The process leading up to the purchase of a home is comprised of a complex chain of decisions, and it takes an educated buyer to make the right choices. Because a home is likely to be a consumer's most valuable asset, each decision made during the purchase process is extremely important. The challenge is that these decisions are often based on moving targets. Nothing in the purchase process is set in stone. As variables in the market emerge and the landscape changes, the prospective buyer must adapt. Throughout the process, however, it is important to consider the following when attempting to answer the three fundamental questions in the buying process:
- Where to Purchase?
- When to Purchase?
- How to Purchase?
Where to Purchase
Location, Location, Location
By now, everyone has heard the age old mantra of "location, location, location." The fact is that it is still the reigning heavyweight champion in the real estate industry. As a seller or seller's agent, the hardest obstacle to overcome is the property's environment because it is out of your control. However, as a buyer, the environment IS something you can control because if the location is not favorable, you can just move on. You are not obligated to buy into it. Once you have purchased the location, however, you are married to it, and you will have an uphill battle if/when it comes time to sell.
The key is preparation. Be selective on towns/cities that interest you, but even more so, be selective within those areas. There are desirable and undesirable sections of every state, city, town, village and even street. Beware of brokers and salespersons that are offering excuses for a location or not mentioning it at all. If a broker says "you can barely hear the train when it goes through the backyard," then it is more than likely that the house will shake and the engineer will frequently feel compelled to sound the horn directly at your bedroom window. If the listing agent does not offer information about the location or responds vaguely to specific questions about the location, then he/she believes it to be an undesirable location. Otherwise, following the oft quoted mantra, he/she would be selling you on the location. If the location is not a focal point of the sales pitch, it is a detriment to the property.
What Makes a Location Special?
A great location is comprised of multiple elements. Buyers often rank the elements differently in terms of priority, but often the overall list of elements is very similar from buyer to buyer. Before determining the overall desirability of a location, it is important to consider the following:
School System - There are many publications available that provide insight and research on the strengths and weakness of local school systems (http://www.psk12.com/ and http://www.neighborhoodscout.com/ are examples). If you are a buyer with children in school or if you are planning on starting a family, the school system in your community can be the single most important factor in determining the town (and potentially the town's district) in which you ultimately buy. Take the time to familiarize yourself with the schools and their reputations. Even if you do not have children or your children are beyond the public school age, towns with strong school systems are generally more affluent and feature other elements that make them desirable.
Commuting Options - Access to major thoroughfares and different methods of public transportation is a key element in determining whether a location is desirable. Settling in a location that is close to work or family leads to a quality of life improvement. The less time spent in the car, bus or train translates directly into more time spent with family, friends or asleep. Sleep is good. Ask your broker or the listing agent about a property's proximity to public transportation as it relates to the places you frequent most. If commuting is something that you do on a regular basis, a location's commuting options will be high on your list when determining its desirability.
In addition to the convenience that commuting options provide for town residents; commuting options also attract service providers, retailers and visitors who tend to avoid areas that are difficult to access. If a town center with lots of shops, services and restaurants is appealing to you, it is important to find a location that is not off the beaten path. Generally speaking, it is more difficult to sell goods and services if the consumers do not want to make the trip to the store. Knowing that, top retailers and service providers battle each other to gain market share in high profile locations. The better the location, the better the options for the consumer.
Attractions and Recreational Options - This can mean different things to different people. Some buyers are seeking remote locations with large lots and trails for hiking and mountain biking. Others are looking for locations near major cultural centers or retail hubs. Many seek locations near public parks, schools and playgrounds. These locations are often ideal for families with small children in places where large lots with big yards are hard to find or are too expensive.
Regardless of the type of amenities that suit you, it is important to make a list (even if it is just an informal list in your head), explore and get to know the areas in which you are considering living. Talk to your buyer's agent. Make sure you communicate to him/her what is important to you.
