Steps in Home Buying Process

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The process of buying a home can be different based on the price range and whether a mortgage is needed. While some things are different, others are similar regardless of price, financing or local customs.

Each year, the National Association of REALTORS® surveys buyers and sellers who have purchased or sold in the previous twelve months in order to identify the process and steps taken. It provides a lot of information for the people who will be going through the process now and in the near future.

44% of all buyers looked online for properties for sale. This might be considered a logical first step to determine the prices of homes in certain areas and what features they offered.

17% of all buyers stated that their next step was to contact a real estate agent. In another REALTOR study, it is reported that 87% of all buyers purchased their home through a real estate agent or broker. Buyers identify a wide range of services the agents offer that is considered valuable in the purchase of a home.

The next step identified by most buyers is to look online for information about the home buying process. In many cases, agents share this information in their first substantial meeting but since it is identified as the third highest steps taken by buyers, some people may not be getting adequate information from their agents or they are verifying the process as explained to them.

The fourth step identified by buyers is to contact a bank or mortgage lender. The position this step takes place is interesting because many real estate professionals suggest that it be one of the first things buyers should do. The reason is to find out how much mortgage they can qualify for, so they are looking for homes in the right price range. This can save a lot of time and frustration.

The three next highest steps included driving by homes and neighborhoods, talking with a friend or relative about the home buying process and visiting open houses.

The buyers in this study mentioned that they depended on several sources for information during the home search. The most frequently used were online website, their real estate agent, mobile search device, open houses and yard signs.

The three most difficult steps listed were finding the right property, the paperwork and understanding the process and steps.

You can download a Buyers Guide that has a lot of interesting information. We have an array of Financial Apps that can provide insight on things like Rent vs. Own, Mortgage Payment and Your Best Investment. And of course, I’d be happy to schedule an appointment with you to go over all these things and talk to you about finding your next home. Call me at (805) 701-8410.

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Invest in Equity Build-up

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Equity build-up could be one of the biggest advantages to buying a home. There are two distinct dynamics that take place to make this happen: each house payment applies an amount to reduce the mortgage owed and appreciation causes the value of the home to go up.

It is easy to make a projection based on the type of mortgage you get and your estimation of appreciation over the time you expect to own the home. Even conservative estimates can produce impressive results.

Let’s look at an example of a home with a $270,000 mortgage at 4.5% for 30 years and a total payment of $2,047.55 payment including principal, interest, taxes and insurance. The average monthly principal reduction for the first year is $362.98. If you assume a 3% appreciation on the $300,000 home, the average monthly appreciation is $750 a month.

The total payment of $2,047.55 less $1,112.98 for principal reduction and appreciation makes the net monthly cost of housing, excluding tax benefits, $934.57. If this hypothetical person was paying $2,500 in rent, it would cost them $1,565.43 more to rent than to own. In the first year, it would cost them over $18,000 more to rent.

Together, the items in this example contribute over $1,100 to the equity in the home . This is one of the reasons a home is considered forced savings. By making your house payments and enjoying increases in value, the equity grows and the net cost of housing decreases by the same amount.

In this same example, the $30,000 down payment grows to $133,991 in equity in seven years. While this is equity build-up, the extraordinary growth is attributed to leverage. Leverage is an investment principle involving the use of borrowed funds to control an asset.

To see what your net cost of housing and the effect of leverage will have on a home in your price range, see the Rent vs. Own. If you have questions or need assistance, contact me at (805) 701-8410.

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America Still Considers Real Estate the Best

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35% of respondents, in a recent annual Gallup poll that dates back to 2002, identified real estate as the best long-term investment option compared to 27% who identified stocks.

The top choices included real estate, stocks, savings accounts and gold. Even with the remarkable prices of the different U.S. stock indices recorded in 2019 through April and May, homes have the highest confidence in the minds of the respondents.

