As a first time buyer, there’s plenty you need to know. You’re about to make the largest financial investment of your life, but with our Financial Guide for First-time Home Buyers, you’ll have all of the information you need about buying a home.
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- To Buy or Not to Buy
- Loan Programs
- What Is A PITI?
- Tax Benefits of Home Ownership
- Do I Really Need a Realtor When Buying a Home
- Starting the Conversation with a Lender… What to Look for
To Buy or Not to Buy
Over the years, we’ve had many clients who wanted to buy a house. They were well-qualified prospective homeowners, but they couldn’t pull the trigger. Sometimes, it was with good reason. They had an unstable job, were likely to transfer out of the area, or simply decided that in order to buy, they might have to sacrifice their ideal location and lifestyle to make it work.
These are logical and very common reasons that influence some of our clients to continue renting as they iron out the details of their lives. While all concerns are valid when you are making a big financial purchase or life change, it’s important to remember that buying a home doesn’t define or limit you. It simply adds to your investment portfolio… not to mention gives you a bigger tax break come April 15th!
Buying a home is a big decision and one that you should consider carefully. Be honest about why are having difficulty making a decision about buying. This is a large financial investment; one that pays off greatly over time for most people. It gives them a head start on their real estate investment portfolio, and, often, the money they make on their first home pays for the down payment of their move-up home. Time and time again, we have had clients that prove it makes great financial and personal sense to buy. If you’re qualified to purchase a home and are planning to live in the area for the next couple of years, it almost always makes financial sense to buy. In our office, we like to say nothing looks sexier on a person than real estate – and it’s true!
In addition to a new sense of self worth and accomplishment you’ll also have a fantastic new financial investment in your portfolio! Not to mention, you can decorate and customize your new home however you want now that you are no longer renting. If you need help deciding if buying makes sense for you, don’t hesitate to reach out to us. We are always happy to walk you through the process, no matter what stage of life you might be in now or whenever you’re ready.
Homeownership has long defined the American Dream. We recognize that it has become more challenging for many people (particularly young people and first-time buyers), to “buy in” to the American Dream of homeownership. Tighter lending restrictions and a difficult economy have presented challenges, especially here in our nation’s capital where home prices are significantly higher than in other parts of the United States. But fear not, American ingenuity will always triumph and the news isn’t all bad. There are several loan programs available that will help you on your quest to homeownership.
VA LOANS – Minimum 0% Down Payment
The best opportunity is for our veterans. Our government thanks members of our armed forces by offering them VA loans. VA loans have become ever more popular with little or no down payment. Although once regarded negatively (undeservedly) in the go-go seller’s market, we have more and more contracts than ever with VA financing and it is now one of the hottest ways to buy a home.
FHA LOANS – Minimum 3.5% Down Payment
FHA loans are another accessible program available to purchasers who are looking to buy a property. Under this program purchasers can put down as little as 3.5% of the sales price in a down payment for a loan up to $625,500.
CONVENTIONAL LOANS – Minimum 10% Down Payment
Lastly, buyers should still consider conventional financing, which is the most popular way to purchase a home. Typically these loans require a 10 or 20% down payment. The benefit of a conventional loan is that you’ll typically pay less mortgage insurance on your loan, which lowers your monthly mortgage payment by a few hundred dollars. Don’t forget: the higher your down payment, the lower your monthly mortgage will be, and the higher your equity will be in the home you own. So, if you can afford to make a higher down payment – go for it!
How you structure your loan can also make a difference.
ADJUSTABLE-RATE MORTGAGES vs. FIXED-RATE MORTGAGES
Another option that is regaining popularity is an adjustable rate mortgage, or ARM. With a traditional fixed-rate mortgage, you lock-in your interest rate for the life of the loan, typically either 15 years or 30 years. You are guaranteed that interest rate from now until the loan is paid off. However, with an ARM, you can get a lower interest rate than you would with a fixed rate. The catch is that after a certain time — 5, 7, 10 or 15 years — your rate will adjust. After that time, your rate will either increase or decrease by a certain percentage (usually 1%), depending on current interest rates. If you are planning on being in the property a short time, an ARM is worth your consideration.
