Before we bought our home three years ago, I had ideas about the home buying process. As it turned out, most of my ideas were wrong.
Here are some of the things I misunderstood.
1. You need twenty percent for a down payment.
Depending on your credit, you can pay as little as 3% down for a conventional loan (though 5 to 10% is more the standard). For an FHA loan, you can put as little as 3.5% down.
But if you put less than 20% down, you will have to pay monthly private mortgage insurance (PMI).
2. You owe PMI until you've made enough house payments to have 20% equity.
As your home's value increases, your equity in the home increases. Your down payment, plus the amount you've paid toward your principal, PLUS an increase in your home's value can bring your loan to value (LTV) ratio to 80% (meaning you have 20% equity).
Here's how the whole PMI thing works.
3. I'm pre-approved for a home loan, so I am guaranteed a home loan.
A pre-approval is based solely on your credit score and your answers to a few questions. Pre-approval doesn't mean anything unless the mortgage company has looked at all of your paperwork (two years of W-2s, current paystubs, two years of tax returns, etc.)
I had one bank pre-approve us for a loan in 20 minutes over the phone, but when it came time to get serious, they didn't know what to do with our freelance income.
The mortgage company that works with our credit union wouldn't pre-approve us until they looked at all our paperwork. Then they were able to give us a much more sound pre-approval and a better idea of what amount of loan we qualified for.
4. Your mortgage payment never changes.
The principal plus interest payment never changes on a fixed rate mortgage (though how much of that payment is interest and how much of that payment is principal changes). BUT your escrow payment (taxes and insurance) can change. And your HOA or condo fees are likely to change over time.
The second year in our home, our escrow payment went down $200 a month. Yay!
The third year, it went up $400 a month from the second year payments. Whoops.
The reasoning is complicated and boring but basically it never should have gone down in the second year. In the third year we are paying $200 a month to make up for the property tax shortage of the second year plus $200 a month to avoid a shortage for this year.
5. If my mortgage is $1,000, then I pay $1,000 toward my home loan each month.
This blew my mind. Only a quarter of my mortgage payment goes toward the principal balance of my home loan. And it will be this way for many more years.
About half of my payment goes toward interest and the last quarter goes into escrow for taxes and hazard insurance.
This amortization table will give you an idea of how much you'll pay in interest vs. principal every payment over the life of your loan.
For example, on a hundred thousand dollar loan at 5% interest over 30 years, you'll pay more interest than principal every month for the first sixteen years of your loan!
6. I'm buying my house for the price on the paperwork.
You agree to buy a house for $220,000. You pay the seller $220,000. But you aren't paying $220,000 for your house.
After paying 4% interest for 30 years on a $200,000 loan, you'll actually pay $343,739 plus the $20,000 you put down for your house. And that price doesn't include taxes or insurance or closing costs.
7. I just need one inspector to tell me what needs work on the house.
You absolutely should get a separate sewer inspection. We were told by our general inspector that the sewer was fine. Because of a friend's bad sewer experience, we got a separate inspection just to be sure. Turns out there was a clog and a leak under the kitchen. Ten feet of pipe had to be replaced at the expense of the seller.
I would recommend you also have a certified electrician and an air conditioning/heating expert take a look. I wish we had done that.
8. As a buyer, I have the power in the negotiating process.
You don't have the power when there aren't a lot of houses on the market (aka high demand and low supply).
When there are multiple offers, you have to be the highest bidder.
Then (if your offer is accepted) the sellers don't have to agree to any of your post inspection demands, because they know that they can sell the house easily to someone else.
9. My offer was accepted, so the house is mine.
So many things can go wrong, from the acceptance of your offer to actually getting the keys in your hand. Deals fall through all the time on the seller's or buyer's end.
Your financing can fall through. There can be problems with the title (aka the seller hasn't been honest about fully owning the home or making payments on time). The inspection can reveal major problems. Or the house can appraise for less than your offer.
10. The seller has to disclose all potential problems with the house.
There is only one Federal disclosure law and that has to do with lead paint. All other disclosure laws vary by state and most of them don't require the seller to look for potential problems.
In other words, in a lot of states the seller doesn't have to have the electricity checked or crawl under the house to look for termite damage. The inspection process falls on the buyer.
And, of course, sellers don't have to tell you about the terrible neighbors.
11. I have to pay a realtor.
Sellers pay a realtor fee and that fee is split between the seller's realtor and the buyer's realtor. A realtor costs a home buyer nothing. Here's how to find a great realtor.
12. Once I've found a house and have pre-approval on a loan, the process should be quick.
It's slow. It's painfully slow.
There's a lot to learn during your first home buying process. You'll be way ahead of the game, if you don't buy into the above myths.
I wish you lots of luck and happy house hunting.
Photo: Brian Rinker