This newsletter is my process of writing a self-help book, tentatively titled How To Make Money: Financial Advice For Poets.
Previously I wrote about how to buy your first house. But a lot of that letter was about why you should buy your first house and how the reasons people give for not buying their first house are often just lies; the kind we tell ourselves about all sorts of things, our entire lives, right up until the moment we die where, if we’re unlucky, there’s a brief moment of clarity before we slip into the ether and never return.
This is a little more nuts and bolts on the process. And will probably be very boring for anyone who is not interested in buying a home.
This isn't about why you should buy a house. The answer to whether you should buy a house is yes, as long as you can make the payments. And often even if you can’t. This is just how one goes about it.
You need 3 things to buy your first home, maybe only 2.
The 1st is a down payment. At least 5% of the purchase price. Because this is essentially a subsidized loan, in America you can purchase a house at a low interest rate with very little money up front. You'll never be able to do this again, with any other purchase. A commercial property, for example, requires 25% down.
I recommend you get the best possible house you can afford. This might seem counter-intuitive because you're nervous making the largest purchase you've ever made. Non-the-less, it's true. As long as you can make the monthly mortgage payments, buy the most house you can afford.
Side note, if you pay less than 20% down you'll also pay up to $200 a month in mortgage insurance. But after a few years you’ll probably be able to refinance and get rid of that expense.
The 2nd thing you need a good credit score. There are ways to buy a house with a lower credit score, government programs and so forth. But I'm not as familiar with the ins and outs. Protect your credit score with your life. It's possibly the most important thing you have. I'm not a big fan of scammy programs to improve your credit. You have to be careful with those. The main thing is to pay your bills, in full, on time. Never carry a credit card balance, ever.
If you have the down payment, and the credit score, the next thing you need is income. Even if you're doing a 5% FHA loan, you need to convince the bank you can make the monthly payments. If you have W-2 income (aka a job), especially if you've worked at the same place for over a year, then you're golden. There is nothing a residential mortgage broker likes more than W-2 income. When a lender sees a W-2 it’s like a werewolf looking at the moon, or Quentin Tarantino looking at Selma Hayek in Dusk Til Dawn.
Next you find the house you want to buy. Where do you find the house? Probably on Zillow, or Trulia, or Realtor.com. There are a bunch of these sites, and they're mostly listing the same places. Many of them have open houses. You can just stop by.
If you know where you want to live you can also drive around and look at for sale signs. Investors often want to find off market houses that need a little work, that they can purchase for less than market value and fix up. But that's probably not what you're looking for when buying your first home. You're looking for a place you can move into. You probably have a job; you're not trying to fix and flip.
Buying a first home has almost nothing in common with buying an investment property.
There's a lot of cost in not buying a home. Let's say you're paying $2,000 in monthly rent, and it takes you six months to find your house. Well that's $12,000 in lost rent while you were searching (not to mention 6 months of appreciation). So if you were holding out for a good deal, and you saved $10,000 on the purchase price, that would actually be a loss.
This is especially true in parts of the country where your mortgage payments are less than your rent payments. But even in places where the mortgage payments are more than rent, like Manhattan, the rents always catch up and eventually the mortgage is less than monthly rent for a similar home.
Figure out what houses cost in the area you want to live in. Remember, you might own this house for 30 years, so paying a little more or less probably doesn't matter as much as you think. Also, the price of the house is amortized over 30 years, the life of the loan. So say the owner wants $450,000, but you only want to pay $420,000 for the house. First, you can just offer whatever you want to pay. And in most situations you should offer less than the house is being marketed for, depending on the local environment. But the difference in monthly payments on a $420,000 home vs. $450,000 is about $130, not as much as you might have thought.
Of course, when you go to sell that house the $30,000 would make a big difference. Real estate investors will tell you you make your money on the purchase. But if you hold onto the house for 20 years the difference in price won't have much of an impact. And the other benefits of owning a home are cumulative. Saving $30,000 on an investment property is much more important than saving $30,000 on your first home that you intend to live in. There is significant benefit to buying your first home as soon as possible.
I'm not saying you shouldn't try to get the best price, you should. But you also need to stop paying rent, yesterday.
