Welcome students of Pat Schneider's
Stoughton High School economics class!

Basics of Buying a House

Instead of making you read this whole website just to get the general idea of how the process works, here's a short summary of everything that follows.

Should I buy or keep renting?

In most cases it's better to buy instead of rent, and to buy as soon as you can afford to do so. The only exceptions are for people who have very low rent, or who plan on moving in a few years. So the first thing you need to do is to figure out whether buying is even a good idea for your situation. My rent vs. buy calculator will help you do that very thing. Unlike many calculators of this type, I've already filled in all the blanks with sample values, all of it realistic. You need change only a few items (current rent, home price, and mortgage rate) to get a good idea of whether renting is better than buying.

Most people think the benefit in buying is to "stop throwing your money away on rent," but in fact the equity you build from buying is mostly offset by the money you will "throw way" on taxes, insurance, maintenance, and mortgage interest, which renters don't pay. The real benefit from buying is that you freeze your monthly payment for 15 to 30 years, and then you stop paying it altogether.

The Basics

You don't pay cash when you buy a house. If you had to do that then nobody could afford a home.  Instead you make a small down payment in cash (3.5 to 20% of the sale price), and you get a loan from a bank called a mortgage for the rest. You make payments on this loan every month for 15 or 30 years, and then you get to stop making payments.  (If you're rich and don't need a loan, congratulations. You can skip every part of this guide relating to loans.)

You used to be able to get zero-down payment loans, but after the lending crisis (caused by banks giving out easy loans like candy), those are pretty rare.  In 2006, a whopping 43% of first-time homebuyers put no money down (USA Today, 2006), but those days are gone.  Veterans with good credit scores can still get no-down-payment loans, but that's about it.

The higher the down payment you can make, the easier it is to get a loan, and the lower the interest rate is, and the lower the monthly payment is. 

What kind of home can I afford?

In general you can afford a home worth about three times your annual household income. If your combined income is $60,000, you could afford a $180,000 house. ("Income" is your AGI, line 37 on your tax return.)

If it looks like you can't afford a home then consider getting a bigger home than you need and renting out part of it. This is especially applicable to single people, where the smallest home they can find might be too big for their needs. Later as your income increases and you can afford to live without renters you can do so, and you'll come out ahead by having bought sooner rather than later. Anyway, here's how the costs compare when you rent out part of a home you buy:

In 2006 a friend of mine was paying $600 to live in a tiny 1-bedroom apartment.  She bought a 4-bedroom house that cost her $1100/mo., and rented out two of the rooms for $600/mo. total. So her net cost per month is only $500. She's spending $100/mo. less, and she has twice as much room, a yard for her dog, and she owns her own house.

Earlier I said you can afford a home worth three times your income. Here are factors that could allow you to buy a home worth more or less than that.

Increases your buying power	Decreases your buying power
No debt	Debt, esp. big debt
Large down payment	Small down payment
Good credit	Bad credit
Duplex where you can get rental income	Single-family home, no bedrooms rented out

On the next page you can use my How Much Home Can I Afford Calculator to see exactly how much you can afford.

How much a home costs

The median price for a home was $171,000 in U.S. metro areas as of September 2011. (Kiplinger)  Of course the price varies according to the part of town, and even the state you're in.  Homes in California cost lots more than homes in West Virginia and Arkansas.  And naturally if the median (middle) price is $171,000, there are houses available for much less.  In 2004 I bought two tiny houses on the same lot for $86,000 total, or $43,000 per house.

Prices were much higher until recently.  Prices surged from 2000 to 2007, then the housing bubble burst, and prices crashed, falling by about 40% by 2012.  (Some markets were even worse, with Las Vegas prices falling 61% from their peak.)  That means it's easier to buy a home now than it was just a few years ago, since houses are a lot cheaper now.

How much will my monthly payments be?

• Your monthly payments will probably be 0.75% to 1.15% of the purchase price. On a $150,000 home that's $1125 to $1725/mo.  This includes taxes and insurance. We'll cover how to estimate your monthly payment more accurately on the next page.
• The bigger your down payment, the lower the monthly payments.
• The lower the interest rate, the lower the monthly payments.
• The longer the loan, the lower your monthly payments. But it's better to get a shorter loan so you pay it off quicker and save on interest, if you can afford the higher payments.
• Don't forget that you can lower your monthly obligation by renting out a room or two (or a whole side, if you buy a duplex).

To afford a house you'll need the up-front money as well as money for the monthly payments

Here's a summary:

Money you need up front • Down Payment (probably) • Closing Costs (possibly) • Misc. Costs

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Monthly costs • Mortgage Payment   (inc. taxes & insurance)

Money you'll need up front

• 3 to 20% of the purchase price for a down payment. The actual amount depends on what kind of loan you get and how good your credit is. Your bank might offer a zero-down loan, but if you can afford to make a down payment, you should do so, because you'll get a lower interest rate and because your monthly payments will be lower.
  
