Home Buying Guide

The very first step in any home buying process, whether for first-timers are real estate pros, is determining how much to spend. In addition to the principal and interest payments towards the mortgage, as well as closing costs, homeowners will have both routine and unexpected expenses to budget for, such as:

• Property Taxes
• Utilities (water, electricity, gas)
• Homeowners Insurance
• Private Mortgage Insurance (PMI)
• Homeowners Association Fees
• Condo Assessments
• Repairs

There’s no one right answer for every buyer, but generally, first-time buyers are advised not to spend so much on their house that they can’t afford to maintain it. Buyer’s who spend more than around 28% of their after-tax income just on mortgage payments often find themselves in a position referred to as ‘house poor,’ where the mortgage payments, property taxes, maintenance, and utilities for their home eat up so much of their income, they struggle to afford their other financial obligations.

Another good rule of thumb is to make sure you have emergency savings sufficient to continue paying your housing expenses for three to six months even if you lose your primary source of income. Make sure to account for your complete living expenses.

The level of property that a buyer can secure financing for will depend on many factors, including:

• Credit History
• Debt-To-Income (DTI) Ratio
• Savings
• Job History
• Collateral
• Down Payment Size

Home shoppers with extensive debts, such as outstanding obligations from a student loan, medical debts, or prior mortgages, may have difficulty securing financing. Most lenders require at DTI that is less than 43% — meaning the individual must not be devoting more than 43% of their monthly income servicing their existing debts.

Credit scores are also very important when hoping to finance a home. Requirements vary by lender and loan type, but generally a score under 620 will make getting a mortgage very difficult and higher scores increase the size of the loan an applicant can get approved for. However, certain government-backed mortgages, like USDA loans for example, permit scores as low as 580.

Government Incentives for First-time Homebuyers

The federal government and many states have programs in place specifically to encourage homeownership. The U.S. Department of Housing and Urban Development (HUD) defines a first-time homebuyer as anyone who meets at least one of the following conditions:

• Individuals who have not owned a principal residence for at least three years (it does not matter if a spouse has been a homeowner in that timeframe)
• Divorced, single parents who only owned a home while they were married
• Displaced homemakers who have not worked full-time in the labor force for several years because they were caring for their family without pay
• Individuals who only owned a home that was never affixed to a permanent foundation (such as manufactured housing and mobile homess
• Individuals who only owned housing that was never in compliance with relevant building codes — and which cannot be brought into compliance without spending more than the cost of replacing the building

Homebuyers that fall under any of those categories may be entitled to financial assistance, tax breaks, and access to federally-backed loans with lower barriers to entry than other types of mortgages (e.g. smaller down payments and lower credit score requirements).

Benefits Only Available to First-time Buyers

• Minimum down payments as low as 3-5% (compared to a more typical 20%)
• HUD grants (and grants from similar programs by states and municipalities) of cash assistance for means-tested recipients that can be directed towards the home purchase, down payment, closing costs, and, in cases, property improvements
• Penalty-free, early IRA (Individual Retirement Account) withdrawals up to $10,000 per person ($20,000 per couple) to devote towards purchasing a home

Tax Benefits For Homeowners

Because the federal government wants to incentivize homeownership, the IRS offers several significant itemized deductions (expenses that offset and decrease taxable income) connected to the cost of buying and maintaining a home.

However, it’s important to note that the Tax Cuts and Jobs Act of 2017 greatly increased the standard deduction (a deduction available to any taxpayer that does not itemize their deductible expenses).

For 2022, the Standard Deductions are:

• $12,950 for single people and for married individuals filing their taxes separately
• $25,900 for married couples filing their taxes jointly
• $18,800 for heads of households (unmarried adults with qualifying dependents, such as minor children, who pay over half the cost to maintain their home)

Consequently, homeowners need to determine whether their itemized deductions would be larger than the standard deduction. Furthermore, not every home expense is deductible. The following common expenses associated with homeownership cannot be deducted:

• Depreciation
• Domestic employee wages
• Fire insurance
• Homeowner association fees
• Homeowner’s insurance premiums
• Mortgage down payments
• Mortgage lender costs (e.g. credit reports, appraisal fees)
• Mortgage principal payments
• Origination points
• Rent paid to live in a home before closing on it
• Transfer taxes
• Utilities (e.g. gas, electricity, water)

Though those expenses are not deductible, there are several major deductions that are available to homeowners should they choose to itemize their deductions:

Mortgage Interest

For most homeowners, mortgage interest will be the single largest deduction on their tax return. The IRS permits deductions for mortgage interest up to $750,000 for single filers or married couples filing together. Married couples filing individually can deduct up to $375,000 each.