THE BOTTOM LINE
Just remember…the American Dream is still possible. All it takes is doing a little research, financing smartly, finding the program that is right for you, and of course – having a great Realtor in your corner!
What Is A PITI?
If you are in the market for a new home, you may hear and see the term PITI quite a lot, especially in the loan application process. PITI represents the four parts that make up your mortgage payment: Principal, Interest, Taxes, and Insurance. PITI is the dollar amount an underwriter factors into your monthly payments when determining how much home you can afford. Lenders like to see PITI less than or equal to 28% of a borrower’s gross monthly income (you may hear this term called a front-end ratio).
Principal is the amount of your loan. You pay a portion of this principal with each mortgage payment. Typically, your principal payments are quite low initially as the majority of these initial payments is interest. This is a great tax benefit (more on tax benefits in the next section). Over time, you reduce the outstanding principal balance and your equity in the home increases. Paying down the principal is what reduces the overall balance of your loan. You can also make additional payments at any time towards paying down your principal. FYI: Interest only loans are also available. With such loans, principal payments don’t kick in until several years into the loan.
The interest is the percentage amount a lender charges you for borrowing the money to buy a home. Your initial mortgage payments will be mostly interest; however, this ratio will shift over time. If you have a fixed-rate mortgage, the rate you pay remains the same over the life of the loan. With an adjustable-rate mortgage (ARM), your rate will fluctuate with the interest rates in the broader economy.
These taxes are those property taxes paid to the municipality in which you live (city, town, or county). They provide the funding for local schools, roads, and emergency services like the police and fire departments. Property taxes can vary widely within a metropolitan area, so always check what the tax rate is in the municipality you are targeting. When you are house hunting, you can find the current property taxes on the MRIS/MLS listing sheet, though these are always subject to change.
You may pay your property taxes directly to your assessor, but often, lenders prefer to escrow them and pay the tax bill on your behalf. This ensures the taxes are getting paid as required. Property taxes are also a federal income tax-deductible item.
This Insurance portion of PITI is your property or homeowners’ insurance. Homeowners’ insurance covers a wide range possible issues, from water and fire damage to weather-related losses. It also covers your possessions (on that note, be sure to make an inventory of your valuables when packing to move). Also included in this portionis liability insurance, which would be used if someone fell down your stairs, for example.
Be sure to shop around and get various quotes for homeowners’ insurance, as it is one area where you do have some control over costs. We recommend doing this before the end of your home inspection or condo/HOA review period in case the insurance on your future home is more than you anticipated.
You may also hear the term private mortgage insurance or PMI. If you have put down less than 20% on your home, your lender will require PMI. This insurance protects your lender, should you become unable to pay your mortgage.
A FINAL NOTE
When comparing mortgage rates from different lenders, make sure the quoted payments represent the same costs (for example, compare PITI with PITI, or just the principal and interest payments).
We know homeownership lingo can be overwhelming. As always, we are here to help! Reach out if we can answer any questions on the home buying process or real estate in general.
Tax Benefits of Home Ownership
Most people know that home ownership offers tremendous financial benefits. Your home is likely the biggest investment you will ever make! As such, it can significantly build your wealth over time. Making that monthly mortgage payment creates equity (vs. paying rent to build up your landlord’s).
Though real estate values may fluctuate, over the long haul, buying your home is always a solid investment.
Homeownership also serves as a good hedge against inflation. With a fixed rate mortgage, you are guaranteed to pay that rate, despite what may happen to the economy. Even adjustable rate mortgages cap how much and how often the interest rate and/or payments can vary in a year and through the entire mortgage period.