Valuation
Do not just "fall in love" with a house and/or a location and then turn a blind eye to the price. Every home is a good investment at the right price. At the same time, and more importantly, every home is a money pit at the wrong price. Chances are if you love the location, then the seller did as well when he/she bought the home and has factored it into the asking price. There are certainly exceptions when it comes to speculation purchases in "up and coming" areas, but generally speaking, transitions in neighborhoods occur over periods of time usually measured in terms of decades or generations rather than months or years. As any real estate agent should tell you, a comparable market analysis ("CMA") is an essential component of the buying process and not just of the selling process. Many real estate agents laud their CMA's when attempting to get your listing, but not all of them are as diligent with CMA's as buyer's agents. As an educated buyer, you need to be aware of the range in which properties are trading in the immediate vicinity of the property in which you are interested. Look market histories for not only the property you like, but for its neighbors and properties of similar size, price...etc in the community. Ask specific questions of the listing agent or the seller if the property had been under agreement and is back on the market. If there are known defects, they must be disclosed. If you have a buyer's agent, demand (politely, of course) that he/she make this information readily available to you. It is part of the job and you should not have to ask for it, but do not leave it up to your buyer's broker to get you as comfortable as you need to be. The buyer's agent has in no doubt sold you on the fact that he/she gets "paid by the seller," but who is paying the seller? You are, so get the most out of your buyer's agent as you can. Make sure that you have all the facts you need to before you decide to proceed to an offer and beyond.
Tangible & Intangible Value
The true value of any property is a combination of its tangible and intangible assets. Tangible assets are the land, foundation, appliances, finishwork...etc. The tangible assets are the aspects of the house (good or bad) that you can see and touch. The challenging part is the other half of the equation - the intangible assets. These are the underlying circumstances under which the property is being sold. This is the part of the process where the gloves come off. An educated buyer knows as much as possible about the seller and the conditions under which the property is being sold. Access to information about mortgages, liens and other information is available through town and county websites. Probe the listing agent about the seller. The more you can learn about the house, the seller and the degree of "motivation" to sell the better. An understanding of the intangibles is essential to completing your valuation of the property.
While all of this is going on, you, the buyer, are charged with determining the right time to get into the game...
When to Purchase
Buyer's Needs/Planning
You have already determined where you would like to live, and you are almost ready to begin your househunting. Before embarking on the search for your new home, sit down and plan out a strategy. The strategy does not have to be formal. It does not even need to be written down. However, it is important to consider what type of property you want before beginning your search. Some of the factors here overlap with those covered in the Where to Purchase section, but that is because these processes are not mutually exclusive. As such, your strategy should be designed around, but not limited to, the following:
Price Range - A thorough understanding of the financial impact of purchasing a home is fundamental to the buying process. As a potential buyer, you should prepare a budget that incorporates all the costs of being a homeowner including, but not limited to, the following:
Down Payment - The down payment is covered later on in the How to Purchase section. If you are a first time home buyer and depending on the nature of your purchase and your credit status, the down payment can amount to a considerable piece of your savings. For those rolling proceeds from the sale of a home into the purchase of another, the down payment is often incorporated therein.
Closing Costs - Depending on the nature of your loan, you can be charged for expenses incurred by the lender, the mortgage broker, the appraiser and other fees such as recording fees and even delivery fees for the paperwork. The Housing and Urban Development department requires lenders to provide "Truth in Lending" statements to its prospective clients prior to closing. These statements serve as estimates as to the eventual settlement statement. Still, it is prudent to ask your mortgage broker or lender about the closing costs to gain a more thorough understanding of how much the loan will cost you.
Attorney Fees - Another source of information on closing costs is through your attorney, if you decide to engage an attorney. Attorneys generally charge a flat rate to negotiate your Purchase & Sale agreement, but depending on the nature of the negotiations, that fee can increase. On top of that, the bank will either provide a closing attorney, at your expense, or you can request that your own attorney represent the bank at closing.
Private Mortgage Insurance and Points
Private Mortgage Insurance ("PMI") is insurance required by lenders in cases where the borrower is putting less than 20 percent down at closing. Your monthly payment will include a premium charge for the PMI. You are eligible to terminate your PMI once you have made principal payments that equate to 22% of the original home value (provided that you are current in your payments). For more information on PMI, visit sites such as http://www.privatemi.com/. PMI is potentially advantageous to certain buyers as it may enable them to obtain financing for a home before they have saved enough for the traditional 20% down payment.
Some lenders charge borrowers "points," which refer to basis points. A basis point is one one-hundredth of a percent. Points are incorporated with and paid at the close of the loan. If a lender is lending a buyer $200,000 at 2 points, the buyer is required to pay the lender $4,000 (200,000 x .02).
As your price range increases relative to your buying power, you are more likely to incur points, higher closing costs and or PMI charges. As such, it is important to take these items into account when determining price range.
Monthly Payments: Principal & Interest vs Interest Only - Some loans require monthly payments including both principal and interest based on an amortization of the loan over its life. Many lending sites offer a free payment calculator (here is one from Leader Bank.) Another easy way to compute payments is through Microsoft Excel as follows:
- Open a spreadsheet file (.xls)
- Click on either the "fx" function icon located adjacent to the cell display box
- From the category offerings, select "Financial"
- Highlight "PMT" and click "OK"
- Rate - your annual interest rate divided by 12 if you are calculating your monthly payment. If your rate is 7%, then enter ".07/12" in the space provided
- Nper - this is the number of periods in your loan. If it is a 30 year mortgage, enter "360" in the space provided.
