How to Buy a House in 2012 – The Post-Crisis Buyer’s Guide
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Is now a good time to buy a home? What will the housing market be like in 2012? What does it take to get approved for a mortgage loan these days? These are some of the questions we receive every week from first-time home buyers. We have attempted to answer them all in this tutorial. It explains how to buy a house in 2012 — the smart way.
Objective: Many of the hardships associated with the housing crisis could have been avoided, if home buyers had access to better information. In this context, “better” means unbiased and factual information. That’s where we come in. We use our publishing reach to educate home buyers all across the United States. Our mission is to help people make better, more informed decisions. The following tutorial was born from this sense of duty.
What’s in Store for 2012?
Despite the continued sluggishness we are seeing right now, the worst of the housing crisis is behind us. Home prices in some areas will continue to decline in through 2012. But the three- to five-year outlook is positive. So if you’re in it for the long haul, 2012 might be a good time to buy a house. “Might” is the operative word in that sentence. Every housing market is different. It might make sense to buy a house in one city, while another city warrants a wait-and-see approach.
Mortgage rates are expected to remain low in 2012. Economists with the Mortgage Bankers Association expect the average rate for a 30-year fixed mortgage to remain below 5% for much of next year. (Refer to our 2012 mortgage update for more on this subject.) Housing will remain at very affordable levels. Mortgage rates will likely remain low. So the decision to buy a house mostly comes down to two factors — financial security and market stability.
How to Buy a House, the Smart Way
If you want to buy a house in 2012, you’ll need to have your financial ducks in a row. It’s tough to get approved for a mortgage loan these days. There’s no point in sugarcoating it. Mortgage lenders are only working with “cream of the crop” borrowers. These are people with good credit scores, stable employment, cash reserves, and a manageable level of debt. Would-be home buyers are being turned away in droves.
But mortgage approval is only the beginning. It’s not enough to get approved for a loan. You need to choose the right type of mortgage. You need to make sure you’re not exceeding your budget by taking on too much additional debt. And last but not least, you must consider the status of your local housing market — past, present and future. Those are the things we will focus on in this tutorial.
Housing Market Variation – Your City is Your #1 Concern
Home prices are up. Home prices are down. Sales are up. Sales are down. Trying to keep track of the U.S. housing market is like riding a roller coaster. You’ll encounter an endless stream of reports that seem to conflict with one another. This is the result of market diversity. Every housing market is different. Some are in terrible shape right now, while others are showing signs of recovery (Washington, D.C. comes to mind). Some cities will see continued depreciation in 2012, while other will enjoy a dose of appreciation for a change.
You cannot summarize all housing markets with a single, generalized statement. Yet this is exactly what the national media outlets attempt to do on a daily basis. They make general statements about the state of the housing market, without taking into account the significant differences at the city and state level. It leaves home buyers in a state of confused paralysis.
If you are planning to buy a house in 2012, you need to focus your attention on your local housing market in particular. National home prices are good for headlines. But pricing trends in your area are the ones that matter most to you.
Consider the differences between Detroit and Phoenix:
- According to the Case-Shiller/S&P Home Price Index, home prices in Detroit have risen by 2.7% over the past year (at the time of publication).
- According to that same index, prices in Phoenix had declined by -7.7% during the same period.
One market is stable, while the other is still in decline. So you should be wary of general proclamations, such as “Now is a good time to buy!” You can’t make a statement like that across the board. There is too much variation from one market to the next.
To learn how to buy a house, you first need to understand when it makes sense to do so. This research needs to be geographically specific. In terms of home prices, you should be studying your local housing market. Don’t spend too much time reading about national trends — they’re simply a composite of the good, the bad and the ugly. You need to think like a real estate investor, and that means researching conditions on the ground in your particular city or town.
So how do you do this? How do you find out what home prices are doing in your area? If you live in or near a major metropolitan area, you could look at the Home Price Index mentioned earlier. It includes pricing trends for 20 of the largest metro areas in the United States.
You could also look at the home-price trends reported by Zillow.com. They have data for almost every city in the country, dating back several years.
