As I've mentioned before, most of the topics I write about in this blog come from the casual (and sometimes not so casual) questions people ask me every day. One of the big topics lately has been buying a home. You'd think that with all of the pressure on Americans to buy their own homes, we would feel a little more comfortable with the mechanics of it. But most of us end up confused or frustrated at some point in the process. To help prevent that, here are a few things to think about if you are considering a new home.

It's your life

Let's start with the obvious. Some of us buy because we are dreaming of that home. Some of us, though, are just feeling like buying is something we are supposed to do. Yes, a home can be a great investment, but like all investments it can go really badly. Before you buy for investment purposes read this post.

Likewise, buying can make you feel more grown up if your idea of dinner at home is a take out carton and a coffee table you picked up on Craiglist. But homeownership is a pretty expensive way to impersonate a grown up. If you are thinking of spending hundreds of thousands dollars to buy a new place, make sure it's a decision that works for you. Put aside any and all advice from well-meaning family, friends and real estate agents and really weigh whether at this particular point in your life (whenever that is) you actually want to be a homeowner. If the thrills of home decorating don't make up for the frustrations of home maintenance for you, maybe you'd be better off getting a real kitchen table and throwing the extra money in your retirement account. If you do want to be a homeowner...

Do the math

There are a thousand and one mortgage calculators on the web to help you figure out how much you would pay per month and in down payment for the house of your dreams (or a smaller replica of the house of your dreams). I've already posted a basic explanation of how banks calculate your mortgage qualifications.

But it isn't just about what you can afford. Be sure to think about the what you actually want to pay given your other monthly expenses and opportunities. Mortgage payments, like rent payments, fit into the category of "fixed expenses," the things that you can't negotiate if you have a difficult month. It's one thing to cut out the fine dining, put off a trip or cut down on your retirement contributions for a bit; it's a whole other thing to be tied to a high mortgage payment if your income suddenly goes down. Which means you want to do some real soul searching about how much of a mortgage payment you are ready to carry, no matter what happens.

Not So Hidden Costs

We all know there are extra expenses to buying a home, but they look pretty inconsequential next to the home prices themselves. They seem a lot less inconsequential on closing day when you actually start to pay them. From the beginning of your search, keep this list in mind and be ready with cash on hand. And of course, bargain with everyone from banks to sellers for the best deal.

The first of the "extra" costs is the real estate agent's commission (typically 6% split between the seller and the buyer agents). If you are smart, you'll also pony up for a home inspector whom you trust—you will feel pretty stupid if you scrimp on the few hundred bucks here and find yourself with thousands of dollars in surprise repairs later.

And then there are the famous "closing costs" that come due on the day you get the keys for your new house. In total closing costs generally range from about 2% to 5% of the value of the property, though it's not unheard of to see that percentage go all the way up toward 8% (ouch).

Bank Fees (the bank giving you the mortgage may charge an origination fee, "discount points", credit report or loan application fees, title search and title insurance fees, a charge for the appraisal, and the initial interest payment)
Initial property tax payment
Charge for a survey of the property
Homeowners Insurance
Attorney fees (for your attorney)
Recording fee (to your local government records office when you file your new title)

Your closing costs will be lower if you get tough with your lender from the start (be sure to ask the bank for a Good Faith Estimate—they are required to give it to you by law!). Costs can be shared with the seller if you and your agent negotiate well, and if you've got a little extra room in your mortgage limits, some of these costs can be rolled into your mortgage. This is the place where having a good agent and communicating well with your bank can make a huge difference.

Don't Rush the Process

In all likelihood, you won't end up buying the first home you think you want. Plan to spend at least 3-4 months becoming familiar with the market and just as importantly, focusing in on what you really want. Real estate agents are notorious for bringing clients to homes that only loosely fit the client's "wish list." It's not that your agent wasn't listening to you; it's just that agents have learned from experience that most people only realize what matters to them most by looking at a lot of different properties and changing their minds over time.

Patience can save you money on your home price. And it can save you money after closing. The adrenaline rush of buying a house tends to send new owners into a follow-up frenzy of furniture shopping and DIY projects. This is all made worse by the fact that the $6,000 dining table no longer looks as expensive when compared with the $600,000 condo. By all means, pick up a new couch if you don't have one from your old place. But you'll save money and be happier with your home in the long run if fill in the gaps slowly (or at least wait until $6,000 looks like a big number again).

Ask Around

At this point it might look like I am trying to dissuade anyone from buying a home. I'm not. Buying a home is an exciting process. If this is the next big purchase for you, start by asking people you know about their own experiences. How was their lender? Who was their agent? Their home inspector? Which areas of town did they search? Why did they buy where they did? What would they have done differently, if anything?

