Should I Refinance My Mortgage Now?
With all the volatility going on in the market, it seems there is one certainty and that is the word “historical” will continue to be in the headlines. Over the past few months, we’ve seen the Dow Jones Average hit historical highs, the 10-year treasury hit historical lows, and historical daily point movements in the market.
Should I Refinance My Mortgage Now?
With all the volatility going on in the market, it seems there is one certainty and that is the word “historical” will continue to be in the headlines. Over the past few months, we’ve seen the Dow Jones Average hit historical highs, the 10-year treasury hit historical lows, and historical daily point movements in the market. Market volatility will always lead the headlines as it does impact anyone with an investment account. With that in mind, it is important to use these times to reassess your overall financial plan and take advantage of parts of the plan that are in your control.
For a lot of people, their home is their most significant asset and is held for a longer period than any stock or bond they may have. This brings us back to “historical” as mortgage rates continue to drop. Whenever this happens, our clients will call and ask if it makes sense to refinance. In this article, we will help you in making this decision.
3 Important Questions
How much will I be saving annually in interest with a lower rate?
What are the closing costs of refinancing?
How long do I plan on being in the home and how many more years do I have on the mortgage?
If you can answer these questions, then you should have a pretty good idea if it makes sense for you to refinance.
How Much Will I be Saving Annually in Interest with a Lower Rate?
With most financial decisions, dollars matter. So how do you determine how much you will be saving each year with a lower interest rate? Below, I walk through a very basic example, but it will show the possible advantage of the refinance.
One important note with this example is the fact that most loan payments you make will decrease the principal which should decrease the cost of interest. To make this simple, I assume a consistent mortgage balance throughout the year.
Higher Interest Lower Interest
Mortgage Balance: $300,000 Mortgage Balance: $300,000
Interest Rate: 4.5% Interest Rate: 3.5%
Annual Interest: $13,500 Annual Interest: $10,500
By refinancing at the lower rate, the dollar savings in one year was $3,000 in the example when the mortgage balance was $300,000.
Savings over the life of a mortgage at 3.5% compared to 4.5% on a $300,000, 30-year mortgage, should be over $60,000 in interest over that time period if you are making consistent monthly payments.
What are the Closing Costs of Refinancing?
After walking through the exercise above, most people will say “Of course it makes sense to refinance”. Before making the decision, you must consider the cost of refinancing which can vary from person to person and bank to bank. There are several closing costs to consider which could include title insurance, tax stamps, appraisal fee, application fees, etc.
If the cost of closing is $5,000, you will have to determine how long it will take you to make that back based on the annual interest savings. Using the example from before, if you save $3,000 in interest each year, it should take you 2 years to breakeven.
One tip we give clients is to start at your current lender. Banks are in competition with other banks and they usually do not want to lose business to a competitor. Knowing the current interest rate environment, a lot of institutions will offer a type of “rapid refinance” for existing customers which may make the process easier but also give you a break on the closing costs if you are staying with them. This should be taken into consideration along with the possibility of getting an even lower interest rate from a different institution which could save you more in the long run even if closing costs are higher.
How Long do I Plan on Being in the Home and How Many More Years do I have on the Mortgage?
This is important since there is a cost to refinancing your mortgage. If it will take you 10 years to “breakeven” between the closing costs and interest you are saving but only plan on being in the house for 5 more years, refinancing may not be the right choice. Also, if you only have a few years left to pay the mortgage you would have to weigh your options.
In summary, taking advantage of these historical low mortgage rates could save you a lot of dollars over the long term but you should consider all the costs associated with it. Taking the time to answer these questions and shop around to make sure you are getting a good deal should be worth the effort.
Public Service Announcement: Like the stock market, it is hard to say anyone has the capability of knowing for sure when interest rates will hit their lows. Make sure you are comfortable with the decision you are making and if you do refinance try not to have buyer’s remorse if the historical lows today turn into new historical lows next year.
About Rob……...
Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.
Will Home Equity Loan Interest Be Deductible In 2019+?
The answer............it depends. It depends on what you used or are going to use the home equity loan for. Up until the end of 2017, borrowers could deduct interest on home equity loans or homes equity lines of credit up to $100,000. Unfortunately, many homeowners will lose this deduction under the new tax law that takes effect January 1, 2018.
The answer............it depends. It depends on what you used or are going to use the home equity loan for. Up until the end of 2017, borrowers could deduct interest on home equity loans or homes equity lines of credit up to $100,000. Unfortunately, many homeowners will lose this deduction under the new tax law that takes effect January 1, 2018.
