A Hunting We Will Go...

"shhhh....be very, very quiet. We're hunting for houses. he he he he."

This is the second time I'm going through the house hunting process. Its a huge investment; probably the biggest one any of us will make in our lifetime. I thought I would give out some helpful tips/info that I have picked up along the way.

The basic process goes like this:

1) Figure out how much you can afford.
2) Find a buying agent.
3) Lie slightly to the buying agent
4) Look for a house
5) Make an offer
6) Haggle
7) Move In.

I'll cover these in a series of posts, starting with #1 today.

1) Figure out how much you want to spend on a house. This should have nothing to do with what the bank will tell you can afford. The bank's typically rule is that you can afford 28% of your gross income for housing. That may be true, but you would have to live like a hermit and never eat anything but Raman noodles:)

Come up with a number that you are comfortable with and use that. Don't forget to assume that your electric and gas are going to be more (more area to heat) and that you are going to get to experience the joy of property taxes for the first time:) Both of those add up each month.

There is also the uncomfortable question of the down payment. At a minimum, the bank wants you to put down at least 5% of the homes selling price. Anything less than that and you are into jumbo loans, where they really nail you with the interest rate. For the rates the bank actually quotes in the newspaper, they will want you to put down 20% of the asking price. Most first time home owners cannot afford that, so there are couple of options to deal with this issue.

* The classic answer is Principle Mortgage Insurance (PMI). PMI is a little extra (typically something like 0.5% interest) that you pay each month on the loan in order to insure the bank's risk that you will not default. With PMI, the bank will let you borrow more than 80% of the home's selling price (again, typically up to 95%).

PMI is like all insurance: If you never default, then you have basically given the bank a lot of money for no reason. Unlike the interest you are paying on your loan, you cannot deduct PMI from your taxes either (one of the best things about owning a home is that all interest you pay on home loans can be entered as an itemized deduction from your federal income taxes). Once you have acquired 20% equity in your home however, PMI goes away. Equity is the difference between what the home is worth and what you still owe the bank. Equity increases when the home appreciates in value and by your payments each month.

* If you cannot put down the full 20%, another option is to borrow the remainder in a second loan. Such loans are referred to as 80/X loans, where X is the percentage of the downpayment you are borrowing. For example, if you put down 5% of the selling price, you would get a 80/15 loan to cover the rest of sale price.

This second loan is typically an interest only loan, which mean you need be aware of a couple of important points: (1) your payment each month only pays the interest. It does not lower your principal. (2) It is in your best interest to pay this loan down as quickly as possible because it is typically a full percentage point higher than your home loan due to the added risk the bank is taking on. Interest loans are more expensive than PMI, but you can end up ahead because you can deduct the full value of the money you pay in interest on this loan from your reported gross income on your federal taxes. Your banking advisor should walk you through both and help you figure out which will be cheaper for you in the long run.