Buying Your First Home
It is just about everyone’s dream to own their own home. Buying your first home can seem like an enormous task. There are a great number of issues to deal with. They include the emotional trauma of a lifestyle change, financial aspects, tax implications and legal considerations. The process may seem a bit overwhelming, but everyone has to go through it. There are many books written on the subject and you certainly should approach the process with your eyes wide open and as prepared as possible for the undertaking. Having a seasoned professional on your side will make the process smooth and fun! The following are some tips to help you down the path to home ownership.• Are You Ready to Buy a Home?
• Home Ownership vs. Renting
• Tax Benefits
• How Much of a Home Can You Afford?
• Location, Size and Amenities
• Selecting a Real Estate Agent
• Creditworthiness
• Shopping for a Loan
• Down Payment
• Holding Title to Your Home
• Maintaining Home Improvement Records
Are You Ready to Buy a Home?
This is the first
question that needs to be answered before making a home purchase.
There is no need to expend the energy and time it takes to find,
finance, acquire, and move into a home if you are not ready. Ask
yourself the following questions:
• Do I have a steady source of income (from a job or business)?
• Have I been employed on a regular basis for the last 2-3 years?
• Is my current income reliable?
• Do I have a good record of paying my bills?
• Do I have few outstanding long-term debts like car payments?
• Do I have money available for a down payment?
• Am I credit worthy enough to qualify for home financing?
• Do I have the ability to pay a mortgage every month, plus additional costs?
If you can answer "yes" to these questions, you are probably ready to buy your own home.
Home Ownership vs. Renting
There
is a big difference between owning your own home and renting.
Generally, renting is free of most home maintenance responsibilities
other than cleaning and yard care and even the gardening is included
with many rental agreements. But at the end of the rental agreement,
you have nothing to show for all those rental dollars that you shelled
out, and you are generally at the mercy of the landlord. You have also
helped the landlord pay down his mortgage and build his equity instead
of yours. That’s not to say home ownership is for everyone; many
prefer a lifestyle unencumbered by the responsibilities of home
ownership.
On the other hand, a home purchase provides
significant benefits, some immediate and some long-term. When you make
a mortgage payment, you are building equity. And that's an investment.
Owning a home also qualifies you for tax breaks that assist you in
dealing with your new financial responsibilities - like insurance, real
estate taxes, and upkeep - which can be substantial. But given the
freedom, stability, and security of owning your own home, they are
generally worth it.
Tax Benefits
The tax benefits available with home
ownership can greatly reduce the cost of ownership. An individual who
rents cannot deduct the cost of the rent on his or her tax return.
However, if you are buying the home, the mortgage interest and property
taxes (1) are a tax deduction (when itemizing) which provides
considerable benefits and can substantially offset the cost of owning
the home. This is best explained by example.
Illustration:
Let’s assume that you are a married couple filing jointly. Your
mortgage payment is $1,500 per month ($18,000 per year) and the
property taxes for the year are $5,000. In the first years after
purchasing your home, the mortgage payment is primarily interest, which
means most of the payment will be tax-deductible (so we will use
$17,000 of the mortgage payment as deductible home mortgage interest).
Assume your “other” deductible itemized deductions (medical, charity,
other taxes and miscellaneous) for the year after AGI adjustments
totaled $4,000 and your standard deduction for the year would have been
$11,400. Assuming that you are in the 25% tax bracket, your tax
savings can be determined as follows:
Deductible Interest $17,000
Property Taxes (1) 5,000
Other Itemized Deductions 4,000
Total Itemized Deductions 26,000
Standard Deduction (2009) <11,400>
Net Increase in Deductions $15,000
Net Tax Savings (25% Tax Bracket) $3,750
This benefit generally can be more or less based on a number of
factors. Had this illustration been for a single taxpayer with a
standard deduction of only half that of the joint filing taxpayers, the
savings would have been $5,050! Tax bracket also has a big impact.
Had the illustration been for a single individual in the 35% tax
bracket, the savings would have been $7,070.
