A B C's (and X Y Z's) of Home Buying
February 23, 2003 By DENNIS HEVESI
Buying a home, particularly for the first-timer, can seem a terrifyingly complex, even chaotic, experience - something akin to running a maze while blindfolded. But the process is actually quite logical, real estate specialists say, though certainly multifaceted.
And, like diamond cutters, the experts are capable of bringing clarity to those facets, of placing the components of the home-buying process in comprehensible order and, at the same time, spelling out its essential dos and don'ts.
As spring approaches, and with it the traditional season of budding buyer interest, new listings and open houses, some of those experts were asked to catalog their recommendations for novice buyers, as well as for homeowners on the move who have been there, done that, but still can't quite fathom what they went through during the last biggest buy in most of their lives.
At the same time, with interest rates hovering at historic lows and record numbers of staying-in-placers wondering whether to refinance, the experts also offered advice for steering clear of predatory lending - including certain warnings that ought to be heeded by current buyers.
To begin with, perhaps obviously, choose a community, or three, that meets your current and prospective needs - transportation, shopping, schools - and begin checking real estate ads and the Internet for what's available at what listing price.
Not so obviously, this is a good time to prequalify for a mortgage, which will let you know how much you can afford even before you've chosen a home, and perhaps make you the preferred bidder if there are several would-be buyers for that home you really like (more on that later).
If you want a broker to show you homes, find one who has substantial experience and a good reputation in the neighborhood. Brokers almost always have a fiduciary responsibility to the seller. But if no deal is closed, no broker's commission is paid, so there is always room for you to bargain on price.
"Once you've decided you want a particular home, the broker may ask you to sign a binder," said Michael Schill, director of the Furman Center for Real Estate and Urban Policy at the New York University School of Law. "But it may not be binding if it doesn't include the price or the date of closing or any one of the other key elements." A binder is more like an an expression of good faith than a contract.
It's a good time to hire a lawyer, who will start a process called due diligence. The primary component of due diligence is a title search, determining whether the seller actually owns the property and if there are legal claims against it. If, eventually, you buy the house, your lender will require you to buy title insurance to protect its investment in your mortgage. The other key element of due diligence is the inspection, assessing the physical condition of the home.
Due diligence on a co-op or condominium, however, is more complicated - particularly for a co-op sale because in that type of transaction, rather than buying an apartment, you are actually buying shares in the corporation and receiving what is called a proprietary lease for the apartment.
"You have to make sure that the co-op corporation or the condominium association is financially solvent," said Stuart M. Saft, chairman of the Council of New York Cooperatives and Condominiums.
"You need to review the corporation's financial statements for the last few years to determine whether there have been any major problems or pending lawsuits," Mr. Saft said, "or if there have been significant maintenance increases or large assessments recently."
You also want to find out if major capital improvements are planned, and whether the board is going to assess the owners directly or refinance the building's underlying mortgage to cover the costs or if there is enough money in the reserve fund to pay for the project. "As for reserve funds, the rule of thumb is that a building should have at least three months' operating expenses in reserve," Mr. Saft said, "although there is no such thing as having too big a reserve fund."
Due diligence is usually performed before you sign a contract.
"Or," Professor Schill said, "you can sign a contract that includes contingencies, which allows you to get back the deposit if, for example, there is a problem with the title, or if the property has serious defects."
"If you want to bind the seller to the deal before checking all of these things because you're worried someone else is going to buy," the professor continued, "you might want to do it the second way: sign the contract and perform due diligence later, with contingencies."
Assuming, however, that due diligence is done before the contract signing, then during that process you and your lawyer will begin negotiating other parts of the contract. Usually, the seller's lawyer will draft the contract and your lawyer will suggest modifications - changing the date of the closing, perhaps, or listing what needs to be fixed, what appliances will remain; perhaps specifying that the seller's family can stay until school lets out in June.
