I’m trying to build a coherent series on the home-buying process, so to help me organize here is an index of posts that I’ve already written so far. Those with no links are outlines for future posts. If you think something is missing or want me to cover a specific topic, just leave a comment. Thanks!

Should I Buy A House?
Buying a house isn’t necessarily the best choice for everyone. There are lots of different pros and cons.

• Famous Housing Bubble Graph (Different Version)
• Interactive Buy vs. Rent Calculator
• Another Buy Vs. Rent Calculator
• Intangible Advantages And Disadvantages Of Owning A Home
• Are Homes Actually A Horrible Investment?

Finding a Real Estate Agent

• Finding A Buyer’s Agent, Part 1: The Search Begins With Ourselves
• Finding A Buyer’s Agent, Part 2: Screening, Trial and Error, Signing a Contract, Offer Acceptance
• Home Buyer’s Agent Commission Rebates
• Guidance Received During The Escrow and Closing Process
• Looking Back: Things I Would Have Done Differently

Finding and Choosing A Home
If you do want to buy a house, what do you look for in a home?

• Our Criteria For A House (How Did We Do?)
• Housings Prices vs. Commute Time
• Condo Living: How Do I Find A Good Homeowners Association?
• Gathering Local Statistics About A Housing Market
• How Many Square Feet Should Our Home Have?
• Open Houses From A Buyer’s Perspective

Mortgage Basics: Choosing Loan Types
You found a home, so how are you going to pay for it?

• How Much House You Can Afford?
• Effect Of Credit Score On Mortgage Rates and Monthly Payments
• Choosing a Fixed-Rate Mortgage Term Length: 15, 30, or 40 Years?
• Loan Payment vs. Term Length
• Avoiding Jumbo Loans By Combining a Conforming Loan and Second Loan

Mortgage Practicalities: Choosing A Specific Lender & Interest Rate/Points

• Homeowners: Who Did You Get Your Mortgage Through?
• Getting Pre-Qualified For A Mortgage
• Comparison Shopping Between Different Mortgage Lenders
• Upfront Mortgage Brokers
• Upfront Direct Mortgage Lenders
• When To Lock Your Rate / Can You Predict Mortgage Rates?
• Reading The Good Faith Estimate

Making An Offer, Inspections, Escrow, and Closing

• Making and reading the offer contract
• Ordering Inspections, Asking For Concessioins
• Snags and Delays
• Signing Day

Housing-Related Humor
Buying a house is a serious and stressful endeavor. Watching these videos is not. 😀

• Bikini Girls + Waterfalls + 90s Real Estate Guru = Tom Vu
• Renting Can Be Rough: The Landlord with Will Ferrell
• Find the Right Property For You…

Here’s a quick graph that I didn’t include in my previous post on choosing between 15, 30, or 40-year mortgages…

I’ve always felt that loan lengths were a bit arbitrary. Why did 15-year and 30-year loans become the industry standard? It’d be just as easy to make a 25-year mortgage. So I took a step back and compared term length vs. monthly payment for a $300,000 mortgage at 5.5%. The result was interesting, and I would think the general behavior should be consistent across different loan amounts and interest rates:

The graph shows that mortgage payment stops decreasing very much as the term goes past 20 years, and really starts to flatten after 30 years. If you use the 30-year as the benchmark, the 20-year payment is 20% higher, while the 40-year payment is only 9% less. Stretching even further from 40-years to 50-years only saves you another 5%.

Given this information, you’d think that having to get a 40-year mortgage should be a sign that you really can’t afford that house. Yet according to Bankrate, 25% of all new mortgages in California are 40-year mortgages (nationwide it’s more like 5-10%). This is partially due to the fact that pseudo-government Fannie Mae buys 40-year mortgages now. In fact, the mortgage industry has already rolled out 50-year amortizations for certain adjustable-rate mortgages. The next few years for housing should be really interesting…

After I made the decision to get a fixed rate mortgage over one with an adjustable rate, the next was to decide what length to get. I thought this would be an easy decision, but there are a surprisingly large number of variables to consider!

Viewpoint #1: Get The Shortest Mortgage You Can Afford
With a longer term, you build equity more slowly but have more affordable payments. With a shorter term, face higher monthly payments but you own the home faster and pay less interest. So the traditional advice seems to be: get the shortest mortgage that you can afford.

This is can be a slippery slope, though. 15-year too expensive? Let’s try 30-year. No? How about 40-year? Hmm… barely. Well, maybe that ARM isn’t that bad after all… Affordability shouldn’t be the only consideration.

