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Buying a

home

Contents

If youre thinking of buying a home Making the decision to buy Mortgage basics Your home search Making an offer and closing the sale Once youve settled in Terms it helps to know

3 4 22 36 44 50 53

Developed with funding from the IBM Global Work/Life Fund and the AT&T Family Resource Program.
2002

Ceridian Corporation. All rights reserved.

If youre thinking of buying a home

You probably have a dizzying number of questions on your mind. Am I really nancially ready for this step? How much do I need for a down payment? What kind of mortgage should I look for? What happens at a closing? If this is the rst time youve entered the real estate marketor even if youve bought a home beforeyou may feel intimidated by the amount of work a buyer needs to do. You may worry about nding the right home at a price you can afford, or about nding the professionals to work with youyour real estate agent, lawyer, inspector, and nancing agent. And you may feel confused about what steps to take and in what order. This booklet was designed to help take the stress out of buying a home. It will take you step-by-step through the home-buying process. From making the decision to buy, to understanding mortgages, making a bid, negotiating a purchase and sale agreement, and closing the transactionwhen the home nally and officially becomes your ownit will help you navigate the process with understanding and condence.

Making the decision to buy


Before you decide to buy a home, its important to take a close look at your current nancial situation, including how you spend your money and how much long-term debt you have. You need to know how much of a down payment you can afford to make and how you can go about saving for it. You need to know what other up-front costs you can expect to pay, like inspection fees, points, and other closing costs. You need to have a good idea of how much cash you can apply every month to a mortgage payment. Finally you need to think about your goals for the futureboth nancial and life goalsand whether buying a home right now would help you reach them.

Your current nancial situation

To get a good picture of your current nancial situation, it helps to look at your short-term expenses and spending habits, any long-term debt you may be carrying, and any savings you may have. This will give you a clearer idea of whether buying a home would be a realistic step for you right now. It will also help you think about ways to trim your spending in order to save for a down payment and ways to reduce your long-term debt, which can help you obtain nancing.

Your short-term expenses and spending habits


The rst step in assessing your nancial situation is to gure out where your money goes by tracking your spending. This can be a lot of work, but its important. You can use the following worksheet to record what you spend in a month. You should include major monthly expenses like rent, heat, and food, as well as smaller items like coffee, laundry, gas, and health club dues. Keeping track for several months will give you an even better idea of where your money goes, but one month can give you a starting point.

Income and expense worksheet

M O N T H LY I N C O M E Gross salary/wages Taxes deducted from paycheck

Federal income tax


FICA

State/local income tax Other deductions


NET PAY AFTER TAXES
Other income

Bonuses, tips Commissions Self-employment income Interest, dividends Capital gains expected Child support, alimony Gifts Other Tax on other income
TOTAL OTHER INCOME AFTER TAXES
T O TA L N E T M O N T H LY I N C O M E

M O N T H LY E X P E N S E S

or if easier to calculate
Monthly total Home expenses Annual total

Mortgage or rent Second mortgage/home equity loan Home insurance Real estate taxes Repairs and improvements Utilities: Oil/gas Electricity Water/sewage Telephone
Transportation

Car loan payments Car repairs Car insurance Bus or train fare Gas Tolls/parking License/registration/excise tax
Food/clothing

Groceries/household goods Clothing


Medical/insurance

Life, disability insurance Medical/dental insurance Medical/dental/pharmacy expenses Dental, eye care, glasses
TOTAL EXPENSES THIS PAGE

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M O N T H LY E X P E N S E S ( C O N T D )

or if easier to calculate
Monthly total Annual total

TOTAL FROM LAST PAGE


Children

Child care Education/tuition Child support Lessons/camp/sitters Allowance/misc.


Education

Tuition, fees Books, supplies


Household

Furniture, housewares Cleaning Garden, lawn, trash, snow


Fun/health/hobbies

Eating out Work/school lunches Movies, videos, music Cable TV Books, magazines, newspapers Computers, electronic equipment Beer, liquor, cigarettes Lottery tickets Vacations, recreation, travel Photos/lm/developing Sports, exercise Hobbies
TOTAL EXPENSES THIS PAGE

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M O N T H LY E X P E N S E S ( C O N T D )

or if easier to calculate
Monthly total Annual total

TOTAL FROM LAST PAGE


Personal care

Dry cleaning, tailor, laundry Hair care, makeup Massage, body work
Debt repayment

Credit cards Student loans Other


Other

Donations, contributions Gifts (birthdays, holidays, etc.) Savings for retirement/college Postage Pet care Professional services (lawyer, tax, etc.) Dues, membership fees Other
TOTAL M O N T H LY E X P E N S E S

Monthly income total from page 6


N E T M O N T H LY C A S H F L O W

(Income minus expenses)