Perhaps the most important of the financial advantages of home ownership are its tax benefits. There are quite a few! We will break down the main ones for you here. Keep in mind, to take advantage of them, you will need to itemize your deductions and consult with a financial professional or tax advisor (we can connect you with some excellent ones). Disclaimer-we are not tax advisors; please consult a professional if you have questions! (Note: This original post has been updated since the passing of the new tax law in early 2018, but again, please contact your tax advisor with any specific questions. You can read more about the new tax law here.)
The Big One: Mortgage Interest is a Tax Deduction
The best tax break of home ownership is being able to deduct your mortgage interest from your federal income tax return. You can deduct interest on up to $750,000 of your home mortgage amount.
For the first few years you own your home, the interest portion of the payment is roughly ⅔ of your monthly mortgage, which can translate into a significant tax break and cut down on what you owe Uncle Sam every April. For example, if you have a $500,000, 30-year mortgage at a fixed rate of 4%, you will enjoy a tax savings of $4,960 in your first year (assuming you’re in the 25% tax bracket). Over the life of the loan, you will save $89,837 in taxes!
The Runner Up: Capital Gains Protection
Tax law also allows you to shelter a large amount of profit you make when you are ready to sell your home. If you’re married filing jointly, $500,000 of your capital gains are sheltered; $250,000 for single homeowners. FYI: your gain is actually your home’s selling price, minus deductible closing costs, selling costs, and your tax basis in the property. So be sure to include the commission you pay, title insurance, any fees (legal, inspection, etc) and money spent prepping the house for sale when calculating your gain.
For example, suppose you are a single woman selling a condo you bought ten years ago for $350,000. The closing price is $650,000. You spent $50,000 in fees, commissions, and getting the condo ready for sale. You may think you had maxed out your $250,000 shelter with the sales price, with the closing and selling costs, you might owe no capital gains tax at all!
Of course, certain conditions must be met:
- you owned the home for at least two years in the five years before the sale;
- the home was your primary residence for a total of at least two years of that same period; and
- you did not exclude these gains from another home sale in the two years before the sale.
To use this exclusion again on another property, please check with a tax professional.
More tax breaks for your federal return:
Points are Deductible Too!
Points, or discount points, are fees paid directly to the lender at closing in exchange for a reduced interest rate. A point is equal to 1% of the loan amount. For example, the value of a point on a $250,000 mortgage would be $2,500. The points paid to ensure a loan rate are tax deductible, as long as the you as the buyer pay them (vs. the seller.) Also, the cash for your down payment must equal to any points paid. Be sure to deduct the points within the year that you bought the home.
As Are Your Your Property Taxes!
Your annual property taxes are a deduction for as long as you own your home up to $10,000. These local taxes are based upon the assessed value of your home. The more your home is worth, the higher your property tax bill. Fortunately, property taxes are deductible from your federal income taxes. You will pay your taxes either through an escrow account with your lender or directly to the municipality. Check your records to determine this amount and deduct away!
Do You Pay PMI? Deduct Those Premiums.
For mortgages issued in 2007 or later, home buyers can deduct the premiums paid for Private Mortgage Insurance, or PMI.
You may be asking, “What is PMI?” If you have a mortgage but didn’t have a 20%+ down payment, your lender will require the mortgage be insured. Many lenders offer programs with just 10-15% down, so we see this scenario quite often. Yes, PMI is another cost, but the good news is that those premiums can be deducted, so long as your income is less than $100,000.
FHA, VA, and the Rural Housing Service loans also require insurance. Some of those premiums are deductible as well. These loans are more complex, so plan to consult a professional to take advantage of these deductions.
First Time Buyer Special
First-time home buyers often tap into their IRAs for the down payment for their first home. Normally, the IRS charges a 10% penalty for pre-age 59½ withdrawals, but not in this case. Homebuyers can use up to $10,000 ($20,000 for a married couple) of IRA funds toward the purchase of a first home.
The best news? You don’t have to be purchasing your very first home to take advantage of this option. Technically, as long as you (or your spouse) didn’t own a principal residence during the previous two years, you qualify. Feeling generous? You can take advantage of this option for a child, grandchild, or a parent.
