Singletude: A Positive Blog for Singles

Singletude is a positive, supportive singles blog about life choices for the new single majority. It's about dating and relationships, yes, but it's also about the other 90% of your life--family, friends, career, hobbies--and flying solo and sane in this crazy, coupled world. Singletude isn't about denying loneliness. It's about realizing that whether you're single by choice or by circumstance, this single life is your life to live.

Monday, March 2, 2009

Single Homebuyers: How to Buy Your Dream House, Part I

Calling all single house hunters! So you've considered whether single homeownership is right for you, and you've decided that being home alone isn't just for formerly cute child actors. Well, you're in the nick of time. Interest rates are at an all-time low, it's a buyer's market, and President Obama just introduced a significant tax credit for homebuyers. You're ready to pluck your castle out of the sky, set it down at the end of a cul-de-sac, preferably next to an in-ground pool, and pay property taxes for the pleasure of doing so. If that sounds like a little piece of heaven to you, then it's time to figure out how to lasso your castle and bring it down to earth!

Your home may well be the biggest purchase you ever make, so the process of house hunting, bidding, and closing can be intimidating even when you have support. When you're on your own, it may seem insurmountable, especially if you're a first-time homebuyer. That's why Singletude is going to break it down into digestible steps.

Before you dial a realtor about that three-bedroom, 2.5-bath steal in the paper, you'll want to prepare yourself for the financial reality of buying your own house. This entails completing a bunch of mundane tasks before you start on the fun part. But if you do the legwork now, you'll be perfectly positioned to make a move on your dream house. Here are the steps you'll need to take in advance:

1. Got credit?
Check your credit reports from the three major credit reporting agencies, Experian, Equifax, and TransUnion. You are entitled to one free report from each agency every year. You can order them separately or all at once. If you notice anything fishy, get that squared away before you continue down the road to your new home. In this economy, lenders are tightening their fists, so you should do everything in your power to reverse a poor credit score and aim for 740 or higher. To that end, rid yourself of credit card debt or at least reduce it to no more than 25-30% of your available credit. Don't open new credit accounts or make major purchases prior to applying for a mortgage. If late payments are a problem, adopt a strict schedule to pay your bills on time. (Hint: Many banks let you authorize automatic electronic payments so that forgetfulness or procrastination won't trip you up.)

2. Bank on your savings.
The gold standard for mortgage down payments has long been 20% of the purchase price. During the housing boom, lenders catered to the nesting frenzy by doling out loans requiring as little as 5%, 3%, or even 0% down, but these liberal lending practices backfired on both banks and homeowners when the recession hit. Most financial advisers agree that the bigger the down payment, the better, but that can be problematic for singles, who don't have a second income to set aside.

Luckily, singles who are scrimping for a down payment have options to help finance that house of dreams. Some mine their retirement accounts, particularly IRAs 0r 401(k)s. An IRA is a good source of funding because there's no early withdrawal penalty if the money is used towards your first home. (Your withdrawal will be taxed, though.) Tapping a 401(k) is trickier. Although you can borrow up to the lesser of $50,000 or 50% of the sales price--and the loan won't count as debt when qualifying for a mortgage--you only have five years to pay it back with interest before taxes and penalties kick in, and if you quit your job or get laid off, the payback period is shortened to a near impossible 90 days.

A popular alternative that doesn't tamper with savings is for parents or other family members to either gift money or participate in a shared equity mortgage, contributing the down payment as a kind of loan that can be returned with interest in the form of a cut of the profit from the sale of the house.

If your father isn't Daddy Warbucks, though, there's still hope in the form of nonprofit state housing finance agencies and other down payment assistance programs, which offer cut rate loans to those of modest means. (Beware, though, that if your financial situation improves dramatically or if you try to "flip" the house, you may be heavily taxed.) Most of these are backed by the Federal Housing Administration (FHA), though some have private funding, such as Habitat for Humanity. FHA-insured loans are subject to stricter regulations since the passage of the Housing and Economic Recovery Act of 2008. For instance, the minimum down payment has increased from 3% to 3.5%, and 5-10% is even better. Also long gone is the much-abused seller down payment assistance program. However, remember that this new legislation is in place to ensure that you don't bite off a bigger mortgage than you can chew.

Now perhaps you're a single who finds yourself in special circumstances. For example, maybe you're a veteran. If so, you're entitled to a loan from the VA. Or maybe you work for a large corporation, in which case it may have a plan to assist employees with down payments.

