CHAPTER 7
Buying Real Estate Is Not a Joke
Do you need to qualify your expert? You have heard the old adage, “If it sounds too good to be true, it probably is.” Many a parent has drilled this into the heads of their children in the hopes that it would repeat in their heads forever as they moved into adulthood. I’ve used it myself when consulting with potential homebuyers about financing options. In order to illustrate how incredibly important it is to interview and qualify your lender, realtor, or builder, I want to tell you a story about a terrible injustice that occurred right near my own hometown of Dallas, Texas.
A well-known semi-custom builder began constructing very nice homes in the area—nice enough to attract a wide array of potential homeowners from all different backgrounds. The majority of these people were not financial experts, and many had not obtained prequalification from a lender beforehand. When visiting the model home, they were greeted by friendly sales people and the smell of fresh-baked cookies. They were encouraged to walk through the beautifully decorated model, admiring the custom paint colors, floor-to-ceiling windows, and enough bedrooms and bathrooms to accommodate a large family. It felt like a dream to these families, most of which had never imagined owning such a luxurious home.
After the tour, the head of the family was encouraged to spend a few minutes talking with the salesperson about the possibility of owning a new home in this subdivision. After all, didn’t their family “deserve” to own this home? The seed of entitlement was planted, and suddenly it didn’t seem so far-fetched. Eventually, they had to face the elephant in the room. This two-income family worked very hard, and had good jobs, but there was no way they made enough money to afford “all of this.” The salesperson then brought out a flier with examples of monthly payments for their homes. Surely, this would offer the answers they needed to make an informed decision. There it was, the 3,500-square-foot model home they were standing in, costing $360,000, but with a monthly payment of only $1,540 a month. At that moment the family had begun to trust the expert, and was convinced that this builder and this home were the answer to their prayers.
Needless to say, these clients didn’t have $360,000 cash, so of course they would need financing. This was not a problem, considering the fact that there was a loan officer sitting at a card table with a laptop, ready to prequalify them right then and there. Again, the emotions ran high (the kids were running around upstairs to call dibs on their new rooms), and they needed to get the contract written quickly, as the salesperson had already told them they were running out of lots that would accommodate such a large house. The loan officer pulled their credit and completed a loan application. They were provided information on a program that required no down payment, and could give them “flexible” payment options. It was even called an “option arm.” Their payment coupons would give them different payment options, but they were only “required” to pay the $1,540 that they were comfortable paying. The happy homeowners closed on their new home a couple of months later, and lived happily ever after—almost.
Here’s the truth.
1. The Option Adjustable-Rate Mortgage (ARM) payment these customers chose was a “negative amortization” payment. The monthly payment wasn’t even sufficient to cover the interest, meaning that every month, their balance increased.
2. The property taxes were not escrowed into the monthly payment, meaning that at the end of the year, these homeowners would receive a property tax bill for $8,500. The salesperson “sold” them on unimproved taxes, which are calculated on the dirt only; the tax assessor’s office updates the taxes to show the true value after the house has been built. By that time the agent’s commission check was cashed and the loan officer had provided them a disclosure somewhere in the mass of paperwork that advised them of the tax liability, although he had made a point not to spend too much time discussing it.
3. The interest rate on the Option ARM adjusted every six months after they moved into their home. The payment was $1,540 for six months, but quickly went to $1,700, $1,920, $2,100—you get the point.
4. They would try to sell the home; however, there was also a prepayment penalty clause, meaning they would be penalized (six months of interest) for selling before the 36-month anniversary. They didn’t have the equity in the home or the money to pay it out of pocket.
5. The worst part of all? The same program was sold to every other family in the subdivision. Within 18 months, 70 percent of the homes in the neighborhood were foreclosed, and those remaining in their homes watched their property values plummet as a result. They couldn’t sell their homes because they all owed more than they were worth, and the once beautiful neighborhood became a ghost town.
The families were devastated, the developer didn’t care, and the loan officer had folded up her card table and disappeared with a huge stack of cash and no legal liability for what she had done. To make matters worse, many of the families didn’t qualify for the loans, and the loan officer used stated income loans to force them into loan contracts they couldn’t possibly repay. This is what can happen when you trust the wrong people. You must do your homework when choosing a lender. Know the ins and outs of the loan program you choose, use a trusted and reputable lender, and remember what your parents told you: If it sounds too good to be true, it probably is.
One of the most shocking realities of American life is the way that some people buy and finance their homes. When they buy household appliances, 92 percent compare prices, but only 42 percent do the same when they buy and finance real estate.

