The 10 Basic Steps to Buying a Home - Part 2
Editor's note: This is the second in a two-part series on buying a home. In the first part, we talked about your housing budget, your credit score, and the different mortgage options available to you. This section picks up with the mortgage pre-approval process.
Step 4. Get Pre-Approved by a Mortgage Lender
Mortgage pre-approval is the next logical step to buying a home. You've got a budget and a spending limit on paper. You've started saving your cash. You've checked your credit reports and scores. And you've researched the different types of mortgages to see which one suits your situation. Now you're ready to talk to a mortgage lender.
I've written an extensive guide to the pre-approval process. So I won't repeat it all here. Let me give you the short version. Pre-approval is when you work with a lender to determine two things: (A) whether or not you're qualified for a loan, and (B) how much the lender is willing to give you. Obviously, these are two pieces of information you are eager to know. Once you know how much you can borrow, you can start shopping for homes that fall into that range.
These ten steps to buying a home are presented in a very logical way. It doesn't make sense to start house hunting before you've been pre-approved. And you should only talk to a lender after you've established your housing budget. So the pre-approval falls right in the middle. It happens after you've done your financial self-assessment, and before you start shopping for a house.
Being pre-approved by a lender will also help you find a real estate agent. Logically enough, that's the next step we are going to discuss...
Step 5. Find a Real Estate Agent
Is this your first time buying a home? Will you be purchasing a home in a city that's new to you? In either of these scenarios, you should have a real estate agent help you. In most states, the seller is the one who pays the agent's commission. So there's really no reason to fly solo.
A good agent can help you navigate the later steps to buying a home (especially steps 6 and 7 below). You should accomplish steps 1 - 4 on your own, before talking to an agent. Once you've been pre-approved by a lender, you can start looking for an agent.
Why is it important to get pre-approved first? Because most agents won't work with you until you have a pre-approval under your belt. And I don't blame them.
Put yourself in the agent's shoes for a moment:
Showing houses to a client can be time-consuming. Imagine you're an agent, and you're spending about 5 - 7 hours a week on a particular client. Eventually, they find the house of their dreams -- or at least a suitable one. So they go to a mortgage lender to get approved for a loan. They've skipped the pre-approval process entirely, so you're not sure what's going to happen. It turns out that your would-be buyers have terrible credit and a mountain of debt. The lender rejects their application. Ouch! They've wasted your time as well as their own.
This is why real estate agents prefer to work with buyers who have been pre-approved. It makes sense, when you consider the scenario I just painted for you. And that's why I've included pre-approval as the #4 step to buying a house. It's a necessary step for several reasons.
So you've got your pre-approval letter, and you're ready to work with an agent. The question is, how do you find one? You can find a local real estate agent in several ways. You can seek recommendations from people you know and trust -- family members, friends, coworkers, etc. This is clearly the best way to find an agent. Do you know someone who has bought a home recently? Start there. Find out who they worked with, and if they were happy with the service the received.
Step 6. Start Shopping for a Home
This is what you've been waiting for! For most people, this is the most exciting step to buying a home. This is when you start looking for the place where you'll live for the next few years (or longer). But you'll notice that it's step #6 in our list. I've asked you to five other things before visiting the first house. Why? Because it will save you and your agent a lot of time.
If you have followed the prescribed steps up to this point, you'll have two important pieces of information. You'll have your own personal budget (step #1), as well as the pre-approval amount from a lender (step #4). Now you can confidently shop for homes that fall within both of those amounts. This will help you narrow down the list of homes you want to visit. It will also reduce your chances of ending up in foreclosure down the road, since you're shopping within your budget.
There are several ways to shop for a house. I recommend using all of them:
- The Multiple Listing Service
You can look for homes on the Multiple Listing Service (MLS). This is a nationwide database of properties for sale. All real estate agents have access to the MLS. It's a basic service they provide to their clients. Your agent will probably create a personalized "portal" for you. He or she will enter certain parameters based on your needs and wants -- minimum size, location, number of rooms, etc. This will generate a list of homes that meet your basic criteria.