Home Equity Loan Interest

Homeowners that tap into the equity they’ve accumulated in their home via a home equity loan or a home equity line of credit can deduct interest payments made on those loans. However, in previous years the tax code did not specify how any funds accessed were spent. The Tax Cuts and Jobs Act of 2017 added a requirement that the borrowed funds must have been spent on home improvements to qualify for deduction.

Property Taxes

Every state and most local municipalities have property taxes (taxes based on the value of a property). The IRS permits itemized deduction of state and local property taxes up to $10,000 for married couples filing jointly and $5,000 for unmarried taxpayers and married individuals filing separately.

Capital Gains

If a taxpayer sells a home for a profit (meaning the sale price exceeds what they paid for the property) they have to pay taxes on that capital gain. However, up to $250,000 of the capital gains associated with the sale of their home are deductible ($500,000 for a married couple) if they used it as their primary residence for at least two of the last five years. To qualify as a ‘primary residence’ the property must be where the taxpayer spends most of their time and the same address listed for their tax returns, driver’s license, and mail.

Necessary Home Improvements

If a taxpayer sells a home for a profit (meaning the sale price exceeds what they paid for the property) they have to pay taxes on that capital gain. However, up to $250,000 of the capital gains associated with the sale of their home are deductible ($500,000 for a married couple) if they used it as their primary residence for at least two of the last five years. To qualify as a ‘primary residence’ the property must be where the taxpayer spends most of their time and the same address listed for their tax returns, driver’s license, and mail.

Home Office Expenses

Taxpayers operating a business in their home can deduct some of the expenses of their home office, but only if that room is used exclusively for their work. The IRS also offers a standardized home office deduction of $5 per square foot (capped at $1,500).

House hunting even in less competitive markets can be difficult, but when bidding wars are the norm, the best properties get snapped up very quickly. A trusted and experienced real estate agent can make a huge difference, helping first time home buyers search for listings online and in person. They will also help represent your interests when interacting with the selling parties, which is why it’s generally a good idea to bring your agent with you to any open houses.

New Construction vs. Older House

One of the most common questions borrowers have is whether they should be devoting more of their home buying research to newly constructed homes or older ones.

The final decision will come down to a number of different factors and preferences including maintenance costs, safety, convenience, and appearance. Brokers can play an important role in guiding borrowers as they navigate this issue, so here are the major pros and cons of buying a new versus an older home.

New Home Pros:

Up to Code

Building codes have changed remarkably over the years in ways that have greatly improved safety for homeowners. For example, lead paint, which can cause neurological issues, was banned at the federal level in 1978. Asbestos, which can cause diseases in the lungs, was commonly used in home construction until the 1970s as well.

Many older houses with lead paint and asbestos have been remediated, but not all. Additionally, some building materials like aluminum wiring, while no longer up to code due to the potential for a fire hazard they pose, have been grandfathered in and therefore owners are not required to swap them out for safer copper wiring. New construction homes don’t have to worry about these safety issues, which can translate into lower insurance premiums and higher resale values.

Lower Energy Costs

The quality of insulation technologies has improved drastically in just the last two decades. Double and triple-paned glass, foam insulation between floors and walls, and other advancements allow modern homes to better retain heat in the winter and cool, conditioned air in the summer.

The difference can add up. The U.S. Census Bureau’s American Housing Survey found that homeowners in older homes spend 17% more on electricity and 38% more on gas per year than their counterparts in newer homes.

Size and Layout

Americans’ desire for more space has led developers to build bigger and bigger houses over time. Hence, new homes are typically larger than older homes. The layouts of newer homes are also more conducive to modern ways of living, with wide open floor plans, more storage space, and features like a family room connected to a kitchen, creating one large area for family gathering and entertaining.

New Home Cons

Buying Cost and Negotiating Power

New homes cost about 30% more on average than older homes. Furthermore, sellers are much less open to negotiating on the price of a new home.