The Match Game: Getting You the Best Loan

If you fall for the hype some lenders put out, including the special no-down payment deals, teaser rates (initial low rates that balloon later), and other forms of creative financing, it is going to cost you. The “no closing costs” deals almost always include special “fees” offsetting your alleged savings, which are financed in with your purchase. There are always costs associated with a mortgage, and if you’re not paying them, ask who is?
Many lenders have created quick interest ads with catchy phrases to get you in the door. They seduce you up front, and only later you find out that it is too good to be true. Buying a house is one of the biggest investments people will ever make, and yet every day customers walk into my office having done absolutely no homework, not even knowing what questions to ask and what answers they should be receiving. So many people do not take the time out of their day to meet with their lender in person, choosing instead to conduct business online. You should always attempt to sit down face-to-face with your lender or at least have a thorough phone conversation so you can discover if and why the lender is a good fit for you. All too often, people email or fax their information and never take the time to find out about the lender or the programs, more importantly, why a certain program is the right one for them.
059 Buying a home is one of the largest investments of your life. Take it seriously. Always know your loan and know your lender.
The only two questions many people care to ask are, “What is your interest rate?” and “Can you email or fax me a Good Faith Estimate?” This opens the door for lenders to bait-and-switch and gives you no guarantees, which can set you up for a huge surprise at the closing table. You must protect yourself at all times. Below, I have provided a list of 10 questions you must ask your lender to avoid becoming a statistic, like millions of Americans already have.
1. How long have you been doing Federal Housing Administration/ Veterans Administration (FHA/VA) and conventional mortgages? The answer you want to hear is that the lender is well-rounded and has many years experience in all of the major programs. This prevents a lender from placing you into a cookie-cutter, “one size fits all” loan that is not always the best option for you.
2. What are all the loan products available to me? Many loan officers only sell best commission products to you, and they have no conscience. It’s all about profit. So make sure the lender has a range of choices and will work with you to compare the features, benefits, and costs of each one. If you are being rushed or steered into only one product, work with someone else unless they can show you why it’s the only option available for you. How does a lender match you up with a loan he or she is encouraging you to buy? What are the criteria? Only by getting these questions answered can you make valid comparisons between products. Incidentally, if the lender is unable or unwilling to explain this to you, it means you need to find someone else to help you.
3. What percentage of loans do you close on time? This question may surprise many lenders because it is rarely asked, but a low percentage can mean expensive delays and even losing a deal. Closing dates are written into the real estate contract, and you do not want to risk losing a good loan or your future home because your lender is disorganized or lazy.
4. Can you guarantee that your Good Faith Estimate is accurate and within $200? The federal law requires lenders to supply you with a written summary of costs and fees you are required to pay to get financing and close the loan. The law is called the Real Estate Settlement Procedures Act (RESPA), and it is designed to prevent overcharging by lenders. The old bait and switch involves telling you one set of numbers and then, just before closing, replacing those with a new summary (including higher interest and points, and loan processing fees, for example) thousands of dollars higher. At this point, many buyers are trapped because they want to close on time. The law requires this to be given to you in writing. Fortunately, new legislation went into effect in January 2010 that aims to prevent this tactic, but buyers still must be on guard. A lender or broker can still present preliminary numbers in one format and then confuse the numbers later with the accurate one. A loan cannot be closed until seven business days after the Good Faith Estimate Truth in Lending disclosure is given to you. And the final annual percentage rate you end up being charged cannot be higher than 0.125 percent of the early Truth in Lending disclosure you were given. If rates have risen above this level, a lender must give you a redisclosure report before they can take you through the process and wait three days before closing the loan. The purpose of these changes is to prevent a lender from rushing you and, more importantly, from doing a bait-and-switch at the last minute.
060 Always call a time out when a lender is changing terms and conditions late in the game. Don’t be a victim of a bait and switch.
5. When can I refinance my loan? When can I not refinance my loan? The terms of a loan include explanation of how and when it can be replaced. You may be subject to penalties if you try to refinance the existing loan too soon, and you need to know this before you sign. The best loan program places no limits or fees on refinancing, giving you the complete freedom to shop and obtain better rates and terms whenever they may be available.
6. Are there prepayment penalties if the loan is paid off early? This important distinction has to be studied with care. Some loans—the better ones—do not charge any penalties for accelerating your mortgage. Others limit the percentage of debt you can pay off without penalty each year. The fees can be quite high. The only reason for charging prepayment penalties is to guarantee the lender will collect interest (income) for a predetermined number of months. But as a consumer, why do you want to be locked in? Imagine how you would react to finding out that your credit card company allows you to only make the minimum monthly payment? You would shun that company and look for others that have no restriction. The same rule should be applied to your mortgage loan.