You must use these IRA funds within 120 days of withdrawal. So act quickly when using this option. Also, know that these funds will be taxed in your top bracket.
Save Those Home Depot Receipts!
Save receipts and records for all improvements you make to your home. In tax-speak, a home improvement project substantially adds to the value of your home, increases its useful life, or adapts it to new uses. Think of additions, remodeled kitchens and bathrooms, decks and fencing, landscaping, electric and plumbing upgrades, and new roofs.
While you can’t deduct these costs now, when you sell your home, they are added to the purchase price of your home. This new number is the “cost basis” of your home for tax purposes, or in lay terms, the amount of your investment in your home. The greater your basis, the less profit (see capital gains section above) you’ll receive when you sell your home, which translates to a lower tax bill when you do sell.
Go Green & Save
Energy-saving home improvements can earn you an additional tax break in the form of an energy tax credit worth up to $500. A tax credit is more valuable than a tax deduction because a credit reduces your tax bill dollar-for-dollar. Click here to learn more about these types of credits (this opportunity only applies to your primary residence).
The Bottom Line
Buying a home is almost always a wise financial decision. It offers tremendous financial benefits, most notably on the tax front. Contact us if you’d like to talk through your options. We can also connect you with a tax professional who knows the ins and outs of real estate tax implications. We are always happy to help!
Do I Really Need a Realtor When Buying a Home
Many buyers are under the impression they don’t need to hire a Realtor when buying a home. While we have certainly come across many unrepresented buyers in our years of experience, we do not recommend this option. There are countless reasons why you want a seasoned Realtor in your corner when buying a home. Allow us to break it down for you.
- Buying a home is a major life decision and also likely the biggest financial investment you will make in your life. You want someone experienced on your team guiding you through the process, which is full of major decisions and a multitude of details.
- Realtors have access to homes you won’t find on Zillow or other real estate sites. There is a “coming soon” status in the MLS (the Realtor listing database that feeds to all of the popular search sites like Zillow and Redfin) that consumers can’t access. Agents have ways of finding homes that aren’t on the market but are available for sale. They have access to other agents’ private listings as well as connections with other agents and sellers.
- The sales contract to buy or sell a house is a legally binding document. If something goes wrong, you could lose hundreds of thousands of dollars. An experienced Realtor will help explain all the ins and outs of the contract documents and ensure you navigate the contingencies correctly.
- You don’t pay commission! Commission is paid by the seller to the seller’s agent, also known as the listing agent. The listing agent then offers compensation to the buyer’s agent when they list the home for sale in the MLS. So, the commission for BOTH agents is paid by the seller. The only thing the buyer might pay is an administrative fee to your agent’s brokerage. This fees usually ranges from $200 to $500 depending on the brokerage and is paid at closing as a part of your closing costs.
- Because of how commission is structured (see above), you don’t save any money by buying without a Realtor. You cannot negotiate money back by using the listing agent. This is an urban legend! In fact, many buyers going it alone end up leaving money on the table. If you have the right buyer agent representing you, you can negotiate a much better deal and terms that work in your favor.
- The listing agent represents the seller and is working for the seller — not you. You need someone advocating for YOU. After all, you don’t know what you don’t know!
- If you are buying new construction, you may be under the impression that the builder’s representative will take care of you. Not so! Read our related article to learn why it’s especially important to use a Realtor for a new construction purchase.
A closing note — not all real estate agents are Realtors! A licensed Realtor is a member of the National Association of Realtors and legally bound to its Code of Ethics. A real estate agent without the Realtor designation is not bound to any such standards. Bear this in mind as you talk to various agents.
A good Realtor will look out for your best interests, knows how to negotiate, and can walk you through every step of the home-buying process.
Your Realtor can help you find an experienced lender so you can secure the necessary financing for your dream home. Realtors also have vast networks of professionals to recommend including home inspectors, contractors, movers, and much more.