Immature Landscaping

New homes are frequently built in newer housing developments. It’s difficult and expensive to keep old growth trees during that development process and many of them are cut down. That means only young shrubs and new saplings are planted to replace the greenery in the neighborhood.

Many common trees take 30 years or more to mature, so new homes rarely have as lush landscaping as older homes, which negatively affects curb appeal and may make it more difficult to sell the home down the road.

Smaller Yards

Though home buyers want larger homes, in desirable areas where land is at a premium they are often limited in how big they can go. Consequently, developers often choose to use up most of the available lot for the house itself, limiting the space for a front and back yard.

Unoriginal Architecture

It’s also expensive to develop a new neighborhood with many different styles of homes. To save costs, modern home developers create few similar-looking models and populate large areas with them. Some borrowers prefer a home that is unobtrusive and matches their neighbors, but others want something with more personality and a unique character.

Older Home Pros

Purchase History

Whether a new housing development will thrive isn’t always certain. Older homes have established records of sales prices both individually and for their area. That information can help buyers track long term trends and make a judgment about how much their purchase will likely appreciate.

Craftsmanship

While newer homes are built from more advanced materials, many older homes were built with time-tested skills and still look and function beautifully. Classic Victorian, Colonial, and Tudor homes can last for generations. However, just because a home is old doesn’t mean it was built well, so buyers should be cautioned against skimping on a highly qualified home inspector.

Closer to Downtown

Because they were developed earlier in a municipality’s history, older homes are frequently closer to downtown areas where offices, shops, and restaurants are. That makes for shorter commutes for work and play.

Older Home Cons

Smaller

According to data from the Census Bureau, the average single-family home in 1973 had just 1,525 square feet of floor space. In 2020, the average was 2,333 square feet. That means older homes typically have smaller bedrooms, less storage space, and will even feel smaller in ways that don’t show up in the square footage, such as lower ceilings.

Less Accessible

Ramps, handrails, room for stairlifts, and other modern accessibility features are less common in older homes. Borrowers with disabilities or who may one day have an older relative living with them should keep that in mind.

Maintenance

Older homes mean repairs for older roofs, plumbing, appliances, HVAC systems, and other parts of a house associated with recurring expenses may come due sooner than in a new home. There’s a whole range of issues that a qualified home inspector should examine closely, including sloping floors, mold behind the walls, decaying foundations, and damaged sewer lines.

These costs can be significant. The American Housing Survey found that the average homeowner spends $100 or more per month on home maintenance, but individuals who purchased homes that were less than four years old only spent $25 per month on average.

Homeowners Associations (HOA)

HOAs are private organizations that manage residential communities. Their leadership, often called the HOA Board, is composed of unpaid volunteers from the community that are elected by their neighbors and tasked with establishing and enforcing rules and regulations that dictate how the community will operate.

Not every residential community has an HOA, but they are fairly typical in many common-interest developments and other housing developments made up of individual units that share some facilities and common areas, such as:

• Condominiums
• Housing Cooperatives (Co-ops)
• Planned Neighborhoods
• Retirement Communities
• Vacation Timeshares

Every HOA operates slightly differently, but generally their rules and regulations are codified in a document called a Declaration of Covenants, Conditions, and Restrictions (CC&Rs). CC&Rs will explicitly address how homeowners can use and alter their home:

• Paint Color: Some HOAs limit the colors that the properties in their community can be painted. Some require homeowners to submit new color choices for board approval before painting can commence. These and other exterior design choices may be strictly limited to ensure that the whole community maintains a common character.
• Hardscaping and Landscaping: Installing fences, stone paths, cement patios, decks, artificial turf, sheds and external garages, and tall shrubs may all potentially require a sign off from the HOA board.
• Usage: For certain issues related to the use of the property, HOA rules can be even more strict than similar regulations that apply to the municipality the community is located in. For example, even if a city doesn’t require quiet hours until 11PM, the HOA can set an earlier time. Furthermore, HOAs can impose other limits on how the property is used, such as by not permitting certain types of pets or pets of certain size. They may also require homeowners to keep their vehicles parked in their garages and not on the street.
• Maintenance: Though HOAs typically manage landscaping and maintenance for the common areas, the individual homeowners are responsible for keeping their own property neat and tidy. HOAs often create penalties (usually in the form of a fine) for units that fail to stay within their guidelines by not performing routine maintenance such as mowing lawns, fixing broken roofs, and otherwise keeping the home safe, functional, and looking good.

