How to protect your biggest investment
Time was, buying a house followed a fairly simple scenario. You found the one you liked, went to the bank, got a mortgage, and moved in. Selling wasn’t challenging either. You hired a real-estate agent, paid a 5 to 7 percent commission, and moved on.
But no longer. For starters, a batch of real-estate services have emerged, many of which were barely noticeable a few years ago: Internet do-it-yourself real-estate agencies, such as Owners.com and ForSaleByOwner.com, and discount full-service brokers, such as Foxtons and Ziprealty, promising home buyers and sellers big savings on commissions; exclusive buyers’ agents negotiating on behalf of purchasers; online mortgage services such as LendingTree.com and Eloan.com offering fast mortgage loans; and, finally, mortgage brokers, independents who say they shop for consumers to find them the most-advantageous loans.
Where once there was the one-size-fits-all fixed-rate 30-year mortgage, now there is a bewildering assortment of home-financing arrangements, including no- and low-down-payment loans, adjustable-rate and hybrid mortgages, and interest-only mortgages, all of them designed to help Americans get into a house with a minimal amount of cash and low monthly payments. And for people already in a house, there’s a variety of deals that allow them to turn their equity into ready cash.
The wealth of new services and flexible lending practices have brought more choice and price competition to the marketplace. But many of the innovations bring new hazards that can trip up unwary homeowners, costing them thousands in unnecessary expenses, draining value from their biggest investment, and, in the worst cases, turning their houses into debt traps.
BUYERS’ DILEMMAS
If you’re thinking of venturing into the housing market right now, you have a lot to consider. Should you buy now or wait? Should you use a real-estate agent or find a buyer’s agent who will negotiate for you? Should you go to a bank for a mortgage or use a mortgage broker? And, what kind of mortgage should you choose?
Buy now? Despite years of dire warnings from some economists that the housing boom is about to end, it hasn’t. Indeed, last year prices rose even more--about 11 percent nationally, according to the Office of Federal Housing Enterprise Oversight. (By contrast, the Consumer Price Index grew only 3.6 percent in the same period.) Even states that suffered the lowest growth in housing values, including Indiana, Ohio, and Texas, saw increases of almost 4 percent.
What to do: You can no more time the real-estate market than you can the stock market. If you need a house and can afford one, go ahead and buy. You minimize the risk of overpaying if you can commit to living in the same home for at least five to seven years. The longer you stay, the greater the likelihood that you will recover from any market downturn. Buy conservatively, keeping your housing expenses, including principal, interest, taxes, and insurance, to no more than 28 to 31 percent of your income.
Real-estate agent or buyer’s agent? According to a National Association of Realtors survey, 90 percent of buyers use a real-estate agent during their search. Though agents may spend hours showing houses to buyers, they collect a commission from the seller and must work on his or her behalf to get the highest sale price.
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In the money |
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WHO Maria Moise, 38, her husband, Max, 46, and their daughters Gabrielle, 12, and Dominique, 9.
WHAT HAPPENED The Moises, social-services case managers, used a do-it-yourself Web site to sell their 4-bedroom house (above) in Peekskill, N.Y., last summer. They estimate saving at least $27,000 in real-estate commissions. Their home sold and closed in three months.
Photo by Kvon Photography
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For the last 10 years or so, more and more buyers have been asking for a “buyer’s agent” who works exclusively for them, not sellers, helping to negotiate the house price, the terms of the sale, and contract contingencies. The buyer’s agent may charge a percentage of the purchase price (usually about 3 percent), a flat fee, or an hourly rate. The percentage generally comes out of the sales commission received by the listing real-estate agent. However, the buyer may be contractually obligated to see that the agent is paid.
In theory, a buyer’s agent could be helpful, especially for home-buying novices. But many who hold themselves out as buyer’s agents work for the same firms as listing, or sales, agents, says Barry Miller, president of the National Association of Exclusive Buyer Agents, a professional organization. That means their loyalties are muddled, and they may not negotiate for the lowest price.
You can find a true buyer’s agent only at a firm that does not accept listings. Currently, there are about 2,500 NAEBA members in the U.S., compared with 1 million real-estate agents. About 50,000 agents are currently certified as buyer’s agents by the National Association of Realtors; many work for listing agencies.