But until a contract is signed, bidding on the property can continue. "Before that, you don't have a binding price," Professor Schill said, also pointing out that "an oral contract for a real estate deal is not enforceable."
At the time the contract is signed, you will make a deposit, typically 10 percent of the purchase price. But most contracts contain a mortgage contingency, providing that if you cannot obtain a loan commitment by a certain date you can terminate the contract and get your deposit back.
So if you have not prequalified for a mortgage, it is time to apply (much more on that later), a process that can easily take three months. But, assuming you eventually qualify, you will receive a mortgage commitment from the bank specifying the amount and term of the loan, your interest rate and the points and fees you will pay at the closing (more on points and fees below).
If you are buying a co-op, it will be during the period when your mortgage (technically called a share loan, since you are buying shares in a co-op corporation) is being processed that you will have to go through the arduous and irritating - especially in Manhattan - board approval process. You will have to provide comprehensive documentation of your financial status, letters of recommendation and criminal record, if applicable. Then you must submit to the board interview.
"Although the process is intrusive," said Mr. Saft, "the idea is to identify problem owners before they buy. The approval process is necessary because the boards are responsible for the payment of the corporation's bills and every resident's peace and quiet."
Whatever the type of home, as part of the mortgage-approval process the bank will usually hire an appraiser - though you get to pay the fee. The appraiser's job is to make sure that the value of the property is sufficient to cover the amount of the loan and whatever portion of the full price you will pay up front at the closing.
Assuming all is approved, take a breath - the closing is coming!
Still, before the closing, you will receive a stack of documents; review them with your lawyer.
At the closing, title is transferred to you and money is passed between the various parties. But you get to sign lots of documents and lots of checks.
You will sign a promissory note, which says how much you owe the bank and when it must be paid. You will sign the mortgage itself, which states how and when the bank can foreclose against the property if you default.
Then you and your lender will pay what is owed to the seller, including the remainder of your down payment. "For example," Professor Schill said, "if the mortgage is for 80 percent of the purchase price and you have already made a 10 percent deposit, you must then pay the remaining 10 percent."
You will then pay points and fees. There are two types of points, with each point equal to 1 percent of the total loan amount: those used to lower the interest rate, which may be negotiable depending on your credit history, and those that are actually fees covering the lender's costs.
Other fees might be for the appraiser, for the bank's attorney, for document preparation. You will also pay for title insurance and perhaps, if your down payment is low, mortgage insurance (which could also become part of your monthly payment). You will have to buy homeowner's insurance, which protects your investment, as well as the bank's, in case the property is damaged.
"You will have to prepay the first few months' real estate taxes, the first month's interest on the loan," Mr. Saft said. "All of these closing costs usually add up to an amount equal to 6 to 8 percent of the cost of the house."
The seller's old lender will give you what is called a mortgage satisfaction, proof that the remainder of the seller's mortgage has been paid off. The seller will then pay the broker's commission, traditionally 6 percent of the purchase price.
If you are buying a co-op, you will then receive the proprietary lease and the seller's shares in the corporation.
And if you are buying a condominium or a house, the seller will - ta- da! - sign over the deed to you.
Go find a mover.
Dos and Don'ts While Searching
• Look at at least a dozen houses. "That lets you become familiar with what you can get for your money," said Jonathan Miller, president of the Miller Samuel appraisal company. "The broker may say that there are a lot of people interested in this particular house. Don't jump. You must feel comfortable making your decision."
• When you find a house you really like, go back and look at it two or three times at different times of the day. There may be problems with noise, a school around the corner, lack of street lighting. Maybe it's in an airport flight path.
• If the broker is not willing to let you visit the property more than once, walk away.
• If you're choosing a home, in part, because of the magnificent view, find out if major construction is coming nearby, or if that lovely forest behind the backyard is camouflaging a dump that will rear its ugly head in winter.
• Ask how long the house has been on the market, both at its current price and at its original price when it came on the market. "The longer a house sits on the market, the larger the discount off the original price should be," Mr. Miller said. "And if it's been sitting on the market for a long time, it's probably overpriced." Or something may be wrong with it.
