The Home-Buying Process

One of the first steps to take when you've decided you want to be a homeowner is to determine how much house you can afford. There are two parts to this. The first is to follow a budget for at least three to six months so you know your spending habits and how much money you have to work with. The second is to estimate how much money the bank is likely to lend you so you don't waste time and emotional energy looking at houses or neighborhoods you can't afford. Buying a house should be an exciting time, and you don't want to be discouraged at having to settle for a two-bedroom bungalow with a carport if you've been looking at four-bedroom colonials with a two-car garage.

Calculate Your PITI

To estimate how much you can expect to borrow, use the two basic guidelines that banks and mortgage companies follow. The first guideline is that principal, interest, taxes, and insurance (PITI) shouldn't exceed 28 percent of your gross income (your pay before taxes). Let's say that your gross income is $50,000 a year. Your principal, interest, property taxes, and insurance shouldn't exceed $14,000 per year, or $1,166 per month.

Property taxes can vary drastically between states and even between towns in the same state, so call the town or city tax assessor and ask what the typical taxes would be on a house that's in your approximate price range. The sales listing for a home you're looking at may also yield some historic information — but things could change. You may be able to afford to buy the house but unable to afford the taxes.

Let's assume that the property taxes on a $100,000 house are $1,800 per year, or $150 per month, that homeowner's insurance is $400 per year, or $33 per month, and that PMI is $50 per month. You would qualify for $933 per month in principal and interest payments ($1,166 – $150 – $33 – $50 = $933). So how much house can you buy for $933 per month? Try plugging several different interest rates into one of the mortgage calculators found at Web sites such as CNNMoney (http://money.cnn.com) or Quicken.com (www.quicken.com).

Consider Your Long-Term Debt

The second guideline is that PITI plus all your other long-term debt shouldn't exceed 36 percent of your gross income. Your long-term debt (car loans, credit cards you won't have paid off within the next ten months, furniture or equipment loans, student loans, child support and alimony, and so on) shouldn't exceed 8 percent of your income (36 percent – 28 percent for PITI = 8 percent for other debt). Again, using the example of $50,000 in gross income, your monthly payments toward long-term debt other than your PITI shouldn't exceed $333 per month ($50,000 × 8 percent + $4,000 Ã÷ 12 months + $333 per month). If your debt payments are more than this, you'll need to come up with a larger down payment so you don't have to borrow as much.

If you make a small down payment, your lender may only use the lower percentages for PITI and long-term debt to protect itself against the possibility that you might default on your loan. However, there's a growing trend for lenders to automatically use the 28 percent guideline for PITI.

Check the Mortgage Calculator

Just because you qualify for a certain amount doesn't mean you can afford it. That's why it's invaluable to have tracked your spending and income for several months. You'll have a better picture of your overall financial condition and how much you can realistically pay for housing.

Play around with an online mortgage calculator that will help you determine how much you can afford to pay for a house. Moving.com (www.moving.com) has an excellent calculator for this. Click on “Mortgage,” then “Tools & Calculators.” Run a few different scenarios to get a feel for the numbers. There are also several helpful calculators related to the home-buying process at Mortgage101.com (www.mortgage101.com) under “Calculators.”

Getting Preapproved or Prequalified

It's a good idea to apply for your mortgage early in the process instead of waiting until you find a house you like. Prequalification means the lender has looked at your credit report, income, and level of debt and determined that you appear to qualify for a loan.

Mortgage brokers bring lenders and borrowers together but do not lend money or service loans. Their fee is added to the cost of your loan. If you don't have great credit, you may get a better rate through a broker than through a bank, but watch out for the fees.

Preapproval means that the lender has actually approved you for a specific loan amount. Preapproval gives you the most credibility with the seller, who may be deciding between two or more offers and doesn't want to accept an offer from someone who may not qualify for the financing. You'll need to provide a heap of paperwork to the mortgage company during the application process, including the following forms:

  • W-2 forms for the prior two years

  • Federal tax returns for the prior two years

  • Documentation for any other income you're claiming, such as overtime, bonuses, child support, or alimony

  • A list of all your debts, such as credit cards, student loans, car loans, child support, or alimony, and the name of the creditor, balance owed, and minimum monthly payment

  • Copies of bank statements

  • Proof of assets, such as stock or mutual fund statements and car and real-estate titles

  • Proof of rent or mortgage payments (canceled checks)

Making and Negotiating the Offer

Once you've found the house you want to buy, the next step is to make an offer, which is a legally binding contract. The offer will be in writing and will include the amount you're willing to pay for the house (it can be more or less than the asking price) and the time frame for the purchase. It will be contingent on a satisfactory house inspection and bank approval. You'll pay earnest money, usually $1,000, which will be credited to the sales price if the sale goes through. In most cases (but not always), you'll get your money back even if the deal falls through. Fees may be deducted, and the seller and buyer usually have to come to an agreement about how to handle the balance.

The sellers may accept or decline your offer or they may make a counteroffer. Sometimes this takes hours, sometimes days. If you come to an agreement, the buyer will accept your final written offer and the home inspections will take place as quickly as possible. Once you notify your mortgage company that your offer has been accepted, they'll perform an appraisal to make sure the house is worth what you offered. When all is in place, you and the seller will sign the Purchase and Sale Agreement.

Closing the Deal

After your bank gives the final approval for your loan, and you have proof of homeowner's insurance on the property, you'll be ready to close the deal. Just prior to the closing, you'll walk through the house, which should be empty and clean, and make sure there are no surprises. Then you'll meet with the seller or his representative, the closing attorney, and your Realtor to sign the mortgage papers and make the transfer of the property.

Understanding Closing Costs

Closing costs are all of the costs associated with the transfer of the property, the processing of your mortgage, and the fees charged by those who make it all happen. Closing costs include:

  • Attorney's fees

  • Property transfer fees charged by state and local governments

  • Property taxes and homeowner's insurance placed in an escrow account (so that they're available to pay when due)

  • Real-estate commissions

  • Lender fees such as appraisal, processing fees, points, origination fees, land surveys, interest from the settlement date until your first payment is due, and title insurance

You may pay for each item, or your lender may quote a “flat” fee that covers a given set of costs. One way or another, you're paying the costs. Make sure to compare quotes “apples to apples” — with the same items included in closing costs.

Closing costs vary by location but are typically 3 to 6 percent of your loan, so if you're buying a $100,000 house, you can expect closing costs to be between $3,000 and $6,000. Like the down payment, closing costs must be paid at the time of purchase. Federal law requires lenders to provide you with a Good Faith Estimate of your closing costs before you go to settlement.

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  2. Personal Finance in Your 20s and 30s
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  4. The Home-Buying Process
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