TO BUY OR NOT TO BUY:

A Guide For First-time Homebuyers

Sponsored by the Community Housing Resource Board

For answers to housing questions call:
The Housing Info Line, 267-5223
Funded by the City of Chattanooga

In operation since 1990, the Housing Info Line provides general housing information, counseling for first-time home buyers, and information on the rights and responsibilities of landlords and tenants. The Housing Info Line also provides training for case workers and non-profit organizations, and neighborhood home buying seminars.

This guide was written by Bob McNutt and Marcia Lillich.

TO RENT OR BUY: How to Make an Informed Decision

Home ownership is the primary way most people build personal wealth: they borrow money to buy a house. slowly pay it back, and eventually build equity worth tens of thousands of dollars.

For many buying that first house signals some dramatic changes in spending habits. People who spend large chunks of their money on entertainment and other pleasures may need to evaluate lifestyle changes that home ownership brings.

Owning is not for everyone. For some people, renting is simply more convenient than owning because they move every couple of years. Buying also requires larger amounts of cash for closing costs, down payment, maintenance, and repairs. Renting only requires a security deposit and the first month's rent. In the short run, renting is cheaper than buying.

In the long run, however, buying saves money, in some cases a lot of money. Unlike rent, mortgage payments won't increase over the years. Also, most houses will appreciate, or increase in value. For example: at an annual inflation rate of 4%, a $450-a-month apartment will rent for $660 a month ten years later, while a $50.000 house will be worth $75.000 over the same ten years with no increase in monthly mortgage payments. That's why most people are willing to put up with the hassles of ownership.

To make the best decision, analyze basic aspects of your lifestyle. Is your job reasonably secure? Do you plan to stay in the same town for the next several years? (Ownership will tie you to your job and to regular mortgage payments for a long time.) What would you do with your money if it were not tied up in a down payment? Make a fortune in the stock market? Blow it on new clothes? Mortgage payments are sometimes looked on as forced savings.

Families with children are usually more stable in their own home and neighborhood, where the kids get a sense of belonging. Older people are much more secure when they've worked to pay off a home of their own. Social Security checks aren't going to cover rental of decent housing in a few years.

Renting usually means more freedom and less responsibility; owning means more security, stability, and privacy.

STEP ONE--Evaluate Your Personal Finances

To make an informed decision on home ownership, be realistic about where your money goes each month. Make a list of your regular monthly DEBTS, including payments on cars, furniture, credit cards, student loans, child support, and any other money you may have borrowed. Do not include monthly bills or utilities, rent or insurance, just payments on debt. Include payments on a washer or dryer, for example, but not your water bill. Some lenders will define child support as debt, so add it to your list.

Your total monthly debt payments should be no more than 10 to 12% of your gross monthly income (before taxes or deductions) in order to qualify for the maximum amount of mortgage. If your regular monthly debt exceeds 10 to 12% of your gross monthly income (about one half of one week's pay), devise a plan to reduce it: sell a car and buy a clunker; pay off small balances ahead of time stop charging and pay cash for everything.

Next. evaluate your savings pattern. The secret to saving is to put aside money regularly and don't touch it. To buy a house, you'll need closing costs ( 2-3% of the price). A 5% down payment plus closing costs on a new house will equal nearly two months income for most families. Usually the lender checks to see that you have saved this money yourself rather than borrowing from other sources.

For example. a $40.000 house will normally require a $2000 down payment, plus about $1200 in closing costs, for a total of $3200. If your savings is low (or nonexistent), devise a plan to increase it: make regular deposits before you pay bills, sell assets and put the cash in savings, or earmark a part-time paycheck for the savings account. Establish a goal and set a time frame to accomplish it. For example, to save $3200, you need to save $133 each month for 24 months.

Saving regularly is an unnatural act for most people and requires discipline. Like losing weight or quitting smoking, saving money usually involves a change in lifestyle, and every member of the family, including children, should understand the importance of regular saving and learn to participate.

Lack of cash for a down payment is a major barrier to home ownership. If owning a home becomes a top priority for your family, then you must cease all unnecessary spending and save. If you fall within certain low to moderate income guidelines, you may qualify for a loan through Chattanooga Neighborhood Enterprise, in which case your up-front cash requirement may be as low as $800.

