Starting the Process
These guidelines can help you to develop your own housing cost limits:
- First, calculate your provable gross income from your employment. Things such as overtime and bonuses that haven’t been regular for at least two years won’t be counted by a lender, but if you will continue to receive them, make a note of it for future reference as it may increase your comfort level. Consider too if a non-working spouse will be able to get a job.
- Next, calculate the total of your obligatory debt payments – car loan payments for example. If you are unclear about the exact numbers, get a credit report so you can use the same monthly payment numbers that your lender will. It’s a good idea to check your credit anyway.
- Finally, examine what you are now paying for housing, either your current rent or payment on your mortgage plus taxes and insurance.
Now you can calculate your own ratios. Here’s an example using simple numbers for ease of calculation:
Say your rent is $1,000 per month and your gross income is $3,300 per month. Your housing expense ratio is $1,000/$3,000 = 33%.
Next add your other expenses, say $300 per month. The total expense then is $1,300 and yourtotal expense ratio is $1,300/$3,000 = 43%.
A lender would say that your ratios are “33 over 43.” Note that these ratios are higher than traditional 28 over 36, but your mortgage might still get approved today.
Now think about how comfortable you are at this level. Perhaps you are single or have no kids and you are able to save money every month. There’s still some room in the budget even though the ratios are a little high. Other borrowers with the same numbers but with two children might feel terribly stressed on this budget.
Some lenders’ prequalification process is pretty basic –they’ll ask you about your income, debts and assets, and they’ll calculate a maximum loan amount and purchase price based on that information. Loan officers may not verify your information or check your credit rating. Other lenders will be much more thorough – there is no industry standard for prequalification.
Basic Prequalification Letter
Once the lender has completed its prequalification process (extensive or basic), it can issue you a prequalification letter. This is what you’ll give your real estate agent (if you have one) or the seller’s agent (if you’reshopping on your own). The basic prequalification letter says something like this:
To whom it may concern:
Ron and Cecilia Jones have been pre-qualified for a residential mortgage of up to $300,000 at an interest rate of up to 5.5 percent. This pre-qualification letter does not constitute loan approval or commitment to rate, fees, or term.Any misrepresentation in the loan application or adverse change in the applicants’ financial position may void this pre-qualification letter, as would a poor credit history by accepted standards.
A completed loan file with an acceptable appraisal must be provided for underwriting review before a loan decision can be made.
If you have any questions or would like additional information, you can reach us by phone at 888-888-8888 or via email at firstname.lastname@example.org
Notice that there is nothing in this letter to indicate that the would-be buyers are capable of being approved for a mortgage. It does,however, indicate that they’re not just looking on impulse; they have at least approached a mortgage lender about financing.
Mortgage Pre-approval Gets a Seller’s Attention
Pre-approval before home shopping helps borrowers in two ways. First, it helps place buyers’ focus on homes that are truly in their price range. Second, and more to the point, pre-approval can offer prospective homebuyers a leg-up over those who haven’t been approved for a mortgage.
Nothing can squelch a house sale quicker than having to wait for credit approval. A pre-approval letter from a qualified lender acts like an express pass. Sellers pay attention to offers from buyers who are pre-approved for a home loan because the sale is less likely to be delayed or fall through due to problems with obtaining mortgage approval.
What’s more, if buying a house comes down to a bidding war, the advantage goes to the buyer who has been pre-approved for a home loan.
Mortgage Pre-approval Requirements
Mortgage pre-approval is based on one’s fiscal health and the state of his or her credit. During the pre-approval process, mortgage lenders ask for proof of income and verify the applicant’s employment and credit rating. This means buyers submit documents like W-2 forms (proof of employment), copies of tax returns from the previous two years’ filings, and statements from savings and investment accounts.
Borrowers should be prepared to address any gaps in employment and explain past glitches in their credit history. Self-employed borrowers can expect to provide additional documentation such as profit-and-loss statements and business licenses.
Once a purchase offer has been accepted, the lender will finalize loan approval after the property has been appraised.