What to do: You may feel that you need a buyer’s agent to get you through the complicated home-buying process. But you take a risk. If the seller refuses to pay the commission, you could be on the hook. If you use a buyer’s agent, make sure you get one who’s genuine. You can do so by visiting the NAEBA Web site, at www.naeba.org, or by calling 800-986-2322. Members can be found in most areas of the country.
Mortgage broker or bank? Mortgage brokers, middlemen who shop for home buyers among banks, now dominate the market, originating 66 percent of mortgage loans in 2002, the last year for which figures were available, according to Wholesale Access, a mortgage-research company in Columbia, Md. Because brokers can choose from programs from many banks, they may be able to offer a variety of deals that are not available at your own bank: first-time-buyer programs, for example; low- or no-down-payment loans for police, firefighters, or teachers; and low-cost mortgages for energy-efficient homes.
However, the bulk of a broker’s compensation comes from fees paid by the lender. One, the “yield-spread premium,” represents a cash commission you pay in the form of points (1 point equals 1 percent of the loan amount) or a higher interest rate.
Here’s a simplified version of how yield-spread premiums work: Let’s say that a lender offers a broker a 30-year, fixed-rate mortgage at a 5.625 percent annual interest rate and 1.5 points. For selling the loan as is, the broker gets 0.5 point. The broker can pass along the deal to the borrower and collect his 0.5 percent, or up the loan’s interest rate to 6 percent and get a yield-spread premium of 0.75 percent in return for getting the bank a higher income stream. Generally, the consumer has no clue that the loan is costlier than it should be.
What to do: You do not need an intermediary to find a good rate and low fees, especially if you’re looking for an ordinary fixed-rate mortgage. Even if you think a mortgage broker could get you a better deal, you should first familiarize yourself with other offerings. You can find them in newspapers and at Web sites such as www.bankrate.com and www.hsh.com. Both sites allow you to click through to lenders whose deals you find appealing.
You should also make inquiries at banks in your community. Arm yourself with your three credit reports and your credit scores when you ask about rates. That way, you’ll be able to tell if a rate you’re offered is out of line. (You can get both reports and scores from www.myfico.com for $44.85, or www.truecredit.com for $39.90.) When shopping for a loan, standardize the comparison by using the same variables such as down payment, points, and type of loan.
If you find that a mortgage broker is offering the best deal, check the Web site of the Better Business Bureau for complaints at www.bbb.org. Most states license mortgage brokers; you can check for complaints.
Which mortgage? The old routine: You put 20 percent down on a house and took out a fixed-rate mortgage. These days, you can choose from a range of mortgages, most of them variations on adjustable-rate mortgages, or ARMs, whose rates drift up and down with short-term interest rates.
The ARM’s advantage: The borrower gets a lower interest rate in the early years in exchange for what could be a higher rate later. There are also hybrid loans, which have a fixed rate for 3, 5, 7, or 10 years and then convert to an interest rate that generally is adjusted annually. (For details on various mortgages, see Mortgages and home equity loans.)
There is a maximum allowable increase, called a cap, that can be charged when the interest rate is adjusted. The cap is usually 1 or 2 points, but it can be as many as 5. The interest-only hybrid ARM allows consumers to defer repayment of principal for 3, 5, 7, or 10 years.
Opting for ARMs scarcely makes sense at this point. The Federal Reserve has already hiked the short-term interest rate, to which ARMs are pegged, six times since the beginning of 2004, and it has given no sign that it will stop. And the difference between the ARM and a fixed-rate mortgage is significant now but may not be later. In early March 2005, the average 1-year ARM was at 4.45 percent, while the 30-year mortgage with points was 5.92 percent. On a $200,000 mortgage, the initial monthly payment for the ARM would be $1,007; for the 30-year, fixed-rate loan, $1,189. If the short-term rate rose to 5.88 percent, the monthly payment for the ARM would jump up to $1,183.