You can
project your savings by substituting your estimated deductible interest
and taxes, using the standard deduction that you would use if not
itemizing and your marginal tax rate (2).
(1) Property taxes are deductible by everyone except those subject to the alternative minimum tax (AMT). To the extent you might be subject to the AMT, property taxes will not provide any tax benefit.
(2) Frequently, a taxpayer’s taxable income before and after the
increase in deductions will straddle two tax brackets and result in a
blended marginal rate.
Keep in mind that the annual cost
of the home will be more than mortgage payments and taxes. The lender
will require the home to be insured for fire and possibly flood. Your
utility bills may increase and an allowance for home maintenance and
repairs should be set aside.
Determine How Much of a Home You Can Afford
First of
all, you will need enough up-front cash to cover the down payment and
closing costs. In addition, unless you are purchasing a furnished
model, you will need some amount of cash to cover curtains, paint, and
whatever other modifications you think are necessary to occupy the
home. Don’t forget that once you buy the house, you will have expenses
moving there.
Before you start looking for a home, the following two things should be determined:
What Can You Afford:
Before anything else, figure out how much you can comfortably afford
for monthly home expenses. That will include the mortgage payment,
taxes, insurance, possible increased utilities and an allowance for
home maintenance. Formulate a budget that includes all of your other
monthly expenses less those expenses attributable to your current
rental. Be careful not to overlook transportation, entertainment,
medical expenses, eating out, etc., unless you plan to change your
lifestyle. Use that budget to determine how much you can afford
monthly for housing.
What Loan Amount Will You Qualify For:
Unless you have affluent family members, you will need to determine the
maximum loan amount that you will qualify for. A potential lender
considers your debt-to-income ratio, which is a comparison of your
gross (pre-tax) income to housing and non-housing expenses.
Non-housing expenses include long-term debts such as car or student
loan payments, alimony, or child support. According to the FHA, monthly
mortgage payments should be no more than 29% of gross income, while the
mortgage payment, combined with non-housing expenses, should total no
more than 41% of income. The lender also considers cash available for
down payment and closing costs, credit history, etc. when determining
your maximum loan amount.
You may wish to get pre-qualified for
a mortgage before you make an offer to a seller. Having been previously
approved by a mortgage lender removes a large amount of uncertainty in
the seller's mind, and increases the likelihood of a quick closing.
With pre-qualification, you'll be in a stronger position to negotiate a
better price on the house that you would like to buy. Prequalification
is quick and easy. Some lenders charge for the service while others
don't. It will also let you know ahead of time how large of a loan you
are qualified for.
Location, Size and Amenities
Before you start
searching for that perfect home, there are several things you need to
determine that will save yourself hours of wasted time. Figure out the
type of house that you want early in the process and set your
requirements. This cuts out a lot of the guesswork and makes it easier
for your real estate agent to find something suitable. Things to
consider are:
Size: How big of a home do you need? How many bedrooms? Will the family size be increasing?
Amenities:
Narrow your search by specifying the amenities that you require, such
as the number of bathrooms, a pool, 2 or 3-car garage, fireplace, yard
size, etc. Categorize these items by the need, from your minimum
requirements to a wish list.
Location:
Select a community that you will be comfortable in. Many people choose
communities based on the schools. Do you want access to close shopping
and public transportation or a more rural area? How close do you want
to be to your place of business or family?
Selecting a Real Estate Agent
Typically, the first
person you consult about buying a home is a real estate agent or
broker. Although real estate brokers provide helpful advice on many
aspects of home buying, they may serve the interests of the seller and
not your interests as the buyer. The most common practice is for the
seller to hire the broker to find someone who will be willing to buy
the home on terms and conditions that are acceptable to the seller.
Therefore, the real estate broker you are dealing with may also
represent the seller. However, you can hire your own real estate
broker, known as a buyer’s broker, to represent your interests. Also,
in some states, agents and brokers are allowed to represent both the
buyer and seller. A buyers agent is definitely the way to go! They will negotiate on your behalf and save you thousands of dollars and hours out of your life, and best part is that they are free to you. They get paid by whom every is selling the home but are bound by the state of texas to represent your interests only. Basically they get paid by the seller to negotiate against them on your behalf!