When More Isn’t Really More
Sometimes a lender may issue a pre-approval letter for a mortgage amount that is larger than the applicant anticipated. Those who are pre-approved aren’t obligated to borrow the amount shown in the pre-approval letter. Pre-approval indicates how much someone can borrow, not how much the borrower is necessarily willing to spend.
Prospective buyers are the best judge of their financial goals and limitations. In the long run, buying a home with a lower mortgage and monthly payment than that indicated on a pre-approval letter can provide financial flexibility. And buyers should consider requesting pre-approval letters with amounts tailored to match their offers — no point in letting sellers know that they could spend more.
Mortgage Pre-approval Expiration Date
Letters of pre-approval typically remain in effect for 60 to 90 days. Unfortunately, that may not be enough time in some cases. Situations that can delay closing of a mortgage include short sales, purchases of homes under construction, the need to complete repairs before closing and the seller’s desire for a longer escrow.
Buyers should forward their most recent documents — pay stubs, bank statements and the like — to their lender to keep their pre-approval in force through the entire escrow period and make sure they close on time.
- If a contract notes that you are entering into a dual agency agreement, that means the real estate agent and/or the firm the agent works for can represent both the buyer and the seller. Though illegal in some states, this is still quite common and can lead to conflicts of interest. This is a stipulation in a buyer’s agent contract that you want to avoid.
- If the contract doesn’t specify that it is strictly a buyer’s agent agreement, you should assume that the agent will be a seller’s representative — not yours.
- You are looking to sign an exclusive buyer agency agreement. It will detail all of the terms of your representative’s engagement: compensation, services and the length of the agreement.
- You may encounter a designated agent agreement. This is used when a real estate brokerage firm has one agent working in the buyer’s best interest, while another agent of the same firm may be working in the seller’s best interest. By signing a designated agency agreement, the buyer (or seller) allows another agent with the firm the ability to represent another party in the transaction. Individuals who are designated agents owe fiduciary duties to their respective clients (the buyer or the seller, but not both). This can work, but it can be a tricky situation.
- Remember, a buyer’s agent has a fiduciary duty to work only in your best interests. There should be language to that effect in any written agreement.
Upon signing an agreement with a buyer’s agent, it is the agent’s responsibility to disclose whether a conflict of interest exists, or if one subsequently occurs (such as representing another buyer interested in the same property as you are). At that point, an agent will often step aside and recommend another buyer’s agent to assist you.
ADVANTAGES OF WORKING WITH AN EXCLUSIVE BUYER’S AGENT
Having an exclusive buyer’s agent on your side means more than just helping you find a great home. Your agent will also:
- Use knowledge and experience to help you navigate local market conditions
- Act as an advocate for the buyer during the entire homebuying process
- Actively negotiate price and terms strictly on behalf of the buyer
- Prepare necessary forms and written offers
- Assist in procuring property inspections, as well as provide advice regarding necessary improvements and repairs
- Consult with the buyer about financing options
- Attend the loan closing to help address any last-minute details and questions
Choosing a Loan Type
ConventionalIdeal for borrowers with or excellent credit
- Cost: Closing costs, down payments, mortgage insurance
- What’s good: Conventional mortgages generally pose fewer hurdles than Federal Housing Administration or Veterans Affairs mortgages
- What’s not as good: You’ll need excellent credit to qualify for the best interest rates.
First-Time HomebuyerBest for homebuyers with small down payments
- Cost: 1.75% of the loan amount at closing
- What’s good: FHA loans are often the only option for borrowers with high debt-to-income ratios and low credit scores.
- What’s not as good: FHA mortgage insurance premiums usually are higher than premiums for private mortgage insurance.
VA LoanIdeal for active-duty military and veterans
- Cost: Funding fee varies from 1.25% to 3.3%
- What’s good: VA borrowers can qualify for 100% financing. Veterans do not have to be first-time buyers and may reuse their benefit.
- What’s not as good: There are limits on loan amounts. The limits vary by county.
Closing the deal
When searching for a home, it’s important to remember your wants, needs, and to take thorough notes.
Before your first walk-through, print a few copies of the checklist below!Print Checklist
A real estate transaction is much more complex than anything you’ve bought or sold in the past. There are piles of paperwork, volumes of laws and rules, and the general emotion involved with either buying or selling a home.