Those lower payments are obviously appealing to families struggling to get into a house, but ARMs are riskier than fixed-rate mortgages. For one thing, homeowners’ incomes may not keep up with the rate increases. And, if the homeowner doesn’t sell and move or refinance before the rate adjustments become too onerous, they can find themselves on the edge of a financial cliff. “Folks who use them are already struggling to get into the market, so anything else can push them over
the edge,” says Javier Silva, senior research and policy associate with Demos, a public-policy think-tank in New York.
The interest-only hybrid ARM is riskier. After the initial interest-only period ends and principal payments are added, monthly payments can balloon about 30 percent. That’s before including the inevitable interest-rate adjustments. Whether the homeowner builds any equity before principal payment begins is entirely dependent on property appreciation, which many economists believe will not continue at today’s brisk pace.
What to do: The fixed-rate loan is still the gold standard for a primary residence because payments are predictable. But ARMs can make sense for borrowers who know they will not be in a house long enough to see many rate adjustments before moving again.
If you choose an ARM, ask about the loan margin. That’s a portion of the rate added to an index (usually the Treasury rate or the London Interbank Offered Rate). The larger the margin, the more sharply your interest rate climbs when the index adjusts. Banks don’t readily disclose the margin, but insist on receiving it--and in writing.
Check the interest-rate caps, which are likely to be 2 or 5 percent on the first adjustment and 2 percent for each annual adjustment thereafter on hybrid loans. The lower the cap, the more gently a payment increases. Don’t forget to check the maximum rate over the term of the loan, which is usually about 6 percent above the initial rate but can vary greatly, says Jack Guttentag, professor emeritus of finance at the Wharton School of the University of Pennsylvania and founder of www.mtgprofessor.com, a Web site offering mortgage information.
THE HOMEOWNER’S TEMPTATION
If you have owned a house for a while, you know that your nest is well-feathered. As housing prices have risen, so has your equity. To remind you, importunings to refinance or borrow money from the equity in your house arrive every day in the mail from banks, brokerage houses, and other lenders. Should you tap the equity, and, if you do, should you refinance or use a home-equity line of credit?
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WHO Roberto Cano, 37, Hollywood, Fla.
WHAT HAPPENED Cano, a cargo-airline operations coordinator earning $43,000 a year, hoped to build his fortune buying and renting out houses. But his dream turned into a debt nightmare when he added to $225,000 in mortgages another $25,000 loan to cover repairs and expenses from the two rentals and his home. Rents didn't cover expenses, and he had to sell one of his properties prematurely. "I bailed out," he says. Cano earned $30,000 on the sale, but he still owes $7,000 on the credit line and scrambles to cover payments each month. Photo by Craig Ambrosio
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| To tap or not? Thanks to home-equity lines of credit and cash-out refinancings (which allow owners to take out a larger loan and pocket the difference), many Americans have been able to unlock the wealth stored in their home equity. A study by Demos found that 51 percent of households refinancing between 2001 and 2003 used home-equity loans to cover living expenses and pay down other debt such as credit-card debt. Given that the family home is most Americans’ largest asset and a major source of retirement funding, the notion of housing debt as “good debt” has been turned on its head. More and more Americans are using their family’s shelter to repay what they charged at the mall.
Some home-equity borrowers are being encouraged by brokers to take on more risk. Indeed, NASD, formerly the National Association of Securities Dealers, warned investors in 2004 to beware of the risks of using home equity to finance stock- and bond-market investments: “We are concerned that investors who must rely on investment returns to make their mortgage payments could end up defaulting on their home loans if their investments decline,” says a statement posted on its Web site.
What to do: Home-equity financing is best reserved for long-term home improvements that add value (i.e., square footage) to your home, putting in a new bathroom or updating a kitchen, for example. If you use the money to pay off credit cards or otherwise refinance higher-interest-rate debts, make sure that it’s a one-time occurrence; don’t keep charging away.
Home-equity loan or HELOC? Home-equity lines of credit, or HELOCs, are variable-interest-rate loans usually tied to the prime rate, like most credit cards. (They are different from home-equity loans, which are fixed-rate loans with a definite repayment period.) While HELOCs often offer low introductory rates, they have no caps. So after time, rates can run as high as 25 percent. “They are the riskiest of all ARMs in that the borrower is most exposed to higher rates,” says Guttentag, of the University of Pennsylvania, adding that he has seen some HELOCs with an introductory rate of 4.75 percent jump to 9.75 percent after just three months.