This seems to be based on the stability of the housing market and the expectation that home prices will continue to rise. Homeowners build equity from both appreciation as well as reducing principal with each payment made. These same factors exist for investors of rental homes in predominantly owner-occupied neighborhoods.

Real estate has another dynamic working to produce favorable investment results due to leverage. Leverage occurs when borrowed funds are used to control an asset. When the borrowed funds are at a lower rate than the overall investment results, positive leverage occurs which can increase the yield from an all cash investment.

Gold and savings accounts must be funded with cash. The maximum borrowed funds allowed for stocks is 50% and generally, at a rate higher than typical mortgage rates.

Homes are a particularly attractive investment because you can enjoy them personally by living in them. The interest and property taxes are deductible and gains on the profit are excluded up $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly.

Many people consider an investment in a home for a rental property an IDEAL investment: Income, Depreciation, Equity Build-up & Leverage.

If you have questions or are curious about the process, contact me at florence or (805) 701-8410.

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Determining Property Type

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The Internal Revenue Service considers four different types of real estate. Specific types of properties have benefits based on their classification. The determination does not depend on the property itself as much as it depends on how the property is used and what the owner’s intentions are.

Principal Residence … a principal residence is the place a person lives or expects to return if they are temporarily away from it. It could be a single family, detached home or condominium or a duplex, tri-plex or four-unit. The owner(s) can deduct the qualified mortgage interest and property taxes on the schedule A of their tax return. There is a capital gains exclusion on profit of up to $250,000 for a single taxpayer and up to $500,000 for a married taxpayer.

Income Property – is improved property that is rented or leased to tenants as opposed to using it personally. It can include houses and condos, apartment buildings, office complexes, shopping centers, warehouses and other commercial buildings. Depreciation is allowed on the improvements. For property held more than one year, the profits are taxed at long-term capital gains rates. This type of property is eligible for a tax deferred exchange.

Investment Property … can be raw land or improved property that is not rented or leased. This property is not subject to depreciation. If the property is held for more than one year, the profits are taxed at long-term capital gains rates. It is also eligible for a tax deferred exchange.

Dealer Property … this type of property is primarily considered inventory because the intention is to sell it without intentionally holding it for more than a year. It could be new construction such as a home builder. It could be an investor who buys a property and expects to sell it for more. There is not a requirement to make improvements. The profits on dealer property are taxed as ordinary, “sweat of the brow” income. Dealer properties cannot be exchanged.

A second home is like a principal residence in that you can deduct the interest and property taxes on your Schedule A, up to the limits. A second home, as well as a principal residence, can be rented out up to 14-days a year without threatening the status of the property. Seconds homes are not eligible for exchange because personal use properties are not allowed. A second home is not a principal residence and profits are taxed like an investment property. If you own it for more than a year, it is taxed at long-term capital gains rates.

Vacation homes are rented for more than 14 days a year and are like income property but with some additional rules that apply. If your personal use is 14 days or less or 10% of the time it is rented, your expenses can be deducted in excess of income. If you use it for more than 14 days or more than 10% of the number of days it is rented, it is considered personal use and your expenses are limited to the amount of income collected with no losses being deductible.

Taxpayers can strategically change the property type based on their intentions. A principal residence can be converted to income property. Dealer property could become a principal residence. A rental property could become a principal residence.

Professional tax advice is always recommended to be able to understand the information and how it applies to your specific situation.

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Get Leverage Working for You

Leverage is an investment term that describes the use of borrowed funds to control an asset; sometimes referred to as using other people’s money. Borrowed funds can affect the investment in your home positively.

For instance, if you had a $100,000 rental property, collected the rents and paid the expenses and had $10,000 left, you would earn a 10% return (divide the $10,000 by the $100,000.) With no loan on the property, there is no leverage.

If you decided to get an 80% mortgage at 8%, you would owe an additional $6,400 in expenses leaving you only $3,600 net. However, your return would grow to 18% because your investment is now $20,000 in cash (divide the $3,600 by $20,000.)