It’s not an easy process on either party, but it can be a smooth one if you plan and prepare in advance.
Price Bidding, Best Offers, & Bidding Wars
Making an offer on the home you want can be intimidating. Although there’s little risk of making a fool of yourself during the bidding process, you should play your cards right before you tip your hand.
Bidding below listing price
Bidding for a property below its asking price is very common during a buyer’s market. A buyer’s market occurs when there’s a surplus of homes on the market relative to demand from sellers.
Many experts advise against bidding more than 10 percent below the asking price. However, you can sweeten a relatively low offer price by guaranteeing the seller a quick closing and a large earnest money deposit. Or, if you accept the present state of the home without demanding free upgrades and repairs, you could sway the owner in your favor over other bidders.
Highest and best offer
Sometimes sellers or their agents get restless during negotiations and ask you to quote them your highest and best offer for the home, meaning it’s a take it or leave it contract and there won’t be a counteroffer. Don’t go out on a limb if you are not 100 percent sure you want this particular property. You can always reconsider if you feel you made a mistake after researching comparable properties.
Full price offers
There’s no shame in agreeing to pay the seller’s full asking price without bartering. If the home you want is worth its price tag, offer to pay the full asking price. Another buyer may show up five minutes after you eager to pay that difference, sending you back to your search for a perfect home.
Engaging in a bidding war for a property with other buyers can be stressful. As one of an unknown number of rivals in a bidding war, you’re blindly competing against each other. Neither you nor your agent will know how many offers the seller has on the table.
You may end up having to cough up a lot of extra cash for the down payment if you’re the winner with the highest bid. Instead, you could keep your cool and stay off the multiple offer- and counteroffer-carousel.
Sometimes all rivals for your dream home may call the bidding war quits. Who knows, the seller may then come knocking at your door to ask you to submit your purchasing offer. In that case, you’ll end up the real winner, possibly holding the power to barter with the seller for a lower purchase price.
Making an Offer & Offer Contracts
There are many parts to an offer and all of them are negotiable. Remember to choose your battles carefully. You can be flexible with some items, while firm on others that you have deemed non-negotiable. Expect the process to be a give and take.
Start preparing when you begin your home search and ask your agent for a blank copy of their standard contract. Familiarize yourself with its provisions and you’ll feel comfortable when it’s time to draft your own.
Most contracts have standard, or boilerplate, language. There will usually be space for you to fill in the exact terms and negotiating points of your offer. If you don’t want to fill in parts of the contract you can simply cross them out and they will be excluded.
Home Valuations & Appraisals
An appraisal is an unbiased estimate of what a buyer might expect to pay for a property. Most home buyers and sellers assume that when they agree to a home’s value, or fair-market value, it becomes written in stone as the contract price.
However, the real estate appraiser, usually hired by the buyer’s mortgage lender, comes up with his own value. This appraised value may be equal to, lower, or higher than the agreed price.
In determining a property’s current value, an appraiser will consider recent sales of similar homes in the area, comparing those that have sold recently – usually only in the last six months.
How the home appraisal process works
A licensed appraiser is contracted to provide an accurate estimate of a home’s value. If the home appraises for less than the contract price, the mortgage lender will only loan the amount of money that is based on the property’s appraised value. The buyer and seller must then agree on how the shortfall will be met. The buyer can put down more money, the contract might be modified to reflect the lower appraised price, or some combination of both.
The appraiser visually inspects the features, number of bedrooms, bathrooms, location, condition, remaining useful life of appliances, and other factors that could affect a home’s value. Rooms are measured, diagrams are drawn, photos are taken of the property, and then the appraiser prepares his report.
After the inspection, the appraiser establishes value by using either the cost approach or the sales comparison:
The cost approach takes available information, such as local building costs and labor rates, to determine how much it would cost to build a comparable home.
The sales comparison approach relies on recent sales in the area and assesses properties that are comparable in age, configuration, condition, and location, adjusting for unique features and nuances by raising or lowering the value.
The appraised value is then used as a benchmark for lenders who don’t want to loan a buyer more money than the home is actually worth.