• During your first walk-through, ask how old the furnace is, the water heater, the central air-conditioning. Have there been any major upgrades in the last 10 years? The rule of thumb is that if something can break, it will.
• If possible, look at the house immediately after a rainstorm, when leaks are apparent.
• Check for watermarks and mold on the walls, particularly in the basement and attic; for curling shingles on the roof.
• A recently painted house may look good, but only for a while if that new coat is covering a leak or mold. So look carefully.
• All property, including co-ops, condos and even new houses, should be inspected by a licensed inspector. "People have the misconception that a new home does not have to be inspected," said Colin Albert, president of Aces Home Inspection Services in Brooklyn and a former vice president of the metropolitan chapter of the American Society of Home Inspectors. "In fact, new homes are often more problematic because they have new material, like electrical wiring, that may not be properly installed." That could not only be costly, but dangerous. Inspections should cost $300 to $500, depending on the size of the property.
• Attend the inspection. "This is your opportunity to learn about the house, especially if you are a first-time buyer," Mr. Albert said. "The inspector can discuss the defects with you as you go along."
• Insist on receiving a written inspection report.
• New York State recently passed a law requiring that the seller of a house (but not a co-op or condo) fill out a form disclosing property defects. It is supposed to be given to you before you sign the contract. Roger Pierro Jr., a real estate lawyer in Queens, points out, however, that there is a loophole. "Sellers can opt out of providing the form by giving the buyer $500 toward the purchase price, whether they want it or not," Mr. Pierro said. "The buyer should still ask for the form."
• Choose a reputable real estate lawyer. "Check with your local bar association; check references," said Pamela Sah, a lawyer with the Foreclosure Prevention Project at South Brooklyn Legal Services. "The usual minimum legal fee of about $1,000 is worth it for the biggest investment that most people will ever make." Legal fees for high-end properties, however, might range from $1,500 to $4,000, and up.
• Think about an eventual resale. "Things about the house that particularly appeal to you - a three-car garage, a school across the street - may be reflected in the price," Mr. Miller said. "But just because it's a positive thing for you doesn't mean that someone who's going to purchase your house down the road won't have problems with it."
• Usually, your lender will hire an appraiser to determine if the house is worth the face value of the mortgage. If, for some reason, the bank is not hiring an appraiser and you feel uncomfortable with the price, you should hire an appraiser to determine if you are overpaying for a property you are in love with. In a middle-class community, an appraisal for a one- family house should cost $300 to $500.
• If it is a foreclosure property, you can be sure it was in foreclosure for a reason, perhaps because the previous owner could not afford to make some kind of major repair.
• Sign nothing you don't understand. You will be signing a lot of documents at the closing, and committing yourself to serious obligations. Make sure you clearly understand those obligations.
• If you are an unsophisticated borrower or don't speak the language or are unfamiliar with the mortgage system, hire an adviser. Your lawyer would typically fulfill this function, but there are also buyer's brokers who, unlike the usual broker who represents the seller, will represent you in the process.
• Stay away from one-stop-shop brokers who say they will provide you with a lawyer, an appraiser, an inspector. There's a likely reason that they want to do all of that for you: to keep you in the dark.
Shopping for a Mortgage
• Contact several lenders. "You don't simply want to jump into a deal without having at least a basic idea what's available in the mortgage market," said Keith Gumbinger, vice president of HSH Associates, a mortgage research company in Butler, N.J.
• If you're a first-timer, consider going to a nonprofit organization that offers home-buyer courses.
• Important. Know what your credit status is beforehand. If you are starting this process for the first time, contact one of the Big Three credit bureaus and get your credit report. It costs $9.
• "Make sure there's nothing inaccurate on your credit report," said Sarah Ludwig, director of the Neighborhood Economic Development Advocacy Project, a nonprofit organization that fights predatory lending. "At the same time, be aware of what is legitimate on the report so you know what your credit picture is before you apply for a loan."
