Pay with your head, not your heart
Buying a house is the biggest financial transaction most of us will ever make, and people can experience both positive and negative outcomes for decades afterward. The most important factor that determines whether the purchase was a success is the value of the home. After all, whether the price was $100,000, or $1,000,000, paying too much for a property is a bad deal.
Of course, a lot of emotion goes into buying a house. You can love a place so much, you can feel that you must own it at any price. But a few years into a mortgage, if your dream house has failed to grow into the inflated price you paid, it becomes a recipe for buyer’s remorse. Not only is the house worth the same—or less—than you paid, but you miss out on financial advantages that come with home equity such as eliminating the added expense of mortgage insurance, and the ability to use your home’s equity to leverage credit. So keep reading to learn the top tips to ensure you get a fair deal in the real estate market and avoid overpaying for a house.
Prepare yourself financially.
Don’t bother shopping for a house before thoroughly reviewing your financial situation to see what you can afford. What is your monthly budget for housing? What is your debt-to-income ratio? How much cash do you have on hand for a down payment? The best deals are available to those who put down at least 20 percent. It must be lower than 43 percent to be approved for a mortgage, but the lower, the better. What is your credit score? For a traditional mortgage, it must be at least 620, but higher is better.
Lenders and other financial experts use a rule of 28/36 percent to help clients determine how much they can afford to spend on a house. No more than 28 percent of gross income should be spent on housing, and no more than 36 percent should go to total household debt. So if your income is $4,000 per month, your house payment (including taxes and insurance) should not exceed $1,120 per month, or 28 percent. Total household debt, including housing and other monthly obligations like credit cards and student loans, should not exceed 36 percent, or $1,440.
Shop for your mortgage.
Getting the right mortgage can potentially save you tens of thousands of dollars over the life of the loan. The money you borrow is principal, and the price you pay to borrow the principal is interest. Over the lifetime of a mortgage, you pay far more in interest than the amount of principal that you first borrowed. The two factors that impact how much interest you pay are the interest rate and the length (a.k.a. The term) of the loan. You pay more with higher rates and longer terms, and you pay less with lower rates and shorter terms.
Simply searching for online mortgage lenders provides great insight into the various mortgage types. Fixed rate mortgages charge the same percentage on the outstanding principal throughout the life of the loan. Adjustable rate mortgage (ARM) rates go up and down with market fluctuations. Terms range from 15 to 30 years.The most popular mortgage is a 30-year, fixed rate mortgage because it comes with a smaller monthly payment, but the rate is higher than with a 15-year mortgage. The lowest rates and least total interest you will pay are on 15-year fixed rate mortgages.
Get pre approved for a mortgage.
After getting to know the current state of the mortgage market, take the time to get pre-approved by a reputable lender — and don’t confuse prequalification with pre-approval. Prequalification is simply an estimate of the amount for which you may qualify, based on financial information you provide the lender. Pre-approval states the specific amount for which you have been approved, and the process to obtain it involves verification of financial information that you provide and a credit check.
Getting pre-approved ensures that the institution will underwrite a mortgage for up to a specified amount when you are ready to make an offer. Attaining pre approval can take several months, depending on your financial situation, the institution you’re working with, and how busy the market is.
Get a buyer’s agent.
When it’s time to start house hunting, build a strong team to help. Along with your trusted lender, the other key professional service you should engage is a buyer’s agent to help you find the right properties in the right locations at the right prices. A licensed agent has access to the most current real estate listings, even before they show up on sites like Zillow, Trulia, and Realtor. They coordinate showings and expertly guide you through the buying process. A buyer’s agent will help you get fair value because they understand the dynamics of the local real estate market. And best of all, a buyer’s agent’s crucial services cost you nothing. Their fee comes from the agent commission, which is paid by the seller at closing.
Define what you’re looking for.
Work closely with your agent to find the properties that best fit your personal criteria. So define your needs and desires up front. What do you absolutely need in a new home? What would you love to have, but could live without if you must? If you don’t want a pool, for instance, don’t bother looking at higher-priced houses that have one.
Know “the comps.”
Home prices vary from one part of a county, city, or metro area to another. Each neighborhood is a real estate micro climate. Gauge fair prices by comparisons within the neighborhood. Listing prices matter to an extent, but actual sale prices matter more. Use recent sales of three to four comparable homes—the comps—in the area to assess fair value. Dive deep to compare specifics about those houses with the house you’re interested in buying. Your agent can help with this.
Explore the neighborhood.
Before making an offer, find out a little more about the seller and the neighborhood. Find out what is triggering the sale of this home—especially if the seller is motivated to make a quick sale. If the seller simply must relocate for work, no red flags are raised, but if the family is moving to be in a better school district, that could be an issue. Is there a sudden influx or exodus of residents? Why? Spend time learning about HOA fees, pending housing and road construction projects, crime rates, school quality, tax rates, and other quality of life and cost of living issues that will impact your life if you move there. Start by checking the local municipality’s official website, Moving.com, GreatSchools.org, and community network sites like NextDoor.com.
Make a fair offer.
Using all the information at your disposal, in consultation with your agent, make a fair offer. Avoid the temptation to low-ball, as others may be bidding on the same house and you will lose out. Consider the asking price, length of time on the market, and the known condition and features of the home.
If the home recently came on the market at a similar price to recent comp sales, it may be a fair price to offer. But a home that has been on the market much longer than the comps, with no recent price adjustment, may go for a lower-than-asking price. If it’s your dream home and the market is super hot, it may be worth offering a bit more.
Avoid a bidding war.
Be prepared to walk away if bidding spikes. Bidding wars are often triggered by low bids and competitive housing markets. If you get sucked in, it’s easy to fall into the trap of overpaying simply because you want to win. Understand the market and be prepared to make a premium offer up front if competition is intense.
Make a more competitive offer without paying more.
Instead of offering a higher price, compete in a sellers’ market by making your offer stand out in other ways. Your financial preparation and knowledge of the seller’s needs will be key. Offer more earnest money (the typically one to three percent “security deposit” submitted with an offer that represents good faith) or a faster closing (if pre-approved for a mortgage, you may be able to close at least a week sooner than another potential buyer). You can also allow the seller to occupy the property for an extra month after closing if the family needs more time to find lodging. Find ways to make selling to you feel like the most convenient option.
Include an appraisal contingency.
When a seller accepts an offer, the buyer’s lender orders an appraisal of the property before signing off on the loan. If the appraisal comes in lower than the offer, it could be a deal breaker. An appraisal contingency, included in the offer, can keep the conversation going. It stipulates that the lender’s appraisal must come in within five to 10 percent below the selling price. The appraisal contingency would initiate a round of negotiations between seller and buyer, based on the lender’s fair market appraisal.
Include a home inspection contingency.
The last key member of your home buying team is a good home inspector. This professional will review all aspects of the home’s physical structure and systems, and provide a clear, concise report of the findings (start your search for one here). Include a home inspection contingency in the offer. Such a contingency would release you from the contract without penalty in the event that the inspection reveals significant defects in the home. You can request credit at closing for less significant findings, and then coordinate repairs with your own contractor after you move in.
Get the help you need for the home you want—sign up for the Bob Vila newsletter today!