Handling Counteroffers & Stalemates
There are three possible outcomes once a purchase contract is presented to the seller: they can accept the terms as initially presented and agree to the contract, counteroffer by modifying some or all of the terms, or reject the terms in entirety and either start over or walk away.
Savvy home buyers who understand the seller’s perspective can pay less or be granted more favorable terms in the purchase contract.
You may need to go back to the seller and ask for a closing date extension or inspection repairs, after reaching an agreement. In the end, goodwill pays dividends during these negotiations.
The counteroffer is the most common scenario in a contract. Many buyers and sellers like the back-and-forth of counteroffer negotiations. Be aware that some people have a low tolerance for prolonged negotiations. A good rule of thumb is to limit the back and forth to a few turns before reevaluating if you want to consider alternate properties, or give on some of your non-negotiable terms.
Sometimes negotiations arrive at an impasse, or a stalemate. If you developed a strategy, stick to it. Your strategy made sense when you came up with it and before the emotions started to kick in.
If you feel you can find something else, or can wait a little to see if the other party will budge, then take advantage of that flexibility. Don’t get stuck with a deal that makes you feel uncomfortable.
Never rush through negotiations. Contract acceptance can be a few hours or a few weeks. A good negotiation should take no more than a few days, with a couple rounds of counteroffers. Give reasonable response deadlines for all your counteroffers.
When you and the seller accept the terms through the counteroffer process it’s known as “acceptance”. Most states require all contracts and offers of price and other terms to be in writing. Each counteroffer should be presented in writing to the seller or their agent; avoid verbally throwing out a number to the seller.
At all stages of the buying process, keep a written record of negotiations between you and the seller, as well as changes to agreements made with any involved parties. In the heat of the home buying process, you may not remember that you wanted the seller to throw in his basement refrigerator or to check on the size and location of a high-rise condo’s storage unit.
Bottom line: develop a strategy and stick to it, but don’t let an amazing home slip through your fingers because of what you might consider to be a nominal difference in contract terms or price. Be diligent with your preparation and you’ll end up happy with the final agreement.
A property appraisal is an estimate of a property’s value. Property value is based on such factors as location, amenities, structural condition and recent sales of similar local properties.
A home appraiser conducts the process. The appraiser will do a walk-through of the property, noting anything that can alter the home’s value. For example, if the house has aswimming pool but swimming pools aren’t popular in the area, it might not add much value to the property—the pool might even detract from it.
The appraiser will sketch and take photos of the property layout and will look for any safety code violations. If there are any, you may need to fix them before the lender approves the loan.
Who Performs Home Appraisals?
Appraisers are third-party certified or licensed contractors, and the lender usually hires them. They are knowledgeable in real estate and are required to know how to evaluate a property on factors such as neighborhood growth, neighborhood housing trends and market conditions.
To be safe, make sure the appraiser is certified and deals with multiple lenders. If the appraiser only works with one other lender, he may have outside interests—and you may not receive a correct assessment.
Who Pays for Home Appraisals?
The cost of home appraisals depends on the property value, location, and size of your property. They cost a few hundred dollars and typically the buyer pays the fee at closing, although you can opt to pay it up-front. A good faith estimate—also known as a GFE—given to you by the lender will supply a fee for the appraisal.
A “drive-by appraisal” does not pay as much attention to detail as the walk-through, and most lenders will not accept this appraisal. Instead of walking through the home, the appraiser drives by the property and then researches real estate records to come up with an estimate.
These home appraisals are cheaper than traditional ones, but you should ask your lender if they will consider it before you purchase.
How Long Do Home Appraisals Take?
For most loans, a typical property assessment takes a few hours or less, and a “drive-by” assessment will take significantly less time. Turnaround time should be within seven business days, although a busy market can mean a longer wait.
The appraiser will give the final documents—called the appraisal report—to the lender, who is required to show it to the buyer. Make sure you obtain a copy for your own records.
Inspections are Optional
To those unfamiliar with real estate, it can seem like inspections are just what’s expected. Watching enough reality TV can give you the impression that everyone completes all of their inspections because they are waiting for a huge problem to arise (right in time for commercial break, of course). In the real world, it’s up to the buyer to decide which inspections they would like completed – if any at all.