STEP TWO--Understand How a Lender Will Evaluate You

When you apply for a mortgage loan. the lender will view you as a set of facts and figures, rather than as a real person. The lender will compare your spending habits and your income with a standard set of rules and numbers. If you fit the pattern, you get the loan.

Lenders usually require that you be employed in your present position or field for two years, have a reasonably good credit report, and have very little long-term debt.

Regardless of your income, your credit report is the primary tool lenders use to determine if you are a good risk. They look for patterns in a credit report, and chronic "slow payers" are less likely to qualify than are people who have had a very bad year and recovered. It's important that you be able to explain any black marks on your credit report honestly and completely. More information on credit reports appears in Step Five.

STEP THREE--Determine An Affordable Price

Once you have begun to get your finances in order, the next step is to calculate a realistic price range for your new house. Here is a handy rule of thumb: the price of your house should be no more than 2 to 2 1/2 times your gross (before taxes) annual income. depending on the current interest rate and the length of the loan.

Assuming you have no excessive debts as discussed in Step One, use the following chart to determine the maximum amount of loan you can qualify for. Multiply your gross annual income by the "affordability factor" in the chart below to calculate your maximum sales price.

Payments on a maximum loan will be one week's gross pay, or 25% of one month's gross pay. In addition to the mortgage payment itself (principal and interest), the lender will collect a small monthly "escrow" payment for your property taxes and homeowner!s insurance. For example, the escrow payment on a $50.000 mortgage will add about $75 to $100 a month to your monthly house payment.

STEP FOUR--15-Year vs. 30-Year Mortgages

An important part of your long-term financial planning should include consideration of the length of time, or "term,'' of your mortgage. Most lenders will give you a choice between a 15- or 30-year term.

The advantages of a 15-year term are that you will pay much less interest over the life of the loan, pay it off sooner, and build equity faster. It also carries a slightly lower interest rate.

On the other hand, with a 30-year term, you can afford a house with a 20% higher selling price. However, you will end up paying the lender back a total of 3 times the sales price of the house over the life of the loan.

The disadvantages of a 30-year term are the greatly increased amount of interest you will pay and the slow rate at which you build "equity" -- that portion of the value of the house which you actually own.

As the graph illustrates, building equity over a 30-year term is a slow process. In this example, a person who borrows $50,000 over a 30-year term will have paid a whopping $72,360 after 15 years, but $62,025 of that amount went to the lender as interest, and only $10,335 toward the principal. By contrast, the person who borrowed the same $50,000 for a 15-year term will have paid only $105 more each month, and will have paid off the loan entirely.

Unfortunately, many people cannot buy the house they want -- or need -- unless they finance over 30 years. However, it is wise to consider buying a less expensive house over a 15-year term. Although payments on a 15-year mortgage are about 20% higher, equity builds five times faster! If owning your house "free and clear" is an attractive idea to you, then opt for a shorter term.

Those who choose a 30-year term should consider making "prepayments" whenever possible to reduce the time and interest on their loan. A prepayment is applied to principal only and must be paid in precisely the right form to receive proper credit. Get exact details from your lender.

STEP FIVE--Check your credit report

It is a good idea to get a personal copy of your credit report before you apply for a loan, especially if you have never seen it. It will cost from 7 to 15 dollars, and is free if you have been denied credit in the past 60 days. In Chattanooga, call CBI (855-8300). The Fair Credit Reporting Act guarantees certain rights which you may need to know if disputes arise.

First. check it for accuracy. Any errors, such as accounts or loans which do not belong to you, should be reported to the company immediately. Both lenders and credit bureaus are legally bound to provide accurate information. All information both good and bad, remains on your credit report for seven years.

The most common credit problem is a record of late payments on credit accounts and installment loans. The easiest way to clear the record is to begin making timely payments. Any late payments will roll off the report in 24 months, and you will have established a new credit pattern. If you have a good reason for a late payment, such as disputed merchandise on a credit card, provide a written explanation to the lender when you apply for the loan.

