Gear Up to Buy

Within these pages you will find tons of information about buying a home. Not surprisingly, most of it is financial.

Content in this section is divided into four primary categories: Credit, Mortgages, Choosing an Agent, and Choosing a House.

CREDIT

What are credit reports?

Credit reports are supposed to provide lenders with a snapshot of your money-management skills. A credit score is given, depending on your creditworthiness - it ranges from 300 to 850.

Data is submitted to a credit reporting agency (Equifax, TransUnion and Experian) by your creditors, the courts and/or public records, and by debt collection agencies. Notes made to your credit report will remain for some time. If they are accurate, they can stay on your report for seven years, or ten years for a bankruptcy.

Personal information, like your name and social security number, previous employers and addresses are on these reports. Liens, judgements, foreclosures, attachments, collections, and bankruptcies are, as well.

A credit history is spelled out in your report - the dates that accounts are opened, types of accounts, balances and limits, payment history, unpaid child support and overdrawn checking accounts, as well.

Inquiries are noted on your report - those made by your current creditors and by yourself are not viewed negatively.

How do I get my own credit report?

The Fair Credit Reporting Act allows you to get a free credit report once a year, but you have to be proactive about getting it. You should ask for it from all three credit reporting agencies. Free reports have been available in Ohio and Indiana since March 1, 2005, Kentucky since June 1, 2005.

To get your free credit report, you need to provide your name, address, SSN and DOB, possibly your previous address, and pertinent information only you would know.

You are also entitled to a free credit report if you are denied credit, insurance or employment, and you ask for a copy of your credit report within 60 days. You can also get one if you are unemployed and plan to look for work within 60 days, if you are on welfare, if your credit report is inaccurate because of fraud.

If you do not get a free report, you may pay as much as $9.50 per report.

There are three credit reporting agencies:

Fixing errors on credit reports - how to:

Under the Fair Credit Reporting Act (FCRA), the reporting agency and the person or business that provided the information about you are both responsible for correcting inaccurate or incomplete information on your credit report.

Fixing your credit report requires a systematic approach, and above all else, keep your originals and make copies of all your correspondence:

Inform the reporting agency/agencies in writing what information you believe is inaccurate. Include copies of the documents that support your position. Be sure you provide your complete name, address, and clearly identify each item you dispute, state the facts and explain why you dispute the information, and request that it be removed or corrected. Enclose a copy of your report, and circle the items in question. Send the letter by certified mail, return receipt requested. Keep all copies.

The reporting agencies are required to investigate the items in question, and they will usually do this within 30 days, unless they consider your dispute frivolous. They contact the person or business who made the report against you, and after they have investigated it, they report their findings to the reporting agency. If the information is, indeed, inaccurate, it must notify all three reporting agencies to correct the information in your file.

When the investigation has concluded, the reporting agency must give you written results and a free copy of your report if the dispute results in a change.

If an item is changed or deleted, the reporting agency cannot put the disputed information back in your file unless the provider verifies that the information is accurate and complete.

If you request, the reporting agency must send notices of any correction to anyone who received your report in the past 6 months, or 2 years if your credit report was used for employment purposes.

If an investigation does not resolve your dispute, you can request that a statement of dispute be included in your file and in future reports. You can ask the reporting agency to provide this statement to anyone who received a copy of your report recently - but you will have to pay for this service.

Also, tell the creditor or other information provider in writing that you dispute the item. Include copies of documentation, again. If the provider reports the item to a CRA, it must include a notice of your dispute. If the information is determined to be inaccurate, the provider may not report it again.

What can be done for bad credit?

Derogatory credit files take time to remove, usually. A credit reporting agency can report most accurate negative information for seven years. Bankruptcies can stay on your credit report for 10 years. Unpaid judgements can be reported for seven years or whatever the statue of limitations may be, whichever is longer.

There is no limit on the time that criminal convictions can be reported; information reported in response to an application for a job that pays more than $75,000/year; and, information because you applied for more than $150,000 in credit or life insurance.

