Buying a Home - How the Process Works

Are you thinking of buying a home? Learn how the process of buying a home works.

by John Stephenson

March 17, 2004

The American dream is to own a home. People love to have property that they can call their own and the typical American moves once every seven years. But for many people, the home buying process is a mystery. In this article we examine the basic steps in buying a property.

The first step before you even begin the search for the perfect home is to decide exactly how much you can afford to spend. If you haven't already set up a budget to show you exactly what you are spending your money on, now might be a good opportunity to start.

Many people start by visiting their local bank where they sit with a loan officer who reviews their finances and either pre-qualifies or pre-approves them for a loan. The difference between pre-qualification and pre-approval? If you have been pre-qualified, it means that a lender has reviewed your financial situation (your monthly income/expenses) and has estimated how much of a monthly mortgage payment you can afford. Pre-approval, on the other hand, puts you squarely in line for a loan (mortgage) because a lender has actually pulled your credit report, done some serious calculations to determine your debt-to-income ratio and has told you the amount that the bank is prepared to lend you for your new home. In most cases, it makes sense to get pre-approved rather than pre-qualified since you will know with certainty what you can really afford and if you are already pre-approved, a seller is much more likely to look favorably on your offer.

Other costs to consider? You should budget approximately 1% of the purchase price per year for maintenance and repairs to your property as well as the monthly cost for property tax and insurance. As well, you will have to incur certain closing costs when the transaction gets accepted and goes through. These closing costs, which can run into thousands of dollars, can really eat into your down payment. If you don't have at least 20% for a down payment, count on having to buy private mortgage insurance. Be sure that you discuss all of these costs with your real estate agent and lender so that you have a realistic budget as to what you expect to spend on your new property.

Once you know what you can afford, you can start the fun part of the process - looking for a home. It's really important when you start thinking about the home that you are looking to purchase that you give some careful consideration to what you really need in a home. Many people confuse what they want with what they need. Being within walking distance of a good school might be a need but a skylight in the family room might be a want. Early on, it will be important for you to consider a whole range of properties including condos and town homes. Until you see a great many homes, you will have trouble really discerning what it is that you actually want as well as need in a home.

If you ask a real estate agent what is the most important consideration in choosing a home they will tell you that it is three things - location, location and location. When you consider the location of the home you are thinking of buying, picture yourself in this home for several decades. Sure, you may be able to move to another home down the road, but many people don't end up moving. You should consider if the location of the home that you are interested in would be a home that you could see yourself in at different phases in your life. Here's a list of some questions for you to consider about the location of your next house:

• Close to Good Schools: Ask around. Are there good schools close by that your kids can walk to? Even if you don't have children yourself, the answer to this question could affect the resale of your house.

• Close to Town: How easy is it going to be for you to cruise into town to see a show or for grocery shopping?

• What About Work: How close is your new home to your job? For many people a long commute is a major source of job dissatisfaction. Why start off on a bad foot?

• What Else is Nearby: If your children play soccer, or you like to play tennis are these or other amenities close by that you can get to easily?

• Crime rate: Just how safe a neighborhood is this? Make sure you are buying in an area that has a low crime rate.

• Public Transit: Sure driving your car everywhere can be fun, but access to decent public transit can be a real plus.

• Taxes: Find out how much you're going to be shelling out for both city and county taxes.

• Zoning: It's extremely important that you do a little research to find out how the area is zoned so that someone can't slap a junkyard up beside your property at some future in time.

• Restrictive Covenants: Can anyone build? Find out if the area has restrictive covenants that will limit what can be built in your area.

• Homeowner's association: Is there an active homeowner's association that will be able to help maintain or better yet improve the area?

• Noise: Are you buying next to a freeway? How about being on the path of final approach for an airport? All of these factors will affect your quality of life.

• Safety/Environmental: Are you planning on moving in next to a nuclear plant (remember Three Mile Island) or is there a landfill nearby?

• Neighbors: Could you live with people like this? Go down to a local park on weekends and observe what they are like. Fights with neighbors are commonplace.

Now that you've thought through some of the major issues, it's probably time to start doing a little looking, but what to do first? Your first step is most likely to contact a real estate agent. An agent can help you sort through what is out there and can help you prioritize your search. Many people forget this key point that real estate agents really are working for the seller and not the buyer. Although they can be helpful, it is best to keep your own council.