What to do: When you are comparison shopping among home-equity loans, standardize the comparison by looking at loans with the same terms. Figure monthly payments and the total cost of the loan, including fees and closing costs, over the entire term. If you opt for a HELOC, use it only for expenses you can repay in a few years to avoid paying extra and unnecessary interest costs.
SELLER’S PARADISE
Long-time homeowners are the big winners in today’s real-estate game. People who have been living in their homes for as little as 5 years should realize profits in most markets; homeowners who bought 20 or more years ago may have seen their homes triple in value. Is now the time to cash in and downsize? If you do, should you pay a real-estate agent 5 to 7 percent or go with a discount or Internet service that charges much less?
To sell or not to sell? There are signs, at least in some communities, that housing already is overpriced, raising doubts about how much longer big gains can continue. In some parts of the country, job losses and local economic downturns have slowed appreciation. At the same time, property taxes are rising across the nation, squeezing many homeowners on fixed or limited incomes.
Another sign that bears watching: a sharp increase in the portion of home buyers who are purchasing for investment or vacation use to 36 percent, higher than previous estimates. People owning second homes and investment properties, like Roberto Cano, profiled above, are much more likely to dump them on the market when they suffer reverses or when prices flatten or fall. Such an event could further depress prices in a downturn, says Ingo Winzer of The Local Market Monitor LLC, a Wellesley, Mass., real-estate consulting company. Edward Leamer, an economist at the University of California at Los Angeles, notes, too, that there are cities where rents are declining in relation to house prices, another bubble sign that may portend future problems. (See National housing markets.)
What to do: If you are thinking of downsizing to a smaller house or less expensive area, there’s incentive to do so now, while prices are high and demand is still strong. To check the current state of your local market, ask real-estate agents or a reputable local appraiser how rents compare to house prices, and whether investors play a large role in the market. If rents are high and investors commonplace, the area may be on the brink of a drop in values, making now a good time to sell and pocket your gains.
Sell it yourself? In return for a lot of extra effort, you can save thousands of dollars selling your home on your own. Most do-it-yourself Web sites charge less than $200 for their basic services, or a few hundred more if you add access to the Multiple Listing Service agents.
Maria Moise and her husband, Max, who are social-services case managers, estimate that they saved about $27,000 when they sold their $475,000, four-bedroom house in Peekskill, N.Y., for less than $1,000 in expenses. Of that, they paid $99 to ForSaleByOwner.com for the listing and $900 to a real-estate attorney to prepare a contract and handle the closing. “I liked dealing with it, if for nothing else, so that people can see pictures of the house without coming by your home,” says Maria. The Moises’ attorney suggested they avoid wasting time by refusing offers from anyone who was not already pre-approved for a mortgage. Their home sold and closed within three months.
Other such national Web sites include Owners.com, founded in San Francisco in 1995. There are regional and local sites as well. Discount brokers, such as Foxtons in the Northeast and Ziprealty in 10 states and Washington, D.C., offer some of the services of real-estate Web sites, along with broker assistance, for commissions that may be as little as half the going rate.
Real-estate agents point out, however, that there’s more to consider than cost. Although sites such as ForSaleByOwner.com allow you to list with a Multiple Listing Service for an additional fee, some agents won’t show such listings because they don’t want to deal with uninformed or inexperienced sellers and lower compensation. “They know they are going to have to be doing a lot more work,” says Anthony Marguleas, a real-estate agent in Pacific Palisades, Calif. Sellers have to make time to show the home to buyers and negotiate the terms of sale.
Fortunately, the do-it-yourself Web sites and discount brokers are giving consumers leverage to shave a point or so off the customary 5 to 7 percent commissions of traditional real-estate brokers.
What to do: If you want to use a full-service broker, negotiate a lower commission, particularly if discount brokers are active in your area. If you decide to use a Web site or a cut-rate realtor, hire a qualified real-estate attorney to handle the contract, title issues, and necessary disclosure statements. (Many states require sellers to alert home buyers to known problems.) Have your home inspected by a professional inspector, and make necessary repairs before selling to minimize last-minute surprises and concessions.
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Wednesday, September 08, 2010
