Meet Emily. Emily has been looking for a house in the suburbs, and just finished touring a beautiful home with her agent. Emily loves the home, but doesn’t know what to do next. What should she do? Well, Emily’s first step is talk to her agent about making an offer for the home. Given the cue, her agent will analyze the prices of comparable properties to determine the best offer price, and then draft up a formal offer letter for Emily to sign and send to the seller’s agent.
Once the letter is sent, Emily’s agent and the seller’s agent will then enter into several rounds of negotiations to reach a mutually agreeable deal. If the seller agrees to the offer, both parties will then sign a purchase and sales agreement.
This document specifies, among many things, the price and closing date of the sale, as well as the contingencies and earnest money. Contingencies are simple: they’re the conditions that need to be met in order to close the sale, such as the house getting a clean bill of health from a professional inspector. The earnest money is a bit more complicated. It’s the amount of money, usually between 1 and 3% of the home’s price, that the buyer pays after signing the purchase and sales agreement.
If the sale closes successfully, that money will be applied to the down payment. If the sale isn’t successful, but for a reason covered by a contingency, the buyer gets the earnest money back. Otherwise, the seller gets to keep the money. Unfortunately for Emily, shelling out cash isn’t all she has to do. Over the next 30-45 days, Emily and her agent will schedule a professional inspection of the home and its title, which is simply a legal history of everyone who has owned the home. At this point,
Emily will also contact her lender, who will schedule an appraisal of the home and require Emily to get homeowners insurance, which we cover in detail in our video “Homeowners Insurance 101”. Then, assuming the appraisal goes well and the house is worth as much as Emily says it to be, Emily’s lender will approve her pre-approval letter and submit a loan commitment letter to the seller’s attorney.
However, this may not happen, especially if Emily invalidated her pre-approval letter, through something like a decrease in credit score. If this is the case, Emily should shop around at several more lenders to get her mortgage, all while following these three rules to avoid financial distress.
Rule 1: Keep the total price of your home below 2.5x your annual income.
Rule 2: Keep your mortgage payments, plus insurance and property taxes, below 28% of your pre-tax income.
Rule 3: Keep all of your debt payments, including the mortgage, below 36% of your pre-tax income. Also, if at any point Emily feels a little lost on loans or how to calculate their payments, we highly recommend she check out our two videos “Loans 101” and “Loans: Mistakes and Best Practices” before continuing.
Finally, assuming the mortgage is ready to go and the title and the home have passed inspection, Emily and her lawyer can review and sign a final stack of documents, including the very important HUD-1. This document will cover the details of the loan, including the closing costs, which Emily will now need to pay.
These costs generally run between 2 and 5% of the home’s purchase price, so Emily should be sure to budget for them accordingly. Then, once the money has been transferred and the documents have been sent to the county government, Emily will be registered as the home’s new owner. Emily and Olivia can finally move into their new home! Congratulations! You have finished the home buying curriculum! If you want to see our free recommendations for real-estate agencies and mortgages, or just more educational material, be sure to check out our website!