Pull your credit report, and pay off any outstanding debts. Once your debt has been paid, follow the instructions for disputing inaccurate credit information - provide evidence that your debt has been paid, and ask that, at least, the account be noted as paid, if not removed entirely. The business or person that reported it has the right to keep the derogatory information on your file for the full seven years, but they can choose to remove it once payment is received.

Once you have paid your debts, and done your best to update your file, take steps to improve your credit score.

Building Credit:

Keep in mind that some creditors do not report to the credit reporting agencies. Travel, entertainment, gas company, local retailers, utilities and credit unions usually do not report. You can ask your reporting agency to add this information for your future reports - they are not required to do this, but will usually do so for a fee, if the accounts are verifiable. However, these creditors will need to report your balances and payment history - if they don't, the added items will not be updated on your report.

Most national department stores and major credit cards do, but not all of them.

What is a credit score and how can you improve it?

Credit scoring is a system used by creditors to determine whether to give you credit and how much to charge you for it. Your payment history, the number and type of accounts you have, any late payments or collections, quanitity of outstanding debt and the age of your accounts is collected. Using a statistical formula, your file is compared to others similar files, and points are awarded. The score is meant to be a predictor of creditworthiness.

There are five parts to a FICO score:

  1. Your payment history - 35%;
  2. How much you owe - 30%;
  3. Length of your credit history - 15%;
  4. New credit - about 10%. FICO scores distinguish between opening multiple new accounts and searching for a single loan. Try to do your loan shopping in 30 days or less;
  5. Other factors - about 10%. Blend of credit types - diversity is normal for people with longer credit histories, and can boost (slightly) their scores.

Scores can not consider your race, color, religion, national origin, sex and marital status, whether you receive public assistance or exercise any consumer right under the federal Equal Credit Opportunity Act or the Fair Credit Reporting Act. Married couples do not have a combined credit score. Increases in income do not affect your credit score.

You will have to pay a fee to get your credit score from the reporting agencies. Your score will be different from each. Learn your highest and lowest score, and try to determine what influenced the score. (Scores range from 300-850, a score about 700 is very good, below 600 and you are a high risk).

The best way to improve/maintain your credit score is to pay your bills on time, and keep your balances low. Call your credit card company and find out when they report your balance to the credit reporting agencies. You might be surprised - most report around the first of the month, even if your payment is due on the 15th! Pay your balances down before they are reported.

It's an old college trick, and many people continue to do it well into adulthood. That offer for 0% on balance transfers for 6 months feels irresistible if you are paying 12%. However, transferring a balance and zeroing out one card only maxes out another balance. FICO isn't fooled, even if you are saving money.

MORTGAGES

There are several variables to consider - mortgage term, fixed/variable, and whether or not to participate in one of the myriad of loan programs out there. A good mortgage broker or lender should help you through this process.

Lenders vs. Mortgage Brokers

Lenders are the ones that provide the funds at closing (ie., banks). Mortgage brokers shop around to find the best deal - they will deal with banks, individuals and groups of investors.

Mortgage Tips

You might be prequalified to borrow a lot more than you are comfortable paying every month. Be mindful of your lifestyle, and only borrow what you can afford. Go over your budget, or write one if you haven't already, and see how strong your money saving skills are. Include the cost of your new mortgage, and be sure to include money for repairs and maintenance, and see where you stand. If you feel comfortable, you have found your comfort level.

Check your credit report. This scares a lot of buyers, particularly first-time ones, who are often convinced that they have poor credit. Knowledge is power, particularly when you are shopping for mortgages. Check your report for any discrepancies and identify any problems.