Failure to abide by HOA rules can result in fines, and failure to pay HOA fines or fees can result in the board placing a lien on the home, which may prevent the owner from selling until they have paid off and removed the lien.

In addition to setting CC&Rs, HOAs also serve as a sounding board for the community. They set up regular meetings where members can discuss the board’s actions and voice their concerns about their homes and the community as a whole. HOA boards also perform a liaison and social role, organizing community parties, setting up a neighborhood watch, and interfacing with local governments.

HOA Fees

The primary goal of most HOAs is to preserve the value of the properties in their community. Protecting the distinct character of the area is often a secondary priority. To achieve those goals, HOA members are required to pay fees, which are collected by the board and spent on maintaining common areas, general upkeep, and administrative costs.

Alternatively, some HOA boards opt to hire an HOA management company, a third party that performs that actual work on behalf of the board. Use of an external management company often means paying slightly higher HOA fees, so it’s important for buyers to inquire about that detail ahead of time.

HOA fees may pay for necessary maintenance issues like trash pickup and repairs as well as for elective expenditures like elaborate landscaping, extra security, and amenities like gyms, pools, party rooms, tennis courts, and other shared community resources. How much a buyer can expect to pay in HOA fees will depend on the value of the property they are looking at, the amount of amenities it offers, and how involved the HOA board is in managing the community.

Some HOAs are more proactive than others about maintaining and improving their neighborhood and hence ask more of their members. HOA fees for a single family home can be as low as just a few hundred dollars a year up to thousands of dollars a year, depending on these factors. It also should be noted that HOA boards have wide latitude to change their fees and can do so with little warning.

Prospective buyers should find out how their HOA fees will be calculated and incorporate that estimate into their total monthly cost analysis before making an offer. Additionally, some communities require the initial HOA fee to be paid at the closing, so buyers should be prepared for that possibility. In cases, the seller may have already paid fees for the current and/or upcoming billing cycle. Buyers should make sure their initial fees are appropriately prorated in that event so they aren’t double paying fees that have already been paid.

Condos and Co-ops

When it’s time to buy a home, some borrowers choose a freestanding house, but others opt for an apartment. Buying a home within a larger building or complex is similar to buying a single-family house, but there are some differences. There are two broad types of apartment units: Condos (short for condominiums) and Co-ops (short for housing cooperatives).

Condos

Of the two apartment types, buying a condo is more similar to buying a house. Like a house, a condo is a piece of real estate that the buyer is purchasing. A co-op, by contrast, is not technically real estate. Co-op buyers aren’t actually buying ownership of their apartment. Instead, they are purchasing shares in a corporation that owns the entire building their apartment is in. Their investment buys them the right to live in the building in the form of a proprietary lease.

Condo owners, however, do own their properties — just not all of it. Specifically, they own the interior space of their unit, but not the whole building or its common areas. Everything else, including the exterior of the building, is owned by a condo association, which functions similarly to a Homeowners Association (HOA) in that it is responsible for maintaining all communal areas. Issues like exterior landscaping, routine inspections and repairs, clean and safe common areas, and regulatory compliance for the building as a whole all fall to the condo association.

Condo owners don’t directly assist in those functions but instead pay monthly maintenance fees often called ‘common charges’ which the condo association collects and uses to pay contractors. Common charges for condos vary a great deal. Buildings with extensive amenities like gyms, spas, gardens, offices or coworking spaces, pools, roof decks, game rooms, and the like will necessarily have more substantial common charges than condos with more barebones communal resources.

Additionally, condo associations, which are comprised of members elected from the pool of condo unit owners, create and enforce bylaws for their building to follow. Bylaws cover things like whether pets are allowed (and what type), when quiet hours are, and acceptable uses for common areas. Condos rarely have as many or as strictly enforced rules as co-ops, but some do, and hence it’s important for prospective condo buyers to discuss all the bylaws they will be subject to up front.

Who Are Condos Right for?

