Buyer FAQ

How much house I can afford?
How much house do I want to afford?
What are some tools that can help me figure out where to buy?
How can I find homes that are out there for sale?
How can an agent help me, and how do agents get paid?
What kinds of things should I look out for when evaluating a home?
How do I know what’s a fair offer price?
What are the elements of the offer?

How much house I can afford?
What you can afford depends on several factors: the amount of money a bank will lend you and the amount of money you’re willing to spend. Back in the heyday of liberal mortgage lending, I was always amazed at what banks where willing to lend me–usually much more than I thought I could reasonably afford. At another time (and with a specific property) I couldn’t understand why a bank wouldn’t lend me money.

How much, on what terms, and, indeed, whether or not a bank will lend you money depends on a variety of factors: credit score, income, assets, and property type. Credit score is fairly self-explanatory: the higher your score the better your rate, or, in many cases, the better chance of getting a loan at all. Income most often means W2 income (the kind you receive as an employee at a job) but can also mean self-employment income. In the first case, you may need to provide a lender with a few recent pay-stubs. In the case of self-employment income, you’ll typically need two years of tax returns. Property types can include single family homes, condominiums, and multi-family homes. For condominiums, a lender will want to know the number of owner-occupied units, the amount of the condo fee and what it includes, and the amounts of any recent or expected assessments, among other things. For a multi-family, a lender will want to know about tenancy and see any leases that are in place.

The simplest way to find out what you can afford from a lender’s perspective is to get a pre-approval from a lender. You’ll need such a letter anyway when you’re ready to submit an offer on a property. This letter states the amount that the lender is willing to lend and any relevant conditions. In order to generate a pre-approval, a lender will run a credit check and may well request other documentation. There are a number of different types of lenders that you might approach, and there’s much more information on this in the Mortgage FAQ

How much house do I want to afford?

This is ultimately a personal questions that, like many other questions about money, comes down to values and goals. One very basic way to think about buying a property, if you’re currently renting, is to figure out what kind of mortgage (plus other expenses, and perhaps minus tax benefits) your current rent check would support. Let’s do a simple illustration here:

Say you’re renting a place for $2,000/month and you pay your own utilities.

You’re looking to buy a condominium and the condo fee (which includes master insurance, maintenance, and a reserve amount) is $150. Since a condo fee includes condo insurance, you don’t need to worry about that, but you may be well advised to purchase a personal policy to cover your own posessions and “content” (kind of like renter’s insurance, but that includes any items not covered by your condo policy, e.g. fixtures and things within your own unit walls). This is relatively inexpensive, say $20/month. You’ll also need to add property taxes. Cambridge and Somerville offer a significant tax break on owner-occupied properties ($1487/year in Cambridge and $1630/year in Somerville for 2008) so make sure that you apply for the residential exemption (assuming that you’re living in the property your purchase) and use this reduced tax number in your calculations. For this example, let’s assume annual property taxes of $1800/year or $150/month. Maintenance and repair of the building overall should be covered by the condo fee (or by assessments — we’ll come to this later), so we won’t add a number for maintenance. So $2000 – $20 – $150 – $150 leaves you with $1680 for a mortgage payment. At 5.0% for a 30-year fixed mortage (find current rates by type and geography at bankrate.com or the Motley Fool Home Center), you could afford a mortgage of about $313,000.

If you want to be fair about this, you should probably add back the tax benefit to your monthly payment. The tax benefit of having a mortgage is that you can deduct mortgage interest payments up to $1,000,000 in home acquisition debt (for a married couple) or $500,000 for a single person (or married filing separately). IRS Tax Publication 936 and this About.com article have more detail on this. And the way amortization works, the payment that you make at the beginning of your mortgage are heavily weighted to interest. So say you’re in a 30% tax bracket, and say that of your approximately $1600 monthly mortgage payment, $1300 of it goes to interest (I’m being conservative here). This mortgage deduction, then, at a 30% marginal tax bracket, should yield a monthly tax savings of $390.00. Add this back to your payment, and you can now afford a mortgage of about $388,000.

The above is what I’d call a “cash flow” buy/rent analysis. It sets aside a whole number of other considerations, such as: equity, property appreciation or depreciation, liquidity, mobility, ability to modify one’s built environment, etc. Here’s a spreadsheet where you can plug in your own variables. There’s also a little Mortgage Calculator on the Motley Fool site that may be helpful.

What are some tools that can help me figure out where to buy?

If you’re like many people, you already know exactly where you want to live. If you’re just moving in from out of town, or about to change jobs, or not already settled in one community because of family or school or work, then there are a number of resources available to you to help you decide what community to live in. A few are below:

• The MBTA Trip Planner lets you track the best route (via mass transit) from one place to another. This is a handy tool for exploring town and specific properties relative to work, school, or other important destinations.
• If you have children (or are thinking of having children) and are shopping for a community based on public school strength, then School Digger offers detailed data on Massachusetts elementary, middle, and high schools. greatschools.net is another resource that includes parent comments on local schools. Each city has its own systems for elementary school admissions, so make sure to ask your agent, call the local school school department and/or talk with local parents in communities that you’re exploring.