  • It is useful to pay off small debts - pay off small credit card balances.
  • Do your best not to incur any new debt, so as to preserve your debt to income ratios. A major purchase could throw off your debt to income ratio, leading the bank to believe you are unable to afford your new house. Banks also consider how much cash you have in the bank when you are making a major purchase, so choosing not to finance that new car may not help you.
  • Don't change jobs - consistent job history is a big plus for a lender;

Collect your documentation - you will need W-2s and income tax returns from the last 3 years, pay stubs, a credit report, records of any past derogatory credit history that has been paid off, records of any child support or alimony, records of any other supplemental income, and bank statements for all accounts for the last few months.

Consider whether you want to pay closing costs in cash or finance them.

Budgets

Make note of the following:

  • Current monthly loan payments;
  • Other monthly expenses (child care, dues, subscriptions, etc);
  • Variable expenses (utilities, food, car repair) for the last year - from this you can estimate your monthly expenditures;
  • Annual or semi-annual expenses (insurance, taxes);
  • Estimated new mortgage payment;
  • Non-fixed expenses for the last 12 months (medical expenses, etc). Estimate the average;
  • Estimate average personal expenses (entertainment, travel).

Allow for increase in your budget - prices go up.

There are lots of good software programs out there to help you manage your budget. We highly recommend using one of them, and suggest that you try to update your accounts weekly, at least. You'll be glad you did - that pile of receipts is just going to keep growing!

Prequalification

Don't you want to know how much you can afford to buy? Prequalification is given based on several variables - notably credit worthiness, your income, and how much debt you already have.

A lender will do a cursory examination of your credit report and use only the information you suppy to determine how much you can borrow. They don't examine your financial accounts or your employment for a prequalification.

Preapproval

Different than prequalification - a lender will take a closer look. Credit and employment history are verified and the mortgage is approved. Preapproval is the first-step to locking in a good rate, as well.

Prequalification vs. Preapproval

Preapproval is by far the most reliable option. The Carol Meadows Team recommends that you get pre-approved before you start shopping for a home.

Front and Back Ratios

These ratios are used to determine how much you can afford, based on your income.

Front Ratio Your total mortgage payment (including PITI and any association fees) is divided by your total gross income. This ratio should be below 28% (or 29% for FHA). This is the maximum percentage of your monthly gross income that the lender allows for housing expenses.

Back Ratio All of your debt is divided by your income - your total mortgage payment plus car payments, credit cards and other loan amounts - are divided by your total gross income. This ratio must be below 36% (or 41% for FHA). It shows how much of your income will be available for a mortgage payment.

Anatomy of a Mortgage

A mortgage consists of four primary parts:

  • Principal The original amount borrowed;
  • Interest The cost of borrowing the principal amount;
  • Taxes Real estate taxes;
  • Insurance Homeowner's insurance, mortgage insurance (paid to protect the mortgage-holder).

= PITI Principal/Interest/Taxes/Insurance

Types of Mortgages

Fixed Mortgage: The term and interest rate are fixed at the start of the mortgage. The payment for principal and interest will not vary during the term of the mortage (although taxes and insurance vary).

Adjustable Mortgage: Sometimes referred to as an ARM (Adjustable Rate Mortgage). Interest will be adjusted according to the whatever index it is linked to.

An index is a guide that lenders use to measure interest rate changes, like 1,3 and 5 year Treasury securities.

ARMs incorporate a margin - this is where the lender recoups their costs and makes their profit. The margin will be added to the index rate to determine the interest rate. The margin usually remains constant.

Interest will adjust within specific periods of time, referred to as the adjustment period. ARMs can be described with figures, ie., 5-1, 2-2, 3-3. The first figure is the number of years that the rate remains constant. The second is the adjustment period, demonstrating how often changes can be made after the initial period has ended.

ARMs are popular because the initial interst rate for an ARM is lower than that of a fixed rate mortgage. An ARM is a good option if you don't plan to own the home for longer than the adjustment period, if you expect your income to increase, as ARMs can help you qualify to borrow more.

Look for an ARM that is attached to an index that has been relatively stable.