- Realtor.com, Trulia.com and Zillow.com
The Internet can help you accomplish most of the steps to buying a home. It's particularly useful when screening homes for sale. It saves you a lot of drive time and wasted trips. There are dozens of property-search websites online these days. But there are only three that I recommend using:
These are the three biggest websites for real estate listings. If you're not familiar with them already, now is the time to start. Some listing agents prefer one website over another, while other agents will list their properties on all three sites. You don't want to miss out on the ideal home just because you're using the wrong site. So use all of them. All three of these websites allow you to save your searches, which makes it much easier the next time you visit.
- RealtyTrac for foreclosure listings
In 2011, foreclosures and short sales made up about 40 percent of the market. This trend will likely continue into 2012. If you don't include these properties in your housing search, you're basically ignoring 40 percent of the inventory that's out there. Some of these properties show up on the three websites mentioned above. Bank-owned homes, in particular, may be included in the listings on Realtor.com and Trulia.com.
But if you're serious about buying a "distressed property," you should sign up for RealtyTrac.com. It will give you access to pre-foreclosure and foreclosed homes in your area. It's not free, like the other three sites I recommended. But they do offer a free 7-day trial. Try it out and see what you think.
Related article: Why you should consider foreclosed homes
- Good old-fashioned yard signs
Believe it or not, there are still a few sellers out there who don't use the Internet when listing their homes. And there's always a chance you missed a property or two during your web-based shopping. For both of these reasons, you should be driving through your target neighborhoods at least once a week. Keep an eye out for yard signs. If you find a house you want to visit, just write down the listing agent's phone number and give it to your agent.
- Focus on the things you can't change
First-time home buyers have a tendency to obsess over the cosmetic features of a home. "The wallpaper is outdated. I don't like these paint colors. The carpet is ugly." You can change all of these things, so you shouldn't pay too much attention to them. You can paint walls, update lighting fixtures, and replace carpet.
Instead of worrying about the decor, you should be focusing on the features you cannot change. This includes the size of the home, the number of bedrooms and bathrooms, the lot, the view, etc.
Step 7. Make an Offer
When you've found a house that meets your needs, you're ready to make an offer. This is one of the most important steps when buying a home. Make a reasonable offer, and the seller will be more likely to accept it. Make an offer that's too low, and you risk insulting the homeowners.
Your offer should be based on comparable sales. These are similar types of houses that have solid in the same area recently. This is the best way to determine the current market value of a home you're considering. Remember, the seller's asking price might be realistic -- or ridiculous. You won't know until you look at the "comps."
Of course, you also need to consider features that might add value to the house in question. If it's priced above the comparable sales, you should ask yourself why. Is it just wishful thinking on the seller's part? Or can the premium be justified in some way? Maybe the house has a bigger lot and a better view than the comps. Maybe it has been renovated and upgrade on the inside. You must take these things into account when shaping your offer.
Here are some related articles to help with this step:
Let's assume you've made an offer and the seller has accepted it. At this point, there are three more steps to buying the home. The lender will have it appraised. You will have it inspected. And then you'll attend the closing and get your new keys. Let's talk about the home appraisal next.
Step 8. Get a Home Appraisal
How much do you plan to put down on the home? Five percent? Ten percent? Twenty? In each of these scenarios, the mortgage lender is making a much larger investment than you are. So they have more at stake. As a result, they'll want to ensure the home is worth the amount you've agreed to pay for it.
The last thing the lender wants to do is invest $275,000 in a home that's only worth $220,000. If they had to foreclose and repossess the home down the road, they would end up selling it for a huge loss. So the lender will have the home appraised to determine its current market value.
There's actually not much for you to do during this step, aside from waiting. The lender will select and hire the appraiser. The appraiser will visit the home and evaluate it against comparable sales in the area. Then he will tell the lender how much he thinks the house is worth.
- If he says it's worth at least the amount you've agreed to pay, then the loan will probably move forward.