Old Rules
Taxpayers used to be able to take a home equity loan or tap into a home equity line of credit, spend the money on whatever they wanted (pool, college tuition, boat, debt consolidation) and the interest on the loan was tax deductible. For borrowers in higher tax brackets this was a huge advantage. For a taxpayer in the 39% fed tax bracket, if the interest rate on the home equity loan was 3%, their after tax interest rate was really 1.83%. This provided taxpayers with easy access to cheap money.
The Rules Are Changing In 2018
To help pay for the new tax cuts, Congress had to find ways to bridge the funding gap. In other words, in order for some new tax toys to be given, other tax toys needed to be taken away. One of those toys that landed in the donation box was the ability to deduct the interest on home equity loans and home equity lines of credit. But all may not be lost. The tax law splits "qualified residence interest" into two categories:
Acquisition Indebtedness
Home Equity Indebtedness
Whether or not your home equity loan or HELOC is considered acquisition indebtedness or home equity indebtedness may ultimately determine whether or not the interest on that loan will continue to be deductible in 2018 and future years under the new tax rules. I say "may" because we need additional guidance form the IRS as to how the language in the tax bill will be applied in the real world. As of right now you have some tax professionals stating that all interest from homes equity sources will be disallowed beginning in 2018 and other tax professionals taking the position that home equity loans from acquisition indebtedness will continue to be eligible for the tax deduction in 2018. For the purpose of this article, we will assume that the IRS will continue to allow the deduction of interest on home equity loans and HELOCs associated with acquisition indebtedness.
Acquisition Indebtedness
Acquisition indebtedness is defined as “indebtedness that is secured by the residence and that is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer”. It seems likely, under this definition, if you took out a home equity loan to build an addition on your house, that would be classified as a “substantial improvement” and you would be able to continue to deduct the interest on that home equity loan in 2018. Where we need help from the IRS is further clarification on the definition of “substantial improvement”. Is it any project associated with the house that arguably increases the value of the property?
More good news, this ability to deduct interest on home equity loans and HELOCs for debt that qualifies as “acquisition indebtedness” is not just for loans that were already issued prior to December 31, 2017 but also for new loans.
Home Equity Indebtedness
Home equity indebtedness is debt incurred and secured by the residence that is used for items that do not qualify as "acquisition indebtedness". Basically everything else. So beginning in 2018, interest on home equity loans and HELOC's classified as "home equity indebtedness" will not be tax deductible.
No Grandfathering
Unfortunately for taxpayers that already have home equity loans and HELOCs outstanding, the Trump tax reform did not grandfather the deduction of interest for existing loans. For example, if you took a home equity loan in 2016 for $20,000 and there is still a $10,000 balance on the loan, you will be able to deduct the interest that you paid in 2017 but beginning in 2018, the deduction will be lost if it does not qualify as "acquisition indebtedness".
Partial Deduction
An important follow-up question that I have received from clients is: “what if I took a home equity loan for $50,000, I used $30,000 to renovate my kitchen, but I used $20,000 as a tuition payment for my daughter? Do I lose the deduction on the full outstanding balance of the loan because it was not used 100% for substantial improvements to the house? Great question. Again, we need more clarification on this topic from the IRS but it would seem that you would be allowed to take a deduction of the interest for the portion of the loan that qualifies as “acquisition indebtedness” but you would not be able to deduct the interest attributed to the “non-acquisition or home equity indebtedness”.
Time out……how do you even go about calculating that if it’s all one loan? Even if I can calculate it, how is the IRS going to know what portion of the interest is attributed to the kitchen project and which portion is attributed to the tuition payment? More great questions and we don’t have answers to them right now. These are the types of issues that arise when you rush major tax reform through Congress and then you make it effective immediately. There is a laundry list of unanswered questions and we just have to wait for clarification on from the IRS.
Itemized Deduction
An important note about the deduction of interest on a home equity loan or HELOC, it's an itemized deduction. You have to itemize in order to capture the tax benefit. Since the new tax rules eliminated or limited many of the itemized deductions available to taxpayers and increased the standard deduction to $12,000 for single filers and $24,000 for married filing joint, many taxpayers who previously itemized will elect the standard deduction for the first time in 2018. In other word, regardless of whether or not the IRS allows the deduction for home equity loan interest assigned to acquisition indebtedness, very few taxpayers will reap the benefits of that tax deduction because your itemized deductions would need to exceed the standard deduction thresholds before you would elect to itemize.
Will This Crush The Home Equity Loan Market?