3. Do the math.

Figure out how much house you can get for your money before you fall in love with that 10,000 square foot mall--err, manse--on a hill. A good rule of thumb is that the house you buy should cost no more than 2.5 times your annual income, but your other expenses, such as student loans, car payments, or credit card debt, may modify your maximum. You can calculate your debt-to-income ratio using a basic formula or input the relevant info and leave the dirty work to an online computer. Ideally, the total monthly cost of all your obligations should not be more than 36% of your monthly income. However, understand that even today's wary lenders may qualify you for a mortgage that exceeds what you can realistically pay each month. So determine how much you can handle yourself, and don't let desperate mortgage brokers talk you into a risky venture. They are infamous for doing just that to inexperienced singles, as we will see later!

4. Obtain your seal of approval.
The only surefire way to know what you're qualified to shop for is to get pre-approved for a mortgage. Pre-approval makes the whole process, from house hunting to bidding to closing, faster, smoother, and less anxiety-provoking. When you visit lenders, be prepared to present your bank statements, assets, proof of income, tax returns, credit history, and records of any outstanding debts.

Don't hesitate to shop around for the financial institution that can give you the best deal. The Internet is a great place to start, but don't overlook local, more personalized banks, which may be hungrier for your business. When making your decision, ask about factors like interest and annual percentage rate (APR), third-party vendor fees, which can add up quickly, rate locks, and prepayment penalties. Sound mind-boggling? See this list for a rundown of questions you should direct to any potential lender. Another talking point should be, well, points! The mortgage game is likely the only one you'll play in which buying points isn't cheating. Each point you buy, typically for a fee equalling 1% of the mortage, will reduce your interest rate by about .25%.

You may also contract a broker (or multiple brokers) to help simplify your decision, but be sure to get full disclosure of his or her fees and verify that he or she is contracted as your agent. Otherwise, that chuckling, cherub-faced broker who looks like the second coming of Santa Claus can sell you on a loan that makes him fatter in the pockets while you're left tightening your belt.

Though the U.S. isn't known as a marketplace for hagglers, this is one purchase you can negotiate. Make it known that you're considering competitive rates from other lenders. Ask your broker outright if the interest rate he or she has quoted was the lowest rate offered that day. Request that he or she make a list of all the costs associated with the loan so you can see the big picture, then bargain for a reduction on the interest rate, points, or other fees. (Check that Mr. or Ms. Craftypants doesn't reduce one fee while increasing another!)

Most importantly, stay alert to singlism. Throughout your journey to the perfect home, you may confront discrimination against singles, which is magnified if you're a woman, a person of color, or both. That's why you should take care to dress and speak professionally, familiarizing yourself with the lexicon of mortgage lenders before you meet with brokers. You may need to be especially forceful when bargaining, so an appearance of self-confidence is key.

One more thing--please remember that pre-qualification is not pre-approval. The former is a much less thorough assessment that can result in an inaccurate loan estimate, so make sure you're getting pre-approved, not pre-qualified.

5. Borrow on your future.
In the wake of the housing market collapse, be aware that you won't see the menu of loans that characterized the early half of the decade. Again, remember that this was a necessary correction that will help keep you from overtaxing a stressed budget and succumbing to foreclosure! The best choice by far, if you can qualify for it, is a fixed-rate loan, and the bigger your down payment and better your credit score, the lower your interest rate will be. Fixed-rate loans usually have a term of 15 or 30 years, and, as of this writing, the current interest rate averages 4.9% for a 15-year loan and 5.4% for a 30-year.

Unfortunately, not everyone falls in the upper end of the credit-worthy bell curve that qualifies would-be homeowners for fixed-rate loans. Before the housing bubble burst, flooding the market with foreclosures, a crop of so-called exotic loans sprang up to fill the void between homebuyers' dreams and interest rate realities. Many of these loans can be grouped under the header of adjustable-rate mortgages (ARMs), which have fluctuating interest rates. Like insidious, creepy-crawly critters lurking in the basement, ARMs come in many different breeds, shapes, and sizes, but, sooner or later, they're all liable to sting when you least expect it. Particularly dangerous varieties of ARM include the hybrid ARM, in which a fixed rate expires and becomes variable after five or ten years; the interest-only (I-O) mortgage, which permits the homebuyer to pay just interest on the loan for five or ten years; the negative amortization (NegAm) mortgage, in which not even full interest is paid each month so that it accrues on the balance; and the payment-option ARM, which advertises shockingly low-interest "teaser rates" for a few months to encourage homebuyers to dig themselves into an upside down grave.

The victims of these predatory lending practices were the most vulnerable homebuyers, the ones who couldn't afford hefty down payments and didn't qualify for guaranteed low interest rates. They were young professionals, students, and--you guessed it--singles. They gambled on rising wages and home appreciation to offset the doubled or even tripled monthly premiums they would eventually face. When the recession collected on its debt, they lost. Single women in particular were targeted by predatory lenders who convinced them that exotic ARMs were their only option even when they qualified for far better rates. Some lenders went so far as to promise that ARMs could be refinanced at a fixed rate, only to renege later, and the most unscrupulous deceived singles into believing that their ARMs actually were fixed-rate!