• Buyers that want to own the interior of their apartment
• Owners that may potentially want to rent out their unit
• Buyers that want to potentially spend less than they would for a freestanding, single-family home

Co-ops

Unlike houses and condos, co-ops aren’t traditional real estate investments. Co-op buildings are owned, including all interior spaces in the individual apartments, by corporations. Co-ops are especially popular in large cities and other places with a high cost of living because they are typically less expensive than condos. Every tenant of a co-op has to be given permission by the corporation’s board, called the co-op board, to purchase shares in the co-op. Generally, the more shares a tenant owns, the more living space they will be entitled to in the building.

Like most other corporations, all the shareholders have voting rights in regard to issues facing the building and the company. Notably, they have voting power based on the amount of shares they own to elect the co-op board. All shareholders split the maintenance fees, property taxes, and mortgage costs associated with their building.

One potential downside (or upside, depending on the buyer’s perspective) is that co-op boards can be very particular about who they invite to join their cooperative. Unlike in the sale of a freestanding home or a unit in a condominium — where sellers are almost solely concerned with whether interested parties are financially able to make the purchase — buying an apartment in a cooperatively owned building can often come down to whether the co-op board thinks the prospective buyer will be a good fit in their community.

They can deny just about anyone from purchasing in the co-op for just about anything reason, so long as it doesn’t conflict Fair Housing laws. For example, they cannot deny ownership to someone based on their race, gender, religion, or membership in any protected class.

Who Are Co-ops Right For?

• Apartment dwellers that want to spend less than a condo would cost
• People that don’t intend to rent out their apartment
• Buyers that want a board that governs who can live in the building

There are many types of mortgage loans, including fixed-rate, adjustable-rate, interest-only, and negative amortization. The right one for each borrower depends on the following:

• The size and stability of their income
• Forecasts for interest rates and their willingness to accept rate fluctuations
• Whether they are willing and able to pay a ‘balloon payment’ of the entire principal
• Whether they anticipate they will want to defer some interest payments at any point

Conforming Mortgages

Mortgages that meet the standards set by the Federal Housing Finance Agency (FHFA) and by the largest mortgage underwriters in the country, Fannie Mae and Freddie Mac, are called conforming mortgages.

The limits set for conforming loans are determined annually on the basis of several criteria, but the most important is data reported by The Federal Housing Finance Agency House Price Index (FHFA HPI®), which tracks changing prices in the housing market. As prices in the housing market fluctuate and lenders adjust their own risk profiles, maximum lending limits rise and fall.

Conforming Limits

As every lender and broker today is well aware, housing prices are at historic highs. The House Price Index reported an 18.05% increase in the third quarter of 2021 — and that figure was used to adjust the conforming loan limit (CLL). Ergo, the largest secured and conforming loan for a single unit home in a typical part of the country was raised 18.05% from $548,250 in 2021 to $647,200 in 2022.

High-cost counties where 115% of the local median home value exceeds the baseline conforming loan limit — as well as Alaska, Hawaii, Guam, and the U.S. Virgin Islands, which are statutorily deemed high-cost areas regardless of actual home prices — can have an increased CLL (up to 150% higher, which they met for 2022). The CLL for single-unit homes in high-cost regions increased from $822,375 in 2021 to $970,800 in 2022.

Fannie Mae and Freddie Mac set these limits because they are designed to underwrite a very large number of homes and thus set standards that enable them to spread the risk they can shoulder as widely as possible. Lenders set their own internal limits based on the risk they are willing to accept.

Lender Limits

Every potential borrower has a maximum loan amount or loan limit that can be authorized by a lender to borrow. That figure is based on several factors that change annually, including changes in the housing market and changes in the hopeful borrower’s financial status and needs, including:

• Credit ratings and histories
• Loan lengths
• Collateral
• Debt-to-income ratios
• Financial profiles

Figures vary by lender and by year, but right now a debt-to-income ratio of 36% or less is generally considered acceptable. Government-backed loans (e.g. Federal Housing Administration, Veterans Benefits Administration, or U.S. Department of Agriculture loans) accept higher debt-to-income ratios, often up to 50%, as do some lenders for highly qualified borrowers.

Mortgage lenders also adjust their loan limits according to optimized loan-to-value evaluations. Typically a lender will lend no more than 70-90% of a secured asset’s value as collateral. Additionally, mortgage lenders consider the borrower’s housing expenses when setting loan limits, such as:

• Mortgage Principal and Interest Payments
• Property Taxes
• Hazard Insurance
• Principal Mortgage Insurance (PMI)
• Homeowners Association Fees

The PITI (the combined amount of monthly payments for the mortgage principal and interest plus all taxes, insurance, and fees associated with the property) is a major factor in setting loan limits. There is a fairly well established guideline in the mortgage industry called the 28/36 rule that helps lenders set their limits. The rule prioritizes borrowers with maximum household expenses that are at or below either 28% of their gross income and those with a total household debt that is at or below 36% of their gross monthly income.