7. Is this loan assumable? The average first-time home buyer stays in that home for about five years; so when you apply for financing, remember that statistics say you are likely to be selling in a few years. In some cases, you want to be able to allow the new buyer to assume your current loan at your rate and remaining term (subject, of course, to approval by the lender of the new buyer’s creditworthiness). It’s a great selling point when interest rates have gone up and you are sitting at a rate well below the current market, if the loan is assumable.
8. Is my interest rate locked? Can you send me the rate lock agreement in writing? A reputable lender will be willing to lock in an attractive rate today for a specified time frame, assuming your property has been identified. Some locked-in rates have a float-down option; your rate will never go higher, but if rates go down, you get a more attractive, lower rate within a certain time period.
061 Never base a decision on a Good Faith Estimate alone.
9. How long will it take me to break even if I pay points? The break-even calculation is not difficult. A loan can be fixed at a lower rate as a result of additional points paid up front (discount points). This means you pay a slightly lower interest rate, but you are assessed points. Each “point” is equal to 1 percent of the amount being borrowed. The lender should be able to help you calculate this. For example, assume you are offered a $200,000 loan at 5.5 percent, but the rate can be lowered to 5.25 percent for one point. This point cost you $2,000 ($200,000 × 1 percent × 1 point). The difference in your monthly payment is going to be $31.17 per month ($1,135.58 for a 5.5 percent loan, versus $1,073.64 for a 5.0 percent loan). So if you save $31.17 per month, but the lower rate costs you $1,104.41, you will break even in about 60 months ($2,000 ÷ $31.17). That’s just over five years; statistically, you will only be in this home for about five years, therefore the reduced rate and points wouldn’t make sense.
10. Is my credit score affecting my interest rate? The right answer, of course, is “yes.” Rates will almost always be based on your FICO score. The best rates (usually what a lender advertises) are going to be available only for those with excellent scores. If your score is less than excellent, you may have to pay a higher rate for the same loan. Knowing this, take steps ahead of time to improve your score.
If you follow these 10 guidelines, you will avoid a lot of grief and save a lot of time and money. Throughout the housing and credit crisis that started in 2007 and 2008, people pointed fingers at lenders, deservedly so. In my opinion, what some of these unscrupulous predators did was tantamount to robbery, burglary, and probably felt like assault and battery. But many escaped prosecution, and they’re still on the loose. Don’t let your guard down or fall into the trap of thinking that the disreputable lenders of the past are simply gone. They have just changed their company names and moved, but they are still out there.

The World of Real Estate Agents

Just like lenders, real estate agents make money on a commission basis. This means they are salespeople. Some agents think that lenders work for them and that their primary focus should be to help them get the sale. I will never forget the day that Lorraine’s agent called to inform me that she had found her the “perfect house.” Lorraine’s agent also instructed me to “talk her into buying the house and closing very quickly,” in order for her to have her paycheck in time to make her mortgage payment. I could not believe my ears. Was this really happening? I said to her agent, “I can’t talk her into buying this or any house.” She got angry and said, “I am going to send her to a mortgage person that will follow my instructions.”
Just as you need to find a lender with integrity, you need to apply the same standard to a real estate agent. The way most people hire an agent is often the least recommended. You are likely to be a cold call into a real estate office or open house. The agent sitting in the office is likely to be there instead of out making sales because he or she is the newest member of the firm. This means they may be also the least experienced, put there because (a) none of the more productive agents want to lose time selling and (b) the broker knows that the “agent of the day” stuck in the office might pick up a few clients just by being there. Although many successful agents are present at open houses, primary agents may also talk a novice into house-sitting for them. The deal they make is that if they get a buyer from the open house, the primary agent will split his or her fee with the novice. This is often an opportunity to give out business cards and bait serious buyers to show them other homes in addition to the open house, but there is no guarantee that the agent on site is experienced.
062 Never confuse “showing up” with experience. A novice agent often is assigned the highest visibility, meaning you are not always meeting the most experienced agent in that company.
As a group, real estate salespeople are often overlooked in the critical evaluation of how homes are bought and sold. Through all the mortgage mess, some real estate professionals have gotten off scot free, even though they have done some of the most dastardly thing to home buyers. It is always a case of caveat emptor, or, buyer beware.