Imagine if 2/3 of your rent was tax deductible and 1/3 went into a long term savings account you could cash out in 10 years, that's what a mortgage is.
When you're buying the home you don't pay the real estate agent, the seller does. The agent doesn't matter very much to the buyer and are essentially interchangeable. If you have a friend of the family, or friend of a friend (no one is too far removed from a real estate agent) that person is fine.
Your agent should not ask you to sign anything exclusive. If they do they're either amateurs or scammers. Walk away and go to an agency. In a real estate agency all the agents work under a broker, so there is a layer of supervision. If you don't have an agent, the seller's agent, by law, has to treat you as a client. People think that's a conflict of interest but if your agent also represents the seller they have a strong motive to encourage the seller to choose you and will likely advocate for your interests if, for example, you request a price reduction. Not having your own agent can definitely be an advantage.
When you're selling a house who you choose as an agent, or whether you choose an agent, matters quite a bit. But that’s not what we’re talking about.
Now in the current environment, with interest rates extremely low, you can expect payments on a $340,000 loan to cost $1,900. That includes insurance and property tax which will be paid by the bank on your behalf. So if you put down $60,000 on a $400,000 house, $1,900 is your monthly nut.
You need to find the person who's going to loan you the money. That's most likely a bank. For a number of reasons (some of them mysterious) your best bet is to go with a small local bank. This is the primary reason why small local banks exist. But there are also mortgage brokers. It's mostly the same. Find out what the fee for the loan is, and the interest rate. It's OK to shop around.
Larger banks, like Wells Fargo, offer worse deals and don’t know your market.
Every lender is different. The most important thing to remember is that if you get turned down for a loan it doesn’t mean anything. I've been turned down 4 times. I was turned down on my very first attempt to purchase my first house (like water off a duck’s ass). You go to the next broker. They all use different metrics. You're communicating with a middle-man who is going to attempt to sell your financial story to an underwriter. They all look at different things, differently, and something is always lost in the telling. It means nothing at all if the first bank turned you down. Until you've been turned down 10 times, for the same reason, pay no attention.
It makes me crazy when I see people who are unwilling to query a second lender. It's like when you're trying to sell a book and you get rejected by an agent. Or your boyfriend breaks up with you. It doesn't matter what they tell you. There is very little to learn from rejection, and people who reject you more often than not lie about their reasons.
You can find a lender first or you can just start looking at houses. I recommend you just start looking at houses. Today. But if not today this weekend is also good. In a very hot market, like Miami, a realtor might not take you as seriously if you just show up to an open house without pre-approval from a lender. But in almost every situation they won't even ask. Because they all know that a pre-approval letter is meaningless. You could write your own pre-approval on a sheet of paper and it would have just as much value. It guarantees nothing, the lender is promising nothing. Any broker can write a pre-approval on company letterhead without talking to their boss. It's essentially bullshit. A small hoop to jump through that signals you’re a little more serious than you were yesterday.
So then you find the house and you make the offer. But the offer, if accepted by the seller, is contingent on the bank approving your loan. If the bank doesn't offer the loan you are off the hook and you get any money you included as earnest money refunded (usually $2000, or something like that). Since funding does fall through, and it takes two months to close a loan, sellers prefer buyers who are making all cash offers. But that only really matters in places like Los Angeles. And if you're offering all cash you can usually get a discount on the price of the home. Often a significant one.
But in most of the country this is a non-issue. Show up. Make the offer. Buy the house.
After you buy your first house you'll be amazed how simple it was. You'll shake your head remembering how intimidated you were and how complex the whole operation seemed. But buying a house is not complicated. Everyone in the process, the seller, the agent, the appraiser, the banker, the mortgage broker, is heavily incentivized to get you across the finish line. With all of them, you are the customer, and their job is customer service.
Don't over think it. You can do this.
Unless you don't have any downpayment, and a low credit score. In which case maybe you can't.
Thank you for reading. I hope this was a little helpful and not too boring.
Don’t forget to like and leave comments and if you share on social media that would make me super happy. The interaction is the only reason for writing really. That was always true. Even when I was a kid.
p.s. I would love it if you would send questions. If I get enough questions I’ll make the next letter about answering them.
Not at all boring, Steve. I may have heard this before but still nice to see it written down!