How can I find homes that are out there for sale?

The great majority of residential properties in this area are listed for sale through the Multiple Listing Service (MLS), a property database that’s geared toward licensed real estate professionals. Most of the information from the MLS, however, including property address, asking price, and description is available online though agent web sites or at Realtor.com, the official site of the National Association or Realtors. Our website for ePlace has an excellent Property Search that lets you search by a variety of different criteria, view properties on an interactive map, and save search as well as favorite properties. To contribute listings to the MLS, to see the complete MLS information (e.g. days on market, special notes), and to perform analysis on MLS data, you need to be a licensed real estate salesperson or broker with an MLS membership.

Properties are also listed on local web sites like craigslist, and advertized in the Boston Globe, Boston.com, and for-sale-by owner sites like isoldmyhouse.com. In my own experience (as a buyer, seller, and former agent), the MLS is quite a comprehensive source for residential property in Cambridge and Somerville and most surrounding areas. Even many for sale by owner properties are actually included in the MLS through what are called “entry only” listings, where a seller receives very limited services from a broker. I have yet to personally find a super non-MLS “deal” on craigslist or a fsbo website, but I’d be interested to hear if other people have. Another source of property for sale, though, is individual owners. If you see a house or an area that interests you, ask around–or ask your agent to contact homeowners in the area.

How can an agent help me, and how do agents get paid?

A good agent and a buyer’s agent specifically can help you through all the stages of the home-buying process, from getting a pre-qualification to locating a property, to evaluating that property (or properties) to offer through purchase. Good agents work in the real estate world day in and day out. They know the market in intimate detail and through time, in a way that even a highly analytical amateur with a pile of data cannot. They’ve negotiated hundreds of transactions and know what levers to pull and what resources to bring to bear. The know all the elements of the buying process in a particular locale and all the characters. They can recommend inspectors, lawyers, architects, plumbers, and any other professionals you might need. But before I continue waxing on about buyer’s agents, let’s back up for a moment . . .

There are three kinds of real estate professionals (under Massachusetts law) that can assist buyers in the purchase of property: buyer’s agents (those whose fiduciary responsibility is to the buyer; seller’s agents (those who fiduciary responsibility is to the seller); and facilitators, who owe fiduciary to no one.

In the old days, agents were invariable seller’s agents. They might driver buyers around and show them property, but they ultimately owned loyalty to the seller alone. Sometime in the mid-90s, buyers agency started to come on the scene in Massachusetts. Now, many of the larger firms strongly encourage agents who work with buyers to practice buyer’s agency exclusively. Some firms have gone so far as to strongly encourage sellers to elect to offer compensation only to buyer’s agents, but we’ll move on to the compensation question in a moment. To me it seems intuitive and logical that buyers be represented by buyer’s agents and sellers by seller’s agents. As for facilitators, I’ve seen very few of these so can’t really speak this this.

So how are agents paid? Most of the time, agents (be they buyer’s agents, seller’s agents, or facilitators) are paid out of the proceeds of the sale, through a listing agreement between the seller and the listing broker, or, in the case of a FSBO, by the seller directly. When a seller signs a listing agreement, s/he usually specifies that half of the commission paid to the listing broker will go to a cooperating agent. In the event that the sale involves a “co-broke” (in which an agent other than the listing agent brings a buyer), which is the case with most sales, then the listing firm keeps half of the commission and the “selling” firm gets half. The agents, in turns get paid out of their broker’s commission, through a “split” that will vary depending on the firm and on the agent’s sales volume.

So what does this all mean? What it means is that, when you’re a buyer working with an agent, you don’t usually have to pay the agent out of your pocket. In another way, buyers and sellers do ultimately pay agents (listing and “selling” agents) at the time of a sale. The plus is that, since these costs are bundled into the sale price, so to speak, they can effectively be financed. Is this an ideal situation for the buyer? Yes and no. In answering this question, it’s important to break out: 1) fiduciary responsibilities from; 2) short-term and; 3) long-term incentives. In real estate, as in a number of other businesses, #1 and #2 in particular are not always aligned.

If you look at things only in the short term and only in terms of financial incentives, it’s in the agent’s best interest to close transactions as quickly as possible and with as little effort as possible. Roughly speaking, getting a slightly higher price (for the seller) or a slightly lower price (for the buyer) does not impact the agent’s own financial profile as much as getting things done quickly and with a minimum of effort. That’s the short-term financial incentive. More important, a person who contracts with a seller or buyers in a fiduciary capacity as an agent owes that person their loyalty, obedience, disclosure, confidentiality, reasonable care and diligence and accounting. These are the basics of agency law and I’m not sure why more of these responsibilities are not spelled out in listing agreements and buyer’s agency agreements, but they nevertheless apply. In other words, a person acting as your agent (and, I’ll add, whether they’re compensated or not), must put your best interest before their own. As explained above, the interests of buyer or seller are occasionally not in alignment with at least the short-term interests of the agent, but fiduciary duty requires an agent to put aside his/her personal interest in service to the client. Keeping a sharp eye on what’s in the client’s best interest at all times and differentiating between a client’s best interest and one’s own is what makes it possible to practice real estate with a high level of ethics.