  
• 1 to 8% of the purchase price for closing costs. You might not have to pay this up front. The bank might be willing to add it to your mortgage. (Add them to the mortgage if you need the cash, but pay the closing costs up front if you don't.) The actual amount of closing costs depends on how good a deal your lender is willing to give you, and the price of the house. The more expensive the home, the less the closing costs are as a percentage of the total price.
  
  
• $250 to $800 in Miscellaneous Costs. These are things like the application fee for the loan, the fee for the bank to run your credit report, professional inspection of the home, and an appraisal (if you can't get the appraisal added to the closing costs).
  
  
• Putting these three things together, on a $150,000 house you'll need
  • $4500 to $30,000 for the down payment (unless you get a 0% down loan)
  • $0 to $12,000 for the closing costs
  • $250 to $800 for miscellaneous costs

  Total: $4750 to $42,800. Yes, that's quite a difference. You'll learn more about estimating the costs for your own situation as you go through this guide.

How to get a mortgage (a loan)

You generally need four things to qualify for a mortgage:

1. Money to make the down payment.
2. Income that's 2 to 3 times higher than your mortgage payment. (more on figuring mortgage payments in a minute)
3. Two years of solid employment history (same job or field).
4. Decent (not perfect) credit.

There are sometimes ways around this if you lack one or two of those, but usually not if you lack three or four. More on this later.

All the costs involved in buying a home

$150,000 avg. 3-20% Cash down 80-97% Mortgage	1-8% of sale price Paid in cash at closing, or rolled into mortgage	$250-800 For app. fee, credit report, inspection, appraisal. Paid in cash

Closing costs are fees charged by the companies and government offices which process the loan and the sale of the property. They're generally 1 to 8% of the sale price. You might be able to have the closing costs added to the mortgage so you don't have to pay them up front.

Where the money comes from

Remember that you might be able to have the closing costs added to your loan instead of paying them in cash.

Remember also that the amount of money you have to put down varies depending on the type of loan you get and what the bank requires, and the closing costs vary too.

How to find and buy a home

1. Read the rest of this guide, especially the parts about estimating how much home you can afford. The rest of this guide covers everything below.
2. Get a copy of your credit report and clean up your credit record as much as possible.
3. Go to your bank, ask to talk to a loan officer, tell them you want to buy a house, fill out an application, and get what's called a Pre-Qual Letter.  You may have to pay an application fee of $40 or so.
4. Find a real estate agent (get referrals from friends).  The seller pays the commission to your agent, so it costs you nothing to have an agent.  Your agent serves you by letting you know what houses are available that meet your needs (they have access to a special database) and by answering your questions about the process.  In theory a agent should also help you get the best price but not necessarily, because the more you pay for the house, the more the agent makes in commission.
5. Tell the agent what part(s) of town you want to live in, what kind of house you want, and how much the bank said they'd loan you. Your agent will give you a list of houses that match your criteria. Go look at them.
6. When you find a house you want get the Disclosure from the seller.  This is a list of problems with the house that the seller knows about, and which the seller must give you by law.
7. If the Disclosure doesn't sour you on the house, ask the agent how much you should offer.  It's rare that you accept the price given by the seller, usually you'll offer slightly less than they're asking.  Get a list of Comparables (similar homes that have sold in the same area recently) from your agent so you can get an idea of how much the house is worth.
8. You'll make the offer by signing a contract.  If the seller accepts your offer then they'll sign too.  At this point you're generally obligated to buy the house and the seller is generally obligated to sell, though depending on the wording of the contract either of you could have the right to walk away from the deal under certain circumstances.
9. Have the house professionally inspected.  You generally have to pay this yourself, at the time, and it will cost $350 or so.  If the inspection turns up problems not listed on the disclosure which will cost a lot to fix, try to get the seller to lower the price or fix the problems before the sale -- or walk away from the deal if your contract allows that and that's what you want.
10. The bank will have the house appraised to make sure it's worth what you're paying for it.  (They don't want to loan you $200,000 to buy a house that's worth only $150,000.)  You might have to pay this up front, otherwise it will be added to your closing costs.  Besides paying for it up front if that's required, you're not involved in this step of the process.
11. Find an insurance agent (ask friends for referrals) and get a quote.  You can certainly price-shop 2-3 different companies if you like.  Pick one and tell them you want the insurance.  The cost will be added to your closing costs, you don't have to pay this at the time.
12. Closing.  You go to the office that's handling the closing (a title company or an attorney, usually selected by the lender or the seller), to take care of the paperwork.  You'll owe some money, such as the down payment, and closing costs unless you got those rolled into the mortgage.  You've either already arranged with your bank to wire the funds to the closing company, or you bring a bank check with you to closing.  You don't need to get a check for the mortgage loan, the bank will wire that directly to the office handling the closing.