- Pv - this is the present value of your loan. If you are borrowing $250,000, then enter that amount into the space provided.
- Fv - this is the future value of the loan. In most cases, this will be zero as mortgages need to be paid off in order to be discharged.
- Type - this is based on whether the loan payment is made in arrears or in advance. Most are made in arrears, so either leave blank or enter "0."
- Click "OK"
This will return your monthly payment of principal and interest. Early on in the life of your loan, the monthly payment is heavy on interest and light on principal, but as your payments progress, the amount going towards reducing the principal of the loan increases as the amount of interest expense decreases. This is because as principal payments are made, the loan balance is decreasing and, as such, there is less principal that is subject to the interest rate.
Interest only loans are those where no principal payments are made until the loan is discharged. Each month, the buyer makes fixed interest payments (rate/12 x principal) until it is time to pay the loan in full - either the term has expired or the buyer elects to refinance or discharge. At that point, the entire balance of the loan is due in full. Interest only loans often have lower monthly payments, but do not allow the borrower to increase his/her equity in the property.
Real Estate Taxes - If you have been renting, you have not had to pay real estate taxes as they have been incorporated into your monthly rental payments. As a homeowner, you are now responsible for your tax payments. Each city, town or municipality has its own formula for computing real estate taxes. Most towns post their tax rate on their website. Click here for a link to the tax rates for the town of Needham, MA.
Taxes are remitted in one of two ways:
Escrowed and paid by the lender - many lenders require that borrowers include a month's worth of real estate tax in their monthly payment to be placed in escrow. The lender will then use those funds to make quarterly tax payments. The benefit to this for the buyer is that it is one less bill to worry about. The downside is that the lender is holding your money that you could be earning interest on somewhere else. The other downside is that upon termination, any excess funds in escrow are held by the lender for 30 days before being returned to you.
Paid directly by the homeowner - this is ideal for buyers, but most lenders require that the buyer escrow funds for real estate taxes.
Homeowners Insurance - Similar to real estate taxes in that homeowners insurance is something new to first time homebuyers. Most lenders require a specific amount of coverage in order to issue a mortgage. Some buyers may elect to purchase additional coverage in the event the amount required by the lender is less than the replacement cost of the home (lenders are primarily concerned with recovering the amount of the mortgage as opposed to ensuring the displaced family can afford to buy a new house). Just as in the case of real estate taxes, homeowners insurance premiums are paid either through escrowed funds or directly by the buyer.
Monthly Expenses - Consideration needs to be paid to how much it costs to maintain a standard of living in a future home. In other words, how much will your heating or cooling bills be? Will you need to spend money to furnish a larger residence? Who is going to mow the lawn? Will you need to pay to have the driveway plowed during the winter? There is a good chance that there will be expenses related to any purchase that are not readily recognizable. It is important to build a cushion or contingency amount into your monthly budget to cover any unpleasant surprises that inevitably arise.
Square Footage/Rooms - What size property are you looking for? Are you feeling cramped in your palatial 4,500 square foot mansion and you need to upgrade to a landed estate? More likely, you have outgrown your apartment or your starter home and you are looking for more living space. Have an idea as to how many bedrooms and bathrooms you need or whether a formal dining room is important to you. The more specific you can be in your requirements, the easier it is for your buyer's agent to assist you in your search.
Understanding the relationship between location, square footage and price is important in your pre-search process. In one location, $200,000 may buy you a 2,000 square foot colonial, but in other locations, it gets you the top unit in a ten story walk-up that has no closet space. When comparing properties, look to the price per square foot calculation to serve as a barometer for gauging the "bang for your buck." For some, it is important to have an idea as to the size of home you are looking for and then to see where you can get it based on your buying power. Others value location above square footage, and work in the reverse, but finding a location and then a property within the location that meets an appropriate price per square foot ratio.
Style - What type of property are you looking for? A Cape Cod? A Colonial? A condominium? Drive around. Attend open houses. Look for styles and features that appeal to you as well as those that do not. It is going to be your home, so you want it to fit your taste. You can redecorate the interiors and exteriors, but redoing the construction and architecture is a major undertaking. The more places you see will actually help to refine your search. It may seem oxymoronic, but it works.
