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t3knomanser's Fustian Deposits

Remy & Minna's Guide to Buying a Home, pt. 1

How Random Babbling Becomes Corporate Policy

run the fuck away

Mad science gone horribly, horribly wrong(or right).

Remy & Minna's Guide to Buying a Home, pt. 1

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run the fuck away
I'm putting Minna's name on this, but she may desire edits. Right now, we're in the process of buying our first home, and we've taken our time doing it. The main reason for taking our time: avoiding the mistakes so endemic to buying a home, and learning about the process. We initially started the homebuying process before leaving Albany, over two years ago. We've been engaged in homebuying ever since.

Homebuying

The Process

Before you can buy a home, you need to understand what you're in for. This is a high-level view of the steps:
  • Save
  • Find a place
  • Put in an offer
  • Get it inspected
  • Get a mortgage
  • Close

Each of these steps is surprisingly complicated. At every step, someone is out to rip you off. At least one someone, probably a bunch. The entire industry of real estate is built around ripping people off. So this homebuying guide is going to focus on avoiding getting ripped off, and avoiding the many pitfalls that most first-time homebuyers fall into. It's only through some good fortune that we've avoided some of them, and some education has helped us avoid the rest.

One note: this assumes that we're talking about conventional, fixed rate mortgages. For some people, an adjustable rate mortgage may make sense, but in most cases, it's a risky gamble. ARMs played a big role in the economic problems we're seeing today, so let's just avoid them and let people who have some experience buying and selling property worry about them. A first time homebuyer should never consider an ARM.

Homebuying Myths


You have to buy a home!


From now on, if someone tells you, "Renting is just throwing money away!", kick them in the groin. Hard. Renting is not throwing money away. Renting is a straightforward economic exchange. The property owner provides a service, and the renter pays a fair market value for said service. If you were homeless and paying rent, then you'd be throwing money away. You're paying money for a service.

The difference between renting and owning is that, when you own, some of your mortgage payment is becoming equity, which I'll discuss in a moment. Short version: you get to keep some of the money you pay into a mortgage, you keep none of the money you pay in rent.

This is true, however, renting gives you freedom that you don't get owning. If you don't like the place you're renting, you're stuck with it, at most, for a year. Maybe less, if there's good reasons for breaking lease. This means you can rent a place that you'll never be willing to own. For example, Minna and I have been renting a 1BR apartment, but we'd never buy a one bedroom place. In the long term, we want more space, but for now, we're willing to settle so that we can save money.

Homeowning builds equity!


This isn't exactly a myth. Yes, owning a home builds equity. The question is: is it a good way to build equity? Absolutely not.

Equity, simply put, is material wealth. It's money or property that can be turned into money. The cash in your wallet is equity. The money in your savings account is equity. Your car is equity. Anything you own with monetary value is equity.

Buying a home does allow you to build equity. Each monthly payment you make against your mortgage is split between principal (the money you borrowed) and interest (the bank's profit). The only part that is equity is the principal.

At the start of a mortgage, most of your monthly payment is interest. Very little of it goes against your principal. With each successive payment, you chip away at the principal, and slowly but surely, your interest payments drop. By the end of a mortgage, most of your payment is against the principal, very little of it is interest.

So, think about it. Which is going to build equity faster? Paying $1,000 as a mortgage payment every month, or paying $1,000 into your savings account. In the first case, most of that $1,000 is you paying interest, in the last case, the bank pays you interest.

Assume you can spend $1,000 a month for living space, and assume the best mortgage you can get offers 5% interest. Assume the best rent you can find is $500/mo. If you take out a $100,000 mortgage, your monthly payment is going to be $994, and for the first year, more than $500 of that is interest. After 14 months, the rental payment exceeds the interest payment. But go back to myth #1- you're willing to rent a place you wouldn't be willing to buy. What you can rent for $500/mo. is probably nicer than what you can mortgage for $1,000/mo. This, of course, varies by region and economic conditions. But remember: equity is just money. There are plenty of ways to save money, such as, saving money.