Find an
agent by interviewing them
before choosing one. Look for an agent who listens well and fully
understands your needs. Pick one who is familiar with the area in
which you wish to purchase your home. You want to choose an agent that
can provide all the knowledge and services that you need. You want an agent who is not attached to a sale but to your needs. Look for the agent who is willing to sit down with you and explain the process from start to finish and answer any questions you may have, no matter how many.
Creditworthiness
When
you’re applying for credit - whether it’s a credit card, a car loan, a
personal loan or a home mortgage - lenders want to know your credit
risk level. In other words, “If I give this person a loan or credit
card, how likely is it that I will get paid back on time?”
There are three major credit reporting agencies (Equifax, Experian
and TransUnion) in the United States that maintain records of your use
of credit and other information about you. These records are called
credit reports, and lenders will want to check your credit report when
you apply for credit. In most cases, lenders will also want to know
your credit score. A credit score is a number that summarizes your
credit risk, based on a snapshot of your credit report at a particular
point in time. A credit score helps lenders evaluate your credit
report and estimate your credit risk. Your credit score influences the
credit that is available to you and the terms (interest rate, etc.)
that the lenders offer you. It’s a vital part of your credit health.
If your credit score is low, you will generally end up with a less
favorable home mortgage. The interest rate most likely will be higher,
which will make the monthly home payments higher.
If you are
in the planning stages of acquiring a home, you may wish to check your
credit score before applying for a loan. If you find errors in the
report, you should take steps to have those errors corrected to improve
your score.
The most commonly encountered credit score is your FICO® score, which is easy to check online. Although in most cases, there will be a charge to obtain the FICO® score. An important time to check your FICO® score is six months or so before you plan to purchase a home. This will give you enough time to verify the information on your credit report, correct errors if there are any, and take actions to improve your FICO® score if necessary. In general, any time you are applying for credit, taking out a new loan or changing your credit mix is a good time to check your FICO® score. Improving your FICO score can help you:
• Get better credit offers;
• Lower your interest rates; and
• Speed up credit approvals.
The payoff from a better FICO® score can be big. For example, with a 30-year fixed mortgage of $150,000, you could save approximately $165,000 over the life of the loan - or $459 on each monthly payment - by first improving your FICO® score from 550 to 720.*
* Based on average national interest rates as of September 2007.
Shopping for a Loan
Your choice of lender and type of
loan will influence not only your settlement costs, but also the
monthly cost of your mortgage loan. There are many different types of
lenders and loans you can choose from. You may be familiar with banks,
savings associations, mortgage companies and credit unions, many of
which provide home mortgage loans. Your agent can recommend lenders that they have seen in action with other clients, and will know if they are dependable, honest, experts in their field and will advise you properly. Most importantly your agent will know, If the lender and their team acutally close the loan on time, and for the terms they quoted up front. There is really know way to know this by talking to a lender. It takes someone who does business with them on a regular basis.
• Mortgage Brokers
- Some companies (known as "mortgage brokers") offer to find you a
mortgage lender willing to make you a loan. A mortgage broker may
operate as an independent business and may not be operating as your
"agent" or representative. Your mortgage broker may be paid by the
lender, you as the borrower, or both. You may wish to ask about the
fees that the mortgage broker will receive for its services
• Government Programs
- You may be eligible for a loan insured through the Federal Housing
Administration ("FHA") or guaranteed by the Department of Veterans
Affairs or similar programs operated by cities or states. These
programs may require a smaller down payment. Ask lenders about these
programs. You can get more information about these programs from the
agencies that run them.
• Computer Loan Origination Systems (CLOs)
- CLOs are computer terminals sometimes available in real estate
offices or other locations to help you sort through the various types
of loans offered by different lenders. The CLO operator may charge a
fee for the services the CLO offers. This fee may be paid by you or by
the lender that you select.
