Whether you’re in your twenties or much older, buying your first home is possibly the biggest single financial decision of your life. Yet home ownership is not for everyone. You not only need to understand the money side of the transaction, but your personal needs as well. After more than a decade of annual double-digit price gains in many markets, the U.S. residential real estate market was starting to cool. This was particularly worrisome for several reasons. Housing debt-fueled by easy access to home equity loans-was eating away equity in a large number of American properties.
The Federal Reserve’s Survey of Consumer Finances, released every three years, reported in February 2006 that average family incomes fell 2.3 percent between 2001 to 2004, dragged down by the sluggish recovery from the 2001 recession.
Generally, there are three primary reasons why people buy homes:
- They want to cut their income taxes. With a mortgage, you may be able to deduct the interest you’re paying and property taxes from your taxable income. This cuts your income tax payment, and may make home ownership cheaper than renting.
- They see it as an investment, not a long-term residence. Some people buy housing they plan to live in as an investment. They live in it while they fix it up and then sell. Recently, the market was hot enough to do that and guarantee attractive profits. But markets slow and investors always need to be aware of that.
- They want to build equity. As a mortgage loan is paid down and housing prices head up in an area, homeowners build value in what they have bought. This provides an ownership stake that can be used for a home equity loan or line of credit or profit when the home is sold.
How Much Down Payment Do You Need?
A decade ago, mortgage loans were fairly traditional. There was little or no talk about home equity lines or interest-only loans. While it is still good to deliver some level of down payment, with the aggressive rise in home prices over the last decade, fewer people can afford such a hefty chunk at the outset. Check with your lender to see how much less PMI will cost you based on how much down payment you can afford.
There’s another alternative to paying PMI: the 80/10/10 loan. Here’s how it works-you take out a first mortgage for 80 percent of the sales price, a second mortgage (or home equity loan) for the next 10 percent of the sales price, and put down 10 percent in cash. This means taking on significant debt, so discuss this choice with a financial adviser first.
What Types of Property are Available?
While single-family homes, condominiums, and rental apartments top the list of real estate most people buy, other people increasingly buy property for rehabilitation and resale and out-of-town rental as well. Here’s an overview of the key categories of properties most people buy and for what purpose:
- Single-family home. This is the most common form of residential property, the single-family detached house. Houses come in all shapes, sizes, and price ranges, but their physical characteristic is that the home sits by itself on its own piece of property. They are generally easier to finance than properties the owner does not live in, because the belief is that they will be better maintained and easier to appraise for value.
- Condominium. Condos exist in virtually every community of any size. When you purchase a condo, you are purchasing an actual unit, as some say, “from the inside paint in”: When it comes to the outside structure of the building and common elements, there is a joint governing body, called the condominium association, that gathers facts, bids, and decides how money for repairs and other projects will be collected and paid out. Financing a condo purchase is similar to obtaining a mortgage on a single-family home, except that your lender may have restrictions on types of condos approved for FHA financing. Some lenders may grill you if you a.re not planning to live in the development because they like to see owners on site.
Why? Because renters sometimes mess up the property or skip on the rent, which destroys your cash flow as an investor.
Cooperative apartments. A housing co-op might look like an apartment or a condo, but the ownership structure is much different. Co-ops (short for “cooperatives”) are apartment buildings owned by a corporation that’s formed by developers or the original tenants of the building. Each resident owns shares of stock in a corporation, not their own unit. Co-op housing residents have the same potential tax benefits as other homeowners, including taking their share of the mortgage interest and real estate taxes as a deduction on their income taxes. While co-ops might be more affordable than similar condominium dwellings, their ownership structure requires that new buyers be approved, something that doesn’t happen in a condo situation.
Townhouses. Like condominium and co-op dwellers, town home-owners typically share a wall in common with neighborhoods. But town home property may be held in a variety of ways. Most row houses built in the 20th century were held “fee simple,” meaning that owners hold legal title to their structure and the land it sits on, and are personally responsible for all taxes assessed to that property.
Mobile homes. These are a relatively cheap housing option, but they can become complicated to own. When buying or investing in a mobile home, it is almost more important to check out where you’ll be placing the home, because management structures vary widely.
Mobile homes are not necessarily treated as any single-family home. It depends on the land-ownership structure underneath. Banks and credit unions may lend for mobile homes, though most manufacturers do as well.
What Type of Financial Shape Should You be in Before You Start Looking?
Before you make any major purchase, you need to do two things. First, extinguish as much debt as you can, and that certainly means credit card debt. Second, you need to make sure your credit reports arc free of inaccuracies.
As tough as it might be, you’d also be wise to get your emergency fund in shape before a big home purchase. That means three to six months of income that needs to be set aside for emergencies-not down payments. It will be your insurance against an unexpected home repair in the future or the loss of a job that could impair your ability to meet your mortgage.
What Expertise Do You Need?
Since sellers pay the real estate commission, not first-time buyers, you’re not going to be stuck with a 4 to 6 percent commission on your first home. But that shouldn’t stop you from making contact with a real estate agent in a community or neighborhood where you really want to buy. Knowledge is power. If you don’t want to consult an agent, there are other resources:
Check local newspaper websites for access to property transfer data in various neighborhoods right down to the specific street address. Start checking “comparables” (comparable prices) on property in the neighborhood where you want to buy. Check to see how far back you can trace transactions on particular properties to see how they’ve appreciated-or not.
Consult various lender Web sites to see to trends for local mortgage rates and mortgage products. A good independent site is www.Bankrate.com, which lists current mortgage rates in various local markets.
Schedule a session with a financial adviser for a holistic view of your financial picture before you start your search. He or she might also have a line on real estate attorneys to help you approve the paperwork when you do buy.