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Saturday, September 13, 2008

So you want to buy a house…

I recently had the unfortunate duty of having to inform a would-be first-time-home buyer that he really wasn’t ready to buy, yet. Having read all of the stories about what a great “buyers market” we are in, this young man was ready to jump into home ownership. He had saved up enough for the 3% down payment that he heard he would need for an FHA home loan (soon to be 3.5% under new FHA rules). He had spent a limited amount of time with his banker to try to find out what he could afford for payments, given his income; and he thought that he was ready to shop. Based upon his credit rating and income, he was told that he could likely afford the payments on a $100,000 mortgage.

Based upon what he thought he could afford for monthly payments, this young man had begun scouring the Internet looking for foreclosed homes that he might be able to afford. For our purposes, let’s just say that he had settled upon that $100,000 figure as his upper limit. He had $3,000 in the bank for a down payment and was ready to go. He found 3-4 houses that looked good on-line and called me to go see them. We visited them and one in particular, priced at $99,900 caught his eye. His Internet research showed him that a year ago this house was valued at $175,000, so it looked like a great deal. It is in good condition for a foreclosure and doesn’t need major repairs or remodeling right away. It seemed to be a good fit. So, the young man wanted to put in a bid for the place. He was thinking of bidding $90,000 for it, which might have worked.

That’s when he hit the reality wall of what it really costs to buy a house. While he had a verbal pre-approval from his bank, he had not asked for a written pre-approval, nor did he have a good faith estimate from the bank that would show him what the costs would be for the 97% FHA loan that he would need. I asked him to call and get both of those, before we went any further. The next day I got a call from him and he was really down. For the first time he began to see what it would really cost him to buy that house.

Yes, he had enough in the bank to cover the 3% down payment; but, when the good faith estimate came back with over $3,000 in fees, plus the estimated tax proration; he saw that he really couldn’t afford it. We discussed trying to get concessions from the sellers, but the FHA limits on concessions still didn’t cover what he is short for this sale (and which banks are loathe to do on foreclosure sales), so he will have to wait, save some more and perhaps set his sites a bit lower for price.

The costs on the buyer side of a real estate transaction come mainly because of the cost of doing the mortgage and from paying the tax proration. Every mortgage company is different in what fees they charge and for what. There are loan origination fees and loan documentation fees and loan recording fees and all sorts of other made-up names for ways that the mortgage company will get money from the buyer. Fees on the loan, plus the title insurance policy on the loan, might add another $2,500 - $3,000. In most cases the bank will ask the buyer to put money into the escrow account that they will be holding to pay the taxes and insurance bills when they next come due. Since we are late in the calendar year, they will likely ask for 9 months of escrow payments in this example that might add another $2,000-3,000. We’ll use $2,500 for our purposes, so the total is now up to $5,000.

And then there is the prorating of the taxes on the property for this tax year. That can be a much bigger chunk of money that expected, especially when dealing with a foreclosed property. What you see as a $100,000 foreclosed bargain may still be on the tax roles as a $175,000 assessed value property with taxes based upon that number. As a buyer, you are responsible for the taxes that have been collected, but not yet used for the year. In Michigan, that means your would end up paying for the rest of the winter taxes from last year and the rest of the summer taxes that were just paid in July of this year. For example, that $100,000 home might have taxes for the year of $4,000, with most of it in the summer taxes ($3,200). Even that figure is probably low, since it assumes that the taxes are still homesteaded. If the taxes are non-homestead, they will be about 40% higher. The tax liability for this house might run as high as $2,600, when it is prorated. It depends on when the sale closes and how much “unused” taxes are still left for the tax year.

Now, the buyer is faced with needing to bring over $7,000 to the closing, to cover those costs, in addition to the $2,700 that he needs for the down payment, Even if the seller was willing to kick in the maximum of 3% concessions that would still leave the buyer over $4,500 short, in this example. Plus, the buyer will also discover in the final mortgage paperwork from his bank that the monthly payments will now contain the actual monthly bills for taxes and insurance and could be considerably above what he has budgeted for, based upon the initial estimates.

So, even though it’s a great time to be a buyer, and there are really great deals out there to be had in the current market; you still need to be realistic and practical about what you can really afford. Those ads and articles about low-cost FHA loans sound great and they are a good deal; however, get a written good faith estimate from your lender and understand what the tax and escrow implications are on any potential purchase. There are many things that you can do on a wing and a prayer - buying a house isn't one of them.

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