Nowadays, "exotics" have fallen out of favor with lenders and buyers alike. But traditional ARMs, whose main high-risk proposition is a variable interest rate, are still part of the mortgage landscape for "subprime" borrowers. Although these loans have not caused as many headaches as expected in recent months, a future resurgence in interest rates could send millions of homeowners into default. If you must accept an ARM, protect yourself by asking the tough questions upfront. Before you sign anything, you should know...

...if you will need private mortgage insurance (PMI), a common requirement for non-FHA ARMs.
...the APR, when it's increasing, and by how much.
...the length of your adjustment period (the time between interest rate changes), which can be anywhere from one month to several years. the interest rate will be calculated.
...the cap on your interest rate.
...the cap on negative amortization if negative amortization is a possibility. long the points you buy will apply.
...if you can convert the ARM to a fixed-rate mortgage and, if so, when and at what interest rate.
...if there will be prepayment penalties should you sell or refinance.
...the worst case scenario (i.e. your monthly payment at its highest should interest rates peak).

The last is the most important because, based on that worst case scenario, you can now conduct a thorough self-examination. ARMs work best for homebuyers who will only be paying an adjustable rate in the short term. So if you plan to sell or refinance at a fixed rate in a few years, an ARM may be worth the risk when interest rates are low, as they are now. However, if you're in it for the long haul, be honest with yourself about whether you can afford the worst case scenario. Unless you're in one of a very limited number of professions, such as law or medicine, in which the timetable for a salary increase is virtually guaranteed, you can't be sure that you'll get that promotion next year or that you'll even have a job, for that matter. And don't forget to account for ongoing expenses that might become part of your life in a few years (think car payments, student loans, and the like).

recommends that you take out an ARM only if you can carry the heaviest monthly payments in the worst case scenario on your current savings for at least six months. That way, if you are deprived of your anticipated source of income at a time when interest rates soar, you will have a cushion between you and your creditors while you find work, refinance, or sell. If you don't have access to that kind of money, then I say start saving. By the time you do, you just may qualify for a fixed-rate mortgage anyway. ;)

In the end, if you realize that you can't afford a single-home mortgage at this stage in life, don't despair! If you're determined to go it alone, you may find that a condo or townhouse is the right size at the right price for a starter. Or, if that's still beyond your reach, perhaps the goal of single homeownership will be your motivation to learn financial discipline or advance your career.

On the other hand, if you believe in teamwork, you may want to join thousands of singles who have paired up with family members or friends to purchase a house together. Since these arrangements aren't formed with the automatic protections that married couples enjoy, you should have a real estate lawyer draw up a legal agreement specifying how the costs of homeownership will be shared and how the profits will be distributed should one or both of you wish to sell. But for open-minded, flexible singles who know each other well and are committed to each other's welfare, buying a home together is the perfect strategy to break free from the tyranny of an economic system that all but restricts quality housing to married couples.

If you're a would-be single homeowner who was dreading the mortgage pre-approval process, hopefully you're now more informed and therefore more confident about applying. The better prepared you are, the more likely it is that you can avoid marital status discrimination and secure the most advantageous loan for you! When our single homebuying series continues, we'll jump right into the good stuff: house hunting. It's not just for TV. :)

If you're an aspiring single homeowner, what tips can you give to singles who are trying to improve their credit and increase their savings? If you're already a single homeowner, what advice would you give to other single homebuyers about the mortgage pre-approval process? What kind of mortgage would you recommend to first-time single homebuyers? Did you experience any singlism when applying? Would you ever consider buying a house with a friend or family member who was not a romantic partner? Why or why not?

Fun Link of the Day

Do you have a question for Clever Elsie about some aspect of the single life? Have a rant or rave about singlehood? Write in, and you just might see your question in a Singletude Q&A or your rant or rave in a Singletude Sound-off!


Anonymous said...

Wowee, what an excellent and thorough resource -- I'm sure it'll be valuable for many house-shopping singles.

Thanks for posting.

-- Lisa at Onely

Clever Elsie said...

Lisa: Thank you for the compliments! Glad to know I could provide some useful info. :)

Alice Kuder said...

I, too, am very impressed by this well-researched, well-written article! As a licensed real estate agent who specializes in helping single home buyers, I am very happy to have found this additional resource. I agree with every word you wrote; I believe it is very solid and practical advice. I only recently discovered your site and I'm looking forward to delving into it more deeply.

Clever Elsie said...

Alice: Welcome to Singletude! Thank you so much for your positive feedback! I really appreciate hearing from an expert in the field. Parts II and III of the house hunting series are coming up soon, and I'd love to get your response to those, as well. I hope you'll stick around.