If The Goodhart Group can help you in your home search, please reach out. Even if you’re not quite ready, we are always happy to talk through the process and your various options.
Starting the Conversation with a Lender… And What to Look for
When beginning the home-buying process, one of the first things you should do is contact a lender to get pre-qualified. It’s important to know what you qualify for and what you are comfortable spending per month before going out to look at properties. Often these numbers aren’t the same and a lender explain the difference in detail. In brief, the number that you pre-qualify for might be a lot higher than what you can comfortably afford to pay each month. There is no fee associated with getting pre-qualified; you aren’t locked into a rate and you aren’t obligated to use the lender. It’s a win/win.
We recommend our clients do their due-diligence and reach out to at least three lenders. It’s important to select a lender you feel good about since you’ll be working closely together throughout the home buying process.
So, what should you look for in your new lender?
- Do they offer a variety of loans? This variety is important if you need a creative loan. For instance, if you don’t have much cash on hand, want to buy before you sell, or have a high debtto-income ratio, you’ll need a lender willing to work with those circumstances (more on this below in #7).
- Do you like their personality? You will be working closely with them, so make sure you connect.
- Do they work on evenings and weekends? This is a biggie! When we find the house you love and want to write an offer, your lender must step in with a preapproval letter for that property with the address, offer price, and down payment amount to submit with the offer. We work with you on evenings and weekends, and your lender should, too. Responsiveness is key!
- Are they local? Believe it or not, a lender in a different time zone can cause problems. Lenders have to meet certain deadlines and if they are late, settlement can be delayed by several days. Imagine questions arising at settlement at 9am or 10am EST, and your lender on the west coast is not yet open for business. What’s more, your lender is responsible for choosing an appraiser and might think that Richmond is close enough to Alexandria to use an appraiser based there. Local lenders are more incentivized to do an excellent job for you and your Realtor: They live in the community and want to please the client and their agents so they will send referrals. A local lender can help give you an edge in a competitive bidding war if the other Realtor knows and trusts your lender, which brings us to our next point…
- What’s their reputation? Are they experienced? Do they have agents and clients to vouch for them?
- Do they have in-house underwriting? This is not a deal breaker per se, but it can certainly be very important. Here’s why: Smaller banks are typically better in the lending world. Big banks like Bank of America and even some credit unions, can be very slow-moving. Small, local banks are much more agile, can make exceptions more easily, and typically know everyone they are dealing with throughout the process. At a larger bank, your lender might have underwriters in a different state.
- Are they creative? Some lenders can easily identify ways to get you to qualify for a loan. For example, paying off one credit card and closing another improves your credit score and makes your more qualified for a loan. Creative lenders can open the door to lower mortgages.
Now that you’ve identified what to look for in a lender, how should you prepare for the call, meeting or e-mail?
- When you reach out to a lender, you will want to know how much cash you have for a down payment and closing costs, plus how much money you feel comfortable spending each month for a mortgage.
- To get prequalified, you will not typically need full documentation on your income and employment history… You will need this information down the line, so it’s not a bad idea to start pulling it together. Think tax returns, W2’s, etc. – generally any documents that illustrate your earnings.
- Be prepared that the lender will ask your permission to run your credit to get your credit score. Your credit score indicates to see what kind of interest rate you will receive.
If you feel like you are months or even a year away from making a move, it’s never too early to reach out to prospective lenders. They can help you figure out how much you will need to save in order to afford the type of home you would like to buy.
The best place to look for a lender is a referral from your Realtor or from a close, local friend who had a great experience working with one. The advantage of a Realtors recommendation is that instead of having dealt with them for one transaction, they have dealt with them for possibly hundreds of transactions and know their overall reputation in the industry. It is not legal for Realtors to get kickbacks for their recommendations, so you can rest assured that any recommendations are not to the advantage of your agent.
Planning to buy your first home in Alexandria, VA and the DC Metro area? Our expert team of Realtors can help! Feel free to book a buyer’s appointment, so we can answer all your questions.
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