Jumbo Loans and Piggyback Financing

Despite excellent credit histories, sufficient income, and a lack of significant debts or expenses, many applicants will still be unable to purchase the home they want with just a conforming loan. Many borrowers (and even some brokers) incorrectly assume that loans of that size, which cannot be underwritten by Fannie Mae or Freddie Mac, must necessarily have very high interest rates to account for the elevated risk they pose.

To the contrary, many non-conforming jumbo loans are available at rates that are at or even below that of conforming loans. However, they do typically require more stringent borrower criteria, such as higher credit scores (usually 700 and up) and larger down payments (usually at least 10-20%).

Borrowers applying for a jumbo loan that don’t make a down payment of at least 20% virtually always have to pay for private mortgage insurance, but there is a workaround that can save them that cost called piggyback financing or an 80/10/10 loan. Instead of one loan, they can take out a first mortgage for 80% of the cost of the home, a second mortgage in the form of a HELOC (home equity line of credit) for 10% of the cost, and then put 10% down.

Fixed vs. Adjustable-Rate Mortgages (ARM)

When the housing boom hit in the 2000s, many borrowers would often choose the ARM to qualify for a home that they may not have been able to purchase with a fixed-rate mortgage. This would allow them to have a lower interest rate initially and have the ability to pay down more principal before the loan is adjusted. Today, fixed-rate mortgages (FRM) are at record lows and with the fluctuations in the housing market, the ARM has decreased in popularity. FRMs now account for 90% of purchase and refinance loans.

But just because something is more popular doesn’t necessarily make it better. For some, it’s a matter of preference based on their financial plans and goals. Others prefer the security of FRMs and knowing that no matter what, their rate will stay the same. But as property prices rise and getting qualified becomes more difficult, the ARM is steadily becoming more favorable.

Fixed-Rate Mortgages

Pros:

• Stability: No need to worry about interest rates changing and your payments increasing.
• Tax benefits: In the early years of FRMs, the payments are heavily weighted with interest and not principle which results in a higher interest tax deduction.
• Low rates: Currently, rates are near all-time lows.

Cons:

• More expensive: Monthly payments are typically higher leading to a large expense over the life of the loan.
• Harder to acquire: Since the interest rates are usually higher than the ARM, it is more difficult to qualify for the loan.
• Slower equity growth: Home equity usually takes longer to accrue vs. an ARM.

Adjustable-Rate Mortgages

Pros:

• Lower initial rate: The lower rate during the fixed period results in lower initial payments.
• Equity builds faster: You’ll be able to capitalize on growing home equity while interest rates are low.
• Flexibility: If you are likely to move again within the next few years, you could do so before interest rates adjust. You can also choose to refinance at any time if you qualify.
• More freedom: Homeowners will need money for other projects and expenses, and an ARM gives them the extra cash to do so.

Cons:

• Uncertainty: Interest rates can and will change.
• Possible higher payments: Borrowers may not be able to afford the higher monthly payments that will occur post-adjustment.
• More complex: ARMs can be difficult to budget, and they can add extra stress and worry for those with hectic lives or adjusting income. Should you choose to refinance, it could end up costing more than holding on to a fixed rate.

Private Mortgage Insurance (PMI)

Most lenders require that borrowers who have less than 20% equity in their home pay for PMI, which protects the lender in the case of a default. Those insurance premiums can be deducted from the homeowner’s taxes, however.

Many first-time buyers mistakenly think that just because they are pre-qualified, they are also pre-approved, but this is not always the case.

To receive a pre-qualification, a borrower provides information regarding their income, employment, and debts to a lender, which is then used to determine the potential borrower’s likelihood of getting a mortgage. This information is not verified until the borrower applies for the mortgage. Often, problems arise at the time of the application process, especially if some of the information is incorrect. The lender will need to verify their credit, employment income, and other financial information to get pre-approved. Once they have, they will receive pre-approve status and be better positioned to obtain the loan.

