I’ve been meeting with lots of First Time Home Buyers lately, and it seems there is still a lot of frustration and confusion out there, even with all the tips and articles on the internet. Lots of websites out there can get pretty detailed, but I've noticed that most first timers need the basics more than anything! (i.e. - loans, credit, debt ratios, etc.)
So, here is a quick guideline that serves as an informal “Home Buying Checklist” for first-timers, novices, and even experienced home buyers. When I sold mortgages, we simplified home buying and making loans into what we called The Five C's: Credit, Cash, Capacity, Collateral, and Characteristics. From these five categories, we were able to cover the majority of topics involved in real estate transactions.
1. Credit – What does your credit look like?
The moment the idea of buying a house crosses you mind, you need to be on the computer checking your credit. Why is this so important? Because dealing with credit score issues takes a long time. Depending on the severity of credit issues, it can take weeks, months or even years to fix! Your main job as a home buyer is to make the bank’s decision to lend you money the easiest decision they’ve ever made. This starts with having a good credit score. So pay your bills on time and keep your credit card balances low. So, even if you plan to buy a year from now, get to work on your credit today.
2. Cash – Do you have enough for a down payment?
Unless you’re a veteran getting a VA Loan, you need a down payment which is a large sum of money. At the absolute minimum, you’re looking at 3.5% to 5% of the price of the house. Just remember, the more you put down, the less you pay each month. This is for two reasons: First, the loan amount will be less, so the payments are smaller. Second, the bigger the down payment, the smaller your mortgage insurance (also called PMI).
The bank can relax when you make a bigger down payment. The way they see it, you’re more “invested” in the house and less likely to just walk away. If you can put 20% down, the bank won’t charge you PMI at all. That’s why you hear about 20% down payments in real estate so often. It’s the bank’s magic number. This is a lot of money, so start saving right now. Or, start sucking up to a rich relative who might give you the down payment as a “gift”. Or, be safe, and do both.
3. Capacity – Can you afford the mortgage?
Here, we’re talking about the monthly payment versus how much money you make. This is one of the trickiest areas of getting a loan since the debt ratio cutoffs have very little wiggle room, and if you’re self-employed, your income is subject to interpretation. If that’s not confusing enough, every lender has different ratios, and worse the same lender can have different ratios depending on the type of loan.
As a rule of thumb, if your mortgage payment (including taxes and insurance) is more than 40% of your total income before taxes, you might be in trouble. If you’re thinking on buying a house, you should be talking to a lender as soon as possible to see if your income (both, the type and the amount) satisfies their requirements.
4. Collateral – This is the house itself.
There are a lot of old houses out there, and people enjoy updating and renovating them after they buy a new home. Just make sure the house is livable now. The bank is going to send an appraiser over there, and if there are pressing issues like leaky pipes, termites, or worse, foundation problems; the lender might just cancel the whole thing. Also, in certain areas of L.A., there are “bidding wars” going on, so the prices are being driven much higher than what the house might reasonably appraise for.
And if you didn’t know, Lenders won’t lend a penny more than the appraised value, period. This is not a big deal if you’re paying cash or have a giant down payment, but if you’re on a budget and can’t make up the difference between the agreed upon price and the appraised value, that’s the ball game.
5. Characteristics – Are you doing this for the right reasons?
Why are you buying? Is it your first home? Upgrading? Downsizing? Moving across the country? Did you graduate college and get a new job? Is this a vacation house, investment, rental? There are lots of “gray areas” to consider when buying a home, from both the buyer’s and the lender’s point of view. Especially after the housing crisis, underwriters pay a lot more attention to the “Characteristics” of the purchase more than ever, and depending on the lender, these details might receive a lot of attention and make or break the loan, or receive very little attention thus not helping your cause. From the buyer’s perspective: Do you really need to buy right now?
Would you be better off waiting another year? If this purchase is for your primary residence, forget about making a profit because it isn’t an investment. While it’s important to remain fiscally responsible, try leave the “return on investment” out of the equation because finances and emotions don’t mix. So make sure you’re buying for the right reasons.
Contact a Real Estate Agent Now!
It is a fact, that due to the advent of certain real estate websites, buyers are starting the process earlier, but bringing in agents and other professionals much later into the process than they used to. This actually makes it harder on the buyers! Why? Two main reasons:
"Some Day" Mentality - Some buyers start searching for houses online and reading articles about real estate very early on. Since they start looking so early, they never reach the sense of urgency to 'get their ducks in a row' with everything they need to make an offer. This Some Day mentality turns Buyers into Spectators!
Over-Saturation of Information - There is way too much unreliable or unrelated information out there. If you are a buyer in Los Angeles, and you're not talking to a living breathing L.A. real estate agent, you're getting the wrong information. Don't believe me? Where else will you read the words "Starter Home" on a $500,000 listing?
These are just a few of the basic ideas that buyers should keep in mind when they first decide to buy a home. Few ideas of many... There are many more important facts to understand, and there are lots of other conversations to be had before buyers are ready to make offers on homes.