Leverage, the use of borrowed funds, causes the return to increase in this example. While, most people associate leverage with rental properties, it also applies to a home. The larger the mortgage, the more leverage you have. A FHA mortgage with a 3.5% down payment has more leverage than an 80% loan.

Assume we’re looking at a $295,000 purchase price with 3% closing costs and a 4.5% mortgage for 30 years with a five-year holding period. The following table shows the return based on different down payments and appreciation rates. The initial investment is the down payment plus closing costs. The equity build-up at end of year five is the result of normal principal reduction and appreciation.

Down Payment 1% Appreciation 2% Appreciation 3% Appreciation
3.5% 21% 28% 34%
10% 12% 17% 21%
20% 7% 10% 13%

Another way to look at the 3.5% down payment example with 3% appreciation would be to say that a $10,325 down payment plus $8,850 in closing costs could grow into $82,482 of equity in a five-year period producing a 34% rate of return on the initial investment.

Estimate what your initial investment could grow to using this florence

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Delay Will Usually Cost More

Two things can happen when the mortgage rates go up before you’ve found a home or locked-in your mortgage. You’ll either pay the current mortgage rate which means a higher payment, or you’ll have to increase your down payment to keep the monthly payment at the same level.

If the rate were to go up by ½%, the payment on a $275,000 mortgage would increase by $82.87 per month for the entire 30-year term. That would increase the cost of the home by $29,835.

Some people are purchasing the maximum home that they can qualify for. In that case, they cannot qualify for a higher payment and the only way to buy the same price home is to put more money down which may not be a possibility. The other alternative is to buy a lower price home which may not be in the same area or size which will involve some compromises.

The rate is not the only dynamic that affects buyers waiting to purchase. The home they want could sell to someone else. Prices could increase as new homes come on the market. The question that many buyers ask themselves when they become a victim of the consequences of delay is “What could we have spent the money on if we didn’t have to make a higher payment?”

Mortgage rates are very attractive currently and within ½% of the all time low of 3.35% in December 2012. The highest rate was 18.45% in October 1981. Whether you’re purchasing or refinancing, it may not be this low again.

To see how it will affect the payment, plug your numbers into this Cost of Waiting to Buy calculator or call me at (805) 701-8410 and I’ll help you with it.

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Measuring Square Footage

Square footage is commonly used to determine if a home will fit a buyer’s needs. The price per square foot can be used to compare the costs of different homes and even, determine the value of a property.

The challenge is what is the source of the square footage measurement and how was it done.

County records use square footage to determine assessed value for property tax purposes. They are assumed to be reliable but there can be inaccuracies in their tax rolls. Another source of square footage could be from the house plans but the problem there is that the builder may have made modifications, or a subsequent owner could have made additions.

Appraisers are required to measure the home to determine square footage and they generally, adhere to a standard method which leads to uniformity in the industry. The ANSI, American National Standards Institute, guidelines are considered the standard but there are no laws governing the process.

Because basements are below grade level, regardless of whether they are finished, they are typically not counted toward gross living area. Attics because they are above grade level can be included in gross living area if they are finished to the same standard as the rest of the home and they meet the minimum height requirement of seven feet.

Unfinished areas are usually not considered in the square footage because it is not livable.

For detached properties, it is common to measure the perimeter of the house but to only include the living areas, not porches, patios or garages. Gross living area includes stairways, hallways, closets with minimum height and bathrooms. Covered, enclosed porches would only be considered if they use the same heating system as the house.

By contrast, condominiums, generally measure the inside area of the unit. Some appraisers may add six inches to account for the wall thickness. If you were to compare the total of the interior room measurements of a detached home, it would be far less than the stated square footage using the normal method.

If the county records are significantly different from the appraisal or the plans, it will be necessary to determine which one is more accurate. This may require getting the home measured by an appraiser which should be less than paying for a complete appraisal.

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