Viewpoint #2: Get The Longest Mortgage You Can Afford
In my previous post 10 Reasons You Should Never Pay Off Your Mortgage, I explored the reasons why certain financial advisors tell people to get the longest mortgage they can get. Basically, your mortgage is a cheap, long-term loan. If you re-invest this money into stocks, which over the long run are expected to return much more than 5-6% annually, why would you want a shorter loan? It’s a great arbitrage opportunity.

If you believe in this theory, then your answer is simple: get the longest mortgage you can afford, as long as the effective interest rate is lower than what you confidently can earn elsewhere.

Viewpoint #3: Longer Mortgages As Paying For Flexibility
Here’s the thing. Just because you have a 30-year mortgage doesn’t mean you have to take 30 years to pay it off. As long as you don’t have a prepayment penalty, you can simply send in additional money towards your loan principal and pay it off in 8, 15, or 23.5 years. However, if you have a 15-year mortgage, you have to make those higher payments every month or risk losing your home. So going for the longer term essentially sets you a “minimum payment”, which you can exceed as you wish. This can make a big difference if I run into extended unemployment or other large financial setbacks.

Example: 15-Year vs. 30-Year + Extra Principal
Of course, as you get a longer term, your interest rate will also go up a bit. But if you run the numbers, it actually doesn’t make that much difference! Let’s say that the 15-year is at 5.125% right now, but the 30-year is at 5.625%. The 15-year payment is $2,392, while the 30-year payment is $1,727 – a difference of $665.

However, if I just paid the $665 extra toward the 30-year mortgage each month, I still end up paying that 30-year loan off in less than 16 years! In exchange for the safety and flexibility of lower minimum payments, I stretched my 15-year loan out for an extra year. I view this extra interest as insurance.

Our Situation and Final Decision
In the case of Viewpoint #1, we can currently afford the payment for a 15-year mortgage. On the other hand, subscribing to Viewpoint #2 this would leave us wanting a 40-year mortgage at a relatively low 6% rate. However, while I see the merits of the arbitrage argument, I don’t necessarily think it’s an apples-to-apples comparison when you have two things with different risk/return characteristics.

I ended going with the 30-year fixed mortgage, primarily due to the reasons explained in Viewpoint #3. I am not against paying off our house early – I actually like the idea of having my home paid off as it would help simplify our income planning in retirement. (I could also treat paying it off early as owning a bond.) However, the flexibility of being able to make the lower payments as needed was a big draw, especially given the relatively small premium for doing so. Finally, if we rent the house out one day, the lower payment would also help with managing rental cashflow.

So why not a 40-year mortgage here as well? As you go longer, the mortgage payment stops dropping very much. A 40-year loan would involve an even higher rate and only lower our payment by 4%.

Conforming loans are those that satisfy the criteria that Fannie Mae and Freddie Mac set regarding what kinds of loans they will buy. Besides certain credit-related guidelines like debt-to-income ratio, one major constraint is the maximum loan amount. Barring any upcoming changes (see below), the current limits are $417,000 in the continental US (AK, HI get $625,500).

Because they can be so readily sold to these psuedo-government entities, conforming loans are usually very competitively priced. Non-conforming loans have to be sold elsewhere or kept in-house, so they usually end with higher rates. But as recently as July 2007, the added cost for a non-conforming loan might have been only 0.20%. However, due to rising default rates and skeptical investors, the premium is currently around a full 1%. This has led to the increasing popularity of replacing a jumbo loan with two loans – a conforming one and a second loan to make up the difference.

Example. Let’s say you wanted to buy a $600,000 home, with a 20% down payment ($120,000). This leaves $480,000 to be financed, which is over the $417,000 conforming cap. With a single Jumbo loan, here’s your scenario. (I’ll use estimated mortgage rates based on current market conditions.)

But, here’s what happens when you split it up into a $417,000 conforming loan and a $63,000 second loan. The second loan usually has a higher interest rate, similar to that of a home equity loan.

By restructuring, you have lowered your effective interest rate nearly 50 basis points .from 6.5% to 6.01%, which in turn lowered the mortgage payment by $127 a month ($1,524 a year). To find the blended rate, I used the this Dinkytown calculator.

