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BUYING PROPERTY |
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Things to Consider Owning a home is viewed as an integral part of the American dream. If you’re saddled with debt, that dream may seem far away. It takes careful planning to buy a home and other real estate investments. Buying a home is not an easy process and won’t always improve your financial well-being. According to the Chicago-based National Association of Realtors, the typical first-time homebuyer is age 32. The way you handle your finances and investments now will have a dramatic impact on whether you’ll be able to buy a home. There are many factors to consider when buying your first home including:
If you only plan to be in your house for a few years, the increase in value may not exceed the fees and expenses you’ll incur when you buy it. Keep in mind that your first home is typically a starter house. It is usually your first foray into real estate investing. If it grows in value and your income increases, you may be able to buy your dream house someday.
Types of Morgages Before you go shopping for a home, you should understand the types of mortgages that are available and how much money you can afford to borrow. Mortgages are available through many sources such as:
It is important to distinguish between two types of mortgages:
Fixed-rate mortgages With a fixed-rate mortgage, your interest rate remains the same for the life of the loan. If interest rates rise, you’ll be glad you have a fixed-rate mortgage. Adjustable-rate mortgages With an adjustable-rate mortgage or ARM, the interest rate adjusts according to an agreed-upon formula. When you sign up for an ARM, you risk that interest rates may rise and increase your monthly payment. It’s also possible that the interest rate will go down and your payment will be less. If interest rates are currently low, there is a greater probability that they will go up and your payment will be higher. Other mortgage types As home prices skyrocketed, mortgage lenders developed new products so new homebuyers would not be shut out of the marketplace. You might be offered a lower interest rate for the first five years of your mortgage or a loan where you only pay the interest for a set period. These mortgages presume that you’ll sell your house or find a different mortgage before the payments escalate. There are even 40 or 50-year mortgages. Being married to your mortgage for decades longer isn’t necessarily a wise choice.
A $100,000 mortgage at 8.5 percent interest for 30 years has a monthly payment of $769. If you took out a 40-year mortgage at the same interest rate, your monthly payment would be $733. With the 40-year mortgage, the monthly payments aren’t that much smaller and you’ll be paying for 10 years longer. Over the life of the 40-year mortgage, you’ll pay $75,000 more than you would with the 30-year mortgage. If you choose a mortgage with an exceptionally long term or an interest only loan, you make no progress toward paying off your mortgage. Even with a 25 or 30-year mortgage, very little of your monthly payment chips away at the principal during the first few years. Shopping around As you shop around for the best deal on a mortgage, remember that interest rates are significantly different from lender to lender. A one percentage point difference on a $200,000 loan makes a difference of almost $50,000 over the life of your loan. Watch out for teaser rates that only last a few years.
Expenses Down payment To buy a home and qualify for a mortgage, you will need to make a down payment. Generally, you are not permitted to borrow money to use for a down payment, because this increases the amount of money you owe and affects your ability to make your mortgage payment. Even a loan from a parent or relative may be unacceptable to your lender. One way to save for a down payment is to look for a lease with an option to buy arrangement. You and the seller agree that some of your rent payment will be credited toward the price of the house. Loan programs through the Federal Housing Administration (FHA) are sometimes a good alternative for first-time homebuyers, because smaller down payments are required. For more information, visit www.hud.gov/buying/#programs. Closing Costs Closing costs add to the cost of buying a home. These are the expenses you pay when the parties meet to transfer ownership of the property from the seller to you. Here are some of the closing costs you may encounter:
Points are a percentage of the loan amount that you pay at the closing. They might also be referred to as origination fees or by some other name. Remember that some of these costs are negotiable. Also, the lender might offer to pay some of these costs in exchange for charging you a higher interest rate. One loan might have fewer points but a higher rate of interest. As you comparison shop for the best deal on a mortgage, pay special attention to the APR of the loan. The law requires every bank to tell you the APR for all types of loans, not just mortgages. Homeowner expenses Aside from your mortgage payment and closing costs, there are many expenses associated with owning a home such as:
In some areas of the country, homeowners insurance may be extremely expensive and difficult to buy, because of natural disasters like hurricanes. You may also need to buy a separate flood insurance policy if you live in a particular area.
