The world is flat

How to turn a burst bubble into a home

During the past year, news reports have shown a deluge of sad stories involving people losing their homes. The majority of people filing for foreclosure were holders of subprime loans—loans that cater to borrowers with a weak credit history. They bought their houses with little-to-nothing down and got an interest-only loan and an adjustable rate mortgage (ARM) in order to keep monthly payments low. They expected the home value to appreciate rapidly, as it had for the past few years. That didn’t happen. Instead, interest rates increased, home sales and values fell, and their mortgages doubled—they found they could no longer make the payments and owed more than what the home was worth.

Investor-buyers were also buying up a number of homes, expecting them to “flip” quickly—to buyers that never came.

Other homeowners are “stuck” in their houses because they’ll lose money selling it.

Still others saw their homes appreciate—example: a $300,000 home going up to $500,000 in a couple of years—and, feeling optimistic, they took out some of the home equity to buy a boat or a new home to rent out. When the market fell, they didn’t have that equity to fall back on to let them keep their home. They’d taken the eternal-sunshine-of-the-spotless-housing-market gamble and lost.

Such reports have made the already intimidating prospect of buying a house look downright scary to some new homebuyers. Now that the glory days of 20-50 percent appreciation are over—at least for now—and the housing market is what you’d call “flat,” what’s a sensible approach for first-time homebuyers?

The process
Establish credit. This is key. It doesn’t mean wracking up a huge credit card bill. Just charge little things—an occasional grocery bill or tank of gas—on your card, and then pay it back on time.

Clean up debt. Outstanding debt should be paid off as much as possible before taking on a debt as sizable as a mortgage.

Find a realtor. This is especially important for first-time homebuyers. Ask friends and do some homework about who is trustworthy, experienced, knowledgeable about the market and able to analyze different people’s situations and goals.

“A good agent can put you in a better spot in the future, appreciation-wise,” says RE/MAX realtor Jerry Morrissey.

Aside from having someone who knows which questions to ask and who can, ideally, help you avoid pitfalls, Morrissey says the liability falls on the agent. He also says that, “about 90 percent of the time, the seller pays the commission [of the realtor.]”

Meet with a lender. It should cost you nothing to meet with a lender to discuss your goals and go over things like pay stubs, bank statements and your credit rating. Try to find someone with a good reputation within a stable company. There are a number of loan programs—beyond the standard 30-year-mortgage—that cater to different people. Depending on your situation, you may do better with a 30-year fixed rate, an adjustable rate, a Federal Housing Administration loan, or, like Lyle and Knight (see main story, “Open house"), a rural housing loan. A good lender can help find one best for you.

“Try to use your home as a financial tool, not just a place to live,” says Michelle Alarcon, a loan officer with CTX Mortgage.

Get preapproved. Find out from your lender what you can really afford, as well as a loan program tailored to your needs, advises both Morrissey and Alarcon. It doesn’t make sense to go house hunting without knowing if your dream house is just that—a dream.

Note that “prequalified” is different from “preapproved.” “Prequalified” means you’ll likely qualify, while “preapproved” means you’re good to go.

That preapproval letter gives you leverage with the seller when it comes time to negotiate everything from the house’s price to closing costs. Sellers are more willing to work with someone they know is preapproved over someone who’s not, says Morrissey.

To get to the preapproval stage, you’ll need good credit, little to no debt, and to show you’ve had at least two years of stable income.

Morrisey cautions that it’s not the lender’s job to determine your lifestyle. “You may be preapproved for more than you can afford,” he says.

Go back to the realtor. Now the house-hunting begins. If your realtor doesn’t seem to understand what you’re looking for, find one who will.

Note the time of day. If you like a house, check in on it morning, noon and night to see if, for example, your neighbors hold house parties every weekend until 6 a.m.

Get a home inspection. Look under rugs, inside the attic and every nook and cranny. Get a full report with pictures before buying problems you neither created nor expected. If there are any problems with the house later, you can refer to the inspection report.