The Fine Print:

• This works best with small 2nd loans. Kind of obvious, but the less you have to put on the 2nd loan with higher interest, the better your blended rate would be. As the loan amount rises, there will likely be a point when the plain Jumbo loan will give you the lower payment.
• The second loan can be structured in a variety of ways. It could be a completely separate loan from a different lender, it could be a home equity loan from the same lender, or it could be a home equity line of credit.
• You might have balloon payments. In my case, I was offered a equity loan amortized over 30 years, but with a balloon payment due after 15 years. So I would need to either pay off that $63,000 within 15 years, or refinance before then.
• Possibly higher closing costs. The second loan may incur closing costs, but they should be a lot smaller than the first loan because things like appraisals have already been paid for.
• Conforming limits might change soon! The pending economic stimulus package legislation – which is almost on Bush’s desk as I type – proposes to temporarily raise the conforming limits to as high as $729,750 in “high cost” areas based on median home price. It is unknown how soon this will take effect, but probably too late for me. (Google News)

Before shopping for rates, we had to figure out what kind of mortgage loan we were going to get. The first decision was between a fixed-rate or an adjustable-rate mortgage. Quickly, here are some very general definitions:

• Fixed rate mortgages (FRMs) provide a constant monthly payment for the life of the loan, no matter what interest rates do in the meantime. Common lengths are for 15 and 30 years.
• Adjustable rate mortgages (ARMs) offer a lower monthly payment for a certain initial period, and then adjust periodically afterwards. Common initial periods are 1, 3, 5, and 7 years. For example, if you see a “5/1” ARM, the rate and payments are fixed for the first 5 years, and then will adjust according to a pre-determined formula one a year after that. A “5/5” ARM adjusts only once every 5 years. Usually they are also based on a 30-year amortization, but not always.

Here were my three main considerations for choosing between ARMs and FRMs:

How long do I expect to stay in the home?
I’ve read statistics that people tend to move about once ever 5-7 years, and that the average mortgage only lasts 7-8 years before being refinanced or paid off (usually from the sale of the home). But who cares about average? Everyone is different.

It’s true that if I bought a “starter home” that with the arrival of kids we might need a quieter neighborhood or more space. In our case, we ended up finding a home that has everything we need for the foreseeable future. While trying to be as objective as possible, if I had to lay odds I’d say that there is a 95% chance that we’d stay past 5 years, and 75% that we’d stay for 15+.

What’s the interest rate savings if I go with an ARM?
Here you’d have to look at current rate curves. At one unlikely extreme, if you’re getting the same rate for both types of loans, of course you’d go for the fixed. Right now, the spread is about 0.5% between a 5/1 ARM and a 30-year fixed mortgage, which is pretty narrow. In the past the spread has been as little as 0.1% and as high as 1-1.2%, possibly more.

Although many mortgages brokers will tell you “even if you end up staying longer than 5 years, you can always refinance”, that’s just not true. You can’t always refinance – check out all those sub-prime borrowers who can no longer get a loan anywhere. They are stuck with rates resetting in the 15% range!

And even if you can refinance, it might be ugly… What if your credit score drops in that time? What if lending standards continue to tighten? What if rates rise significantly? What if your home value drops and your loan-to-value (LTV) ratio is now horrible?

I think ARMs can be a smart buy if you can assess your situation accurately. Some people know they’ll be gone in four years or less. Who knows, rates might actually drop like we’ve seen recently. But no matter what there is an element of risk involved. With rates still at historical lows, we see the downside being a lot worse than any potential upside.

Do I want to rent it out?
This is one consideration I don’t always see mentioned. If I do end up moving, there is a very good chance that I’d like to make my home a rental property. With a fixed mortgage, again I have stability. Rents will rise with inflation, but my mortgage payment will always stay the same. I also don’t have to worry about obtaining a investment-property mortgage, as primary-home loans are usually much cheaper.

In the end, all the signs pointed towards a fixed-rate mortgage for our situation, so that’s what we’re getting. 🙂

I’m curious as to where people initially found their mortgage loans, even if later on it was sold to someone else. Here are the options, along with a brief and very generalized impression of their pros and cons.

• National Banks. In general have above-average rates, but may have special programs for certain groups of people. May be more comfortable and/or reputable. Relatively rigid lending standards. Examples: Bank of America, Wells Fargo.
• Local Bank. May have a good relationship and be easier to communicate with, and may be more flexible with underwriting.
• Online Bank. May offer competitive rates, but the communication and service might not be as good. Example: Capital One Consumer Bank.
• Local Broker. May offer a better rate by shopping around for a wholesale rate and adding their commission. However, the quality and honesty of these brokers can vary wildly from great to subpar. The rates quoted might not actually materialize.
• Credit Union. Limited membership field, but may still offer good rates to members. Example: Navy Federal Credit Union.
• Online Broker. You can compare lenders online at a distance. However, the service again might not be that great. Example: LendingTree.com.