Types of Loans
- Loans can have a fixed or variable interest rate. Fixed rate loans
have the same principal and interest payments during the loan term.
Variable rate loans can have any one of a number of "indexes" and
"margins" which determine how and when the rate and payment amount
change. If you apply for a variable rate loan, also known as an
adjustable rate mortgage ("ARM"), a disclosure and booklet required by
the Truth in Lending Act will further describe the ARM. Most loans can
be repaid over a term of 30 years or less and have equal monthly
payments. The amounts can change from time to time on an ARM depending
on changes in the interest rate. Some loans have short terms and a
large final payment called a "balloon." You should shop for the type
of home mortgage loan terms that best suit your needs.
Interest Rate, "Points" & Other Fees
- The price of a home mortgage loan is usually stated in terms of an
interest rate, points and other fees. A "point" is a fee that equals 1
percent of the loan amount. Points are usually paid to the lender,
mortgage broker, or both, at the settlement or upon the completion of
the escrow. Often, you can pay fewer points in exchange for a higher
interest rate or more points for a lower rate. Ask your lender or
mortgage broker about points and other fees.
A document called
the Truth in Lending Disclosure Statement will show you the "Annual
Percentage Rate" ("APR") and other payment information for the loan you
have applied for. The APR takes into account not only the interest
rate, but also the points, mortgage broker fees and certain other fees
that have to be paid. Ask for the APR before you apply to help you
shop for the loan that is best for you. Also ask if your loan will
have a charge or a fee for paying all or part of the loan before the
payment is due, otherwise known as the prepayment penalty. You may be
able to negotiate the terms of the prepayment penalty.
Lender-Required Settlement Costs
- Your lender may require you to obtain certain settlement services,
such as a new survey, mortgage insurance or title insurance. They may
also order and charge you for other settlement-related services, such
as the appraisal or credit report. A lender may also charge other
fees, such as fees for loan processing, document preparation,
underwriting, flood certification or an application fee. You may wish
to ask for an estimate of fees and settlement costs before choosing a
lender. Some lenders offer "no cost" or "no point" loans but normally
cover these fees or costs by charging a higher interest rate.
Comparing Loan Costs
- Comparing APRs may be an effective way to shop for a loan. However,
you must compare similar loan products for the same loan amount. For
example, compare two 30-year fixed rate loans for $100,000. Loan A
with an APR of 8.35% is less costly than Loan B with an APR of 8.65%
over the loan term. However, before you decide on a loan, consider the
up-front cash you will be required to pay for each of the two loans as
well.
Another effective shopping technique is to compare
identical loans with different up-front points and other fees. For
example, if you are offered two 30-year fixed rate loans for $100,000
and at 8%, the monthly payments are the same, but the up-front costs
are different:
Loan A - 2 points ($2,000) and lender required costs of $1,800 = $3,800 in costs.
Loan B - 2 1/4 points ($2,250) and lender required costs of $1,200 = $3,450 in costs.
A
comparison of the up-front costs shows Loan B requires $350 less in
up-front cash than Loan A. However, your individual situation (how
long you plan to stay in your house) and your tax situation (points can
usually be deducted for the tax year that you purchase a house) may
affect your choice of loans.
Lock-ins
- "Locking in" your rate or points at the time of application or during
the processing of your loan will keep the rate and/or points from
changing until settlement or closing of the escrow process. Ask your
lender if there is a fee to lock-in the rate and whether the fee
reduces the amount you have to pay for points. Find out how long the
lock-in is good, what happens if it expires, and whether the lock-in
fee is refundable if your application is rejected.
Tax and Insurance Payments
- Your monthly mortgage payment will be used to repay the money you
borrowed plus interest. Part of your monthly payment may be deposited
into an "escrow account" (also known as a "reserve" or "impound"
account) so your lender or servicer can pay your real estate taxes,
property insurance, mortgage insurance and/or flood insurance. Ask
your lender or mortgage broker if you will be required to set up an
escrow or impound account for taxes and insurance payments.