There is a litmus test you need to give real estate agents before you decide to trust them with your transaction and your money. To simplify what can be a very daunting process, I’ve organized this test into three parts: questions that will help you decide which realtor to hire, questions to ask your realtor once you’ve narrowed in on your desired neighborhood, and the questions to ask your realtor when you’ve found the house you wish to purchase. Before deciding upon which realtor to work with, these three questions will help you decide who the best fit is for you:
1. How much time a week do you devote to real estate, or is real estate your part-time job? If this is a part-time job you should reconsider working with the agent. Considering how much money you are going to spend on finding a home, you need (and deserve) a full-time, qualified professional. Believe it or not, many, and I mean many, are in the business for the weekends as a way to make ends meet. Ask them how many times it took them to pass the real estate exam. You want to work with an agent who knows what he or she is doing in any transaction, and getting credentials should not be an afterthought. The real estate exam is not too tough for most reasonably intelligent people to pass with some basic study, on the first try. You’ll see why the difference between a weekend salesperson and a full-time professional is important as you read the following questions.
2. When are you not available? Are our schedules compatible? If the agent spends days on another job (their “real” job?), that is a clue that you should move on to someone else. Real estate is all about timing, and if you can’t get a contract delivered within a narrow time limit, that makes a lot of difference. Not being able to reach your agent after hours or on weekends could cost you the perfect home you’re trying to buy.
3. Have you ever personally bought or sold a home? Let’s be real about this. There is something about real-time experience that is hard to beat. You should expect your real estate professional to have owned real estate in the past. For example, would you hire a stockbroker who had never put money into the market? Probably not. The same should apply to hiring a real estate salesperson.
Later on in the process, ask your realtor the following three questions to ensure the neighborhood you have found is a good long-term investment:
4. How many foreclosures are in the neighborhood? This is a key question. Your agent should know exactly how many homes are in foreclosure; the truth is, every realtor should have this information at his or her fingertips and be willing to share it with you. While someone may have gotten an exciting “steal” by purchasing a house valued at $230,000 for only $200,000, your future neighbors may have purchased theirs for only $180,000, and the people across the street got a deal for only $160,000! This information is of great importance because it can be an indicator that market values may continue to fall in the area.
5. How many houses are owned by investors? There is an important distinction between properties that are owner-occupied and those held for investment. Just like the foreclosure question, a professional real estate agent should have this information already and be willing and able to share it with you. A larger percentage of owner-occupied homes is desirable because owners are more likely than tenants to keep their property well maintained, report crimes like drug dealing and burglary, and care about neighborhood conditions. Tenants are not invested in terms of equity or place, and are probably thinking ahead to move somewhere else to buy a home—if they think that far ahead. If a neighborhood has a high percentage of tenants, then the investment value of homes is not going to be as strong as elsewhere.
063 A neighborhood filled with investment properties is not generally going to hold value as well as a more established neighborhood with a majority of owneroccupied homes.
6. How well do you know school districts, builders and obstacles in this area? A qualified agent should be extremely well versed in these matters because they determine value and desirability of living there. What about traffic flow, congestion, and noise? Have any lawsuits been filed suing builders for construction-related problems? Are there any known pollution problems or nuisances you need to know? You can certainly research these matters for yourself by reading headlines for the local paper over the past year; but your agent should help you find these answers rather than “forgetting” to mention them. Ultimately, the value of your property and your quality of life are going to be directly affected by these issues. So you have to find out before you buy, and not after, that the bargain-priced home you’re looking at sits at the end of a major airport.
Once you’ve found the house you’ve been searching for, make sure to ask these three final questions to ensure you have diligently researched every aspect of the home-buying process:
7. How much are the utility bills for the house? As a hard-and-fast rule, always insist on seeing a full year’s utility bills for any house you’re thinking seriously of making an offer on. What you see might change your mind. If you’re moving from a moderate climate like the West Coast to the Deep South, you don’t want to be surprised. You may learn that air conditioning and heating are going to cost you $5,000 more per year than you have been accustomed to paying in an area where you rarely used your heater and didn’t even have air conditioning. If your real estate agent is not willing to help you get this information, it is a warning sign.
8. What inspections do I need to have? As a general rule, you should always get an independent home inspection. The inspector should belong to the American Society of Home Inspectors (ASHI) or one of the other national associations. In many areas, you also need a pest inspection, or if topography is an issue, a soils inspection as well. Also make sure that the property lines are well documented. If they are not or, worse, if there is a dispute, you should insist that the seller pay for and produce a survey.