Any irregularities, even a legal judgment or a bankruptcy, should be explained in a written statement that is permanently attached to your credit report. Health problems or a divorce often put people in a temporary ''hole." Most lenders will consider your loan application if a bankruptcy is at least two years old and you have reestablished good credit.

STEP SIX--Prequalify with a lender

If you have never owned a house and are unsure if you can qualify for a loan, you should consider "prequalifying." Most banks and mortgage companies will tell you, before you begin looking for a house, the maximum amount they will lend, based on your credit history, income, amount of debt, employment history, and savings. The staff at the Housing Info Line (967-5223) will also be glad to assist you.

Prequalifying is a "dry run" that can prevent the disappointment of being turned down after you have fallen in love with your dream house. Prequalifying can often be done over the phone if you have the right information; however, a face-to-face appointment with a lender will probably be more effective.

In preparation, get a personal copy of your credit report as suggested in Step Five. List any long-term debts as discussed in Step One, along with other information not included on your credit report which will make you look good, such as a payment record from your landlord. Next, gather verification for all regular income -- recent paycheck stubs, contracts, and tax returns for the past two years. Child support, part-time jobs, or overtime pay will only count if they have been consistent over the past two years. The lender will want to see consistent employment, so be prepared to explain any gaps. List checking or saving accounts, along with current balances.

Based on the information you provide, the lending institution will use a formula like the one discussed in Step Two to determine you if you qualify for a mortgage, and for how much. Ask for a letter of commitment which spells out the maximum loan amount, the interest rate, and the terms. Now you can shop for a house in a price range you can afford with the assurance you won't be disappointed later on.

The Equal Credit Opportunity Act prohibits discrimination in the granting of credit on the basis of sex, marital status, race, religion, age, or receipt of public assistance. Be aware of your rights. If your loan application is rejected, ask for specific reasons in writing.

STEP SEVEN--The real estate agent

A real estate agent can be a very helpful source of advice and information, but choose carefully. Interview more than one. Does the agent understand your needs and appear willing to listen? Does the agent specialize in houses in your price range? What times of the day (or night) will the agent be available? Ask about connections with local lenders, and which neighborhoods the agent is most familiar with.

Remember: unless you have a "buyer s contract," the real estate agent always represents the seller, not you. This does not mean that the agent will be unethical or misleading, just that the agent is contractually obligated to disclose to the seller anything that might affect the seller's interest. Assume that anything you tell the agent will be passed on to the seller. Keep your bargaining strategies and your maximum sales price to yourself. For example, if you submit a low offer on a house but are willing to increase it if the seller turns it down, don't tell the agent. Be businesslike and play your cards close to your chest.

The agent must, by law, tell you about known defects in the house -- if you ask the right questions. Call the Housing Info Line for advice on inspecting houses with your Realtor.

Federal Fair Housing law guarantees equal opportunity of choice and equal service by the real estate agent, regardless of the race of the buyer, and forbids "steering" a buyer to a predominately white or black neighborhood. Buyers should shop various parts of town including unfamiliar areas. Call the City Fair Housing Office for literature on fair housing rights.

The real estate agent cannot tell you what to offer for a house. It is up to you to look at enough houses in the same price range to determine whether or not a house is priced fairly.

The real estate agent cannot -- by law -- recommend one neighborhood or school district over another, but the agent can supply you with comparable sales prices to determine if property values in a given area are going up or down. Values of neighboring houses should be the same or higher than the house you're considering.

STEP EIGHT--Shopping and Inspecting

One advantage of using a real estate agent is access to the Multiple Listing Service, which means that you can get information on all houses for sale in your price range.

Look at several neighborhoods closely. Interview neighbors about schools, noise, pollution, flooding, zoning, traffic, and how houses are holding their value. Location is a very important consideration, so brave unknown neighborhoods in your search for the best available house in your price range. Find out if there's a Neighborhood Association and contact the president for an overview of the community.

Take time to shop. This is the single most important element in finding the right house. Don't react too quickly or panic just because a house may be sold out from under you. There are hundreds of other houses. Don't be pushed by anyone.

You and your spouse should each profile your ideal house on paper first, then discuss, compromise, and prioritize your needs for garage, yard, storage, number of baths and bedrooms, type of heat, size of rooms, kitchen features, commuting time, and maintenance time.