- If he says it's worth less than the purchase price, the lender might withhold financing. Related article: What to do about a low appraisal
Here's a video the explains the appraisal process in more detail:
Note: The next step to buying a home (inspection) can be done before or after the appraisal. It depends on how quickly the lender moves forward with the appraisal process. I have the inspection listed after the appraisal in this article, but that doesn't mean it has to happen that way. Some buyers choose to have the home inspected a couple of days after the offer acceptance. I can see the logic in doing this. Just be flexible and seek your agent's advice on the timing.
Step 9. Get a Home Inspection
Are you a residential contractor? Do you have a background in home construction? If so, you can probably inspect the property by yourself. But the rest of us need to hire a professional inspector to get the job done.
A home inspection is a non-invasive examination of the house that usually takes place after the offer has been accepted. I say it's "non-invasive" because the inspector won't be pulling up carpet or prying off any panels to examine the home. He will examine everything he has access to, and nothing more.
Most inspections will include the visible portions of the roof, foundation, plumbing, electrical system, and heating / cooling system. If there are any other installed systems (like a garbage disposal or sump pump), the inspector will look at those too.
The inspection is entirely for your benefit. It gives you a better picture of the home's true condition. A layperson, like you and I, can only tell so much about a house. We have an untrained eye. We can't look at a circuit breaker and spot safety issues. We can't see the not-so-obvious signs of water damage when there's no water present. We can't tell the difference between "cosmetic" and structural cracks. But home inspectors can. They receive special training to identify these types of problems.
From an investment standpoint, this is one of the most important steps to buying a home. You wouldn't buy a company's stock shares without researching the company. The same goes for buying real estate. You shouldn't pay tens or hundreds of thousands of dollars for a house until you know what you're getting.
Your purchase agreement should give you a way to back out of the deal, if the home inspector finds a serious problem. This is referred to as a contingency. Your offer should be contingent upon a successful inspection. This allows you to walk away from a problematic house while keeping your earnest money deposit.
The inspector will present you with a report that details his findings. If he found any problems with the home, he will explain what they are and what it might take to repair them.
Next, you will have to decide which problems you're comfortable "inheriting," and which ones you want the seller to fix. In a seller's market, the homeowner might not fix anything. In a buyer's market, the homeowner will be more willing to accommodate your repair requests. The rule of thumb is to ask the seller to fix anything that is (A) clearly broken or inoperable, or (B) a safety issue. Most sellers will accept such requests.
You're almost done! The closing process is the last step to buying a home, and that's what we are going to discuss next.
Step 10. Settlement / Closing
The period of time between the purchase agreement and the final settlement is known as escrow. You've probably heard somebody use this phrase in the past: "We can't spend a lot of money right now, because we're in escrow." When the property is fully transferred from the seller to the buyer, you are said to have "closed escrow."
The transfer process itself is referred to as closing. It involves a lot of paperwork and the final distribution of funds. The seller gets paid, if applicable. The real estate agents receive their commissions. The lender fees will be paid. And you'll walk away with the keys to your new house.
Make sure you save up enough money to cover your closing costs. Your lender will give you a written estimate of these costs in advance, at the time you apply for the loan. But you should expect to pay more than the estimated amount. If your lender estimates your closing costs to be $7,000, you should prepare for them to be $8,000 by the time you actually close. It's called an "estimate" for a reason. It's common for home buyers to pay more than the estimated amount on closing day.
Between the time the seller accepts your offer and the day you are scheduled to close, the best thing you can do is stay in touch with the mortgage and escrow people. Escrow companies coordinate all of the paperwork for closing, as well as the distribution of funds. It's their job to make sure everything is on track for the big day. You should find out who the escrow agent is, and keep in touch with this person. Make sure they have everything they need from you, as far as documents go.
This article explains the major steps to buying a home. You'll find a wealth of additional information on this website, as well -- more than 1,000 pages worth. There are numerous hyperlinks spread throughout this article, to help you find related information. You can also use the search tool located at the top of this page. Good luck!