This post continues Erik’s series of “Who Says Houses Aren’t Good Investments”, which is a series of posts on the story of how I decided to buy a house, and his experiences which have followed. In this series of posts, I want to hit on a lot of different things: income from roommates, benefits of owning real estate, stresses of home ownership, pride of a job well done, and why I’d recommend all young people to buy a house or duplex and rent it out if possible.
If you haven’t read the previous posts of the series, here are the links to those posts:
At the end of post 1 of my series “Who Says Houses Aren’t Good Investments”, I had just finished telling you about my fast paced 5 day house search. I had just made and had my offer accepted on a 3 bedroom, 2 bathroom house which had many amenities I wanted.
In this post, I want to go into my experience of closing on the property. First though, I want take one step back to discuss the process of acquiring financing for a property and also share my experience.
Housing in the United States
Let’s face the facts, the median home price in the United States is roughly $200k. Since most people don’t have that kind of cash laying around, they must go to a bank, a credit union, or online to acquire financing. There are many types of loans. Let’s focus on the 3 main products most home buyers use: 30 year fixed rate mortgage, 15 year rate fixed mortgage, and 5/1 adjustable rate mortgage. In addition to the type of loan, there are variations within each product: Conventional and FHA to name two.
30 Year Mortgage vs. 15 Year Mortgage vs. 5/1 Adjustable Rate Mortgage
Let’s discuss the 30 year fixed rate mortgage (yes, it is as simple as it sounds). For 30 years, you have the same (fixed) interest rate on your loan. Similarly, for the 15 year fixed rate mortgage, you have the same interest rate for the 15 year period. Each month, you pay interest equal to the interest rate multiplied by the principal balance. The remaining portion pays off some of the principal.
Typically, the interest rate on a 15 year mortgage will be less than the 30 year mortgage, but due to the time difference, but the payment on a 15 year mortgage will be higher.
Next, we have the 5/1 adjustable rate mortgage (ARM). This product probably sounds complicated but it really isn’t. For the first 5 years, you have a fixed rate. Then after 5 years, your rate will adjust each year after that. The adjustment will typically be based off of LIBOR rates (a common one is 2.25% + 3 month LIBOR). The fixed rates on ARM’s are generally lower than mortgages with a fixed rate for the whole term since they can increase after the fixed rate period.
With these 3 products, after 15 or 30 years, your loan is paid off and you are debt free!
Conventional vs. FHA Mortgage Loans
As I mentioned above, there are a few variations of the mortgage products: Conventional and FHA to name two. Conventional loans are straight forward loans: lenders typically require a 5% down payment and rates are determined by the market and your credit score. If you don’t make a down payment of 20%, lenders will have you pay Private Mortgage Insurance (PMI), which protects the lender from a loss if you default on your loan, until you get to 80% Loan-To-Value (20% equity) in the house. Once you get to 20% equity, you don’t have to pay PMI anymore!
FHA loans are mortgages insured by the Federal Housing Administration. Borrowers with FHA loans pay PMI. Since borrowers pay PMI, lenders offer FHA loans at attractive interest rates and with less stringent and more flexible qualification requirements. Lenders will allow a 3.5% down payment for FHA loans. A big difference between FHA and conventional loans is with an FHA loan, you will always pay PMI, no matter how much equity you have in the house (until the loan is paid off).
Back to My Story
I want to touch on a few things: obtaining financing, negotiating, the inspection, and closing.
When I started my search in June 2015, I didn’t know anything about financing a house through a mortgage. First, I went online and went to my bank’s website and got pre-approved. I typed in my income and monthly debt information and out spit a number! At the time, I was making $63,000 and had a student loan in the deferral period.
Mortgage lenders typically will try to keep your “Debt-to-Income” ratio below 43% of your pre-tax income (per CFPB rules). Given I was making $63,000 a year, this equates to $5,250 a month pre-tax. 43% of $5,250 is roughly $2,200. After determining the final debt number, the lender will do a calculation based on current interest rates. According to the bank, I was pre-qualified for a loan of $330,000. Essentially, getting pre-qualified is code for “now the bank can contact you and try to get you to originate a mortgage with them!” 🙂 One additional note: pre-qualification does not affect your credit score.
After being pre-qualified, I sat down with the mortgage loan officer and we chatted about different options. At the time, I only had about $3k in cash and was making payments of $2k per month towards my student loan. Since cash was an issue, the lender suggested I do FHA financing and put 3.5% down. After doing a full credit check, I was pre-approved for a $300k loan. A 3.5% down payment on a $300k house is a $10.5k down payment. This would be tough to get to, but I was still optimistic…
After getting pre-approved, sellers and agents are more willing to work with you because they know you are serious: you already have thought about getting financing and have taken action.