My friends in the banking industry have already started to ask me, “what impact do you think the new tax rules will have on the home equity loan market as a whole?” It obviously doesn’t help but at the same time I don’t think it will deter most homeowners from accessing home equity indebtedness. Why? Even without the deduction, home equity will likely remain one of the cheapest ways to borrow money. Typically the interest rate on home equity loans and HELOCs are lower because the loan is secured by the value of your house. Personal loans, which typically have no collateral, are a larger risk to the lender, so they charge a higher interest rate for those loans.
Also, for most families in the United States, the primary residence is their largest asset. A middle class family may not have access to a $50,000 unsecured personal loan but if they have been paying down their mortgage for the past 15 years, they may have $100,000 in equity in their house. With the cost of college going up and financial aid going down, for many families, accessing home equity via a loan or a line of credit may be the only viable option to help bridge the college funding gap.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Can I Use My 401K or IRA To Buy A House?
The most difficult part of buying a house is coming up with the down payment. This leads to the question, "Can I access cash in my retirement accounts to help toward the down payment on my house?". The short answer is in most cases, "Yes". The next important questions is "Is it a good idea to take a withdrawal from my retirement account for the down
The most difficult part of buying a house is coming up with the down payment. This leads to the question, "Can I access cash in my retirement accounts to help toward the down payment on my house?". The short answer is in most cases, "Yes". The next important questions is "Is it a good idea to take a withdrawal from my retirement account for the down payment given all of the taxes and penalties that I would have to pay?" This article aims to answer both of those questions and provide you with withdrawal strategies to help you avoid big tax consequences and early withdrawal penalties.
401(k) Withdrawal Options Are Not The Same As IRA's
First you have to acknowledge that different types of retirement accounts have different withdrawal options available. The withdrawal options for a down payment on a house from a 401(k) plan are not the same a the withdrawal options from a Traditional IRA. There is also a difference between Traditional IRA's and Roth IRA's.
401(k) Withdrawal Options
There may be loan or withdrawal options available through your employer sponsored retirement plan. I specifically say "may" because each company's retirement plan is different. You may have all or none of the options available to you that will be presented in this article. It all depends on how your company's 401(k) plan is designed. You can obtain information on your withdrawal options from the plan's Summary Plan Description also referred to as the "SPD".
Taking a 401(k) loan.............
The first option is a 401(k) loan. Some plans allow you to borrow 50% of your vested balance in the plan up to a maximum of $50,000 in a 12 month period. Taking a loan from your 401(k) does not trigger a taxable event and you are not hit with the 10% early withdrawal penalty for being under the age of 59.5. 401(k) loans, like other loans, change interest but you are paying that interest to your own account so it is essentially an interest free loan. Typically 401(k) loans have a maximum duration of 5 years but if the loan is being used toward the purchase of a primary residence, the duration of the loan amortization schedule can be extended beyond 5 years if the plan's loan specifications allow this feature.
Note of caution, when you take a 401(k) loan, loan payments begin immediately after the loan check is received. As a result, your take home pay will be reduced by the amount of the loan payments. Make sure you are able to afford both the 401(k) loan payment and the new mortgage payment before considering this option.
The other withdrawal option within a 401(k) plan, if the plan allows, is a hardship distribution. As financial planners, we strongly recommend against hardship distributions for purposes of accumulating the cash needed for a down payment on your new house. Even though a hardship distribution gives you access to your 401(k) balance while you are still working, you will get hit with taxes and penalties on the amount withdrawn from the plan. Unlike IRA's which waive the 10% early withdrawal penalty for first time homebuyers, this exception is not available in 401(k) plans. When you total up the tax bill and the 10% early withdrawal penalty, the cost of this withdrawal option far outweighs the benefits.
If You Have A Roth IRA.......Read This.....
Roth IRA's can be one of the most advantageous retirement accounts to access for the down payment on a new house. With Roth IRA's, you make after tax contributions to the account, and as long as the account has been in existence for 5 years and you are over the age of 59� all of the earnings are withdrawn from the account 100% tax free. If you withdraw the investment earnings out of the Roth IRA before meeting this criteria, the earnings are taxed as ordinary income and a 10% early withdrawal penalty is assessed on the earnings portion of the account.
What very few people know is if you are under the age of 59� you have the option to withdraw just your after-tax contributions and leave the earnings in your Roth IRA. By doing so, you are able to access cash without taxation or penalty and the earnings portion of your Roth IRA will continue to grow and can be distributed tax free in retirement.
The $10,000 Exclusion From Traditional IRA's.......