Busy Season
Traditionally, the real estate "busy season" is between April and June with a lull between the 4th of July and Labor Day and then another busy stretch through Thanksgiving. These periods are "busy" because of the volume of transactions that historically occur within them; however, they do not necessarily represent the most strategic time to be a buyer. During the busy season(s), there are more homes on the market, but often more buyers. The presence of multiple buyers at open houses and in the market in general can create a buzz around the real estate frontier and lead to bidding wars or price increases. From a macro perspective, factors such as interest rates, the consumer price index ("CPI"), the unemployment rate and other economic indicators contribute greatly to the rise and fall of housing prices, but nothing guarantees a payday more for a seller than multiple buyers scribbling out offers in the front seat of their brokers' cars parked outside an open house.
If possible, try to avoid purchasing during the busy seasons. Certain factors often prevent this flexibility, such as job transfers, school schedules and financial or personal developments. But if time is on your side, you will be better positioned to make a smart buy. The majority of sellers do not possess the luxury of being able to strategically place their house on the market at just the right time when supply slips below demand on the invisible scale that is the real estate market. Conversely, most sellers are selling for many of the same reasons that buyers are buying - a new job in a different city, downsizing once the nest has emptied, moving to a new school district or if the seller has already bought a new house. The latter being the most motivating of factors for a seller. A seller with a deadline is going to be more receptive to a low offer or at least an offer with more favorable terms for the buyer. The challenge for the buyer is identifying sellers in this position.
Timing
Unfortunately and more often than not, the playing field is either level or at least level on the surface, and those once in a lifetime chances to purchase your dream house come along but only by outbidding the competition to get the deal done. Still and frequently enough, however, the educated buyer is the patient buyer. The patient buyer begins to look for a house well in advance of when he/she needs or wants to purchase. If the dream house is available, then the patient buyer will be in the position to rationally and thoroughly review all the facts and make a decision to proceed. In a market that is settling down, as the Metro and Suburban Boston markets are, let properties settle in to their price range. Paying attention to market trends and projections assist in the buyer's effort to prepare for the purchase process. Clearly, there are no constants or sure things when it comes to projecting the housing market, but it never hurts to check in on the latest comments from the Chairman of the Federal Reserve or learn what you can about trends in new construction loans or the unemployment rate. All of these are indicators as to which way the market is leaning on a macro level. On a local level, the spring following the release of the local study showing Anyville as the number one city in which to raise a family is not likely the time to go bargain hunting there. If value is your primary motive, then you need to be patient. If you have decided that you need to move to Anyville in time for your children to start the next school year, be prepared to either pay a premium for the house you want or settle for the house you are not in love with. If you can keep timing on your side, you will have a better opportunity to maximize value and make the smart buy.
How to Buy
The Process
Once you have identified the property you are interested in purchasing, you are ready to make an offer. Generally speaking, offers to purchase real estate need to be in writing in order to be enforceable. As such, standard offer forms have been created to facilitate this step. Sample offer forms can be viewed on-line, but are generally not available for free. All real estate brokers have access to these forms and others, so your buyer's agent should have copies for you. If you do not have a buyer's agent, ask the listing broker for a copy. Deciding on the terms of the offer is the most delicate step in the process. All of the factors discussed in preceding paragraphs, along with the general condition of the market affect how much you are willing to pay for the property. It is up to you and your broker to determine your strategy here. If the seller has made it clear that the asking price is the purchase price, then you need to decide if the property is worth that much. If not, perhaps you wait until the property sits on the market and the seller relents. Of course, you run the risk of another buyer entering the ring and meeting the seller's price. Other variables to consider when making your offer include:
Inspection Contingency - It is common to perform a home inspection on the property prior entering a purchase and sale contract. This involves engaging a professional home inspector to view the property and identify any structural or other defects that may potentially require repairs in the future. The inclusion of this contingency in your offer allows you to revoke your offer should the results of your home inspection be unsatisfactory. The waiving or omission of this contingency strengthens your offer when compared to others that include it, but leaves you unprotected should you discover that the home has significant structural or other material damages after you have made an offer and the seller accepted. Generally, the home inspection is performed within ten days of the acceptance of the offer.
Mortgage Contingency - This contingency states that if the buyer cannot obtain the necessary financing despite reasonable (and often specific) efforts, then he/she can revoke the offer. As with the inspection contingency, an offer waiving or omitting the mortgage contingency clause is more attractive to a seller as it provides the buyer with fewer "outs." Most sellers require a pre-approval letter from a lender or broker for at least the amount of the mortgage referenced in the offer to be submitted with the offer.