Believe it or not, Google is a great tool for housing market research. The Google News service in particular allows you to search all news stories over the last few weeks or months, for the topic of your choosing. You’re trying to determine if it makes sense to buy a house in 2012. So your topic of choice should be “My City Housing Market.” Obviously, you would fill in the name of your city. You could also do a news search for home prices in your area, foreclosures, real estate predictions and more. After doing this for a day or two, you’ll have a much better understanding of your local market.
ARM Loans – A Risky Option for Long-Term Buyers
Adjustable-rate mortgage (ARM) loans can be tempting. They can also be downright dangerous, when used in the wrong circumstances. This is one of the key lessons we took away from the housing crisis. It’s not that these mortgage products are inherently evil — they’re just commonly misused. When you buy a house in 2012, you need to choose the best financing option for your particular situation. And this might mean avoiding the ARM loan entirely.
Most of the ARMs in use today are technically “hybrid” loans. That is, they combine certain qualities of both the adjustable-rate mortgage and its fixed-rate counterpart. The 3/1 ARM loan is a good example. This is a mortgage product that starts off with a fixed interest rate for the first three years (indicated by the ‘3’ in the designation). After this period of stability, the rate will begin to adjust every year (as indicated by the ‘1’ in the designation). If the rate rises after the fixed period, your monthly payment rises along with it.
Why would somebody buy a house with such an unpredictable loan? Why not just use a fixed-rate mortgage to avoid the uncertainty of rising rates and payments? People use these loans to secure a lower rate during the initial phase.
Consider the table below. This snapshot was taken from the Freddie Mac website on November 23, 2011. Note the difference in rates between the 30-year fixed mortgage (3.98%) and the 5/1 ARM loan (2.91%).
According to this data, a borrower who chooses a 5/1 ARM loan might secure an interest rate that’s more than one percent lower than the average rate on a 30-year fixed mortgage. Doing so would result in a smaller mortgage payment each month — during the first five years, at least. This is the primary appeal of the adjustable-rate mortgage.
When buying a house in 2012, you will be presented with such options. You will have to choose between the long-term stability of a fixed-rate mortgage, and the short-term risk and reward of an ARM loan.
There are problems associated with the adjustable-rate mortgage, especially over the long term. You face the uncertainty of an interest rate that rises from one adjustment period to the next (annually, in most cases). But there are situations where you may want to at least consider using an ARM loan. If you only plan to be in the home for a few years, you could use an ARM to secure a lower interest rate. And you could sell the house before the loan starts to adjust. This is a common scenario for people who move around a lot, such as those in the military.
Before you buy a house in 2012, you need to understand the pros and cons of these two loan options. We have a wealth of information on this website to help you get started. You can use the search tool located at the top of this website to find related information. You could also do a Google search for the “pros and cons of adjustable-rate mortgages.”
Make sure you get the facts about your financing options. Study them before you start talking to mortgage lenders. Think about your long-term plans for the home. Choose a loan that exposes you to the least amount of risk during your stay.
You Need Solid Credit to Buy a House
Mortgage lenders have tightened up their credit-score requirements since the housing crisis began. This was one of the very first changes they made when the market started to crumble. In the days of the housing bubble, you could buy a house with terrible credit. You’d be stamped with the “subprime” label and charged a ridiculously high interest rate — but you could at least qualify for a loan. Those days are over, and so is the subprime mortgage industry. If you want to buy a house in 2012, you will need a solid credit score.
We queried more than 150 brokers and lenders when researching this tutorial. We asked them what their absolute minimum credit-score requirements were for (A) a conventional mortgage and (B) an FHA loan. The survey group included a broad mix of companies, including national lenders, state and local banks, and credit unions. Here’s a summary of what they told us:
- Most required a credit score of 640 or higher for a conventional mortgage.
- Most required a score of 600 or higher for an FHA loan.
- Some had the same requirement across the board (620+), for both types of loans.
Keep in mind there are exceptions to every rule. For instance, the New York Times reported in February 2011 that Wells Fargo was relaxing their credit criteria for FHA loans. According to that report, the nation’s largest mortgage lender reduced its minimum credit-score requirement from 600 to 500 (for an FHA home loan). So it never hurts to apply for financing, regardless of your credit score. You have nothing to lose, and you will at least find out where you stand.