Typically if you withdraw money out of your Traditional IRA prior to age 59� you have to pay ordinary income tax and a 10% early withdrawal penalty on the distribution. There are a few exceptions and one of them is the "first time homebuyer" exception. If you are purchasing your first house, you are allowed to withdrawal up to $10,000 from your Traditional IRA and avoid the 10% early withdrawal penalty. You will still have to pay ordinary income tax on the withdrawal but you will avoid the early withdrawal penalty. The $10,000 limit is an individual limit so if you and your spouse both have a traditional IRA, you could potentially withdrawal up to $20,000 penalty free.
Helping your child to buy a house..........
Here is a little known fact. You do not have to be the homebuyer. You can qualify for the early withdrawal exemption if you are helping your spouse, child, grandchild, or parent to buy their first house.
Be careful of the timing rules..........
There is a very important timing rule associated with this exception. The closing must take place within 120 day of the date that the withdrawal is taken from the IRA. If the closing happens after that 120 day window, the full 10% early withdrawal penalty will be assessed. There is also a special rollover rule for the first time homebuyer exemption which provides you with additional time to undo the withdrawal if need be. Typically with IRA's you are only allowed 60 days to put the money back into the IRA to avoid taxation and penalty on the IRA withdrawal. This is called a "60 Day Rollover". However, if you can prove that the money was distributed from the IRA with the intent to be used for a first time home purchase but a delay or cancellation of the closing brought you beyond the 60 day rollover window, the IRS provides first time homebuyers with a 120 window to complete the rollover to avoid tax and penalties on the withdrawal.
Don't Forget About The 60 Day Rollover Option
Another IRA withdrawal strategy that is used as a “bridge solution” is a “60 Day Rollover”. The 60 Day Rollover option is available to anyone with an IRA that has not completed a 60 day rollover within the past 12 months. If you are under the age of 59.5 and take a withdrawal from your IRA but you put the money back into the IRA within 60 days, it’s like the withdrawal never happened. We call it a “bridge solution” because you have to have the cash to put the money back into your IRA within 60 days to avoid the taxes and penalty. We frequently see this solution used when a client is simultaneously buying and selling a house. It’s often the intent that the seller plans to use the proceeds from the sale of their current house for the down payment on their new house. Unfortunately due to the complexity of the closing process, sometimes the closing on the new house will happen prior to the closing on the current house. This puts the homeowner in a cash strapped position because they don’t have the cash to close on the new house.
As long as the closing date on the house that you are selling happens within the 60 day window, you would be able to take a withdrawal from your IRA, use the cash from the IRA withdrawal for the closing on their new house, and then return the money to your IRA within the 60 day period from the house you sold. Unlike the “first time homebuyer” exemption which carries a $10,000 limit, the 60 day rollover does not have a dollar limit.
About Michael.........
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Should I Buy Or Lease A Car?
This is one of the most common questions asked by our clients when they are looking for a new car. The answer depends on a number of factors:
How long do you typically keep your cars?
How many miles do you typically drive each year?
What do you want your down payment and monthly payment to be?
This is one of the most common questions asked by our clients when they are looking for a new car. The answer depends on a number of factors:
How long do you typically keep your cars?
How many miles do you typically drive each year?
What do you want your down payment and monthly payment to be?
We typically start off by asking how long clients usually keep their cars. If you are the type of person that trades in their car every 2 or 3 year for the new model, leasing a car is probably a better fit. If you typically keep your cars for 5 plus years, then buying a car outright is most likely the better option.
“How many miles do you drive each year?”
This is often times the trump card for deciding to buy instead of lease. Most leases allow you to drive about 12,000 miles per year but this varies from dealer to dealer. If you go over the mileage allowance there are typically sever penalties and it becomes very costly when you go to trade in the car at the end of the lease. We see younger individuals get caught in this trap because they tend to change jobs more frequently. They lease a car when they live 10 miles away from work but then they get a job offer from an employer that is 40 miles away from their house and the extra miles start piling on. When they go to trade in the car at the end of the lease they owe thousands of dollars due to the excess mileage.
We also ask clients how much they plan to put down on the car and what they want their monthly payments to be. If you think you can stay within the mileage allowance, a lease will more often require a lower down payment and have a lower monthly payment. Why? Because you are not “buying” the car. You are simply “borrowing” it from the dealership and your payments are based on the amount that the dealership expects the car to depreciate in value during the duration of the lease. When you buy a car……you own it……and at the end of the car loan you can sell it or continue to drive the car with no car payments.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
The Process Of Buying A House
Buying a house can be a fun and exciting experience but it’s also one of the most important financial decisions that you are going to make during your lifetime. This article is designed to help home buyer’s understand:
Buying a house can be a fun and exciting experience but it’s also one of the most important financial decisions that you are going to make during your lifetime. This article is designed to help home buyer’s understand:
The home buying process from start to finish
The parties involved in the process (real estate agent, attorney, bank, etc.)