When viewing houses, take notes -- otherwise details will begin to blur. Many features must be investigated and the Housing Info Line (267-5223) will mail you complete information on inspecting houses or you may hire a professional for about $200. Be especially wary of moisture and don't be fooled by cosmetics. No house will be perfect, but if you find problems such as rotten windows, a bad roof, or an old furnace, get estimates for repairs and negotiate the sales price accordingly, or insist the seller make them.

STEP NINE--The sales contract

Most often the buyer makes a written offer to the seller accompanied by a deposit, or "earnest money." The terms of the sales contract may pass between the buyer and the seller several times before a final agreement is reached.

Put everything in writing in the sales contract, no matter how trivial. The real estate agent will probably be the primary source of help in writing the contract; however, remember that the agent represents the seller's interest, not yours. If you are negotiating directly with the owner without help from an agent. contact a title company to assist you with the contract and closing. Don't depend on the seller's attorney to look after your interests.

The sales contract specifies how much you are offering for the house, and typically include provisions for obtaining financing, inspecting the house, and termite protection. Insist that the house be inspected by a professional of your choice and at your expense. You should also list any items not attached to the house which you want included in the sale: draperies, appliances, or window air conditioners. Sometimes the offer on the new house may be contingent on the buyer's selling an old house.

If the seller agrees to make repairs to the house or is willing to pay all or part of the discount points and closing costs, these provisions should be spelled out in the sales contract too. Otherwise, the buyer will assume these costs.

Remember anything which bears on the sale of the house should be put in writing in the sales contract. Don't take anything for granted or rely on verbal assurances.

STEP TEN--Closing costs

Once you have negotiated a contract with the seller and been approved for a mortgage loan, the lender will set a date for closing, or settlement, as it is sometimes called. At closing, the money from you (in the form of a mortgage loan) is paid to the seller. along with various fees and commissions. The closing costs will typically be as much as 2 to 3 percent of the amount of the loan. Though the seller can pay for the closing costs under certain conditions, these charges are usually paid for by you, the buyer. You are legally entitled to receive a good faith estimate of the closing costs when you apply for the loan, and to received a copy of the actual closing costs one day before closing.

Closing costs usually include an origination fee charged by the lender (normally one percent of the loan), and fees for the appraisal, credit report, mortgage insurance, and title search. The real estate agent's commission is usually paid by the seller.

STEP ELEVEN--What to do after the purchase

It is unwise to put every dime of your savings into the purchase of the house. Most people find that their wants and needs increase after moving in: a lawnmower and yard tools, miniblinds, a ladder, paint, and perhaps a new stove and refrigerator.

"Needs" are one thing, but the long list of "wants" should be carefully considered and probably delayed: the old sofa looks threadbare next to the new carpet, you finally have room for that dining room table you always wanted, or the new basement workshop tempts you to buy more tools. Then there's that big, empty deck...

Many first-time buyers get in trouble striving for "perfection." Lenders call it "post-purchase euphoria," when debt suddenly surges because of all the new purchases for the home. Get used to making your mortgage payment before saying "charge it" at the furniture store.

Also, unless the house is new and has a warranty, no part of it is guaranteed. You can't call the landlord for repairs: you must put money aside each month for maintenance. Continuing a pattern of regular savings is especially important. Your new goal should be to save the equivalent of three month's salary to ensure that the mortgage will be paid in case of emergency.

In the unfortunate event that you cannot make your mortgage payment on time, contact your lender immediately about the problem. Don't go into "denial" and hide. Very few people lose their homes to foreclosure, but remember, legal proceedings can begin when you get more than two payments behind.

STEP TWELVE--Your neighborhood association

One of the most productive ways to find your niche in your new community is to attend meetings with your neighbors about the problems and goals of your immediate area. You will meet the folks on your block who know how to get things done. Becoming active in your neighborhood association (or starting one) is a good way to safeguard your property values and to form communication links that may be vital if crime or other threats arise. These groups are also a good way to learn how local government operates and how you, as a homeowner and taxpayer, can influence city and county representatives.

For answers to housing questions call THE HOUSING INFO LINE, 267-5223

Sponsored by the Community Housing Resource Board