Successful Home Ownership I – “Qualify” vs. “Afford”
In my many appointments with hopeful homeowners to be and with those hoping to make a transition to another home or purchase a second home, I often draw a simple distinction between two words—qualify and afford.
The word qualify is my word. As the lender I need to make sure that I can “qualify” the borrower for the loan and ultimately the home that she wants.
The word afford is the customer’s word and is often ignored in the lending office. This is the process whereby the potential borrower determines what she is able to pay each month based on her income and other bills and lifestyle habits.
Let me give you an example of the conflict:
A couple recently applied for a mortgage and said they could afford a payment of $1750 per month. She was employed full time making around $39,000 per year her husband was between jobs. He had been off for 6 months and had three prior job changes in the past two years including one complete career change 15 months ago. His salary in his most recent position was around $60,000. The job he is looking at currently will pay a smaller base salary and a commission based on his production.
Because they have no other debt and a nice emergency fund, they feel comfortable paying up to $1750 per month for a house payment. They feel that her income is stable and that his income will be at least as much as hers and likely over $50,000. I like folks who are confident in their ability to earn money. That however, does not get them approved.
Right now I can only qualify them for a payment around $1200 – this is calculated on her base salary alone. After he has been employed for at least 30 full days (and because of his recent 6 month hiatus, maybe a little longer), I will be able to add his base salary to the mix increasing their qualifying payment to something higher than $1500 and closer to their high-end “afford” number.
I recently read an article on-line that commented on a recent survey of loan officers who were willing to make general comments about their customer’s mortgage decisions. The survey highlight was that most (7 out of 10) loan officers nationwide were of the opinion that their customers accepted mortgage payments in excess of what they could afford.
Though that number seems high to me, I did recently have one of those cases; it’s not something that I get a lot. The client learned about me through this website, and we began discussing his needs and financial situation. He ended up in a deal that would not only require most of the cash he had saved, but the house would still need a lot of work after closing.
As soon as I see a transaction hit a level where I’m getting nervous, I call my customer and tell them. They generally appreciate it, and when I brought it up in this case, I was reminded that he would be getting married this summer and that his fiancé had some cash to contribute to the repairs. We went through the likely reality of the next year together—the wedding, honeymoon, home repairs, car purchase, and anything else we could think of—and found out that it all worked. It was closer to the line than the customer thought but better than I had suspected. We both appreciated the conversation and moved forward.
The point here is that this entire last conversation happened AFTER the lender had already given the all-clear on the mortgage approval.
So, a lender saying yes does not equal your being able to afford the loan. Your loan officer should help you see all the angles of the situation, but if he doesn’t, take a few minutes and add it up yourself. My next four posts over the next couple of weeks will help.
Successful Home Ownership II – Know the Real Cost of Owning that Home
From time to time we see a home on the market that is completely ‘gutted’ and listed for sale by a bank. As we look into it, we find that a different bank, not long before, had foreclosed on a different borrower. It is very likely that the buyer who purchased it from the first bank did not add things up before they got into the deal. They got half way through the remodel project and were unable to finish it. It’s likely they didn’t know what they were getting into until it was too late.
By doing some simple number crunching in five key areas, you can avoid getting into a scenario like this…
1. Next year’s taxes. This can be tricky. Make sure you have computed the actual tax rates and estimated correctly what the taxable value is and will likely be next year. Future tax bills on the home you are buying could go up or down based on many variables.
2. Utility bills have more to do with the particular home you own than with you. How many lights come on when you flip the switch, and how much electricity is used when you forget to turn it back off? How well insulated is the home, and how many windows does it have? How old is the furnace? Many of these variables contribute more to the amount of the bills you will pay than you do. Either make a very high estimate going into the deal until you’ve seen the real bills or get some past data on the home from the utility companies. And with past data, be sure you’re comparing apples to apples. Was the previous owner the sole occupant or did he share the space with a wife and eight kids?