Reselling Your Property A home may be the best investment you ever make. Aside from the potential profit you may make, you get a place to live and the personal satisfaction of owning your own home. You can also put a nail in your wall to hang a picture without worrying if you’ll get your security deposit back. Selling your house someday for more than you paid doesn’t necessarily mean it was a good investment. In determining the return on your investment, you need to figure in the:
In theory, you might have invested your down payment, as well as some of the money that went toward the cost of owning a home. You may have heard the term, “real estate bubble.” This term describes a period when the price of homes in one area, or across the country, are escalating rapidly. During a real estate bubble, there is a seller’s market and buyers are plentiful. During a buyer’s market, sellers are more desperate and are inclined to lower the price of their homes.
Tax Benefits One compelling reason for owning a home is that you’ll pay less taxes. Subject to limitations, the following home-related expenses are deductible:
Generally, the points you pay on your mortgage are deductible in the year you pay them. If you refinance your mortgage, the deduction is spread out over the life of the loan. The tax breaks from buying a home may not be as good as you think. You’re really only getting the benefit of a tax deduction to the extent that it exceeds your standard deduction. The standard deduction for a single person is $5,150 in 2006. Your home-related tax deductions are only beneficial to the extent they exceed your standard deduction. The best tax break from a home is that you may make a profit of up to $250,000, if you’re single, or $500,000 if you’re married, on the sale of your primary residence without paying federal taxes. Here’s how you qualify for that tax break:
Tips & Common Mistakes Common mistake: Buying a money pit There’s a Tom Hanks movie called The Money Pit. In that film, Hanks bought a house that nearly bankrupted him because it needed so many repairs. The exaggerated lesson from that movie is that after buying a house, you may spend thousands of dollars on repairs. And unless you’re handy, you really shouldn’t buy a fixer-upper. Watch out for serious house-related problems such as a:
Tip: Hire an inspector To avoid these problems, you should always hire an objective home inspector before closing on your dream house. He or she should be a member of the American Society of Home Inspectors. In addition, the seller and real estate agents may owe a legal obligation to inform you of potential problems. Common mistake: Banking on a bull market You can’t bank on housing prices in general going up or in your particular area. At any given moment, a hot housing market may cool off, making it much more difficult to sell your home and recoup your investment.
Getting Started When you’re ready to look for your first house, here’s how to get started:
To qualify for better terms on a mortgage, here are some strategies to utilize:
FAQs How much of my income should be spent on a home? When you borrow money to buy a home, lenders want to be sure you make enough money to pay back your loan. Most lenders look at your debt-to-income ratio. Your loan and other home-related expenses should not exceed 28 percent of your income. Your total debt, which includes car payments and student loans, should not exceed 36 percent of your income. If your mortgage and home-related bills are too high, you may wind up as “house poor” which means you have little money left for your other expenses. Your bank may agree to give you a mortgage because lending standards have been relaxed, but that doesn’t mean you can truly afford it. Once you’re working, you shouldn’t count on receiving pay raises that will help your home become affordable. Those pay increases may be needed to pay your other expenses, home related or otherwise. Should I buy a home if I’m not sure where my career will take me? Because there are many up-front expenses incurred when buying a home, you may be better off renting if you expect to leave the area in five years or less. You can’t bank on housing prices escalating dramatically during a relatively short time frame. Am I better off buying a home or some other investment? When you buy a home, you’re probably looking at it as more than an investment. Aside from its investment potential, you believe it will enhance your lifestyle and quality of life. If you’ve lived in a dorm room or a building owned by someone else for many years, the prospect of owning a place you can call your own is quite appealing.
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