Closing Date - If you are obtaining a mortgage, your lender will normally require at least 30 days in order to perform its due diligence on the loan. You need to keep this in mind when filling in a target closing date in your offer. A rule of thumb is to take ten days for the inspection, add a week for the purchase and sale and then give another 30 days for the lender. That puts the target closing date at 47 days from the date of the acceptance. If you want to strengthen your offer, an accelerated closing date is often attractive to a seller, but not to a seller who needs to find a new house. In this case, offering to push the closing date back to 60 or 90 days may make your offer more desirable to the seller.
The Lender
In recent months, obtaining a loan has become increasingly easy in the Boston area. Due to soaring housing prices and low interest rates, lenders have been quick to finance buyers who may not have qualified in the past. As such, lenders have become commodities. Banks that once turned people away because they were on their second job in 10 years are issuing no money down, 30 year fixed rate loans at interest rates that look more like batting averages to people without routine income. This trend cannot continue, but while it does, take advantage. If multiple lenders are willing to take your business, make them earn it. Take the time to talk to mortgage brokers and find out what sort of packages they can make available to you. Mortgage brokers are not like real estate brokers. Real estate brokers all reference the same multiple listing service, but mortgage brokers work with different lenders. In other words, one broker may have access to a deal that is not available to another. Find the best deal for yourself. At the end of the day, you need to pit two or more mortgage brokers against one another until there is one left standing. If your real estate agent is pushing a lender or a broker, do not shy away, often the best deal comes through that pipeline, but do not stop there. Pursue your own angles. Ask your friends and families for referrals. A few basis points over the life of a loan can add up to several thousand dollars, and it is worth your time to shop for the best deal.
The Loan
Part of the process of vetting potential lenders includes deciding on which type of mortgage is best for your situation. Buyers looking for a transition home (one to hold for a relatively short period of time before moving on) may be more inclined to take advantage of the low rates available with Adjustable Rate Mortgages ("ARMs"). ARM's provide low introductory rates that are subject to market corrections after a designated period of time - usually three to five years. Once the introductory phase expires, the rate is adjusted up or down depending on the economic index to which it is linked. Generally, an ARM is less attractive to a buyer looking to finance a home for the long term because of the risk that the rate will increase substantially at the end of the introductory period. For these buyers, a fixed rate mortgage is the likely option. Fixed rate mortgages feature an interest rate that does not change during the life of the loan, which is usually either 15 or 30 years.
Regardless of the loan you decide upon, the option to refinance is almost always available. Buyers should ask their mortgage broker or lender about pre-payment penalties. If possible, the loan should allow the borrower to payoff the principal at anytime without incurring pre-payment penalties. This gives the buyer the freedom to continue to seek a more favorable loan even after closing on the property.
The Down Payment
Your cash is your cash. At the end of the day, your lender likely owns more of your house than you do until you pay off the debt, but the question is, how much of your money do you pool with theirs? If you have profit from the sale of your old house to pool into the purchase of your new house, you can invest your gain into your down payment and mitigate your exposure to capital gains taxes. The question is what to do with the rest of the equity you pulled out of your old house? In the days before usury laws, the obvious answer would be to roll any cash from the previous transaction along with the change from the ashtray in your car and whatever is under the couch into your new property and thus reduce your loan. Those days are gone. As discussed above, lenders are banging down your door to loan you more money than you thought you needed at low rates (despite recent activity by the FED resulting in an increase in interest rates, rates are still at what is considered to be "historical lows" when translated into buying power). Considering any mortgage interest you pay is tax deductible, you are potentially better off putting as little down as possible and investing the rest where your return on investment, plus the tax savings from the interest payments, exceeds the amount you pay in interest on an annual basis. Granted, there is some math involved here, but that is what accountants and financial planners are for. This strategy is not for everyone, but it is something to consider if you are in a position to determine the best use for your "excess cash."
Another possible scenario that involves minimizing your down payment is to use the cash towards improving the property you just purchased. If you are looking to stay in the property for five to ten years, then making significant improvements right away is a smart move. It is true that a homeowner cannot expect to receive a 100% return on home improvements in the short term, but over time, coupled with the appreciation of the property that history shows to be inevitable, the improved property should more than recover its costs at resale. Plus, there is a significant increase to the standard of living of its owners.
There is no right answer that works for everyone, but it is prudent to consider all possible investment scenarios before committing to a large down payment.
There you have it. As with most "how-to" rants, there are going to be other obstacles that arise and there are inevitably portions that do not apply, but understanding these issues, terms and processes will give you a leg up in your search for your dream house. Good luck and Happy Hunting!!