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Home Buying Process
The first step in home buying is to understand what purchase price the much the homeowner can afford, how large of a down payment is required and what the monthly are likely to be given various mortgage options. Many home buyers begin the home buying process by looking for the 'perfect' house in their favorite neighborhood without really understanding the factors that contribute to being able to afford a home. As a result, it is easier than one might think to make a decision that costs a lot more on a monthly basis than the buyers originally thought.
The first factor in affording a home is the buyer's income and liquidity as compared to established and ongoing debts. While homebuyers will place a priority on making the mortgage payments at the expense of other obligations if need be (like credit cards and student loans, for instance), neither the lender of homeowner want to undertake a long-term mortgage commitment without being relatively assured of monthly liquidity. Aside from the actually monthly income, the buyer's job security and the stability of the industry and income should also be closely examined. Finally, a down payment of 20% in the recent standard requirement, so the buyer will have to a substantial amount of cash saved for the purpose of the down payment.[footnoteRef:1] [1: www.Mortgage-x.com/library/h-much-a.htm]
The location is the second biggest contributor to the affordability of a home. Beyond having a significant impact on the price of the home itself, a neighborhood or geographic location will often bring about hidden costs not apparent in the purchase price of the house. Homeowners association fees, real estate taxes, local taxing districts (such as for schools) and special risks (such as flooding, high winds or earthquakes) will all significantly increase the monthly expenditure for a homeowner beyond the price of the mortgage.[footnoteRef:2] Therefore, when assessing whether a buyer can afford to move into a particular neighborhood is very important to look beyond the mortgage alone. [2: www.moneyinstructor.com/art/homelocation.asp]
One way to minimize some of the risk of hidden costs is to incorporate the cost of as many of these expenses into the mortgage as the lender will allow. In fact, many lenders today will only give a mortgage if the buyer agrees to pay the taxes associated with the house directly to the lender as part of the mortgage payment. This prevents the lender from putting their investment at risk due to defaulted taxes and allows the buyer to have a more consolidated payment schedule.
The following charts graphically illustrate how to compute the maximum monthly mortgage payment a buyer can reasonably afford based on a certain level of income, amount of other debt and additional 'hidden' expenses, such as taxes and insurance related to the house:
Gross annual income:
(eg. student loan, credit card payments)
Annual property taxes:
Annual homeowner insurance:
Minimum house price:
Monthly mortgage payment:
Total monthly payment:
Most lenders follow the same guidelines to arrive at an "affordable" home price: A total debt-to-income ratio of no more than 36%, a housing payment-to-income ratio of 28% for a conservative estimate, and 33% for the aggressive one. A home's affordability is also contingent on health care, food or disposal income needs and other savings needs, including retirement or the children's college.[footnoteRef:3] [3: http://cgi.money.cnn.com/tools/houseafford/houseafford.html. The above tables assume a 30-year fixed mortgage, with an annual property tax of $3,500 and homeowners insurance of $481. The monthly payments will vary based on different numbers.]
The Mortgage is the type of loan that most buyers will obtain to purchase their home. In the standard case, the mortgage will be a purchase money mortgage, where the lender provides the funds for the buyers to buy the home and the loan is secured by the property itself. The mortgage consists of two parts, the promissory note and the mortgage security instrument. If the buyer defaults on the loan, the lender has the right to foreclose on the property (use the courts to take the house back) to satisfy payment due.
Mortgages vary based on the length of the mortgage, the interest rate, the variability of the interest rate, the priority of payment (principle or interest). A buyer can usually choose from a 15-year, 25-year and 30-year long mortgage program. Most buyers will select the 30-year mortgage because this will allow for the lowest monthly payments (of course, the total amount paid will be a lot higher after 30 years than after 15 or 25 years due to all the additional interest paid. The interest rate will always be determined by the prevailing national interest rate and will for the foreseeable future always be a fixed rate. Adjustable interest rate mortgages (ARM) were very popular in the early 2000s, however, due to the avalanche of foreclosures that were engendered from adjustable rates increasing, it will be a while before they are en vogue again (perhaps if interest rates soar again, and an impending fall in interest rates can be safely predicted, it would be safe to take an adjustable rate mortgage). Similarly, interest-only loans were quite popular during the most recent real estate boom, but the danger of the lack of equity that results from only paying the interest on a mortgage has scared most buyers and lenders from choosing an interest-only loan. Especially with the interest rates so low, a wise buyer will opt for a 30-year fixed rate money.
The following chart illustrates the relative shifts in interest rates for various fixed-rate and adjustable rate mortgage loans:
HSH National Interest Rate Benchmarks
For Week Ending 10/29/2010
30 Yr FRM
15 Yr FRM
1/1 Yr ARM
3/1 Yr ARM
5/1 Yr ARM
7/1 Yr ARM
10/1 Yr ARM
FRM= Fixed rate mortgage / ARM= Adjustble rate mortgage
While the ARM appears to be a sound option over the past year, as the interest has dropped over one full point, from July of 2004 through July of 2006, the prime rate rose 4%.[footnoteRef:4] This increase, which was not anticipated within the housing market, caused millions of buyers' mortgage payments to double and triple. Thus, this should not be considered a viable option. [4: http://www.federalreserve.gov/releases/h15/]
In most states, only certain creditors can force the sale of one's home in order to satisfy a financial obligation. These include the mortgagor, a condominium or homeowners association, a local, state or federal taxing authority, child support obligations and a mechanic who has improved the home. Therefore, there are relatively few risks for the lender or the buyer regarding a creditor seizing the home to satisfy a debt.
A buyer, even an experienced one, will want to enlist the help of a seasoned real estate agent throughout this process. First and foremost, the agent works for the buyer for free (her commission will be paid out of the sales proceeds and is therefore absorbed by the seller). More significantly, the agent guides the buyer through every step of the process, from understanding the terms of the contract to finding reliable and trustworthy inspectors to informing the buyers of all the hidden costs and the good and bad points of the neighborhood. Perhaps the agent's most important role is to keep the buyer calm and rational as obstacles in the process appear or when the buyer starts to take things personally in the course of the sale.[footnoteRef:5] [5: http://www.bls.gov/k12/money05.htm]
The agent's most tangibly helpful guidance usually centers around the contract. The contract chosen by the seller will impose certain obligations and rights on one party or the other. convey to the buyer exactly what the contract of buyer and of seller. These terms include when payments are due, who has the duty to make certain repairs and under what conditions the contract is null and void. A proper explanation by the agent of the contract, before it is signed, often prevents a tremendous of headaches for the buyer and seller alike.
The agent can also help streamline the process by which a buyer finds the right home. The agent has access to the MLS service, which provides a database of all homes available for sale. The database is searchable by geographic area and also by more particular criteria such as number of bedrooms, price, square footage etc.… The agent will also have access to comparable sales figures, which are the final sales figures for similar homes. This helps the buyer gauge the actual value of a home vis a vie its listed sales price. Finally, the agent (or the buyer) directly will engage in negotiations…[continue]
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