Rate caps limit how much interest you can be charged. There are two kinds:

  • Periodic caps - limit the amount your rate can increase from one adjustment period to the next;
  • Overall caps - limit how much the interest rate can increase over the life of the loan. Carryover is possible in an ARM - this means that if the interest rate is capped, but the index goes up, the amount of the index can be carried over into the next adjustment period.

A payment cap limits how much your monthly payment can increase at each adjustments. Watch out for negative amortization, though, or when the payment is capped to the point that it does not cover the cost of interest.

FHA Loans: FHA loans are great for people without much money available for a downpayment. You can put as little as 3% down on an FHA loan. FHA loans also let you stretch the ratios just a little bit more than most conventional programs will - PITI is normally limited to 26-28%, and FHA will go to 29%; debt to income is normally limited to 33-36% and FHA will go to 41%.

The Fed does not make home loans, but it will insure loans that lenders consider high-risk. To get an FHA home you need a good credit history and sufficient income.

VA Loans: Lenders will make a special type of home loan to veterans - a portion of these loans is guaranteed by the Veterans Administration. The portion guaranteed is called an entitlement. To get a VA loan, you need a certificate of eligibility - this is a document issued by the VA.

There are specific requirements for length of service - check the VA's web site for these.

There are a lot of benefits to a VA loan - you can get 100% financing, no PMI is required, no prepayment penalties, and great interest rates are but some of the perks of a VA loan. However, they can take longer to process, and sellers are sometimes asked to pay part of the closing costs which can make them less than willing to give on purchase price.

Regional Loan Center for Indiana and Ohio:

Department of Veterans Affairs
Cleveland Regional Loan Center
1240 East Ninth Street
Cleveland, OH 44199

1-800-729-5772

For Kentucky:

Department of Veterans Affairs
Roanoke Regional Loan Center
210 Franklin Road SW
Roanoke, VA 24011

1-800-933-5499

Construction Loans: Construction loans are not standard. They are specific to the planned construction project. However, they typically require interest-only payments during construction and become due upon completion (when the house has its certificate of occupancy).

They are usually variable-rate loans, with the index being the prime rate or some other short-term interest rate.

A schedule of draws is determined by you, your contractor and your lender based upon the stages of construction, and interest is charged on the amount of money disbursed to date.

If you already own the land, it can be used as equity on a construction loan.

It is possible to find a construction-to-permanent financing program where the construction loan is converted to a mortgage loan after the certificate of occupancy is issued. You can also look for a rate-lock, but be conservative about the length of construction - there are always delays.

Truth in Lending Act (TILA)

Lenders are required to detail the costs associated with a loan, so that you fully understand what you are paying and can make an educated decision about which lender to choose. You will receive several disclosures during the loan process, some when you apply, and others before the loan closes:

  • Amount being financed and APR;
  • Points or fees;
  • Due date and terms;
  • If loan is assumable - meaning, can it be transferred to a new owner;
  • Service fees and prepayment penalties.

Real Estate Settlement Procedures Act (RESPA) RESPA was designed to protect real estate consumers, and to encourage them to shop around. RESPA requires lenders to give various disclosures that make it easier for the consumer to shop loans.

Good Faith Estimate: When you apply for a loan, a lender/broker is required to give you a good faith estimate of the loan-related expenses due at closing. You must receive this within 3 days of your loan application, unless your application is rejected during that time period. Estimates are not guarantees of actual closing costs, but keep it and compare it to the actual closing costs. Ask your lender to explain any changes.

Servicing Disclosure: A lender or broker is required to tell you, in writing, if someone else will be collecting payments after closing.

Affiliated Business Arrangements: This disclosure is required if a lender, agent, or anyone else involved in your loan refers you to someone that is owned or controlled by the same parent company - for example, if you go through a lender's title company.

HUD-1 Settlement Statement This form is used by the person conducting the closing to itemize all the charges incurred by a borrower and a seller.

Down payment

This is mostly up to the buyer, although some loans require more downpayment, and a lender may ask for more money down. Downpayments can go anywhere from 0-25%. If you put less than 20% down, you should expect to pay PMI.