Then we get to the long-term perspective, where the interests of the clients and agents can and often do indeed meet. Most agents who succeed (both on a financial level and on the level of personal satisfaction) in real estate do so by doing primarily referral and repeat business. In other words, they work primarily with a core group of clients who buy and sell over and over again, and with friends and referrals from those same clients. This tends to make the work more personally satisfying and more profitable. Your business gets built on a foundation of trust. This is no different than with many other kinds of businesses. And of course the way to make sure you have satisfied clients and clients who refer you to their friends is to make sure you work hard and act in the client’s best interest at all times. It’s that simple.

So in terms of choosing an agent, should you choose to work with one, I would suggest asking friends, asking people you trust, and then interviewing the agent to make sure s/he’s a good fit. After all, this is someone who will be helping you with one of the most (if not the most) important investments of your life.

Feel free to email me if you have any further questions or need clarification. I practiced as an agent for almost four years and dealt with these questions day in and day out.
What kinds of things should I look out for when evaluating a home?
There are several things that you want to look out for when buying a home.

First, you want to make sure that the property that you’re buying is as represented by the broker or owner. If you’re dealing with a single family, this is fairly simple. You can pull up the basic property information (living area and lot size) from your local assessor’s database. Cambridge and Somerville databases are here. If you’re dealing with a condo, then you’ll want to get a copy of the architect’s drawings and (if available) a site plan. Floorplans are required to create a condo (at least in Cambridge and Somerville) so you should be able to obtain them either from the listing agent, owner, or property management company (if you’re dealing with a larger building). When looking at a condo, you’ll want to confirm that the living space is as represented, and that the area marked as common or exclusive use are also as represented, and whether or not you have parking. This includes porches, hallways, yard, driveways, etc. I have witnesses a number of transactions where this kind of information was either represented inaccurately, willfully misunderstood, or simply not reviewed carefully before the offer stage, resulting in much grief for all concerned. Needless to say, agents and owners should be fastidious in their representations. And if you’re a buyer, by all means, review all of this and protect yourself.

Second, if you’re dealing with a condo, you’ll want to know something about the condo association. The things you’ll need to know are the same types of things that your lender will want to know:

• How many units are in the association, and of these, how may are owner occupied?
• Does any one person own more than one unit?
• What is the monthly budget and what items does it cover? Do these appear to be adequate?
• Have there been any recent assessments? If so, what were they for? What was the assessment for your unit?
• Are there any upcoming assessments that are being planned or are under discussion? What would the estimated assessment be for your unit?

You may also want to meet some of the other condo owners and/or talk to the president of the condo board (in the case of a larger association). This might give you a sense of the people you’ll be dealing with. After all, how a condo board functions and the people in your building may or may not have a big impact on the quality of your life once you move in, and in fact on the value of the property that you’re considering purchasing. In terms of getting this done, you can ask to meet or speak with other owners before the offer stage, or simply write it in as a condition of your offer.

The most obvious thing to look out for is the physical condition of the home. This condition gets addressed during your home inspection, and on your personal inspection of the property. Here’s a .pdf spreadsheet with ranges for major home renovation costs that may be useful.

How do I know what is a fair price is for a home?

The most scientific way to arrive at a market or fair price for a property is by doing one of the things that an appraiser does: a comparative market analysis. (Appraisers also use two other methods to value property — cost approach and an income approach, but in this marketplace the comparative market analysis is the most relevant to lenders and to buyers of residential property). A comparative market analysis is also the process that a real estate agent will use when pricing your property to list it for sale. To do a CMA, you select recent sales of properties that are similar to the subject property in size, location, and general level of renovation. This being said, and depending on the type or property, this is not always easy to do. Sites like Zillow.com will give you a “zestimate” and a suggestion of comparable properties, but I have not personaly found this to be accurate. The assessment is best done by comparing your subject property against properties that you’ve seen or that others (agents, friends) have seen. You can use the public record to find similar recent sales, or use historical MLS data if you have access to this through your agent.

What are the elements of the offer?

The offer is the template for the entire purchase. It includes a brief property description, a mention of what is and is not included in the sale, any contingencies of the offer, and timelines for the fulfillment of the transaction and satisfaction of any contingencies.

• Typical Home Purchase Timeline
• Blank Offer to Purchase Form.
• Blank Contingency Addendum Form.
• Blank Lead Paint Disclosure Form.
• Consumer Relationship Disclosure Form.

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Links that are relevant to this FAQ and to the Home Buying Process Workshop can be found here.