The home hunting season starts up in late February. Good luck!

We've had a number of clients in the office lately asking about qualifying for mortgages. Despite the fact that just about everyone and everything in U.S. policy is trying to get us to buy homes, we Americans are often confused about how our mortgage system works. So here are the basics to know before you go shopping for a mortgage:

Down Payment Realities

Before the 2008 housing market crash, banks had all sorts of inventive programs to get people in new homes. It turns out some of them were too inventive, and banks are back to some more familiar requirements. If you can do it, your best bet is to put at least 20% of the total price you are paying down on the house. Why? A 20% down payment will almost always get you a better interest rate. And since your large down payment is considered less risky for the bank, you won't be required to pay private mortgage insurance (PMI). Folding the PMI into a higher interest rate might help, but there is no way around the much higher cost, in loan terms and PMI if you dip below that 20% down payment.

But....

If you are going to have trouble coming up with a larger down payment, you might qualify for a special loan through the USDA's zero-down payment for rural low-income buyers, VA loans for veterans, Fannie Mae's Homepath Program or a first-time home buyer program in your area. Start with the link to HUD's website at the bottom of this post if you think you might qualify for home buying assistance.

Know Your Ratios

For obvious reasons, most people figure that they can afford a mortgage if the monthly payments are comparable to their current rent payments. But banks takes a completely different approach to whether you can afford a mortgage—they use very specific income-to-debt ratios. Here's how the math works:

The first number the bank will calculate (the "front" ratio) is the percentage of your income that will need to go to housing costs. In this case, your income is everything you earn before taxes*, and the housings costs include mortgage payments, taxes, insurance and even homeowners or condo association fees. Let's say you gross monthly income is $5,400, and your monthly housing costs are $1,800. That give you a front end ratio of 33% (1800÷5400=.333).

Now for the "back" ratio—use the same numbers as above but add your consumer debt (car loans, student loans, credit card debt payment, etc...) to your housing cost. If the consumer debts were another $500 per month, you would add that to the $1,800 for a total of $2,300. Now divide that $2,300 by the same $5,400 income as before and you get about 43% (2300÷5400).

Your ratios will be written: 33/43 ...and you will probably have trouble with your bank. Why? Because while a 33% front ratio is just fine, banks are usually looking for a lower back ratio—something closer to 38. Some of the subsidized loan programs I mentioned above might let you go up to 41 on that back ratio.

Know Your Terms

In addition to interest rates, down payments and mortgage insurance, the way that you repay your mortgage loan can vary. A 10-year mortgage means lower monthly payments but less interest paid over time; a 30-year mortgage can lower your monthly costs, but means you will pay substantially more interest over the course of the loan.

You also need to watch out for the difference between fixed rate mortgages (your interest rate & payments stay the same until the mortgage is paid off) and Adjustable-Rate Mortgages (ARM's). Most banks will offer you a lower initial interest rate if you are willing to sign on to an ARM, but there's a big down side. ARM's mean that you (and not the bank) are taking the risk that rates might go up. In that case, you could end up paying much more per month or having all of your payments go to interest (which means that your loan could actually be getting larger!). Because of this unpredictability, we usually recommend fixed-rate loans if you are buying a home.

Be Prepared

Now that you know how the calculations work, you should have an idea of what you can do before you go to the bank to put yourself in a position to get the best terms on your mortgage:

Save up for a healthy down payment of 20% if at all possible (that will not only get you a better interest rate but also reduce your monthly payments, which means better ratios);
Lose the consumer debt payments. As you can see, paying off some of those consumer debts can make all of the difference in qualifying for a mortgage. Even if you qualify, waiting until you have debts under control can improve the interest rate you get;
Rehabilitate your credit score. This one gets lots of press, and for good reason. The interest rate you will get and often, you ability to qualify for a loan at all depend on your credit rating. Fortunately, you can improve your rating if it has fallen over the years.

Find A Good Bank

Mortgages work just like any other product—you need to shop around. If you belong to a credit union, start there, but be sure to talk to a few different lenders before you make a final choice. You might also consider a mortgage broker, who will scout around for you to find the best offer (be aware, though, her fee is paid by the bank that secures the deal so she is not working entirely for you).

Don't be tempted to skip this step! Banks can offer wildly different terms and rates for the same home purchase, which means you could end up paying thousands more for your home loan.

Check Out Resources

The U.S. Department of Housing and Urban Development (HUD) provides step by step information for home buyers, including links to home buyer programs in your area. Check them out on HUD's site.

*Note that you have to be able to document your income, usually through tax returns. Self-employed buyers can still qualify, but the process may be slightly more complicated.

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So You Want To Buy A House