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You can also check with your credit card company to see if it offers an annual report summarizing your categories of spending, or look into purchasing a software program to help you organize and track your spending. Ways to reduce spending Once you have an idea of how you spend your money, look for areas where you can cut back on spending and increase your savings. For example, you might want to consider brewing your own travel coffee in the morning if you dont already. You could save thirty to forty dollars a month if coffee is a daily habit. Every little bit helps. You might also want to

Rethink your transportation. Can you carpool, ride a bike, or use public transportation? Use your local library. Instead of buying or renting, borrow books, videos, audiotapes, books on tape, and CDs. Cut down on take-out food and eating out. If youre going on a car trip, bring food that youve made. Its less expensive and usually healthier. Leave your credit card at home. Stop using your ATM card. When its more difficult to get cash, you may think twice about what youre spending your money on. Always make a list ahead of time when you shop, whether its for clothes or groceries, and stick to it. Avoid using shopping as entertainment. For example, dont keep mail-order catalogs within easy reach. Eliminate expensive membership fees. Find out if your employer or health insurance plan offers a discount toward gym or health club memberships or contributes to the fees. Remember that walking and running offer tremendous health benets and are free.

Long-term debt
Mortgage lenders will look at your sources of income and your long-term debt when they assess your eligibility for nancing. So its important to have a clear understanding of your long-term debt and possible ways to reduce it. Your long-term debt might include school loans, credit card debt, or car payments. Take a close look at the agreements and other documents that relate to your longterm debt. How close are you to paying any of it off? Are there any penalties for paying your debt off early?

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Ways to reduce long-term debt In addition to freeing up money for your monthly mortgage payment, reducing long-term debt can make you eligible for a larger loan.

If you have a large amount of high-interest debt, pay it off rst. For many people, this means credit card debt. You may think that by saving money in a savings account, youre being wise. But even though getting into the habit of saving is a good idea, letting money sit in an account returning only 2 percent interest when you could be reducing a balance costing you 18 percent interest (as credit cards often do) is not. Put your long-term debt in order from highest to lowest annual percentage rate and work on paying off those high-interest balances rst. Consolidate your high-interest debt on one lower-interest card. If you shop around, you can often nd credit cards offering a temporary low rate for balance transfers, and sometimes the low rate continues for the duration the balance is carried. Be sure to nd out if the low rate is temporary; rates can increase substantially after the initial low rate expires. And dont transfer balances too often. It can reect badly on your credit report. Use your debit card instead of a credit card. Most nancial institutions offer debit cards. This way you spend money that you actually have in your account instead of taking on debt, which you do with a credit card. No single plan is right for everyone Only you can decide what kind of long-term nancial planning makes sense for your individual situation. Paying off debt before saving for a big purchase may sound logical, but when that big purchase is a home you also have to factor in the nancial benets of building equity. For example, since you can ordinarily deduct all the interest you pay on your mortgage (which means most of your entire monthly payment for the rst year or two you own your home), you may receive a tax benet of several thousand dollars. You could use the money to pay off long-term debt. Or once youve accumulated some equity in your home you could take out a home equity loan (or second mortgage) to pay down your non-tax-deductible, high-interest debt. There may be other sensible strategies, too, depending on your nancial situation. It can be helpful to talk with a nancial adviser about whats right for you.

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Savings

In addition to reviewing how much you have in any existing savings, checking, or other money market accounts, you will need to think about how much you can afford to save on a regular basis toward a down payment on your home. Down payments can range anywhere from 3 percent to 20 percent of the total purchase cost. Since the amount you have for the down payment will affect your mortgage payments and interest rate, its important to estimate it as accurately as you can.
The costs of buying a home

Many of the costs associated with buying your rst home are up-front costs costs that you pay one time when you participate in the transaction of buying your home. These usually include a down payment, closing costs, and other fees. Your other major cost is the monthly mortgage payment you will make to the bank or other nancial institution that holds the mortgage on your home. If you are thinking about buying a condominium or co-op you need to factor in the monthly fees associated with that kind of ownership, too. You also need to keep maintenance costs in mind. The costs of replacing a roof or furnace, paving a driveway, or xing a leaky pipe can come as a surprise if youre used to renting.
Up-front costs

For most people, the down payment is the biggest up-front expense related to buying a home. But there are other up-front costs that you need to know about, too. They include points, inspection costs, and a variety of closing costs, including the fees you may need to pay to a real estate agent and lawyer. The down payment For most mortgages you will need a down payment of 5 to 20 percent of the price of the home you want to buy. For low-down-payment loans, you will need 3 percent. (You must qualify for low-down-payment loans, and usually end up paying a higher interest rate and additional up-front fees such as the cost of private mortgage insurance, which is usually required for down payments less than 20 percent.) For example, if you are buying a $100,000 home or condominium, a 20 percent down payment would be $20,000; a 5 percent down payment would be $5,000; and a 3 percent (low) down payment would be $3,000.