Note, above, I assumed that you weren't investing the money you saved by renting. If you did, it would probably beat buying for the first few years. This is important: renting, in the near term, beats buying in the same term, in most cases, in most economies. In the long term, buying may win. The NYTimes has a good rent vs. buy calculator. Plug in numbers, and you can see how long it takes for owning to beat renting. This graphic assumes a 30 year mortgage, but the advanced settings let you change that.

It's important to note: if Minna and I were happy living in a one bedroom apartment for the rest of our lives, owning would never beat renting. We would never actually save money by owning, unless rent or property value were increasing at much better than inflation.

The Intangibles make it worthwhile


This isn't a myth so much as personal preference. If you own a place, you can paint the walls pink. You can change the light fixtures. You can drill a hole in a wall, line it with silicone, and fuck the shit out of it, if you want. If you rent, you can't make many modifications, in general. It varies by landlord (my landlord in Albany didn't care what you did so long as it was reverted to rentable condition).

If you really want to have pink walls that you can fuck, then by all means, buy. But if you don't really care what color the walls are, don't figure intangibles into the equation.

Your Realtor is there to help


It doesn't get much more false than this. When you want to buy a place, you will often retain a buyer's agent to help you in the transaction. You probably should have a buyer's agent. But you should never, ever, trust a buyer's agent.

You won't pay a dime for retaining a buyer's agent, in most cases. Buyer's agents are paid in commission by the seller. In PA, for example, 6% of the sales price is paid in commission. 3% to the seller's agent, and 3% to the buyer's agent.

The more you spend, the more your agent makes. At a fundamental level, your interests (the best property for the lowest price) are fundamentally opposed to your agent's interests (the more you spend, the more they take home). Until you've found a place you totally want to buy because it is absolutely perfect, do not listen to your agent. You should pick the places you want to see, you should make the appointments for showings. You decide what you think a fair offer is based on your own research (tools like Zillow are invaluable for this). Know, intimately, how much you're willing to spend, and play with your preferred mortgage calculator to understand what you can afford.

Not only that, but there's a knowledge disparity. They buy and sell houses every day. You are going to do it a handful of times in your entire life. This gives a realtor an incredible advantage over you. You need their knowledge, but they also are dealing from a position of power: they can screw you up the ass and you won't even know what just happened. The only way to protect yourself is research research research.

It's also worth mentioning exclusive buyer's agents- they work for a flat fee, not commission, and never sell property. If you're worried about potential conflicts of interest, this is an option. We considered going this route, but we found an agent we liked, and decided to use her. You may save money doing this- since an EBA doesn't take commission, the seller doesn't have to pay them as much, and may be willing to take that out of the sale price.

Just get a starter home


A starter home is about the worst thing you can possibly do, financially. The idea of a "starter home", is that you buy a property that you don't want, so that you can "build equity" and sell it in a few years to buy what you do want. This assumes that your property increases or holds its value, that you've actually chipped away at the principal owed, and that someone is willing to buy your property. Plus, selling a home isn't free; you have to pay some percent of the sale price to the realtors, plus transfer taxes (2% of the sale price, split between the buyer and seller, but it does vary by region), and depending how desperate you are to sell, meeting some of the seller's demands for repairs/enhancements.

As a rule, don't buy a property unless you're planning to be there for 10 years. Otherwise, you're gambling that the real estate market is going to be in the state you hope it's in when you try to sell.

You can save on taxes!


Yes, you can. Every dollar you spend in interest is tax deductible. But they're still dollars you spend. If you're teetering on the edge of one tax bracket, the loan interest may send you into a lower tax bracket, and save you money. But with each loan payment, the amount of interest you owe is going to decrease. In the first year, you may pay $1,000 in interest, but by the 10th year, you'll only be paying $200 in interest.

And either way, you're still paying interest. You may as well donate to charity instead, if you just want to reduce your income to save on taxes. It's the same deal, either way. The difference is who gets the money: a charity that means something to you, or the bank.