As I wrote in the first post of the series: “I made an offer at $280k, down from the $289k offer price. The owners stuck tight at 289k. I said, “Okay, how about $285k”. They came down to $287k and we made the deal.” Well, I left out a few important details.
- Contingent upon inspection
- Any repairs from inspection
- Contingent upon funding
- Mortgage Closing Costs
- Buyer’s Agent Fees
First off, you should always say the offer is “contingent upon inspection”. This protects you as the home buyer if the inspector finds something alarming, seriously broken or out of code. “Contingent upon funding” is also used to protect the home buyer if the home buyer cannot obtain financing. If the home buyer cannot obtain financing, then the home buyer is not obligated to buy the house.
In my case, I was not in a position to pay mortgage closing costs and agent fees. These are two additional things a buyer can negotiate. Many times, if the seller is looking to move the house fast, they will pay your mortgage closing costs. This usually is a few thousand dollars. In addition to the mortgage closing costs, you can ask if the seller will pay the buyer’s agent fees. Usually the seller’s agent will charge 3% and the buyer’s agent will charge 3%. If you can get the seller to pay the buyer’s agent’s fees, you can save a fair amount of cash!
It never hurts to ask, I was able to get the seller to pay for my closing costs and my agent’s fees. This was very lucky for me and I look back and realize how fortunate I was. I was going to get into a $287k house for about $10k total in cash out of my pocket (more on this later).
One last point, when you make an offer, it is good to put earnest money into an escrow account for the seller. Earnest money is used to show the seller you will stay true to your word of following through with the purchase. If you don’t, you lose the earnest money. Typically, $1,000 will do. I did $1,500 for my earnest money. The earnest money goes towards closing costs and the down payment.
Before buying a house, it is very wise to get an inspection. This is done by a professional inspector who will go around the property checking pipes, the HVAC system, the circuits, roof, insulation, and every other little thing you can think of in a house to ensure it is up to code. Anything which is not up to code will be listed in the inspector’s report.
After receiving the inspector’s report, as a buyer, you can request some of the items be taken care of. For example, there were some branches hanging over a power line. I asked if the seller could hire a tree service to cut back the branches. Again, it never hurts to ask!
The inspection was complete and the financing lined up. I was going to get a FHA loan at 3.75%, make a 3.5% down payment, and be a home owner! Things weren’t all sunshine and daisies. I needed to come up with about $10k in cash.
When I made the offer, I had about $3k in cash,, of which I put $1,500 towards the earnest money. I had 3 paychecks where I would bank roughly $1,600 and a rent payment of $500 in the next 6 weeks. Given these parameters, I was forecasting about $5,500 in my own cash. I needed about $3,000 to make sure I could close the deal.
FHA loans allow borrowers the option to receive a gift from a family member to help with the down payment. Luckily, my father is successful and has a few businesses. I asked if he would help me with the down payment and he agreed to gift me $3,000. I was in a good situation, I’d have enough cash to cover the closing.
Closing was set for July 23rd on a Thursday. A week before closing, Iwas stressed out. I had pain in my chest and was not feeling myself. I was feeling a lot of stress due to the closing and was very anxious. Going on a walk with my girlfriend at the time, I wasn’t feeling any better. I needed to relax, but it wasn’t working.
The next day, I went to work and again, I was feeling tightness in my chest. I was nervous and anxious. To add to my anxiety about the house, I was thinking about how heart troubles run in my family: my grandpa had a heart attack at 52 (he is still living and healthy at 76 now). This only made it worse… After work, I was with my girlfriend again and decided to have a doctor check me out. Chest pain is never anything to scoff at!
Well, long story short, I was healthy and it was stress. My heart was completely fine and I was not at risk of having a heart attack or heart troubles anytime soon. This was a relief and I was able to take a deep breath and prepare for the week ahead…
Finally, Thursday, July 23rd hit. Closing isn’t that exciting. You sit around a table with your agent, the seller, the seller’s agent, and a person from the title company. You sign a bunch of papers (sign your life away… mortgage = death 😉 ), and receive the keys to your new place! I finished up the paperwork around 4 P.M. and was off to the new place! I was a home owner!
- Mortgages come in all shapes and sizes. Do your research to find which one is best for you.
- Negotiate everything!
- Make sure to relax and ensure your actions are beneficial for your health.
- Your health is your wealth!
This concludes part 2 of my house story.
Have you ever been so stressed out it hurt you? Do you mediate to relax yourself or perform yoga? What kind of financing do you prefer in a mortgage?
Stay tuned for part 3 on my experiences with having friends as tenants and my time as a landlord.