Both pre-qualification and pre-approval speed up the process of obtaining a mortgage and making a winning bid on a property. Pre-qualification is just a basic step where the lender collects self-reported financial information from the hopeful borrower. Pre-approval is a more rigorous investigation where the borrower’s income, employment, and credit history are independently verified. Pre-approval gives brokers and lenders a true idea of what type and size loan is right for the borrower and lets sellers know that the borrower is ready at that moment to make a genuine offer.

The underwriting process for a mortgage involves significant due diligence to ensure the borrower is capable of taking on the debt they are applying for and will likely be able to repay it. In addition, lenders and brokers need to verify that the person is who they say they are. Required documents include:

• Photo ID: driver’s license, passport, official state or federal identification
• Proof of Income: 30 days of pay stubs, federal income tax returns for the previous two years, W-2s (if applicable) for the previous two years, and any other documentation of income
• Financial Statements: bank account statements from at least the previous two months, investment and retirement account statements
• Property Settlement Documentation: a statement proving the settlement of the borrower’s prior home (if they had one)
• Other: Gift letters from individuals providing financial assistance, landlord contact information (if applicable), divorce settlement documents (if applicable)

With guidance from a real estate agent, first-time homebuyers can decide on a strategic offer price to begin negotiations with the seller. That price will reflect:

• What the buyer can afford
• What they think the seller might accept
• How competitive the current housing market is
• The costs that the buyer anticipates for necessary repairs or remediation’s to the property

It’s also a smart idea to request utility bills from the previous sixth months to a year to account for the ongoing expenses associated with the house.

The seller and their agent can then choose to accept the offer, reject it outright, or make a counteroffer. Both sides continue back and forth until a deal is struck or abandoned. If an agreement is struck, the homebuyer’s next step is to make a good faith deposit, called earnest money. That money will eventually be transferred to a secured, third party account called escrow.

Understanding Escrow

Escrow is a financial tool where a third party holds money on behalf of two other parties that are engaging in a transaction. There are two types of escrow that may be required of home buyers. The first is used during the buying process. Hopeful buyers pay earnest money (a deposit that demonstrates their serious intent and ability to buy the property) which is held in escrow. This escrow amount is generally 1-2% of the asking price of the home.

The seller will then take the home off the market and provide access to the buyer’s home inspector. Once the home is officially purchased, the deposit held in escrow will be applied to the buyer’s down payment and/or closing costs.

Escrow is used after the sale of a home to ensure that there is always money set aside to pay for the taxes, property insurance, and (if applicable) private mortgage insurance (PMI) associated with the property.

Funding Escrow Accounts

At the closing, the lender will open the escrow account and the homeowner must fund the account with at least one-sixth of the agreed upon annual escrow payment. Lenders are permitted to maintain that “cushion” (two months worth of payments) in case the taxes or insurance premiums rise unexpectedly. From that period on, the homeowner will make monthly payments towards the escrow account. The lender will draw from the account to pay the tax and insurance bills as they come due.

The mortgage escrow will be estimated during the mortgage application process. The closing documents will include the finalized amount which is calculated based on:

• The expected property taxes
• A homeowner’s insurance quote
• Expected PMI costs (if applicable)

The lender will analyze the actual insurance and tax payments being made on an annual basis to determine if the monthly escrow payments are sufficient to keep paying all bills on time. If tax rates or insurance premiums substantially increase or decrease, the mortgage escrow payments will be adjusted accordingly.

If there is ever more than two months worth of payments in the escrow account, a payment will be made to the homeowner (either by check or as an account credit on their mortgage). Certain states require lenders to keep escrow payments in interest-bearing accounts, but not all.

There are a few situations in which a mortgage escrow is a hard requirement. For example, government-backed FHA, VA, and USDA loans always require a mortgage escrow. For conventional loans, every lender sets their own escrow requirements, but generally they are necessary for any loan with less than a 20% downpayment by the borrower. However, some lenders will permit borrowers to forgo a mortgage escrow account in exchange for a waiver fee.

Any money left in the escrow account must be returned to the homeowner within 30 days after the mortgage is fully repaid.

Home inspections are optional, but they are still a very good idea. Letting a professional evaluate the home will let you know about existing problems as well as those that will surface down the road. Inspections are also a safety measure and there to protect the buyers. Certain toxins such as mold and carbon dioxide could be detected and rooted out. An inspection ranges anywhere from $250-$400. Work with your sellers and see if negotiations can be made.