A Thirty Year Mortgage is fine


Again, not exactly a myth, but you can save a great deal with a 15 or 20 year mortgage. In the short term, your payments will be higher, but in the long term, you will see a significant cost savings. Minna and I need to borrow $159,950 to buy the place we're interested in.

Current rates for a 15 year mortgage mean we will have payments of $1,200 with 4 3/8% interest (4.375%). At the end of the loan, we would have paid $159,950 against the principal, and $58,464 in interest, for a total payment of $218,000.

In a thirty year mortgage, our monthly payment would only be $860, but by the end of the loan (at 5% interest), we would have paid $309,000. Short term savings turn into long term losses. Certainly, one could invest the difference (nearly $400/mo.) into an index fund and expect about 10% returns over the course of the loan- at the risk of being leveraged for 30 years. And there's always the selling problem- if the price of your home tanks, due to market fluctuations, you may be up shit creek when you try to sell. In a 15 year mortgage, you build up equity much faster, for less expense to yourself, and hence have more freedom to sell.

Your down payment controls how much you're going to need to borrow, so this leads right into the:

Steps of buying a home


Save!


If you wanted to buy in the neighborhood I live in, a basic two bedroom home runs more than $200K. That means, just to buy the home with 20% down, you need at least $40,000. If you don't have 20% down, you have to pay mortgage insurance, which really is throwing money away. Every region, of course, is different. On the West Coast, $200K would buy you a small closet, in Manhattan, it might get you a mailbox. In a more rural area, $200K is a mansion.

Before you buy a home, you need to research how much a home you like goes for in your area. It varies a great deal, based on geography. Only you know what you like, and only you know what you're looking to spend each month. Don't assume your income is going to increase every year, either- economic contractions like the one we're in put lie to that strategy.

In addition to that 20% down ($40K in my example), you're going to need to pay closing costs (a generous assumption is 25% of your down payment, so in this example, another $10K). This means, to buy a $200,000 home, you need at least $50,000 in the bank. And you don't want to clear out your entire savings- you may have an emergency or want to improve the home you purchase.

Let's say you buy a $200,000 place and get a 15 year mortgage. If you only did the minimum down payment, you're facing a $1,200/mo. payment. If you only have $1,000 budgeted for housing, that may be too much to spend. But if you did a 30% down payment, you'd only be facing a $1,062 monthly payment: much closer to your goal.

The more you save, the easier it is to buy a house. And the more you have on hand, the easier it is for you to get the home you want, instead of settling for a "starter home".

Find a Place


Once upon a time, a realtor was your gateway to the wild, wonderful world of the Multi-List Service, MLS. If you wanted to find a property for sale, your realtor would have to do the research and get back to you with listings. No more!

First, any realtor worth having can give you access to the MLS system online, and you'll be able to do the search yourself. Second, many tools have access to MLS already, like Trulia, which I used a great deal during my home search. And don't overlook Craigslist either! (I actually found this place on Craigslist first)

Trulia lags by a few days, and depending on how hungry the market is, that time may make the difference. Honestly, though, you don't want to get in a bidding war, so that lag just means you notice things that haven't already gotten scooped up.

If you've already secured a buyer's agent, you can get them to show you properties you're interested in. If you haven't, you can contact the selling agent (attached to the listing), or see if there's an open house. What worked well for us, was talking to the selling agents. We met one we really liked, so when we found a place to buy, we called her to represent us in the transaction.

How do you know which place is right for you? Obviously, price is a big factor, but most important: you have to like the place. Sadly, it's harder to know that than you think it is. If you let yourself get sucked up into "I MUST BUY A HOUSE" mode, you'll find yourself liking things that, a few months later, you would regret. Like somebody desperate for a date, you settle and then find yourself stuck with someone that you can't get rid of.

The best thing to do is look at a bunch of places. Your brain is instantly going to give you an emotional vibe off of them. Listen to that vibe, and then cross-check it with your common sense. Spend some time deciding how much time and effort you're willing to put into making a place "yours", the "must have" features, etc. Jonah Leher's book, How We Decide talks a bunch about how people choose homes, and surprisingly, an emotional decision usually makes people the happiest.