3. Water, sewage and trash are different in many different neighborhoods. Be aware ahead of time of the kinds of bills that will be coming to the house.
4. Yard, mulch, mowing, and the outdoor appearance of the home will all look either very nice if you are buying a home from a private party or very bad if you are buying from a bank. Either way these items will generally cost you more than you think in money and time. When I talk with clients a year or two after they’ve purchased a home, they often talk about the outside issues as the ones that caught them off-guard the most.
5. Deferred maintenance items like rebuilding a deck, replacing an old furnace, redoing a roof, new carpet and paint, appliances, electrical and plumbing are all things that need to be understood well ahead of time. As you go into any home you’re considering buying, make three lists:
First, what can I get the seller to fix before closing if anything? Make sure these are items that you are not concerned about being done correctly – a furnace that you choose for example is a good one for this list where as new kitchen layout is something you want to have more involvement in and would need to wait until after closing.
Second, what will the lender require to be repaired prior to closing? This one is important because it could mean your loan approval is in jeopardy if items required by the lender cannot be done prior to closing. A new roof is sometimes a good example here. The roof is a major repair so sellers are often leery of having it done before the home is sold, yet lenders might require it based on the remaining life of the roof remaining.
Lastly, what will you want to do once you take possession? Make sure you do a good job with this one in advance. It’s easy to assume that once you’re in the home you can begin the improvements, but these can get out of control if you don’t have a prioritized list in advance. Make sure you understand the cost of the remodeling you plan to embark on it so that you don’t end up putting the improvements on a credit card just to finish them.
So count the cost in each of these five areas before you dive in. You’ll have a better idea of what’s ahead, and be able to write a more informed offer on the home up front. You’ll also be more likely to hang onto that home once it’s yours.
Successful Home Ownership III – When Does it Make Sense to Take the Plunge?
It’s easy to print the “regs” and find out from FHA or VA or Fannie Mae just what it takes for them to approve a loan for you. The rules and guidelines are very detailed but they’re understandable.
But did you know that I can approve a person whose gross (before taxes and all other withholdings) income is $60,000 per year for a $2500 house payment under the right list of conditions? That’s half the borrower’s income. The before tax income! In this case the person would have approximately $1200 left every month to pay all utilities, car insurance, life insurance, groceries, Christmas presents, etc. Not sure how this make sense, but FHA will do it – and with only 3.5% down.
Here are some helpful benchmarks to consider before trying to buy a home or make a move up into a more expensive home.
Set a goal to have all of your debt paid off. No car loans, no credit cards. For most people, that would free upwards of $600 or more per month, money that can be used to make home improvements and to take care of home-related things that must be planned for like a new roof or septic repair.
You should never get into your home using your last saved dollar. Emergencies happen in life, but buying a home is not an emergency. Even non-emergency-type events happen that cost money. So consider saving up to three months of your current monthly budget over and above what you need for your down payment. A new $300 water heater can be a very calm and non-emotional event – if you have the money to pay for it. When you don’t then something that simple (which is inevitable if you think about it) can be a day or even a week wrecker.
We can never be sure that our income will continue exactly as it has, much less that it will increase – just ask state employees and General Motors union workers. Nothing is certain, and that’s a certainty. Yet it makes sense to remember a few things: Don’t commit yourself to a payment based on needing to make overtime or bonuses; And wait until you’ve settled into the job and like it (and they like you) before taking any step like a home purchase.
Put a ring on her finger and get Married already
I would never recommend buying real estate with a friend, or even with someone who is more than a friend. Tie the knot first. I don’t mean to be preachy, but I find more often than not, folks who are not married and buy a home together end up in a difficult spot. Getting into a home is much easier than getting out of one. Make sure it’s forever before taking this step.
Let’s face it, lenders are good at getting deals approved and closed. They’re motivated because they get paid for it – this is good for you. You want the person working for you to work hard and not give up until the deal you want is closed. But that means you need to be watching your own back. If you walk into a lender’s office and express a desire to own a home or move up to a larger one, don’t expect much from the loan officer except for him to get that done for you, whether or not you are actually ready for it.