If numerous or serious issues are revealed by the inspection — particularly if they are issues that were not meaningfully disclosed by the seller, the buyer should consider rescinding their offer completely.

Closing is a process in which all the final details are double checked, the paperwork is signed by all parties, and property begins to change hands. Closing costs vary, but buyers should prepare to spend around 2-5% of the total purchase price of the house on the closing.

The purchase contract will specify the date to close the escrow account, but borrowers are dependent on their lender getting everything done in time. Some lenders will guarantee their closing dates. Others won’t, but they may offer to compensate the borrower if their interest rate lock-in expires and the rate increases as the result of a delayed closing. They may also offer to cover other expenses such as fees charged to reschedule movers.

Typical Closing Costs

• Attorney Fees
• Home Inspections
• Appraisals
• Escrow Fees
• Homeowners Insurance
• Title Searches and Insurance
• Discount Points
• Property Taxes

Appraisal and Title Search

One of the costs of closing is often a final appraisal of the home’s value. Most mortgage providers will insist on this step because they need to know that the money they are lending accurately reflects the value of the collateral tied to it. Closing costs also often pay for a title search, which is an inquiry into the legal status of the property.

Good title means there are no legal or financial encumbrances on the property, such as lien, other mortgages, taxes in arrears. Title searches will also reveal if there are any covenants, easements, or other non-possessory rights to access or use the land or the structures on it by any other parties.

Discount Points

Mortgage points, also called discount points, are fees that a borrower can pay their lender to lower their interest rate. Each point costs 1% of the loan amount. The amount each point lowers the interest rate varies by lender, but 0.25% is a typical amount. Points are paid at closing and are tax-deductible.

The question of whether it’s worth it for borrowers to buy discount points is determined by their ability to pay elevated closing fees and whether they are planning on keeping the property for a long enough time that the reduced interest rate will more than offset the cost of the mortgage points.

Remote Closing

Remote closing, also called virtual closing or eClosing, is a process in which all the parties involved in a mortgage transaction have their identities verified online and all documents are signed electronically. In a completely remote closing, buyers, sellers, realtors, brokers, lenders, lawyers, and everyone else that might play a role in putting keys in a new homeowner’s hands never need to even be in the same room together.

In some states, refinancing can also be performed remotely. Remote closings are often connected to eMortgages, which are mortgages in which the loan is originated via a digital process in addition to being consummated electronically with digital signatures that are stored online.

The qualification of ‘some states’ matters greatly for virtual closings generally because this area of law and finance is still fairly new. There is a patchwork of differing and sometimes conflicting laws and regulations governing mortgage transactions — and not all sufficiently address or entirely permit electronic alternatives to traditional practices.

In a standard, in-person closing, a so-called “wet signature” is required, meaning parties must use their own hands and an old-fashioned, ink-filled pen to sign their name to all relevant documents. Some states still demand wet signatures for mortgage closings. However, there is a workaround that is legal across the country called a hybrid closing

Hybrid Closing

A hybrid approach combines elements of both traditional and remote closing. It may still require a wet signature with a notary, but that is the only time parties are required to be physically present. Everything else is done beforehand from the comfort of the parties’ private homes and offices and communicated securely online. Because they don’t run afoul of any state’s mortgage closing rules, hybrid closing methods are among the most common and popular in the nation right now.

Remote Online Notarization

A second closing option is called Remote Online Notarization (RON) in which identities are all confirmed electronically via a video conferencing session in which identifying documents like passports and driver’s licenses are presented for inspection by a state-licensed notary public. RON is desirable for some buyers because it makes it easier for transacting parties to access notarizing services and reduce the risk of fraud.

In-Person E-Notarization

Lastly, some states and lenders permit a closing process called IPEN, short for In-Person E-Notarization, where closing documents are signed digitally but not remotely. That step sacrifices some of the convenience associated with a RON closing, but includes the greater security associated with digital processes and the reduction in wasted paper.

The laws and regulations covering eClosings are still shaping up, but there has been strong and growing demand from lenders, buyers, and sellers to allow them because they save everyone time, money, and effort, and because they are proving to be even better at mitigating risks and preventing fraudulent transactions than traditional closing methods.