Common pitfalls to avoid
What to expect when applying for a mortgage
How to calculate the amount of your down payment
Owning Versus Renting
You first have to determine if owning a house is the right financial decision for you. Society wires us to think that owning a house is automatically better than renting but that is not necessarily true in all situations. From a pure dollar and cents standpoint, it may make sense to keep renting given your personal situation. We typically tell clients if there is a fair chance that they may need to sell their house within the next 5 years, in many cases it may make sense to keep renting as opposed to buying a house given all of the upfront costs associated with purchasing a house. It takes a while to recoup closing costs and when you go to sell your house you will most like have to pay your real estate agent 5% - 6% of the selling price.
Determine How Much You Can Afford
Before you even start looking at houses you have to determine two things:
The down payment and closing costs
The amount of the monthly mortgage payment that fits into your budget
There is no point in looking at $300,000 houses if you cannot afford the down payment or the monthly mortgage payment so the initial step involves determining what you can afford.
Calculating Your Closing Costs
Closing costs are in addition to your required “down payment”. First time home buyers often make the mistake of just using the 5% down or 10% down as a rule of thumb for their total upfront cost for buying a house. They often forget about closing costs which can add an additional 2% - 5% of the purchase price of the house to the amount due at closing. Closing costs include:
Discount Points: An up-front fee that you can choose to pay if you want to reduce the interest rate on your loan.
Origination Charge: Fee for processing your mortgage application, pulling credit reports, verifying financial information, and creating the loan
Rate-lock Fee: If you choose to lock in your interest rate beyond a certain period of time
Other Lender Fees: Document preparation fee, processing fee, application fee, and underwriting fees
Appraisal & Inspection Fees: Fees for the lender to inspect and appraise the value of the house
Title Services: Fee charged by the title agent to determine the rightful ownership of the house you are buying and some lenders require title insurance.
Government Recording Charges: Every home buyer must pay these charges for the state and local agencies to record the loans and title documents
Transfer Taxes: Depending on where you live, your state, county or city may charge a tax when the ownership of a home is transferred
Escrow Deposit: At the closing of your home loan, if you decide to escrow or if an escrow is required, there will be an initial deposit in your escrow account to pay for future recurring charges associated with your home, such as property taxes, school taxes, and insurance. You will typically need to pay for the first year of your homeowner’s insurance in full before your home loan closes.
Daily Interest Rate Charge: This charge covers the amount of interest that you will owe on your home loan from the time your loan closes to the first day of your regular mortgage billing cycle.
Flood Insurance: This is a form of hazard insurance that is required by lenders to cover properties in flood zones.
Attorney Fees: Fees typically vary from $300 - $1,000. Most individuals will work with a real estate attorney to review and negotiate the purchase agreement on their behalf. These fees are sometimes paid to the attorney prior to the closing.
As you can see there are a number of fees that you have to be prepared to pay in addition to the down payment required by the lender. Lenders are required by law to give you a “good faith estimate” (GFE) of what the closing costs on your home will be within three days of when you apply for a loan. However, these are just estimates and many of the fees listing on the GFE can legally change by up to 10%, potentially adding thousands of dollars to your final closing cost bill. A day before your closing the lender should provide you with a copy of your HUD-1 settlement statement, which outlines all of the closing fees.
Calculating Your Down Payment
The amount of your down payment will vary based on the type of loan that you received to purchase your house. The three main types of home loans are:
FHA Loan
Conventional Mortgage
VA Loan (Veterans Affairs)
FHA Loan: FHA stands for Federal Housing Administration. The loans are made by banks but they are guaranteed by the FHA which added additional protection for the lender. FHA loans come with a minimum down payment of 3.5% which make them very popular. With these loans borrowers pay PMI (private mortgage insurance) premiums both upfront and each year until the loan is paid down to a specified level. Loan limits vary by housing type and county. These loans tend to favor low to middle income borrowers who do not have a means to make the traditional 10% - 20% down payment at closing.
Conventional Mortgage: Minimum down payment varies from 5% - 20%. Borrowers that put down less than 20% will have to pay PMI (private mortgage insurance). Conventional mortgages typically require a higher FICO score than FHA loans. These loans tend to favor borrowers with higher credit scores and have enough cash on hand to make a sizable down payment.