Successful Home Ownership IV – Do Your Market Research
The Case Shiller Index gives a national and regional home prices overview, and indications are that now is an excellent time to buy a home. That does not mean that someone can’t pay too much for a home in today’s market.
When you’ve decided about the area in which you would like to live, set up a meeting with a full-time Realtor, preferably contracting with a Buyer’s Agent, one that you were referred to or already know and trust.
When you’re looking at a particular home, make sure you obtain ALL listed and sold homes in the area surrounding that home. The listings should all be active listings, and the sold homes should be from the last 6 months if there are any. Going back a little further can be helpful to give a little bit of perspective to the price – the farther back in time the sale closed, generally speaking, the higher the sold price will be (as of the date of this writing).
You also need to know what the Assessed Value of the home is as well as the Taxable Value of the home. In Michigan, these figures can be accessed for the past three or four years. Get them all. There’s no iron clad rule of thumb about the current taxable value of the home as it relates to the amount you should offer, but you want to know in general where you stand compared to what the seller may have paid for the home and how long they may have owned it. Go over these details with your Buyers Agent; he or she will explain the values here and what you are looking for.
Lastly, if the home is bank owned, you’ll need to know if the tax rate is inflated for the first year. This has the potential of adding thousands to the closing settlement amount, so it ought to be considered in the offer price and terms.
When you have all of the above information, you can begin to formulate a price. It’s likely that your agent will not be able to “give you a number” based on their code of conduct as Realtors, but they can give you great advice, so do ask lots of questions along the way.
Successful Home Ownership V – Negotiating with Maturity
Negotiating with maturity does not mean that you cannot “low ball” a seller in certain circumstances, but it does mean realizing what it is you’re doing.
If a seller has a home listed for $200,000 and you offer $140,000 – you have just low balled the seller’s number. There is nothing wrong with that, you just need to think it through ahead of time.
The seller has a few options, and a mature negotiator has his response to each one.
1. The seller could accept your offer.
If that happens, the two things that will enter your mind are 1) could I have gotten a better deal? And 2) what might be wrong with this home?
These are legitimate questions, but realize up front that you will want to take this into consideration before you make your offer. Ask yourself: if they accept my offer, will I kick myself for not going lower? There is a price that is too low and will move you to one of the next two options which are more difficult. To deal with the second question ahead of time, you’ll need to have a good home inspection done. You would do this anyway, but make sure you know what the added costs of deferred maintenance might be – costs like a new roof, a furnace, etc.
2. The seller might counter at $197,000 or something very close to their original price.
If the seller does this you can really do only one of two things: You can counter a few thousand higher than your original, or you can walk away for a while (30 days). If you come up more than they came down, then you essentially tipped your hand about one thing – you will come up. And they’ll keep drawing you up.
3. The seller could reject your offer.
Similar to the high counter, this kind of response basically says that you need to wait before you can offer again. Give it 30 days and then offer the same thing you did before. Do this a few times and keep waiting. Again, the obvious risk, especially if the home is a great deal, is that someone else may make a higher offer and take the home off the market.
How bad do you want it?
If you really want the home, then don’t low ball unless the low offer is the most realistic price based on your research. Make a fair offer and acknowledge that you are already getting a great deal. If you can take it or leave it, then you have little to lose if the seller starts playing the counter game with you. You can just walk away.
A good reminder
Also realize that your Buyers Agent has a family and a life too. After your 20th unrealistic offer, you may find yourself looking for a new agent since you’re not acting like you really want to buy a home.
Don’t wait this market out simply because you’re new to it. Go for it. If you make a mistake, apologize for it and move on. If you have to ask a ton of questions, then ask a ton of questions. This market is almost fool proof. You will do much better buying a home today than you would have (or did) three years ago.