process of buying can be daunting. It requires some basic knowledge about money, interest rates, risk, housing market dynamics and risk. It also requires the ability to compare the pros and cons of buying vs. renting.
Within the mortgage market itself the buyer needs to choose the set of terms that is a best fit to their lifestyle. This includes the selection of a fixed vs. variable rate mortgage or a term that lasts 15 years or 30 years.
Any curriculum that addresses home ownership should include material on:
- How you buy and sell a home – an overview of the entire process
- The types of mortgages available
- How to shop for a mortgage
- How to apply for a mortgage
- Income requirements
- How to discriminate between the many home buying choices including the ability to measure value gained vs. dollars spent
Many of these topics are discussed below.
The Advantages of Renting vs. Buying a Home
There are several advantages to renting a home. These include:
- Lower monthly costs than is involved in paying a mortgage
- No responsibility for property maintenance
- Lower tax obligations
The disadvantages of renting:
- No accumulation of wealth as you pay off a mortgage
- Restrictions imposed by the landlord
- Unpredictable increases in monthly costs through annual rent increases
- Reliance on others to make repairs
- No control over neighbors that live on top of or below your unit
- No interest tax deductions
Buying a Home
There are several advantages to buying a home:
- Tax benefits
- Control over where you live and how it looks
- Savings and economic gain
- Obligations to maintain a home such as painting and appliance repair
- Unexpected expenses such as water damage
- Insurance obligations
- Losses from downturns in the housing market
- Inability to sell at the desired price
The Retail Mortgage Home Buying Process
There are several phases a homeowner goes through when purchasing a home. These are:
- Outlining requirements: determining the size of the home, desired location, and budget. Options include a single-family home, condominium or multi-family homes. Properties that are in some state of disrepair are available for a lower cost than those that are in move-in ready condition.Location based factors have a strong influence on home price:
– Accessibility to public transportation or highways
– Distance to shopping or downtown areas
– Public school quality
– Distance to religious institutions
- Shopping: looking at and comparing properties that are a the best fit or compromise for the requirements
- Negotiating: making an offer and coming to an agreement
- Obtaining financing: comparing mortgage rates and costs among different lenders such as banks and loan originators such as Freedom Mortgage
- Signing the Mortgage: concluding the purchase process with the help of an attorney and a title search
The Mortgage Application Process
Because of the complexity, a new homeowner may need assistance with understanding the loan process. They need to understand how to avoid unscrupulous players that may not be exercising a fiduciary duty to protect the borrowing.
- Getting an estimate for the home to be purchased that is acceptable to the lending institution
- Pulling together the funds for a down payment that is at least 20% of the purchase price
- The impact your credit score and work history has on the price of the mortgage and on your ability to borrow
- How to compare offers from multiple brokers or banks
- How to complete a mortgage application and manage the process
There are many types of mortgages available. Homeowners should outline what is important, such as a lower down payment or monthly payment, and then shop for the kind of loan that meets their needs.
|Conventional||Options include the term (15, 30, 40 years) as well as being a fixed rate or variable rate mortgage. A conventional conforming mortgage that meets certain standards is backed by a quasi-government agency and can offer lower rates. Conventional loans feature a stable and equal mortgage payment over the life of the loan. The payment amount does not change month to month.|
|Government-guaranteed||These programs are put in place by the U.S. government to encourage home ownership among lower income groups or special groups such as the Armed Services. The Veterans Administration or the Federal Housing Authority (FHA) backs these loans.|
|Balloon Mortgage||A balloon mortgage starts with small payments. These lead up to a large amount at a predetermined point in time. These loans keep payments low for 3 to 7 years and then require full payment for the outstanding loan balance. Homeowners that are not planning to stay in a home longer than seven years can benefit from these types of retail mortgage programs.|
|Adjustable Rate Mortgages (ARM)||An ARM uses a low initial rate to keep payments low. The loan adjusts along with increases or decreases in interest rates. Since the loan originator takes less risk in loaning money, these loans cost less than taking a fixed-rate mortgage. The time when the loan adjusts and the standard it adjusts against can differ by the loan. For someone that prioritizes lower costs in anticipation of a higher salary down the road, this could be the best option. It could also be advantageous in periods of high-interest rates where rates are expected to come down over time allowing the borrower to benefit from this reduction.|