The search will begin with the agent reviewing all of the appropriate listings in the multiple listing service (MLS). Once you have a short list of all of the homes that meet your criteria, you will be off looking at houses. As you start to see your first few homes, you will be struck by certain features that you just can't stand in a home and others you rather like. It is a good idea at this point to create a journal of the items that you like and dislike so that you can refer back to it as you begin to narrow your search. Another way to remember the features and the homes that you liked best is to bring along a camera to record the features that are most appealing.

Once you find a home that really peaks your interest, spend the time to be sure. It makes a lot of sense to view the home at different times of the day and to see what is going on in the neighborhood. Use this time to review any homeowner's association dues (if applicable) and to inquire about any restrictive covenants in the area.

Once you've found the house of your dreams, it's time to get down to business and make an offer. It's during the offer phase that your real estate agent or attorney is really going to earn his/her money. Once you make an offer, you are committing to a legally binding contract so it's important that you think through the offer carefully. The most important feature is the price that you are willing to pay (offer) for the property. But what's a fair price? Your real estate agent should be able to supply some answers by showing you a list of comparable properties in the area that have recently sold and what they sold for. If there are areas of concern about the property you are planning on purchasing, then make the offer conditional upon satisfying your concerns.

Some typical examples of items to include in your offer are:

• Home Inspection: You are laying out a lot of money for this new purchase. This is not an area to scrimp as a quality home inspection can turn up many faults that a casual walk through might not.

• Financing: Give yourself a little wiggle room. Make sure your offer is conditional upon your getting the mortgage you want.

• Purchase Price: How much are you offering to pay for the house?

• Timing: What is the deadline for the seller to respond to your offer?

• Items included in the purchase: Make a list of all of the items that aren't nailed down (major appliances, shrubbery) that you are interested in purchasing.

• Title contingencies: This is where your lawyer will go to work to do a title search for you and make sure there aren't any liens against the property or other legal claims and that the seller has clear title to the property.

In all likelihood, unless your offer is ridiculously low, you will be presented with a counter-offer from the seller. This is the seller's attempt to get as much from the transaction as possible. While their counter-offer may be perfectly reasonable, it is extremely important that you keep your head and not get emotional at this stage. Many people make the mistake of getting emotionally involved in a home purchase and forget that this is also a financial investment. While it may be exciting to bid for your dream, keep in mind the budget you set out at the beginning and try not to get too carried away.

It is always a good idea to make your offer conditional on a professional home inspection. Professional home inspections cost anywhere from $200 to $500, but are well worth it. A professional home inspector usually has some technical training (engineering, building) and has the advantage of seeing a huge number of homes. A professional inspector can point out the flaws and necessary repairs and give you an idea as to the cost associated with making the house ship shape. In choosing a home inspector, make sure that he/she is someone who is certified by the American Society of Home Inspectors and will follow a certain standard of practice that will be your assurance that the home you are buying is in the best shape possible. A home inspector will look for any defects that might end up costing you a boatload of money down the road.

Some of the features that an inspector will examine include:

• Foundation: Are there any water or structural problems with the house?

• Plumbing: Has it been properly installed? Is there any evidence of leaks?

• Electrical: Is it in good condition? Is there any evidence of code violations?

• Construction: What is the overall quality of the construction? Has the flashing been properly installed to protect the wood?

• Heating and Air Conditioning: Are they in good condition? Will a repair be needed shortly? Are they properly sized for the job they are being asked to perform?

• Interior: Are the floors level? Do the windows and doors function properly? Are the bathrooms and kitchen in good shape?

Once you have conducted the home inspection, your lawyer will take the final step of checking the title to make sure that it is free of liens or any other claims against the home. If there is free title to the property, your offer has been accepted and your home inspection turns up a clean bill of health, you have yourself a new home.

- John Stephenson

John Stephenson speaks and writes on a variety of money and wealth creation topics. His principal expertise is in the areas of investing, capital markets and small business. John is the founder of Report on Money and also runs The McConnell Group, an investment research and consulting practice. Visit his website ReportOnMoney.com to learn more about investments.