Money Book for the Young, Fabulous & Broke: Big Ticket Purchase: Home
April 6, 2008, 11:26 am
Filed under: Books, Money Basics | Tags: ,

This is the ninth installment of my review of Suze Orman’s The Money Book for the Young, Fabulous & Broke. The previous installment, Big Ticket Purchase: Car, covered money saving strategies for buying a car.

Please note: I’m not sure if all of the information in this chapter is still relevant since Orman’s book was written in 2005 and the real estate market has undergone some major changes since then. Take the following with a grain of salt. 

A home is the best big ticket purchase you will ever make. Orman affirms that mortgage debt is good debt, just like student loans. You need to understand mortgages, how to get the best deal, and real estate booby traps before you even start looking at any houses in order to ensure that your home buying is a financially smart move.

Right off the bat, Orman urges you to make sure your credit score is as high as possible. Pay off as much credit card debt as you can before applying for mortgages so you can get the best interest rate.

You need cash for not only your down payment (typically 3-20% of the home’s selling price), but for private mortgage insurance (PMI) and closing costs as well. A 20% down payment makes lenders happiest. When your down payment is less than 20%, your lender will make you pay PMI, which is basically insurance lenders take out to ensure that they’ll get their money if you wind up defaulting on your mortgage. Closing costs are typically 2-3% of the price of your mortgage.

Mortgages are set up for a finite period of time called a term. You are required to pay back your entire mortgage by the end of the term. Mortgage terms are usually 15, 20, or 30 years. You can save a lot in interest by going with a 15 year term, but your monthly payments will be significantly higher. Orman points out that paying off your loan faster only makes sense if you expect to live in the house for a long time. Don’t rush to pay off your mortgage if you are only going to buy another house in a few years. Your mortgage’s amortization schedule shows you how much your monthly payment goes towards paying off your principal and how much goes towards interest. In the early years of your mortgage, the vast majority of your payments goes towards interest so that lenders can collect their profit early on in the term.

There are several different kinds of mortgage interest rates:
Fixed– the rate will never change
Adjustable rate mortgage (ARM)– the initial rate is lower than a fixed rate, but can change once a year, up to a maximum change of 2 percentage points each time
Hybrid– the rate is fixed for 3, 5, 7, or 10 years, then converts to an ARM. The initial rate is lower than a 30 year fixed rate, but is more than an ARM. Orman points out that a hybrid is great for 20somethings since you will likely only stay in your home for 5-7 years.

Orman recommends getting a mortgage broker when you start searching for the best mortgage deal. They can get a lower interest rate than you could get by yourself with a bank loan officer. Ask the broker for a prequalification. A prequalification is a professional assessment of how big of a mortgage you can get based on your income, credit score, and debt to income ratio. Your monthly mortgage payment shouldn’t be more than 28% of your gross monthly income and the total of all your monthly debt payments should be less than 36% of your gross monthly income.

Another person Orman recommends you have when house hunting is a real estate agent. They will be making 6% commission on whatever you wind up buying, so they obviously want you to pay more. Set your own budget and don’t let others tell you you can afford a bigger house. To get an idea of the true monthly cost of home ownership, add 40% to your mortgage payment to account for property taxes, home owner’s insurance, repairs, etc. While you will get a tax break on the interest you pay on your mortgage (mortgage interest deduction), do not rely on that break to make it affordable to own a home.

Don’t know if you can afford to own a home? Orman offers up a “play house test” so you can better gauge where you stand:
-Figure out the cost of homes in your area and estimate what the monthly mortgage payment would be
-Add 40%
-Subtract your current monthly rent
-Deposit the difference into your bank account for six months
If you can “pay” on time and in full every month, you’re in good shape to buy a house. By doing this exercise, you will also have added significantly to your down payment fund. It’s a win-win.

When house hunting, Orman recommends the following:
-Do not look at houses above your target purchase price
-Stay rational when you fall in love with a house
-Figure out what kind of housing market you’ll be shopping in before you actually shop. If homes are selling faster in your area and for more than the asking price, you’re in a seller’s market. If homes are selling slower and for less than the asking price, you’re in a buyer’s market.

Once you’ve found a home you’re interested in, ask the following questions:
-How much have similar homes sold for recently? -How long has the house been on the market?
-When did the seller buy the house?
-Has the seller already bought a new home?
-Has the seller been relocated by his/her employer?
-Is it an estate sale?

When it comes to bidding on a home that you want to buy, do not get into a bidding war. Use the answers to the above questions as a guide to figuring out what your bid should be. Have in mind a set amount of how high you will go. If the price goes beyond that figure, walk away. Orman suggests looking for less expensive houses so that you will have more room to bid.

When you make a bid, hire a professional home inspector to conduct a thorough check up of the house. If you find any problems, you can either walk away or negotiate with the seller to get the cost of the repairs deducted from the sales price. You should definitely go along on the home inspection. The inspector can point out areas that pass, but will need repair soon, giving you the opportunity to do some preventive maintenance in the near future instead of emergency repairs down the road.

Once your bid is accepted, the closing date will be negotiated with the seller and lender. You will need to pay the closing costs and provide proof of home owner’s insurance at this time. Before closing, arrange a final walk-through with your real estate agent and make sure everything checks out.

As far as home owner’s insurance goes, Orman cautions to not rely on your lender to tell you how much to insure the house for. You will need coverage for the house itself and everything inside of it. Only go for a policy that offers replacement cost coverage. Replacement cost coverage reimburses you the full amount of how much it will cost to replace a damaged item that is covered in our policy. By comparison, actual cash value coverage only reimburses you the depreciated value of items. Save money by paying the premium in full every year. If you break up your payments, service charges are added.

One last bit of Orman wisdom: if you pay just one extra mortgage payment a year towards your principal, it will take years off of your mortgage. You can split up the extra payment so that you only pay a little extra every month. Just make sure there is no prepay penalty on your mortgage.

Jake and I don’t own a home and we are not planning to for a long time. We definitely do not have the money to do so and we are unsure as to where exactly we’re going to settle down. While the falling price of homes is tempting, renting is definitely the way to go for us right now.

Next up for my Money Book for YF&B review is relationships.

1 Comment so far
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There isn’t much difference between ARMs and hybrids. Still better off with a traditional loan in an affordable house. Do your homework with a realtor. Don’t be afraid to stop working with one as buyer if they don’t seem to be on your wavelength, and DO NOT sign any agreement with them as a buyers agent. And take lots of pictures when looking. It will help jog your memory when you see many.

Comment by Sara

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