|Graduated Payment Mortgage||A graduated payment mortgage starts with smaller payments and then gradually increases those payments according to a preset schedule. This type of mortgage is ideal for a young family that expects salary increases along the way. They can buy more house than they could potentially afford since the initial payments are within their budget. There are risks that as payments rise, their income will not keep up.|
|Growing Equity Mortgage||This type of mortgage is designed to pay down the home faster than the term. The payments increase over time but are applied to the equity in the home. This reduces the amount owed in interest at an accelerated pace, allowing the homeowner to eliminate the mortgage note on a faster timetable. The same effect can be achieved by paying a conventional mortgage bi-weekly (26 payments) instead of monthly (12 payments).|
|Buy Down||A buy down occurs before a mortgage is finalized. The borrower pays a sum of money up front in exchange for a lower interest rate on the mortgage.|
|Shared Appreciation Mortgage||While not common, it is possible to share the appreciation in the home with another person or institution such as the bank. In exchange for financial assistance or better mortgage terms the borrower can choose to allow the lender to share in the home value when it is sold.|
|Interest Only Mortgage||As the name implies, this type of mortgage allows a borrower only to pay the interest on the loan. An interest only mortgage is akin to renting for the price of interest, with no accumulation of principle. The advantage is that it gets the borrower into a home when they may not have the financial resources to actually pay down the loan amount. When the home is sold, the lender is repaid, assuming the value of the home equals or is greater than the amount borrowed. If it is not worth more than the outstanding blance, as was the case in the recent financial crisis, then the borrower is what is termed “being under water” with the loan.|
One last thing to know is the concept of pre-qualification and pre-approval. Being pre-approved makes the purchase process easier to navigate. The lender will certify what you can borrow. Sellers will prefer to sell to someone that they know can make the required payments. The pre-approval process also guarantees the rate you would pay if you meet the requirements of the bank or lender.
Note that there are several types of financial institutions that offer mortgages:
- Retail mortgage lender such as Freedom Mortgage
- Credit unions
- Banks and savings and loans
The Cost of Home Ownership
Budgeting is an important part of the home buying process. There are many costs that a renter may not account for.
- Property taxes
- Insurance (homeowners, fire, storm)
- Costs to maintain the property such as landscaping
- Any fees paid to neighborhood associations
There are several types of closing costs that impact the price of purchasing a home.
- Commissions paid to the realtor
- First 30 days interest on the loan (paid up front)
- 1st loan payment
- Fee to inspect the property
- Fee paid to a title insurance company that guarantees that the home is lien free (obligations from the current home owner that have not been paid and tied to the house such as a home equity loan). Called title insurance.
- Points paid to reduce the interest rate paid on the mortgage
- Appraisal fee
- 1st months property taxes
- Attorney fees to review any contracts and for managing the home purchase process
How to Make an Offer on a Home
Once you find the perfect home, the next step is to make an offer. Here are several considerations before making an offer:
- Is the home in poor condition or move in ready?
- What repairs need to be made immediately?
- Has the home been on the market for several months? If yes, make a lower offer.
- Why are the sellers moving? Are they in a rush?
You do not need a real estate agent to make an offer. On a piece of paper you can outline the terms of a sale:
- Name of the purchaser and home owner
- Address of the home to be purchased
- List any items that will be staying in the home such as custom furniture
- Amount offered
- Amount of any deposit n the home that is paid once a Purchase and Sale Agreement is executed
- Deadlines for completing the mortgage process
- Contingencies such as the home being subject to a satisfactory inspection
Ideally you would work with a realtor and a lawyer to finalize these types of documents.
Selling a Home
While the focus of this article is the home buying process, selling your home also has several steps that are worth reviewing:
- Preparation of the home so that it can attract the maximum value possible. It is common to replace any worn carpets and make visible repairs. A home stager can be hired who can modernize furniture and the way the home is arranged.
- Comparisons to similar homes to determine a competitive selling price. Considerations include home location, quality of schools, accessibility to public transportations, the overall appearance of the neighborhood, tax rates, and many other factors.
- Determining if you want to sell the home yourself or higher a real estate agent. Realtors have access to buyers and can vet those individuals before showing them your home.
Every homeowner has to do an individual assessment of the benefits and disadvantages of home ownership.