RateWatch #410 – Purchasing A Home.  Where to Begin.
June 5, 2004 by Dick Lepre

What's Happening

Non-farm payrolls were +248,000 a bit above consensus but below last month which constitutes a comfort zone for Treasuries which were little moved by this report.  The real news, almost buried, was that April was revised from an original +288,000 to  +346,000. In the past 3 months the economy has added 947,000 jobs.  The "jobless" part of the jobless recovery is officially over. Also, Average Hourly Wages were +0.3% constituting a modest case for wage inflation. 

The overall effect of an increasing jobs market is, at the present time, tempered by higher oil prices which tend to depress GDP growth.  The result may well be an economy growing at a healthy pace without the "boom" that can cause inflation.

The betting will now be on a 25 basis point increase at the FOMC meeting on June 30. The Fed will start acting to abate inflation well before it is a concern.  Higher U.S. rates and contained inflation will make for a stronger dollar. In fact, rates will still be very low so the effect of a Fed
hike will be a "market psychology" one.

Since spring is here, I will use this as a convenient excuse to issue my annual reprint (slightly revised) of my home purchase guide.

Purchasing A Home.  Where to Begin.

Buying a home is a big deal.  I get a lot of e-mail from folks who are starting out and really don't know what to do.

Why Do This?

The first question to ask is: why buy a home? I live in a beautiful Victorian home in San Francisco that was built in 1880. It's solid redwood, it's cool.  Shortly after I moved in in 1970 I stood in the dining room and threw a rubber ball against the wall and caught it. I did this 20-25 times.  (I made 20-25 spots.) But it felt great.  When I was a kid I couldn't do this. But now I owned a house and I was going to throw MY ball against the wall of MY house and make MY spots and that was it.

I think that that little kid in all of us who doesn't want his or her parents or anyone else telling us where we can put our feet and what color we can't paint our walls is the real reason we buy houses.  It gives us a sense of freedom that we could never have at someone else's house.

But What About the Money?

For most people buying is more expensive than renting but the tax deductibility of our mortgage expense makes the prospect of owning a bit more practical.  In essence, our Uncle Sam is
making about a third of our mortgage payment.

Once you have made the leap and decided that you are going to buy a home you have to find out what you can afford.  That is where we come in.

When you decide to buy you should first contact a mortgage lender. You should discuss why you want to do this and see if it makes sense. Unless you fit into one of the "special categories" of
loans: VA, FHA, special Census Tract, First Time homebuyer you are going to get a "conventional loan".  Some areas, by their demographics, have a lot of these special case loans, some do not.  The remainder of this discussion pertains to "conventional loans".

The purchase price that you will be able to afford will depend on 3 main factors:

1) your income and how much other debt you have.  This will determine how large a PITI (principle, interest. tax and insurance) payment you can afford

2) how much cash you have for down payment and closing costs, and

3) your credit history.


You need to understand 3 terms to follow the rest of this:
1) loan-to-value (or LTV).  This is the loan amount as a percentage of the purchase price or appraised value (whichever is less).  If you are buying a $150,000 home with $15,000 down payment you have a 90% LTV. Loans over 80% LTV require either PMI (Private Mortgage Insurance) or a combination of a 1st and 2nd mortgage this avoids the PMI or a loan where the PMI is, in effect, built into the rate.

2) housing ratio, this is your total monthly housing expense (principle, interest, tax, insurance, and PMI and homeowners dues, if applicable) divided by your gross monthly income.  Note "gross" not net.  If you have a "W2" job your income is easy.  If you are self-employed please note you gross income is what you bring from your Schedule C onto line 12 of your 1040.  Also, a 2 year history of consistent self-employment income is necessary.

3) debt ratio, this is your total monthly housing obligations plus your monthly payments of your installment and revolving debt.  Some details here: this would include child support, alimony or separate maintenance.  Any debt with fewer than 10 months to go does not count. A debt such as "buy furniture now make no payments until more than a year from now" does not count as long as there are 12 months to go without payments.  The same goes for student loans.  If no payments are necessary for the next 12 months, the liability is not counted against you.

We often see young couples "blow it" by buying a couple of nice cars. If you are spending 15% of your gross income on your auto loans you are going to have difficulty buying a house.

OK, Now What?

The next step where we come in.  It use to be the case that there were certain rules regarding loan size, combined loan to value and debt ratios but the fact is that the mortgage industry is now much more liberal in the case of folks who have excellent credit.

You need to let us know what your income and assets are and, once we get your credit report, we can tell you how much of a loan amount you can qualify for.

The best advice I can give young people just thinking about this is to keep absolutely perfect credit.  Once you get out of college your credit score is like your SAT was before you got into college. It is the key to opportunity.

Your income and credit will determine what size loan you can qualify for. You now need the cash to make it happen.  You need cash for 3 things: 1) the actual "down payment" 2) closing costs.
This is where a lot of people get misled.  You need to cover your one time or "non-recurring" closing costs, your recurring closing costs: prepaid interest, insurance, impounds if there is PMI
and potential pro-rated property tax 3) reserves.  Your lender does not want to see a loan application the shows that when you close the deal you will have $5.99 left in the bank. They want
to see 2 months PITI in reserve.  Don't try to minimize this. Make sure that you get together all of the cash necessary to close.

Once you have determined what size loan you will be able to qualify for and where the money is coming from we can determine how expensive a home you can afford.

If you are planning on seeing Realtors and potentially making an offer it is essential that you get "preapproved".  Using my WWW site you can fill out the on-line application, and we can
prequalify you. Then you can walk into a Realtor's office with a letter stating that you can close a given deal.  This will get the attention of the Realtor, it will get the attention of the seller, and it will mean that you can close quickly.  This is very important for properties for which the seller has multiple offers.  In May I closed at least three loans where the fact that the buyer had my approval letter in had was the major reason why their offer was accepted.


Once you get preapproved you should identify where you think you want to live and find a great Realtor in that area.  To me, a great Realtor is someone who is going to listen to what you want and help you to find out what you want so that you do not have to tour every "open house".  If you are relocating the Internet can be a great resource.  You can find demographic information about areas, schools, mortgages and real estate listings.

The process should consist in the Realtor showing you several houses and getting your feedback and then getting a very clear idea of what you want and finding it.  Finding it  may take weeks or months.  It's up to you.  A good Realtor will not let you buy a house that is overpriced or that has physical problems that you do not have the experience, ability or money to deal with.  In times when every listing is getting multiple offers a good Realtor will help you to strategize your offer.

That's it.  Come to us, get preapproved, find a Realtor and bounce that ball off your very own wall!

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