PMI (Private Mortgage Insurance)

PMI is insurance that most lenders require if buyers put less than 20% down. A lender wants to be protected against a buyer's risk of defaulting, and they perceive the risk to be greater with buyers that put less than 20% down.

You should really try to put 20% down, to avoid paying PMI. However, if you can't do that, you can get a 2nd mortgage for what you can't put down - it can be for up to 20% of the value, meaning that you are putting no real cash down, but avoid PMI.

However, this 2nd mortage will have a higher interest rate than the 1st, it might have a variable rate, and it may have a balloon payment (balance will be due before 1st mortgage is paid off).

PMI can be cancelled. With loans that originated after July 29, 1999, except for government-insured FHA or VA loans or those where the lender paid PMI, a homeowner can request cancellation when their mortgage balance is less than 80% of the original purchase price or appraised value (whichever is less). The loan must be current with no delinquencies in the last 2 years. An appraisal might be required. When balances reach 78%, cancellation is automatic - if the loan is current, you aren't considered a high-risk for defaulting, if you don't have a poor payment history, or if you haven't placed other liens on your property.

Bi-Weekly Equity Plans

These help you to pay less interest and build equity in your new home. Making a half-payment every two weeks is one of these ways. You pay more every year because you make a total of 13 full payments every year. Most lenders put that entire extra payment towards your principal. These programs usually require that the payment be automatically deducted, and they might charge a one-time fee to enroll you.

Closing costs

Can go from 2-5% of sale price, and are due at closing.

Points

An amount of money paid to either maintain or lower the interest rate charged. Each point is equal to 1% of the loan amount. So, it's a toss-up over whether to pay points - if you are getting a high-interest loan, it might be better to pay upfront than to pay over time. Try to imagine how long you will keep the house, and evaluate the cost of carrying a higher interest rate mortage for that time - is it a cost-effective decision? It probably is if you plan to hold on to the property for 30 years, but it probably isn't if it's a 3 month flip.

A seller may be able to pay points for you - it may raise the sales price, but it's less cash upfront.

Points paid for residential real estate are tax deductible in the year they are paid - a buyer can deduct them even if a seller pays them at closing.

CHOOSING AN AGENT

Interview questions for buying agents:

  • Ask your agent about their typical home buying experience;
  • Ask for a blank offer form to take home and study;
  • Ask what disclosures are required;
  • What is a standard home inspection, and does your agent recommend any others? o How much do inspections cost, and who pays for them?
  • What does a title search review - does it provide any security for you as a buyer?
  • Does he/she really understand what you want?
  • Will they work with you until your needs are fulfilled?
  • Professionalism;
  • Full-time;
  • Familiarity with target neighborhoods;
  • Familiarity with your price range;
  • References
  • Years in the business;
  • # of sales in past year;
  • Average price of home sold last year;
  • Number of buyers currently working with;
  • Number of sellers currently working with.

Agency

It's important to know, as a buyer, that the agent you are working with may not necessarily be your advocate. This is the world of agency - a domain that trips up inveterate buyers and novices on a fairly regular basis because ... it doesn't make a lot of sense.

Traditionally, all agent's primary responsibility was to the seller, not the buyer. Bet you didn't know that. Even if the agent was not the listing agent, and their only client in the world was the buyer, their loyalty was to the seller. In fact, the agent had to reveal to the sellers any information they knew about their buyers - how motivated they were to buy, how much they could really afford, etc.

Seller Agency is the default. If you contact an agent who has a property listed, know that agent will always represent the seller.

Buyer Agency is the option we recommend, obviously. This gives you a choice in representation - and wouldn't you prefer to work with someone who is on your side? A buyer's agent represents the buyer. They look out for a buyer's best interest, and will point out the pros and cons of any purchase.

Dual Agency - this happens from time to time. Dual agency is when two agents, or the same agent, are working for the same broker and each represent a buyer and a seller in a transaction. This situation must be disclosed to both the buyer and seller. Privileged information can not be disclosed to either party without express permission.