VA Loan: VA loans are available only to veterans. The greatest benefit of these loans is they require no down payment and they allow qualified borrowers to purchase a home without the need for mortgage insurance. VA loans also tend to have more flexible and forgiving requirements. The VA charges a mandatory Fund Fee of 2.15% for regular military and 2.40% for Reserve/Guard on purchase loans.Let’s bring it all together in an example. If you anticipate on buying a house for $200,000 and you plan on taking an FHA loan, the amount that you will need to save for the closing will be in the range of $11,000 - $17,000 (3.5% for the down payment and 2% - 5% for the closing costs). This calculation will obviously vary based on the type of loan you plan on taking to purchase your house.
Determine what your monthly mortgage payment
After you have determined how much you need to save to meet the upfront cost of purchasing a house, the next step is to determine the monthly mortgage payment that fits into your budget.
Step 1: Establish your current monthly and annual budget. There is no way to determine what you can afford if you have no idea where you are now from an income and expense standpoint. Tip: Be brutally honest with yourself when listing your expenses. The last thing you want to do is underestimate your expenses, buy a house you cannot afford, and then go through a foreclosure. You will also have to factor in additional expenses into your budget as if you owned the house today such as lawn care, snow removal, appliances, and maintenance expense. As a renter you may not have any of these expenses now but as soon as you own a house, now when something breaks you have to pay to fix it. Homeownership is often times more expensive than most individuals anticipate.
Step 2: Based on your current monthly income and expenses, how much is left over to satisfy a monthly mortgage payment? The general rule is your monthly mortgage payment (including property taxes, PMI, and association fees) should not exceed 32% of your monthly gross income. Tip: Leave some extra room in your budget for life’s unexpected surprises. For example, furnace need to be replaced, dishwasher brakes, spouse loses a job, plumbing issues, etc.
Step 3: Use an online mortgage calculator to determine the loan amount that meets your estimated monthly mortgage payment. Do not forget to take into account property taxes, school taxes, association fees, PMI, and homeowners insurance when reaching your estimated monthly payment.
The parties involved in the home buying process
There are a lot of different professionals that you will interact with during the process of purchasing your house. It’s important to understand who is involved, what their role is in the process, and how they are compensated.
Buyer & Seller: This is pretty self-explanatory. Most buyers and sellers work through realtors and attorneys to complete the real estate transaction so there is typically little or no direct interaction between the buyer and the seller. However, in a “for sale by owner”, the buyer or the buyer’s realtor/attorney will be in direct communication with the seller since there is no real estate agent on the sellers side.
Real Estate Agent (Realtor): Real estate agents are important partners when you are buying a house. They can provide you with helpful information on homes and neighborhoods that isn’t easily accessible to the public. Their knowledge of the home buying process, negotiation skills, and familiarity with the area you want to live in can be very valuable. In most cases, as the buyer, it does not typically cost you anything to use a realtor because they are compensated from the commission paid by the seller of the house.
Real Estate Attorney: Remember, buying a home is a legally binding transaction. A real estate attorney can help you avoid some common pitfalls when purchasing your home. The home buying process eventually results in a formal purchase agreement between the buyer and seller. The purchase agreement is the single most important document in the transaction. Although standard printed forms may be used, a lawyer can explain the forms and make changes and additions to reflect the buyer’s wishes. Examples are:
What are the legal consequences if the closing does not take place?
What happens if the inspection reveals termites, radon, or lead based paint?
Will money be held in escrow from the seller’s proceeds to replace certain items?
How much does a real estate attorney cost? It varies, but expect to pay somewhere in the range of $350 - $1,000. Often times you have to pay the attorney a retainer or pay them in advance of the closing. The amount an attorney charges is usually dependent on the level of services that they are provided to you. Some attorneys may just be preparing the deed while other attorney’s may provide you with a more complete package which can include deed preparation, title examination, purchase agreement review, and lender work. Make sure you fully understand how the attorney’s fee structure works and it often helps to ask your professional network or friends for attorney’s that they have worked with and would recommend.
Bank / Credit Union: Most home buyers need a mortgage to finance the purchase of their house. It is recommended that you contact a few banks and credit unions in your area to compare interest rates, closing costs, and fees associated with the issuance of your mortgage. Similar to selecting a real estate attorney we strongly recommend asking your professional network (accountant, investment advisor) for lenders that they recommend working with. You will have a lot of interaction with the lender throughout the home buying process and working with a lender that makes the underwriting process as smooth as possible will make the overall home buying experience much more enjoyable.
