By: Melissa Banion, CPA, MT
Buying a house will likely be the largest purchase you make in your lifetime. It is a significant investment and much consideration should go into your decision-making process before executing the transaction. Yes, it is scary and can be overwhelming if you are not prepared and do not do your homework before jumping in. Luckily, the Tax Warriors® are here to give you guidance before you contact a real estate agent.
The home-buying market is different than it was a decade ago. Caused in part by faulty mortgage loans, the real estate market crash put the brakes on lending for all but those with perfect credit and large down payments. Today, credit is harder to obtain, but it is cheaper than ever. Use this post as a checklist to prepare for the home-buying process.
Know your budget
Just as you would do with any apartment search, you must know what you can afford after factoring in your other monthly expenses. Remember to compare your net pay (after taxes, payroll deductions, etc.) to your monthly outputs for food, clothing, student loans, car payments, insurance, etc. It wouldn’t hurt to include a little extra cushion for “fun” for those unexpected outings with your friends or surprise expenses.
Check your credit
Among the criteria banks check before lending you money is your credit score. Know what adverse factors could show up on your report and what you can do to either eliminate them or improve your score before attempting to become pre-approved on a mortgage. There are free online credit report services you can check before an official report is run by a lender. Review your credit report for inaccuracies and resolve any that exist as soon as possible.
The pre-approval process takes a few minutes and will require you to answer some questions. Your realtor can suggest different mortgage companies to contact. Many offer assistance programs for first-time home buyers. Once pre-approved, the approval lasts 60-90 days. Use this time to search for your home. The pre-approval is necessary so the lender already knows your credit history and the loan amount for which you qualify.
Be open minded
While searching for a house, remain open-minded about the process. Prioritize your preferences and accept it may be difficult to find a home with everything you want. Also, keep in mind the potential resale value of the home. Promotions, relocations and other life events may suddenly cause you to move.
Find a trustworthy realtor
Find a realtor who will be honest with you during the entire process and who will do their due diligence when finding houses for you. If you do not know much about the process, which is typical of first-home buyers, you will need to rely on your realtor’s knowledge and experience. A referral from someone you know and trust who has already gone through the home-buying process is a good way to go.
Don’t assume once you submit an offer, it is smooth sailing and the house is yours. Remember not to get your hopes up on a specific house because others may have their eye on the same property. Be prepared to submit various offers; and, even after your offer is accepted, you are still not home free.
If your offer is not the only one, a bidding war could erupt. You will likely need to increase your offer or negotiate other terms such as the down payment or the seller’s assist to make your offer more attractive. A seller’s assist is closing costs included in the purchase price and it also increases your mortgage. Sellers want reassurance that your mortgage is secured and the closing will go smoothly.
Shop for inspectors
You can either use an inspector your realtor recommends or you can research different inspection companies and hire your own. Referrals from people you trust are always an excellent way to go if you are not familiar with what happens during inspection or how much it costs, which is typically a few hundred dollars.
If this is your first time going through the process, ask questions. The more knowledgeable you are before making a decision, the better. Important information about properties is discovered during the inspection, so learn as much as you can to minimize surprises and potential future issues. If something about the house doesn’t feel right, don’t settle or be afraid to walk away.
Lock in your interest rate
Be familiar with current interest rates and trends while searching for a home. Once you lock in your rate, you cannot change it until you refinance which depending on the mortgage company, you usually cannot do until six months after closing. You will pay a lot of interest over time on the money you borrow to buy the house so any slight change in the rate, even 0.25%, can heavily affect the economics of financing your home.
Figure your down payment and know what you will need at closing
In addition to developing your budget, know how much you can put down on the house at closing. Don’t forget to factor in closing costs, which can be several thousand dollars. Closing costs include things such as escrow for real estate taxes and home owner’s insurance, transfer taxes, loan origination fees, and title insurance. Know what is included in your future monthly mortgage payment so you know you can afford it. Your mortgage payment will likely include escrow for real estate taxes, home owner’s insurance, and PMI (private mortgage insurance, which is additional insurance you must pay if your down payment is less than 20% of the cost of the home).
Gather documentation and be timely
Once you decide on a mortgage company, they will ask you for various documentation such as bank statements, tax returns, W-2’s, etc. Be prepared to provide these documents. Most can be retrieved online, from your employer, or from your bank. The more organized you are, and the more timely you gather the information, the smoother the process will be.
Be sure all issues have been resolved
Do a final walk through of the house with your realtor to ensure all issues arising during inspection are resolved by the seller or credits will be factored into the closing price, covering repairs after the purchase.
Read what you are signing…entirely…yes, all of it
You will be presented with countless documents and pages of legal language, which can be overwhelming. Reading every page at the table is a little unrealistic. Read as much of the draft documents provided as you can before closing so you know your rights, the timeline, and what you might be liable for if the deal falls through.
The mortgage interest and real estate taxes you pay at closing and throughout the year are tax deductible and reported on Schedule A as itemized deductions. Usually, first-time buyers have been taking the standard deduction on personal income tax returns, so this is a change some do not realize will occur. With the uncertainty around itemized deductions related to potential tax reform, the deduction for real estate taxes paid may change; however, President Trump has stated he plans to specifically retain the deduction for mortgage interest.
A credit of up to $500 is available with the purchase of qualifying energy-efficient improvements such as appliances, windows, HVAC systems, etc. When making large purchases for your new home, check if they qualify for one of these credits and note different limitations exist depending on the property.
Later, upon the sale of your personal residence, any gain you make from the increase in value of up to $250,000 (if filing single, $500,000 if married filing joint) is excluded from your taxable income if certain criteria are met. You generally must have lived in the home for two out of the five years prior to the sale to qualify.
Hopefully these tips will help you secure your first home with as little stress as possible. As they say, being well informed is half the battle. Do not forget to ask questions along the way. Good luck in your search!