Putting an Offer In


Okay, you've found a place. You love it. But real estate isn't like the supermarket- you can't just drop coin and walk away with it. Putting in an offer is a formal ritual, and realtors are the priests.

Research the local market. While your realtor should know what fair prices are for property in the area, remember what I said earlier: their interests and yours are not the same. Listen to them, but don't trust them. Keep in mind that they'd rather close the transaction faster than cheaper, and you'll be all right.

Your local county website will likely have valuable information about the property, including its last tax assessment and the previous purchase price. Knowing what the seller paid, and when, gives you a feel for how much of a profit they're trying to turn. They've likely put at least some work into it, so if they're trying to turn a big profit, ask your realtor to find out what they've done. They may be trying to turn a big profit, but they may just be trying to recoup big expenses.

Regardless of all this, if you've done your homework, you've got an intuitive feel for what a place like this should cost. Go with your instinct, run it past the realtor, and then decide how much under that you think you should offer. Usually, if there's already a bid on the place, the selling agent will let you know. Don't get involved in a bidding war. My advice, and you can decide if you want to apply this or not, is not to waste time. Decide what you're willing to pay, offer that, and say it's your "last and best". You won't move up above that point, so it's up to the other prospective buyer to beat your offer. This prevents the seller from being able to keep going back and forth, getting you up a grand here, them up a grand there, until you're paying more than you want. Maybe you like negotiating, but me, I just wanted to get it over with. If there's another offer on the table, just go in with your best offer you're willing to make, and let the chips fall where they may.

Your realtor will help you assemble the offer, and at this point, it is very valuable to be pre-approved for a mortgage. Call your bank, or any other lender, and get them to run you through the process. You aren't committed to anything, and neither are they. They've just stated that they'd theoretically be willing to lend you $X amount with Y% interest. A pre-approval letter shows the seller that you're not wasting their time and could probably get the mortgage. This does require a credit check, so only do it when you're putting your offer in.

The other thing you need to do is provide "hand money". Again, the seller needs to know that you're not wasting their time. So, when you submit your offer, you include a check for 5-10% of your offer. This hand money is your commitment to the deal. It gets put into an escrow account, and will be part of your down payment when you close, if your offer is accepted. If your offer isn't accepted, the check just gets ripped up, and nobody gets your money.

But, if you flake out and walk away from the deal for no good reason after the seller accepts your offer, the seller gets your hand money. There are contingencies that let you walk away: if you actually can't get a mortgage, if there's a deal-breaker in the home inspection, for example. But you must make an honest effort to see it through to the end, or you lose your hand money.

Despite that, once the seller accepts your offer, it's easier for you to walk away than them. But it's still not a done deal.


The remaining steps, getting an inspection, getting a mortgage, and closing, are ones I haven't done yet. But, once your offer has been accepted, you have a clock ticking to accomplish two major tasks: get an inspection and apply for a mortgage.

Depending on your local rules, and the stuff you put in your offer, you're going to have about 10-15 days to get these tasks done, so it is important to jump on them quickly. I applied for a mortgage today, but it takes days or weeks to get an approval back (depends on the bank, your credit rating, and how their underwriting process works). But when you apply, you do lock in your interest rate, usually for 60 days. This means, when we're approved, we're locked in for a 4.375% interest rate which is suhweet.

As for the inspection, you do want to find an American Society of Home Inspectors (ASHI) certified inspector, and there's a lot of things to consider in that step.

Everything I've covered so far in this post has been stuff I've actually done. Since I haven't actually gotten approved for a mortgage or had a home inspected, I will refrain from commenting further on them, for now. Expect a part two next week, discussing the inspection, and future installments as I cover the remaining steps.
  • Ah, now to pay off the consumer debt and start saving the $40k. Which we have to do while I save to buy a car. Oof. (No way in hell am I getting another 5 year auto loan. Ridiculous. When this car craps out for good - hopefully after 2013 - I will use what I've got saved up to buy one with cash.)
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