CHOOSING A HOUSE

Determine your wants and needs:

  • Your price range, given your prequalification amount and your budget;
  • Type of house (single family, townhome, condo);
  • Minimum requirements, needs and wants;
  • Desired location;

Then make a list of things you do not want:

  • Highway or airport adjacent;
  • Type of architecture;
  • Home that needs a lot of work

Looking for resale value

As odd as it may feel, you should be thinking about resale value even before you buy a house. More than likely, you will move in your lifetime, so it is important to think about the value of what you are purchasing. Moreover, when you make plans to rehab the home or add your personalized touches, it should be done with the end in mind.

  • Location - some neighborhoods are hot right now, but which neighborhoods in Cincinnati have consistently ranked near the top of the list? A purchase in one of those neighborhoods is a safer bet.
  • Sprawl - follow the growth of the various neighborhoods, and see if they are spreading towards a certain area. What kind of infrastructure exists there (Interstate, groceries, schools);
  • Demographics of the target area - who is buying in your target neighborhood? If the majority of buyers are senior citizens, it makes sense to look for a one-level home. If it's families with children, look for plenty of bedrooms and bathrooms.
  • Obsolescence - this can either be a payday for you, if you plan to rehab and sell, or a real headache if you don't want to remodel. One bedroom houses, electric heat, shag carpet and fuzzy wallpaper are obvious signs that a house is out-of-date.
  • Aesthetics - dated paint colors, appliances and light fixtures can really hurt a home's market value. However, these are the easiest things to repair, and an inexpensive way of increasing a home's resale value.
  • Standard buyer wants and needs are closets, good light, storage space, attention to layout and how the property is situated are similarly important.

Property disclosures and a home inspection should help you discover most of the more fundamental issues in a home. Things to be sure of:

  • Age of the roof;
  • Leaks in roof or foundation walls;
  • Mold or mildew;
  • Termites;
  • Sewer/septic system;
  • Square footage;
  • Road improvements could cause you to lose property;
  • Proximity to an airport;
  • Liens;
  • Lawsuits;
  • Any structure (shed, fence, etc) that encroaches on neighboring property;
  • Buried oil or gas tank on property.

Making an offer

An offer does actually bind you to a specific property, so don't rush in unless you are sure. A seller can reject the offer, or ignore it, and it will expire. Or, a seller may counter the offer - you have the option of accepting it, making a new offer, or not responding.

If a seller accepts your offer, it is a legally binding contract.

Offers address the following issues:

  • Proposed selling price;
  • Concessions you wish the seller to make;
  • Financing;
  • Inspections;
  • What is included in sale (make a list of items you feel should be part of the purchase price - outdoor storage areas, window treatments, garage door openers);
  • What you want buyer to remove (make another list, like old cars in driveway, etc)
  • Earnest money

Fixtures:

Fixtures are things that are permanently attached to a house, like built-in bookcases, the central air and the kitchen cabinets. You would expect these items to remain in the house.

Home Inspections

Most buyers make an acceptable home inspection a contingency of purchase. It's great if you can be there while it's being done, as it puts the (sometimes) long list of problems into much needed context.

A home inspector evaluates the structure of the house, as well as the roof, plumbing, electric, HVAC, insulation, doors, windows, etc.

Hotspots that inspections can cover:

  • Mold and mildew;
  • Wet basements/crawlspaces;
  • Roof, gutters, flashing, mortar & bricks;
  • Plumbing;
  • Electrical;
  • HVAC;
  • Structure;
  • Foundation;
  • Appliances;
  • Smoke Detectors

Home Warranties

Home warranties cover the repair and/or replacement costs for appliances and other systems associated with a home. This warranty can be purchased by the buyer or seller, and usually lasts for one year.

A warranty will cover items damaged on their own, while your home insurance policy will replace those damaged in fires, by wind, etc.