Home Inspector: After your offer has been accepted by the seller you will need to hire a home inspector to visit the house. Your real estate agent will most likely recommend a home inspector to use. The job of the home inspector is to visit the property to make sure there are no issues with the house that may not be apparent to the untrained eye. They look for termite damage, structural issues, mold, condition of the roof, electric, plumbing, drainage, septic, radon levels, etc. A few days after their visit they will provide you with a formal report of their inspection. You typically pay them at the time they conduct the inspection. The cost of a home inspection typically ranges from $250 - $600.
Insurance Broker: You will need to obtain a homeowners insurance policy prior to the closing date. Since you are adding a house to your insurance coverage, often times this is a good opportunity to look at your insurance coverage as a whole because insurance companies will usually offer discounts on “bundling” your insurance coverage. Meaning that a single provider covers your house, cars, and personal umbrella policy. The annual cost of your homeowners insurance will vary greatly depending on the value of your house and where the house is located. For homeowners that have an escrow account associated with their mortgage, the homeowners insurance premium is typically baked into your total monthly mortgage payment , the insurance company issues the invoice directly to the bank, and the bank pays your homeowners insurance directly out of your escrow account.
Timeline: The home buying process from start to finish
Now that we have explained how to determine what you can afford and the parties involved in the home buying process it’s time to put it all together so you know what to expect step by step through the process of purchasing your new home.
Step 1: Get prequalified for a mortgage. You may think you can qualify for a $250,000 mortgage but you really do not know until you actually apply. In the preapproval process you will provide some information to the bank that will be issuing your mortgage such as tax returns, statements showing investment and savings accounts, and they will usually run a credit report. The more intense financial due diligence happens after an offer has been accepted on your house and they are actually preparing to provide you with the loan.
Step 2: Begin looking at houses. Most individuals at this point will hire a real estate agent to help them find and look at houses.
Step 3: Make an offer. Once you find the house that you want, you will have your real estate agent present the seller with your offer. This is where the negotiation process begins. If the seller is listing the house for $200,000, you can make an offer for whatever amount you choose. Once an offer is presented to the seller, three things can happen:
The seller can accept it
The seller can reject it
The seller will counter offer
Your real estate agent can really help you in this process to determine what may be a reasonable offer. It is usually dependent upon how long the house has been on the market, where is the property located, is there a situation that requires selling the house quickly, and what have other similar houses sold for in the area. After making the offer you will typically receive a response within 48 hours. The seller will sometimes give their real estate agent a range saying that they will accept less than the asking price but only to a specific threshold. In most situations the buyer and the seller meet somewhere in the middle. If the house is listed for $200K, the buyer may put in an offer for $180K and after some back and forth they eventually meet somewhere around $190K. But that is not always the case. If there are multiple offers on the house you could end up in a “bidding war”. Offers are “blind bids” meaning that you and your real estate agent have no way of knowing what other people are offering the seller for the house. Buyers are essentially making their “best guess” that their offer will win. You may make an offer for full price only for another buyer to come in two hours later and offer $10,000 over their asking price. You really have to lean on your real estate agent to give you some guidance based on their knowledge of the market.
Step 4: Offer accepted……now what? Typically, purchase offers are contingent on a home inspection of the property. Your real estate agent will usually help you arrange to have a home inspection conducted within a few days of your offer being accepted. There are usually contingencies in your offer agreement that provides you with the chance to renegotiate your offer or withdraw it without penalty if the inspection reveals significant material damage. If the inspector discovers issues with the house you will have to make the decision if you want to ask the seller to fix the issue prior to the closing date. Prior to the close you will have a walk-through of the house, which gives you a chance to confirm that any agreed-upon repairs have been made.
Step 5: Apply for a mortgage. Now that your offer has been accepted the mortgage underwriting process will kick into high gear. The bank will assign you a “loan officer” or “mortgage broker” to serve as the direct contact at the bank throughout the mortgage approval process. You will provide them with the information on the house that you intend to purchase, they will send you the mortgage application with all of financial documents that they will need to formally approve you for the mortgage. The bank will also arrange for an appraiser to visit the house and provide an independent estimate of the value of the house. After all if they are giving you a loan for $200,000, they want to make sure that house is worth at least $200,000 in case you were to stop paying the mortgage then essentially the bank would own the house and have to sell it. You will receive a “commitment letter” from your bank once your mortgage has been formally approved.
You will need to show the bank documentation of the account that is currently holding the cash that will be used for your down payment and closing costs. If someone gifts you money to buy your house, the person that made the gift will most likely have to sign a letter stating that it was an outright gift and not a loan.