Credit scores aren’t the only things lenders look at when you apply for a loan. They’ve gotten stricter in other areas as well. For instance, you will need to have a manageable level of debt to qualify for a mortgage in 2012. When you buy a house, you are adding a new (and often significant) debt obligation on top of your existing debts. You must have a sufficient amount of income to cover these obligations. Lenders refer to this as your debt-to-income ratio, or DTI.
The limits for DTI ratios are more varied than credit-score limits. We could not get a common answer when querying lenders about this topic. Most lenders had a maximum allowable DTI ratio between 37% and 43%, depending on the type of loan and other factors. This includes the mortgage payment. So if your combined debts (including your monthly mortgage payment) exceed 43% of your gross monthly income, you could have trouble qualifying for a loan. If you want to buy a house in 2012, you should take a good, hard look at your current debt obligations. They will limit your borrowing power.
Set Your Budget Before Talking to Lenders
In September 2010, we conducted a survey to find out what home buyers feared the most. The most common fear was having a mortgage payment that’s too big.
Chart: Home buyers are most afraid of overwhelming mortgage payments. Full story here
I found the results of this survey baffling. After all, we have complete control over the size of our mortgages. Why was this so worrying to home buyers? A later survey revealed the reason for this seemingly irrational fear: Most home buyers fail to establish a housing budget before applying for a loan. They have no idea what they can truly afford. They entrust their mortgage lenders to tell them. What a big mistake.
Before you buy a house in 2012, you need to have a budget on paper. It should include the maximum amount you can afford to pay toward your mortgage every month, given all of your other debt obligations. Here’s how to do it.
Home buyers should never think of their mortgage lenders as financial advisors. They are in the business of selling money, not giving financial advice. But our surveys suggest that many buyers make this very mistake. The lender can turn around and sell your loan into the secondary mortgage market, in the form of mortgage-backed securities (MBS). So why would they care about your long-term financial stability?
Out of the millions of homeowners who were foreclosed on in the last few years, I would wager that at least one-third of them started off with mortgages that were too big from the start. Here’s a warning sign. If you find that you have to cut back on everything just to afford the house payments, you’re taking on too much of a mortgage debt. What happens if you suffer a loss of income? What happens if you encounter unforeseen expenses, such as a medical bill or a major auto repair? If you don’t leave any breathing room in your budget, your mortgage will smother you.
If you’re preparing to buy a house in 2012, you should already be working on your budget. Start by creating a list of your monthly expenses. Subtract this number from your monthly take-home pay. How much is left over each month? Keep your housing costs below 75% of that remaining amount. This is a good starting point for your budgeting process.
Consider Buying a Bank-Owned House to Save Money
In most parts of the U.S., there are plenty of bank-owned homes for sale. These are properties that have been foreclosed upon by lenders, and are now back on the market. These homes are commonly (though not always) sold below their current market values. This is due to the bank’s desire to get the property of its books, ASAP.
According to RealtyTrac, the average sales price of a bank-owned home in the second quarter of 2011 was $145,211. This is approximately 40% lower than the average sales price of a non-foreclosure home during that same period. This doesn’t mean you’ll always get a 40% discount from market value on a bank-owned home — the size of the discount will vary, based on location and other factors. But it does indicate the potential for savings when buying a bank-owned foreclosure.
As you prepare to buy a house in 2012, you should do some research into bank-owned homes. How many of them are available in your area? What’s the average discount for such a property, compared to a non-foreclosure home? What is the process for buying distressed property in your city? You might even want to talk to a real estate agent in your area who specializes in foreclosures. The potential for savings is too great to dismiss the subject outright.
Summary and Conclusion
Is it a good idea to buy a house in 2012? This is one of the most common questions we have received from readers over the last few weeks. Everyone wants to know what home prices are doing, where the housing market is headed, etc. This article is our attempt to answer these questions. Or, more accurately, it is our attempt to help you answer these questions for yourself.
Mortgage rates are expected to remain below 5% for much of 2012, though there is no guarantee that will happen. Home prices are expected to fall in some cities but rise in others. Many housing markets will remain flat in 2012, in terms of home values.
Home buyers should focus their attention on local conditions in the city where they are planning to buy a house. They must weigh the pros and cons of FHA loans versus conventional mortgages, and review the differences between adjustable and fixed mortgages. Home buyers should have a budget on paper before they start talking to mortgage lenders. These are the keys to success when buying a house.