• Get your credit score - a computer-calculated number from 300 to 800 based on a host of factors in your credit history - along with your credit report; sometimes it is included free. "That way," Ms. Ludwig said, "someone can't say to you, `Oh, too bad, you have a low credit score; but we're going to make you a loan anyway, even though we'll have to charge you 12 percent interest."' Too many people think they have bad credit, she said, and end up with a high-priced loan when they actually could qualify for a conventional loan.
• Credit scores have come into widespread use in recent years and are increasingly the determining factor for what type of loan you can get, and at what price. Generally, you can be approved for a conventional loan with a score of 620 or higher; below that you will probably have to accept a more expensive mortgage, called a subprime loan.
• There can be wide variations in mortgage pricing, meaning the interest rate, points and fees and mortgage types. Don't assume the first deal offered is the last.
• Get it in writing. "Any offerings made to you, any deals or fees you may have negotiated, any agreement on an interest rate should be in writing and signed," Mr. Gumbinger said. "Ask the broker to put it in writing at that moment, so you have a physical record of the deal."
• Ask about and be aware of early termination fees, prepayment penalties or other potential charges you might encounter down the road, for instance if you have to move and sell sooner than you expected.
• For most buyers, it's probably a good idea, especially in this time of historically low mortgage rates, to stick with a fixed-rate mortgage, one where the interest rate never changes throughout the full term of the loan, which is usually 15 years or 30 years. "Sometimes mortgages claim to be fixed-rate, but actually change to an adjustable interest rate after a certain number of years," Mr. Gumbinger said. "Something called a hybrid adjustable rate mortgage may, for example, have a fixed rate for only seven years of a 30-year term, but may still be advertised as a fixed-rate mortgage."
• As already mentioned, it is highly recommended that you get prequalified for a mortgage. That means you go to the bank or other mortgage lender and fill out a mortgage application even before you have a house selected. That will tell you how much you can afford per month and, therefore, how much of a sale price you can afford. So when you find the house you want, you are ready to make your offer. And that makes you more attractive to the seller because you can go to closing quickly.
• The other advantage to being prequalified is that you can weed out properties that are out of your price range. "Something that adds to the stress of home searching is if you started by looking at properties that you can't afford," Mr. Gumbinger said. "By then, your psychological standard has been raised and the homes that you can afford seem unsatisfying."
New options in guarding against mortgage default: Your Home
Avoiding Predatory Lenders
• Most important: it should be you who is looking to refinance your home, not someone knocking on your door or calling on the phone and trying to persuade you to take out a new loan so you can pay off that credit-card debt or undertake some major home improvement you didn't even know you needed. "Avoid unwanted solicitations where you've been targeted because some lender thinks you'd be a likely candidate for their high-interest loan," Ms. Ludwig said.
• If you are, in fact, looking for a loan, make sure you are dealing with a reputable broker or an established bank or lending institution. "Even if you think you won't qualify for a conventional loan, you might be pleasantly surprised because they might be willing to work something out with you," Ms. Ludwig said. "So start with the most conventional lenders you can think of."
• Don't try to get "fast cash out of your home," said Ms. Sah. "If you borrow money on a credit card and can't repay it, that may look bad on your credit report. But if you consolidate credit-card or other debt into a home loan and fall behind, you could lose your home."
• Go to a nonprofit community group that offers information on loan resources and provides mortgage counseling.
If you are refinancing to pay for a major home repair, before you hire a contractor verify that the company is licensed by calling the New York City Department of Consumer Affairs or the Better Business Bureau.
• Don't sign anything that has blank spaces, something that someone else will fill in later.
• Know that you have a legal right to cancel a refinancing loan up to three days after closing. If you have second thoughts immediately after signing, you can get a second opinion and get out of the deal.
• Walk away from a mortgage broker who tells you there are no other options.
• If you're feeling pressured, walk away.