Generally speaking, inspections are a great idea. They give you an idea of a home’s problems before you buy it and most times will allow you to negotiate with the seller to cover the cost of some repairs. Essentially, they give you an idea of whether or not you’re equipped to handle this property or if you should move onto another that better suits your needs.
However, there are a few possible exceptions: mainly condos and other living situations where the bulk of home maintenance is covered by an association. Before you decide to go this forgo the inspection make sure you’re aware of your responsibility when it comes to fixing problems that arise when you own the property. You should also check with your bank to make sure they don’t require one as a condition of the mortgage.
Buyers Are Responsible for Inspections
Most first-time homebuyers don’t realize that they are responsible for the inspections. This means that, in order to get to the settlement table, they agree to hire the home inspector, have the inspections completed within a reasonable amount of time, and shoulder the cost.
Remember to leave yourself a sufficient time to pick an inspector and bring him out to view the property. Trust us, a home inspection is not something you want to rush through last minute. Do yourself a favor and leave a little wiggle room since you’ll likely be putting that timeframe in a binding legal document.
Financially, you need to budget for the cost of inspection services. While your initial reaction may be to balk at the price tag and wonder why the seller isn’t covering this cost, paying truly is for your benefit.
Think of it this way: The home inspector really works for you, not the seller. He or she is there to point out all the potential problems in the home. Even though it would be extremely dishonest, if the seller were to hire the inspector, there is a chance of the two working together to falsify the report. Since the seller has no impact on the inspector when you pay, you can rest easy knowing your report is sincere.
The Inspector Must Be Certified
A home inspector and a contractor are not the same thing. While a contractor may have know how to fix existing home maintenance problems, home inspectors are specifically trained on how to identify problems, even if they are slight enough to be easily missed by others.
Every country has its own home inspection standards that must be met. But, the unifying factor for a sale to be considered legitimate? The home inspection must be done by a certified professional. While qualified home inspectors may cost more than a contractor, you’ll know that you’ve received a complete report.
As for how to find a home inspector, your realtor is a great place to start. He or she probably has a few reliable contacts from past transactions. The internet, is always another option. Either way, be sure to ask the inspector if they are certified and keep up with any continuing education credentials.
What Do Home Inspections Cover?
As a rule of thumb, think of a home inspection like a well visit to the doctor. Your doctor takes looks at several of your body’s individual components – reflexes, blood pressure, and medical history – to make an overall all determination of your health. Home inspectors work in much the same way.
Since every property is different, the specifics of what is checked during your home’s inspection may very slightly. But, the American Society of Home Inspectors (ASHI) suggests that qualified inspectors will check the following areas:
- Foundation and basement
- Any additional structural components
- Interior plumbing systems
- Interior electrical systems
- Heating and cooling systems
- Condition of windows
- Condition of doors and door frames
- Condition of floors, walls, and ceilings
- The attic and any visible insulation
What Doesn’t An Inspection Cover?
Of course, no single inspection is going to cover every aspect of your new home. Be aware that there are limits to what an inspector will check. To use the same doctor analogy, consider how some ailments require a referral to a specialist, who will give you a more in-depth examination.
Here are some areas that don’t often make the cut for home inspectors and may require another professional:
- Inside the walls
- Roof or chimney repairs
- Septic tanks
- Wells, sheds, or additional structures separate from the main house
Just because something isn’t covered in a home inspection, don’t think that it can’t be inspected. You may simply have to look into other sources. If there is an aspect of your new property that is giving you pause, do some research. Ask your realtor about the possibility of getting it checked out so that you can go through the rest of the transaction with confidence.
You Can Attend Inspections
Did you know that most home inspectors recommend that buyers attend their property inspection? They see it as an opportunity to thoroughly answer any questions that the buyers may have about the property’s condition. Most also will provide instructions on how to maintain the property after settlement.
In return for their instructions, it’s your job to be respectful of the inspector’s time. We know that it’s difficult to remain unemotional when it comes to buying a home – especially if unforeseen complications keep popping up – but do your best to keep your cool. Try to keep questions brief and refrain from fixating on tiny details. There will be time to negotiate repairs later.
