Planning to Buy a Home

Here's an easy, high-level view of things to think about and know when buying a home. You will also find useful tips the following articles: Steps to Buying a Home, How much can I Afford?, Getting a Mortgage, What's the Process, Home Buying should be Approached as a Well-Planned Business Project! and also visit the Tools section for handy mortgage calculators.

How does a bank decide if we get a mortgage or not?
There are many factors that go into the bank's decision, from how long you've been at your job to how many credit cards you carry. The most important thing lenders look at, however, is your ability to meet your obligation to them, which is a function of your income and debt levels.

To gauge your ability to pay, lenders look at a pair of numbers called the "housing ratio" and the "total-obligation ratio."

They're not as daunting as they sound. The first is just the percentage of your gross monthly income that you'll need to spend on housing expenses after you buy the new home. It includes your mortgage payment, taxes, insurance and maintenance. Lenders will want to see a ratio of 28% or lower. The total-obligation ratio, meanwhile, is the portion of your income that goes to covering both your housing expenses and any other obligations, such as credit cards, car loans and child support. There, your lender will want to see a ratio of 36% or lower. Both of these ratios are often negotiable upward.

How much cash are we going to need?
These days, not much. Ideally, you would have enough cash for a 20% down payment, closing costs equal to about 3% to 5% of the purchase price, and enough left over to cover two or three months of monthly housing expenses. That gives you a big chunk of equity in your house upfront and makes the lender happy -- something that usually translates into a better deal. The trouble is, coming up with that much cash can be all but impossible for many first-time buyers. After all, we're talking $40,000 on a $150,000 loan or $70,000 on a $250,000 mortgage.

The good news is that lenders over the last couple of years have become increasingly willing to finance as much as 95% or even 97% of a home. The reason: They can now unload the risk of such loans onto somebody else. To limit their exposure, many lenders regularly sell their loans to the Federal National Mortgage Association (Fannie Mae), which then bundles them into securities which are eventually sold to investors. It used to be that Fannie Mae only would buy loans for 80% financing. But it recently standardized the lending criteria for 97% financing and will now buy these loans, making lenders much more willing to provide them to you. It's now common for first-time buyers to put down only 5%, or $7,500 on a $150,000 loan.

While this sounds enticing, remember that puny down payments have their price. First of all, you start with very little equity in your home. Also, if you don't have 20% to put down, you'll probably have to ante up for mortgage insurance (which protects the bank against default and can top $1,000 a year if you put 5% down on a $200,000 loan).

If you are buying in an urban area or have low to moderate income, look into programs offered by your city or state that provide below-market loans with little or no down payment required. If you're really cash-strapped, you can get 100% financing by "piggy-backing" a second loan equal to 20% of the purchase price on top of your 80% loan. But that 20% second mortgage will come at a much higher rate.

Just what are mortgage points?
Lenders and home buyers are constantly referring to "points" when talking about mortgages. This is a fancy term for the considerable fees you pay when you take out a loan. One point is equal to 1% of your loan amount. So, if you need a $150,000 mortgage and you have to pay one point in fees, that charge equals $1,500. Lenders refer to points variously as loan-origination fees, discount fees or buy-down fees.

Like the interest you'll pay each month, points are essentially finance charges -- only you pay them up front. Lenders blend them with interest rates to come up with the characteristics of the loan. For example, the more points you pay up front, the lower the interest rate the bank will charge you over the course of the loan. Also, like interest, points are 100% tax deductible in the year you pay them.

How long after we apply will we get the money?
These days it can take anywhere from two weeks to two months to get a loan commitment from the bank, depending on how complicated your application is or how flooded your lender is at the time you apply. If your loan is fairly standard, you should be able to get a commitment within two to four weeks after you apply.

Once the lender says it will give you the money, you'll probably still have some hoops to jump through. Most commitment letters come with certain conditions that you'll have to meet, like providing more financial information or submitting to a final inspection of your property.

You won't actually get your hands on the money until you close the deal, usually a week or two after you get final approval from the bank. Don't dawdle. Loan commitments expire about 45 days after you receive them and the rates and terms you agreed to may have to be renegotiated with the bank. All in all, you should count on it taking six to eight weeks from the time you apply until the home is yours.

How do we know the house won't fall apart?
You won't know for sure until you move in, but the best way to protect yourself is to hire an experienced home inspector to check the house's structure and systems, including the roof, heating, plumbing, electrical and air conditioning systems.

The cost of a home inspection ranges between $250 to $500. If you can, have the home inspected after you agree on a price, but before you sign the contract and put down a deposit. If you are in a rush to go to contract to lock in the deal, make sure your contract states that the terms of the purchase are conditioned on the approval of a professional home inspector.

Just because you need to hire a pro, doesn't mean you can't do some checking around yourself before you make an offer. Check for soft spots in the flooring and look for freshly painted patches on the ceiling or walls that could be hiding water damage. Turn electric switches and water faucets on and off. If it's summer, turn off the air conditioning and turn on the heat to make sure it works. Likewise, if it's winter, test out the air conditioning. Tour the basement looking for water on the floor and see if the hot water heater looks rusted or cracked. A little diligence before you start negotiations could save you a lot of time, effort and disappointment.

We've got a deal with the seller. Now what?
Now it's time for your attorney and the seller's attorney to create a formal contract that includes the specific terms of the deal. Maybe the seller agreed to give you certain things or you agreed to give the seller certain things. These are all included in the contract. Your attorney will also order title searches and other final documents required by the bank and to schedule the closing -- the time and place where cash and ownership of the property changes hands.

The closing can take an hour or two and requires the presence of eight to 10 people -- you, your attorney, the seller, his attorney, the bank, its attorney, and the broker. You'll spend the bulk of the time signing documents and endorsing certified checks. This can all be pretty scary for a buyer, but rely on your attorney -- they are working for you. Make them earn their fee.

This is where you can expect to shell out the bulk of the cash. Along with the rest of the down payment, you'll have to cover an assortment of fees known collectively as "closing costs." Lenders are required under federal law to give you a "good faith estimate" of all these charges and you should come ready to pay with a certified check. If your bank requires mortgage insurance (which is likely if you aren't putting at least 20% down) you'll also need to pay the first premium. Ditto for homeowners insurance.

Be sure to inspect the home right before you actually close the deal. Make sure it is in good condition and any property, such as light fixtures or built-in bookcases that you were told you would get with the house are still there. All the appliances should work and it should be broom clean. After the closing is over, have the locks changed and the home is yours.

When do the tax benefits come in?
You've heard again and again how buying a home is the best tax break around. Maybe you've even been called a chump for renting. After all, paying $1,200 a month for your mortgage is really the equivalent of paying $900 a month in rent. But how does that work exactly?

Here's the deal: Mortgage interest (including points)and real estate taxes are tax deductible. That doesn't sound very sexy, but it adds up. Since most of what you pay for your mortgage in the first years is interest, on a $1,200 mortgage payment you get to deduct about $1,080 a month. That reduces your taxable income by about $13,000 a year. If you're in the 27% tax bracket, that deduction is worth a little under $300 a month.

To see the benefit, you can either wait for a big payout after you file your income-tax return, or adjust what is withheld from your paycheck each month. Claim additional allowances on your W-4 form and your paycheck will jump immediately. You'll have to do the worksheet on the back of the W-4 form to figure out how many additional allowances you can claim. But using the above example, you could take two or three more.

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