Here’s is the poll:

Feel free to explain your decision in the comments if you have time!

I mentioned before that we plan to have just my wife apply for our new home mortgage loan, and not have my name on the mortgage at all. I had been playing around with this idea for months, but it looks like we will be going through with it. Here are some of my supporting reasons:

Helps Prevent Overspending On A House
One of our primary life goals is to be able to live on the equivalent of one income so that we can both work less and enjoy our lives. In order to do so, obviously we will need to maintain a reasonable housing payment. Although it’s clear now that lenders aren’t always the best judges of what is “affordable”, if we couldn’t qualify using only one of us, that would surely be a bad sign. While going through the pre-qualification process, we found banks willing to lend us over 5 times our income!

Although this is usually one of the main drawbacks of only having one spouse on the loan, but we actually saw it as a positive way to help us make sure we weren’t spending too much on a house.

Saves Time and Hassle
We want the best mortgage rate possible, so we are doing a full-documentation loan to prove our financial worthiness. Not only did I only recently finish school again, but a chunk of my income is self-employment income. Doing a full-doc loan with self-employment income involves a ton of scrutiny and at least 2 years of detailed profit/loss records. They also only take the average income over the last two years into consideration. It was simply easier and faster to submit my wife’s more stable and salaried job information.

Projecting A Better Credit Score
Sometimes one spouse has bad credit, so you want to keep their name off the mortgage in order to get a better rate. In our case, it wouldn’t have really mattered since we already got both our scores checked while getting pre-qualified. But my wife’s score is still slightly better than mine – since she doesn’t play silly credit card games – so we figured it wouldn’t hurt.

Leaves Room For Future Mortgage
After we buy the house, I still won’t have a mortgage on my credit report. Supposedly having a mortgage helps your score, but I’ve been doing just fine for over a decade without one, so it doesn’t matter to me. However, if later on I apply for a mortgage myself (investment property?), then I’ll be able to use my full income to qualify since I’ll have no other visible liabilities. Hopefully this will result in a better rate later on down the road as well.

Worst-Case Scenario
Although we never plan on taking advantage of this, if our home does get foreclosed upon, ideally only my wife’s credit score would be hurt as she is the only one responsible for the loan. Of course, I’d also lose my interest in the house.

Both Spouses Can Still Own The House
In our case, we plan on putting both our names on the title of the house with rights of survivorship. From what I’ve read, in many states both spouses have equal interests in any purchased house no matter who is on the mortgage, so it may not even matter.

So no mortgage for me! 🙂 Let me know if I missed something, positive or negative.

This my second post on our experience in Finding A Buyer’s Agent. In Part 1, we tried our best to figure out what we wanted from an agent. Again, we are first-timers and are not real estate gurus. This is a long post, but it definitely shows a real story of how we found our agent – and how she helped us find our house!

Screening Tips

Given the hundreds if not thousands of real estate agents in our area, it was going to be a daunting task to find the “perfect” agent. We had to filter them down somehow. After reading up at a couple of books and websites about how to select a buyer’s agent, here’s what we were told:

• Ask trusted friends for recommendations. Ask about the reputation of both the agent and the brokerage house he/she works for.
• Ask potential agents for testimonials and references. A long list of references is good, but it’s unlikely you’ll hear from the unsatisfied folks.
• Check the local real estate board if your agent has any complaints against them. This is pretty unlikely in my experience, they aren’t exactly regulated that closely.

Our First Experience

First, we asked our friends and family for experiences. One of our family members actually used to be an agent, but she retired a while ago. Another family friend volunteered to be our agent, so we decided to try him out. It didn’t work out as he seemed to only want to show us certain houses in certain areas, and wasn’t very responsive to our specific requests. I guess we weren’t the ideal “let’s see 3 houses you recommend and we’ll just buy one of them” couple. Not wanting to mix friendship and business anymore, we decided to find our own agents from then on.

Interviewing Agents

After browsing some newspaper ads, I decided to visit HomeGain.com and used their free “Find a Realtor” feature to compare some agents. You provide your information like neighborhood, price range, etc. and then a bunch of agents try to create a custom “proposal” for you. However, it’s all done online through their interface, and none of your contact info is shared without your permission. I liked the idea of not keeping my name and phone number private. You also get client testimonials and their experience level. Here is a sample (click for full size):

Most of the proposals sounded the same… “I know all about your neighborhood, let me help you etc. etc.” We picked our favorite five, and asked them the same interview questions online:

[Read more…]