9. What are the barriers to reselling this house? You may be excited to make your purchase today, but what will your investment look like five years from today? There are pros and cons to neighborhood expansions; while the neighborhoods change and evolve, new highways, schools, and shopping centers must be built as well. That empty lot behind your backyard could be the next Wal-Mart Supercenter! Your realtor needs to check and provide to you all of the potential zoning changes that could have a negative impact on the house’s value or the resell of your home.

Home Buying Budget Busters

The worst outcome in buying a home is to discover—after you close—that your expenses in the new home are far higher than you expected and perhaps even over your budget. This happens all too often and can lead people down a path to foreclosure. The problem can be avoided with a little research.
The biggest budget busters are:
1. High utility costs. If you don’t research utility costs in advance, you may be surprised—especially if you are moving to a climate with seasonal extremes. As a homeowner, all of your normal costs—maintenance, for example—are going up, but if you are surprised by the level of utility costs, you could find yourself in a real budget squeeze. A $200,000 house with a $300 utility bill will cost you less than a $175,000 house with a $600 utility bill. It’s all about the net outflow of cash.
064 Always ask for copies of utility bills for the past year. Buying your “perfect” home without calculating all these costs will be a very expensive mistake.
2. Unexpected bumps in property taxes. Some states base property tax assessment on periodic estimates of values in each neighborhood. This is very informal. In some states, assessors often just drive up to homes looking for anything unusual and, if nothing is found, homes in the area are re-assessed at a higher rate than in the past. The amount of increase often is dictated by the city’s or county’s budget demands, more so than to reflect real market values of homes. An exception to this general rule of thumb: Some states reassess homes as soon as a sale is closed, with the new assessed value equal to the sales price. In these areas, you cannot simply look at a listing and assume that last year’s property taxes are going to remain unchanged. The increase could be substantial, especially if the current owner has lived there for a long time or is paying a reduced rate (some states reduce property taxes for senior citizens, for example).
3. Homeowner’s insurance shock. How much is your annual homeowner’s insurance going to cost? A swimming pool might seem like a nice luxury, but, before getting excited, ask your homeowners insurance agent to give you a quote with a pool added. Be ready for a shock. Your premium is going to be much greater.
Remember that homeowners’ insurance renews every year, meaning you are subject to increases annually. You might be in for a surprise, and you need to shop around to compare rates. After a couple of years with high claims in Mississippi and Louisiana due to devastating hurricanes a few years back (remember Katrina and Rita?), many residents in those states and neighboring states were shocked when their homeowner’s insurance bill doubled or even tripled. If you check rates for national companies, you will find that rates are higher even in states without a history of disasters, because the insurer needs to spread its claims experience among all of its policyholders. Insurers operating only in your state may have much lower premiums for the same coverage. In other words, you need to shop around to make sure you get the best coverage for the least cost.
4. Unexpectedly high homeowner’s association dues. If you are going to buy a home in a condominium development or even a neighborhood with a Home Owners’ Association (HOA), you need to do some research ahead of time. What are the annual costs? How often have they been raised? Are there any deferred repairs that are going to require higher dues in the future? How many members are delinquent in their dues? All of these questions have to be asked to assess the real added cost of joining the association (which is mandatory). Some mixed-use HOA arrangements are unfair to some portions of the members. For example, if the HOA includes both homeowners and condo owners, what are the relative costs assessed to each? Do the bylaws specify how future cost increases are spread between the two groups?
5. Added commute costs. Depending on the distance between home and work, you might have to pay much higher commuting costs because of your move. Check into this and find out how much more per month you will have to pay for a rapid transit system fare or, if none is available, for driving into work (including gas, wear and tear on your car and higher insurance rates, bridge and tunnel tolls, and parking). Depending on where you live and work, commuting can be a major monthly expense. When gas prices are high, I have seen people having to sell their homes just to move closer to work, in order to afford their commutes.

Buyer Beware

In this chapter, I have covered some of the most important considerations you need to think about when buying a home. Of course there is much more involved in deciding where to live, what you can afford, and what defines a safe and high-quality investment versus a more affordable but less desirable one. Everyone who is going to buy a home should look into all aspects of the city or town, the neighborhood and the specific property before making an offer. I have focused on the three areas I think are the ones where the greatest and most expensive mistakes are made: financing, real estate professionals, and home budgets.
In the next chapter, the even more troubling question of losing your home to foreclosure is addressed. This is a painful and frightening possibility that millions of Americans have had to face in recent years. But there are ways to reduce the expense and burden of going through foreclosure.
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