Transfer of Your Loan
- While you may start the loan process with a lender or mortgage
broker, you could find that after settlement another company may be
collecting the payments on your loan. Collecting loan payments is
often known as "servicing" the loan. Your lender or broker will
disclose whether it expects to service your loan or to transfer the
servicing to someone else.
Mortgage Insurance
- Private mortgage insurance (PMI) and government mortgage insurance
protects the lender against default and enables the lender to make a
loan which is considered a higher risk. Lenders often require mortgage
insurance for loans where the down payment is less than 20% of the
sales price. You may be billed monthly, annually, by an initial lump
sum, or some combination of these practices for your mortgage insurance
premium. Ask your lender if mortgage insurance is required and how
much it will cost. Mortgage insurance should not be confused with
mortgage life, credit life or disability insurance, which is designed
to pay off a mortgage in the event of the borrower's death or
disability.
You may also be offered "lender paid" mortgage
insurance ("LPMI"). Under LPMI plans, the lender purchases the
mortgage insurance and pays the premiums to the insurer. The lender
will increase your interest rate to pay for the premiums - but LPMI may
reduce your settlement costs. You cannot cancel LPMI or government
mortgage insurance during the life of your loan. However, it may be
possible to cancel private mortgage insurance at some point, such as
when your loan balance is reduced to a certain amount. Before you
commit to paying for mortgage insurance, find out the specific
requirements for cancellation.
Flood Hazard Areas
- Most lenders will not lend you money to buy a home in a flood hazard
area unless you pay for flood insurance. Some government loan programs
will not allow you to purchase a home that is located in a flood hazard
area. Your lender may charge you a fee to check for flood hazards.
You should be notified if flood insurance is required. If a change in
flood insurance maps brings your home within a flood hazard area after
your loan is made, your lender or servicer may require you to buy flood
insurance at that time.
Down Payment
If you have the funds for a down payment
and a good credit rating, this is probably a good time to purchase a
home, since there is a large inventory of property available and the
prices are lower than they have been for a number of years.
The
typical down payment required for the purchase of a home is twenty
percent of the purchase price. In the past, banking on steadily
increasing home values, some creative financing arrangements required a
much smaller down (some no down payment at all). However, with the
decline in home values during 2008, these creative home loan
arrangements are generally no longer available.
If you lack the ready cash for the down payment or are short on the amount you need, the following may be possible sources:
IRA Account
- If you have an IRA account and you qualify as a first-time home
buyer, tax law permits you to make up to a $10,000 penalty-free
withdrawal from an IRA to purchase a home. (Please note that even
though the withdrawal might be penalty-free, it is still taxable). The
tax definition of a first-time homebuyer is quite different from the
literal definition of a first-time homebuyer. As it turns out, you can
qualify even if you owned a home before. Generally, you are a
first-time homebuyer if you had no present interest in a main home
during the 2-year period ending on the date of acquisition of the home
which the distribution is being used to buy, build, or rebuild. If you
are married, your spouse must also meet this no-ownership requirement.
To qualify for the first-time homebuyer penalty exception, the
distribution must be used to pay qualified acquisition costs before the
close of the 120th day after the distribution was received. When added
to all of the taxpayer's prior qualified first-time homebuyer
distributions, if any, the total distributions cannot be more than
$10,000. If the taxpayer is married, both can withdraw up to $10,000.
Other Retirement Accounts
– The penalty-free withdrawal from IRA accounts does not apply to other
types of retirement accounts. However, funds can be rolled from a
qualified plan to an IRA and then a penalty-free distribution can be
taken from the IRA.
Gifts – Often parents or other relatives can assist a potential homebuyer by gifting them the funds to help with the down payment.
First-Time Homebuyer Credit
– For home purchases made after April 8, 2008 and before July 1, 2009,
a first-time homebuyer (no present ownership interest in a principal
residence in the U.S. during the 3-year period before purchasing the
home) can receive a refundable tax credit equal to 10% of the home’s
purchase price, but capped at $7,500 ($3,750 for married taxpayers
filing separately).
