There have been rumblings for years from the Federal Reserve that interest rates are going to rise. But so far that hasn’t quelled homebuying activity. Median existing single-family homes clocked in at $229,400 in the second quarter of 2015, up from $177,000 in 2012, a rise of more than 29 percent.
In some markets, such as New York and San Francisco, prices have climbed much faster than the national averages, due to a supply-and-demand imbalance. That means buyers must do their due diligence and be in good financial shape before showing up at an open house; otherwise, it’s likely they’ll lose out to others more prepared to make a solid offer.
To navigate this often complicated and stressful process, here’s what both buyers and sellers need to know about homebuying.
For buyers …
Are you mortgage-ready? Banks’ willingness to lend money ebbs and flows with the economy, said Las Vegas Realtor Linda Rheinberger, regional vice president of the National Association of Realtors.
“The pendulum is swinging,” she said.
To be sure, borrowers with a credit score of 760 or higher (850 is the highest score) get the best interest rates. On a $300,000 mortgage, top borrowers would pay about $100 less per month than those with a score between 660 and 679, according to Fair Isaac, a credit score company.
If your credit score isn’t up to snuff, take some time to fix it before you start home shopping.
“You can turn your credit around in six months,” said Linda Ferrari, a Los Angeles real estate broker and author of “The Big Score: Getting It and Keeping It.” “If there are a lot of challenges,” she added, “it might take a year.”
Start by getting a copy of your credit report, Ferrari said. First, look for any errors and correct them. Second, pay down some debt. You can improve your score quickly by keeping the amount of money you owe to less than 25 percent of the credit you have available. That could boost your score by 25 points, Ferrari said.
Preapproval: a must-have. In a hot real estate market, a mortgage preapproval can make all the difference between winning a bid or not.
“If there are multiple buyers, you want the seller to know that you know what it takes to get this deal done,” said Jeff Goodman, a New York-based real estate agent with Halstead Property.
And if yours is the only offer on the table, a preapproval might help you snag a property for less than asking price, Goodman said. It signals that you’ve done most of the legwork already and there aren’t likely to be delays.
“In real estate, time kills deals,” he said.
What’s more, preapproval tells you how much you can borrow, explained Julie Held, co-owner and broker of Maple and Main Realty in Northampton, Mass.. “Otherwise, you may be looking at completely the wrong price range,” she said.
It’s important to know the difference between preapproval and prequalification, which people often use interchangeably. They’re different. Prequalification is an estimate of how much you can borrow. A prequalification may or may not affect your credit. It all depends on whether a lender checks credit reports during this stage and how often you apply.
Preapproval goes a step further and analyzes your creditworthiness. After that, all that’s left for the lender is to evaluate the property you wish to buy.
Down payments and closing costs. How much to put down for a down payment varies by market and by property type.
“Twenty percent is ideal in order to avoid private mortgage insurance,” Held said. Private mortgage insurance, which runs about 1 percent to 2 percent of your loan amount, will be tacked on to your monthly mortgage if you have less than 20 percent equity in your home.
First-time homebuyers under certain income thresholds can get a loan through the Federal Housing Authority for as little as 3.5 percent down. FHA will insure mortgages made through FHA-approved lenders.
FHA loan limits vary based by region. In the Bay Area and New York City, for example, the limit is $625,000 for single-family homes. Meanwhile, it is $271,050 for most counties in Alabama.
However, not all sellers will want to accept an FHA offer, because they worry that the appraisal might take longer and the inspections will be more rigorous. “The truth is, if you go in with 20 percent down and a preapproval, you’re going to get the home instead of someone with 3.5 percent down and FHA financing,” Ferrari said.
After the down payment, you’ll still need to have cash on hand for closing costs, which typically run 1 percent to 3 percent of the purchase price. In addition to fees paid to the bank, you’ll also need to pay for an inspection, property taxes and title insurance. Some lenders may roll up closing costs into your mortgage.
Remember to budget for your move, too. Along with direct moving costs, you’ll probably be running out to a hardware store every few days for something new to feather your nest with.
For sellers …
Watch the taxes. The federal allowance for how much profit you can get without paying capital gains tax is pretty high — $250,000 for singles and $500,000 for couples. To walk away without paying the capital gains tax, you must have lived in the home two out of the last five years.
But that doesn’t mean you won’t pay taxes on the sale of your home. Most states and municipalities also levy a transfer tax.
In some parts of Nevada, where Rheinberger of the National Association of Realtors works, that amounts to just a few dollars per $1,000 of the sale price. But in the Bay Area, where Linnette Edwards is an associate broker with Better Homes & Gardens, it runs to $15 per $1,000.
“On a million-dollar home, you’re talking about $15,000,” Edwards said.
Goodman, the New York City broker, tells of a Harlem townhouse whose owner needed six months to clear out a lifetime of papers and mementos.
“The buyers weren’t thrilled,” he said. “But they got the property, even though they bid $40,000 less than someone because they were willing to wait.”
Bridge loan. When you have children and pets, not to mention piles of laundry lying around, it can be nearly impossible to make your home ready for showings at a moment’s notice. Families, said Goodman, often prefer to sell their home after they’ve moved out.
In this case, if you don’t have the income to pay two mortgages at once, a bridge loan may be the answer. A bridge loan, also known as gap financing or interim financing, is a short-term loan — usually up to one year — that is backed by some form of real estate. Most borrowers take the bridge loan against their current property to finance the purchase of the new property.
Interest rates are high, however. Expect to pay about two percentage points more for a bridge loan than a conventional mortgage.
— By Ilana Polyak, special to CNBC.com