Step 5½ : You will simultaneous engage a real estate attorney to begin working with at this time. Your attorney will review the purchase agreement, initiate a title search and review the results, begin prepping the deed, and communicate directly with the seller’s attorney if changes or additions need to be made to the purchasing agreement.
Step 6: Set a closing date. The closing date is the date that you will sign a huge pile of papers and the house officially becomes yours. There is typically an “estimated closing date” set in the purchase agreement but a firm date needs to be set by the buyer, seller, attorneys, and the bank. The seller’s real estate agent, the buyer’s real estate agent, your mortgage broker, and the attorneys on both sides will typically communicate with each other to establish the closing date. A special note……..a lot can happen during a real estate transaction that can delay the closing date. Issues can arise on the seller’s side or the mortgage process could take longer than expected. In other words, even though you have a “final closing date” be prepared for the closing date to change. If you are renting right now and have a lease, if your closing date is May 1st it’s usually recommended that you have your current lease run until May 30th or June 30th in case the closing date gets pushed back. Real estate transactions have a lot of moving parts and a lot of unexpected things that are out of your control can happen.
Step 7: Contact your insurance broker to establish a homeowner’s policy. Your bank will require you to have homeowners insurance on the property. You must pay for the policy and have it at closing. You are free to select your own insurance carrier but the lender will typically require the insurance company issuing the policy to be a specific rating or higher.
Your insurance broker may also help you with your title insurance policy. Many lenders will require you to have a title insurance policy at closing. As part of the home buying process a title search should be conducted which results in a report that shows who owns the property and if there are any liens against the property. Title insurance protects you and the lender up to the full value of the property if fraud, a lien, or faulty title is discovered after your closing.
Step 8: The day BEFORE the closing. It is recommended that you send a reminder email to your real estate agent, attorney, and mortgage broker to confirm that everything is a “go” for the closing the next day. You and your real estate agent should make a final inspection of the property within 24 hours prior to the closing. In many cases, the lender will make a similar inspection before closing. The bank that is issuing you the loan should also be able to provide you with a copy of your HUD-1, which is a long, one page document that details all of the financial activity associated with the purchase of your house. You should review this document with your mortgage broker and/or attorney prior to the closing to make sure everything is accurate.
You will also need to confirm with your attorney/mortgage broker the amount of the certified check that you will need to bring to the closing. A certified check is a special type of check issued by a bank that guarantees that the funds to back that check are guaranteed by the bank issuing the check.
Step 9: The date of your closing. You made it!!!!!! Today is the day your new house officially becomes yours. There are two primary things that you need to bring with you to the closing:
Certified check
Homeowners policy and proof of payment
The actual closing is conducted by a “closing agent” who may be an employee of the lender or title company, or it may be an attorney representing you or the lender. The lender and seller, or their representatives, and the real estate agents may or may not be at the actual closing. It is not unusual for the parties to the transaction to complete their roles without ever meeting face to face.
For the most part, your role at closing is to review and sign the numerous documents associated with a mortgage loan. The closing agent should explain the nature and purpose of each one and give you and your attorney an opportunity to check them before signing.
At the conclusion of the meeting you receive the keys to the house and you are officially a new homeowner.
Step 10: Begin making your monthly mortgage payments. One of the top questions that we get is “What is an escrow account?” You will hear that term a lot when you are going through the mortgage process. Think of an escrow account as a separate savings account that is attached to your mortgage. When you make a monthly mortgage payment, it is made up of a few components:
Principal & Interest Payments: Amount applied against your actual loan
PMI (if applicable): Mortgage insurance
Escrow: Cash reserve to pay taxes and homeowners insurance
If my monthly mortgage payment is $2,000, only $1,100 of that amount may actually be applied against the loan. The other $900 may be used to pay my monthly PMI and the remainder is deposited to my escrow account.
When your property taxes and school taxes are due, the county that you live in will typically send those tax bills directly to the bank holding your mortgage and then the bank in turn pays those bills out of your escrow account. The bank will typically mail the homeowners a receipt that the tax bill has been paid. It’s basically a forced monthly savings account for your anticipated tax bills. The same thing is true for your homeowner insurance premium payments. The bank that is holding your mortgage forecasts how much your taxes and homeowner insurance is going to be for the next 12 months and then builds those amounts into your monthly mortgage payments. The bank does not want you to lose your house because you were unable to pay your property or school taxes. The property and school tax bills show up once a year and depending on where you live those bills can be for thousands of dollars.
If there is additional money left in your escrow account after the taxes and homeowner insurance has been paid, the bank is usually required to send a portion of that additional cash reserve to the homeowner in the form of a check. Those are fun checks to get in the mail.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