The credit is essentially an interest-free
loan that must be paid back. The repayment will be in the form of an
additional tax amount on the homeowner’s federal tax returns for 15
years. If the home is sold or no longer used as a primary residence
before the end of the 15-year period, the balance of the un-repaid
credit must be repaid in the year the home is sold or no longer used as
the taxpayer’s primary residence. There are special rules for
divorced taxpayers, deceased taxpayers, and where the un-repaid credit
exceeds the gain when the home is sold. The credit is phased out for
high-income taxpayers and not allowed for nonresident alien homeowners
or homes financed with tax-exempt mortgage bonds or property purchased
from a related party.
Holding Title to Your Home
You also need to consider
how you intend to hold title to the home. Surprisingly, many home
purchasers don't give much attention to the question even though the
manner in which the title is held can have far-reaching ramifications.
The
best way to come to a decision about the title is to consult with a
real estate attorney. Before you do that, however, you may want a
little background on the more prevalent title-holding methods:
• Title held in the name of one individual.
Single individuals would probably be the most likely candidates for
this method of holding title. However, married individuals may also,
for one reason or another, choose to take title individually rather
than with their spouse. When the owner of the property dies, probate
is necessary. However, the property takes on a new value for the
beneficiary - equal to its fair market value at the date of the
original owner's death.
• Joint tenancy with right of survivorship.
Under this form of ownership, all (two or more) owners hold title to
the property. Each owns an equal share of the property. When one
owner dies, the others become owners of the decedent's portion. An
advantage of joint tenancy is that it cuts probate costs since the
decedent's portion of the property normally reverts to the remaining
joint tenants automatically (ownership recording, of course, need to be
changed). The basis of the decedent's part is revalued at the date of
death.
• Community property. Married couples in community
property states of Arizona, California, Idaho, Nevada, New Mexico,
Louisiana, Texas, Washington and Wisconsin can claim community title to
property. Under community property rules, each spouse owns half of the
property and each spouse can pass his/her portion either to the other
spouse or to someone else. An advantage of community property is that
when it is willed to a surviving spouse, the entire property gets
revalued to its fair market value at the date of the decedent spouse's
death.
Other methods of holding title, like tenancy in common or holding property in trust, are also available. All have their "special" pros and cons. Some community property states also have special methods of holding title such as California’s “community property with right of survivorship,” which combines the tax benefits of holding title as community property including a double step-up in basis with the ease of property transfer available to the survivor of joint tenancy property. Before making your final decision, take some time to check out the different methods of holding title to determine what’s best for you.
Maintaining Home Cost & Improvement Records
One of
the benefits of home ownership is the ability to exclude up to $250,000
($500,000 for a married couple) of gain from the sale of the home. To
qualify for the exclusion, taxpayers must meet the ownership and use
tests. This means that during the 5-year period ending on the date of
the sale, taxpayers must have:
1) Owned the home for at least 2 years (if a joint return, only one spouse needs to meet the ownership test), and
2) Except for short temporary absences, lived in (used) the home as their main home for at least 2 years.
The
required 2 years of ownership and use during the 5-year period ending
on the date of the sale does not have to be continuous. Taxpayers meet
the tests if they can show that they owned and lived in the property as
their main home for either 24 full months or 730 days during the 5-year
period ending on the date of sale. Where taxpayers do not meet the
two-out-of-five use and ownership requirements, they may qualify for a
reduced exclusion if the home was sold as a result of unforeseen
circumstances.
Maintaining good records will help reduce any
future gain and minimize any potential tax when the home is sold.
Therefore, it is important to keep a copy of your purchase documents
that itemize the costs of purchasing the property, along with
substantiation for all subsequent improvements to the home. Don’t make
the mistake of thinking that the $250,000 or $500,000 gain exclusion
will cover all subsequent appreciation in value of the home.
**all information provided is for your convenience and informational purposes. Terms, Conditions, Taxes & Programs etc change all the time, so seek the advice of a competent professional about all matters**