One more important note: The inspector is not responsible for making any repairs, only identifying them. It’s considered rude to ask your home inspector to perform handy work. It’s better to ask them if they can recommend another professional.
Request An Inspection Report
Coming out to view the property is only half of a home inspector’s job requirements. After their site visit, they are required to provide you with an official home inspection report, which details their findings in writing. It should include pictures of the damaged areas as well.
If you’re working with a real estate agent, he or she should receive the report automatically, but it’s a good idea to ask the inspector to also send it directly to you. Once you have it in hand, make two copies. Use one copy now and save the other in your legal records – just in case.
Read it over thoroughly before you sit down to negotiate repairs. Don’t hesitate to ask questions if there is a portion of the report that you don’t understand or is unclear. We recommend taking a highlighter and noting which sections of the report that are most important to you. That way, it’ll be easier to refer back to them when you discuss repairs in the future.
Repairs After Inspections Are Negotiable
Unlike paying for the inspections themselves, who pays for the necessary repairs is up for discussion. There are three typical outcomes to these negotiations: the seller can perform the repairs before settlement, the seller can credit you money for the repairs, or they can become your responsibility.
Our suggestion for a successful negotiation: prioritize. If you send the sellers a long list of trivial repairs, they will likely become defensive and less willing to bear some of the cost. However, if you focus on a few, key points from the report, they will be more likely to assist you.
One exception to this is if a home is being marketed “As Is”. In real estate terms, “as is” means that, for whatever reason, the seller is unwilling or unable to make repairs. These types of properties will feature have a lower sale price to compensate for the lack of negotiating room. But, if you bid on one, you may want to pad your budget to include potentially extensive repair costs.
You Can Walk Away After Inspections
Let’s say that you get the inspection report back and it features something truly catastrophic like toxic mold or severe structural damage. Alternatively, let’s say that you and the seller have gone back and forth in negotiations and can’t seem to reach a satisfactory conclusion. What happens now?
Luckily, buyers have the upper hand in this scenario. As long as you respond to the seller within the inspection timeframe and have a legitimate reason (i.e. you found the repairs too extensive) you will likely be able to walk away from the transaction largely unscathed. Most times, the sellers will just keep your initial deposit as collateral.
It’s a different story entirely if you decide you want to leave after signing off on the inspection negotiations. While you’ll still be able to terminate the transaction, you’ll likely suffer a much bigger loss and you could even face legal action. Take the time to make sure you feel comfortable with your end of the bargain before signing any binding documents.
Collect Paperwork for Completed Repairs
After you’ve made it through the inspection negotiations, both you and the seller will likely have a long list of repairs to complete and, yes, pay for. Both sides may be tempted to do the repairs themselves or to call in a friend-of-a-friend to do the work as a favor. Don’t go this route – at least not for anything bigger than a leaky faucet.
Cutting corners at this stage could harm the transaction. Hire professionals to do the work and be sure to collect paperwork – repair estimates and invoices – as proof. Mortgage and title companies will ask for these documents at settlement. In the event that supporting documents cannot be produced, they would be within their rights not to grant you the deed to your new property.
It’s a good idea to keep the repair invoices after settlement as well. While no one wants to think about broken heaters and leaking pipes in connection to their new home, it can happen. An invoice could save you from having to pay for a follow up visit.
During the closing, or settlement as it may be called in your area, you will sign many documents. Some key documents that you will sign include:
- Closing Disclosure: This form contains the terms and costs of your transaction. By law, your lender must provide the Closing Disclosure to you three days before your closing.
- Promissory note: This document is your promise to repay the loan (mortgage) to your lender. The note provides details regarding your loan, including the amount you owe, the interest rate of the mortgage loan, the dates when the payments are to be made, the length of time for repayment and the where the payments are to be sent. The note also explains the consequences of failing to make your monthly mortgage payments.
- Deed of trust: This document, which may also be called a Security Instrument or Mortgage, transfers legal ownership of the property with the condition that the lender may foreclose on your home if you fail to repay your mortgage. This document restates the basic information included in the Promissory Note, as well as explains your responsibilities and rights as a borrower.
Congrats!You're officially a homeowner!