Know what you’re signing. Make sure you fully understand your loan and any agreements regarding buying the home.

“When you enter into a purchase agreement, it’s a legally binding agreement, so be sure it’s how you want it,” says Alarcon.

You can’t make an offer, have the seller pull the house from the market, and then change your mind without expecting to pay big.

Keep in mind
Lease-options. Morrissey suggests that buyers who have little money but who are able to make monthly payments should look into lease options, or “rent to own.” He says that, in this market—with 30 percent of homes vacant—renters could ask that all of their rent be applied when they buy the home in 18 months.

“You’re paying their bill, so you win, they win,” he says.

Realize a new home is more than just paying the mortgage. There are also home insurance, property taxes and maintenance to take into account. When you forget to adjust your pipes for the winter, and they break and flood the basement, that’s on your dime, not the landlord’s.

Watch out for association fees and assessments. Know what these will be before getting into a home. You may buy a condo, for example, in an older area, without knowing the whole building is getting a new roof, which may require thousands of dollars in “assessments” from you.

Be wary of the vacant lot. Morrissey discourages people from buying homes next to vacant lots, as there’s no telling what that property might become. For example, that view that sold you on the house could easily be obstructed by someone else’s to-be-constructed, three-story dream house.

New construction. Know what you’re getting into before buying a newly constructed home or one in the works.

“You walk into a model home, almost everything in there is an upgrade,” says Morrissey.

Those granite countertops and hardwood floors won’t likely be in the actual home unless you throw down thousands of dollars to put them there. You’ll likely also have to install a sprinkler system, provide landscaping and add other amenities to make the home more livable. Those upgrades typically come out of your pocket, not the loan, and you’re not likely to get more than 30-40 percent of it back when the house is appraised come sale time, says Morrissey. He emphasizes that such upgrades may make the home “more salable, but not more valuable.”

Newer versus older neighborhoods. Despite the new- construction cautions, Morrissey says homes that are 3-10 years old in newer neighborhoods tend to have higher appreciation rates than older ones. A glut of rentals tend to “bring down the whole neighborhood,” he says, as renters tend to not have the pride of ownership of homeowners. Since appraisals are based on square footage and location, “Your neighbors determine your home’s price more than you do,” he says.

Pre-payment penalties. Make certain that any loan you get doesn’t have a pre-payment penalty, says Morrissey. If you refinance or sell the home “too soon” under the pre-payment penalty conditions, you could be penalized $10,000 or more.

Buying with friends. If going in on a house with friends, do it as business partners and not as friends, says Morrissey. A time may come when your friends want to sell, and you don’t want to, so you’ll have to buy them out. Draw up a contract that stipulates financial obligations under those kinds of situation. Otherwise, things could get ugly.

Do it in writing. This goes for everything. “Do nothing verbal,” says Morrissey.

Buying with lovers
Be committed. During the housing boom, a couple who bought a house together and then broke up may have come out all right, financially. But, says Morrissey, “in this market, if someone bails on you, nobody makes any money.”

Draw up a contract. While it’s not fun to think about, Alarcon says it’s wise for couples—any couple, whether single or married—to draw up a contract deciding what happens to the house if “forever” turns out to be a much shorter “for awhile.” For example, if one person puts down almost all of the couple’s down payment, and that couple decides to split, the house’s equity is still divided equally.

Also, if something tragic were to happen to the boyfriend, for example, would the girlfriend get his portion of the house (like a wife would), or would it go to his family? There should also be something in writing determining that, says Alarcon.

Expanding families. If you’re a young couple, think about whether and when you might have children. If it’s soon, take that into consideration for not only the space of the home, but also the monthly payment you can afford. What you can afford as a couple is different from what you can afford as a family.

New life, new everything? Not necessarily. Newlyweds have a tendency to want a new everything to start out their new life—new house, new car, new furniture. Meanwhile, they’re probably still paying off the wedding. Be conservative in taking on too many new debts while trying to meet house payments.

“The last thing I want to do is get you into a house you feel married to,” says Alarcon.