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Points Some loans require extra money up front in return for a lower interest rate. Each percent of the loan amount is called a point. For example, if you take out a $100,000 mortgage and agree to pay two points, thats 2 percent of $100,000 or $2,000. Points are tax deductible for homebuyers. Inspection fees You can expect to pay between $200 and $500 to have your home inspected. You may need to pay additional amounts for inspections for things like radon, lead, and termites. These inspection fees will vary with the type and size of the property. Attorney fees Attorney fees vary depending on where you live and how much legal work will be needed to complete your purchase. Ask your attorney ahead of time to provide you with an estimate. Broker fees Broker fees are negotiable and commission based. If a sale isnt made, your broker (or real estate agent) doesnt get paid. Commission rates vary, but usually range from 4 to 7 percent of the sales price of a home. Commissions are often folded into the total sales price of a home, depending on what kind of broker or agent you use. (See page 37 for more information about choosing an agent.) Be sure to talk with your broker ahead of time about his or her commission and when and how it will be paid. Closing costs There are a number of costs and fees buyers ordinarily need to pay at the closing of a real estate purchase. Some are required by state and local laws while others are required by the institution that provides your nancing. In general, closing costs can add an average of 3 to 5 percent of the price of the home to your total costs. Closing costs can include any or all of the following: escrow fees title insurance survey charges transfer tax water and sewage fees homeowners insurance property tax appraisal fees contract registration deed recording fees private mortgage insurance notary fees

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Banks are required to tell you ahead of time what they estimate closing costs will be. Take a close look at the statement of these closing costs, and be sure to ask your lender to explain any estimates that seem high or inated to you, or any expenses you dont understand. Other costs Other costs that youll need to keep in mind can include costs of any repairs that should be made, moving costs, and any cost of taking time off from work.

Monthly mortgage payments


To fully understand what owning your own home is likely to cost, you need to estimate your monthly mortgage payment. Its also important to understand the tax advantages of making mortgage payments. Estimating your mortgage payments How do you know if you can afford a home with an asking price of $150,000? You can use the following chart to determine what your monthly mortgage payment would be. First, choose an interest rate. Then multiply the size of your mortgage in thousands by the gure in the 15-year or 30-year column. For example, if you assume a 7 3/4 percent interest rate on a 30-year mortgage of $135,000 (assuming you made a $15,000 down payment on the $150,000 home), your monthly payments would be $967.95. (Multiply 135 by 7.17.) For that same interest rate with a 15-year mortgage the monthly payments would be $1,271.70. (Multiply 135 by 9.42.) (You can read more about mortgage eligibility on page 23.)

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Mortgage payment estimates

INTEREST RATE (%)


5 51/8 51/4 53/8 51/2 55/8 53/4 57/8 6 61/8 61/4 63/8 61/2 65/8 63/4 67/8 7 71/8 71/4 73/8 71/2 75/8 73/4 77/8 8 81/8 81/4 83/8 81/2 85/8 83/4

TERM OF MORTGAGE 15-year 30-year


7.91 7.98 8.04 8.11 8.18 8.24 8.31 8.38 8.44 8.51 8.58 8.65 8.72 8.78 8.85 8.92 8.99 9.06 9.13 9.20 9.28 9.35 9.42 9.49 9.56 9.63 9.71 9.78 9.85 9.93 10.00 5.37 5.45 5.53 5.60 5.68 5.76 5.84 5.92 6.00 6.08 6.16 6.24 6.33 6.41 6.49 6.57 6.66 6.74 6.83 6.91 7.00 7.08 7.17 7.26 7.34 7.43 7.52 7.61 7.69 7.78 7.87

INTEREST RATE (%)


87/8 9 91/8 91/4 93/8 91/2 95/8 93/4 97/8 10 101/8 101/4 103/8 101/2 105/8 103/4 107/8 11 111/4 111/2 113/4 12 121/4 121/2 123/4 13 131/4 131/2 133/4 14 141/2

TERM OF MORTGAGE 15-year 30-year


10.07 10.15 10.22 10.30 10.37 10.45 10.52 10.60 10.67 10.75 10.83 10.90 10.98 11.06 11.14 11.21 11.29 11.37 11.53 11.69 11.85 12.01 12.17 12.33 12.49 12.66 12.82 12.99 13.15 13.32 13.49 7.96 8.05 8.14 8.23 8.32 8.41 8.50 8.60 8.69 8.78 8.87 8.97 9.06 9.15 9.25 9.34 9.43 9.53 9.72 9.91 10.10 10.29 10.48 10.68 10.87 11.07 11.26 11.46 11.66 11.85 12.05

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How tax benets can reduce the real costs of mortgage payments If youre renting an apartment or house right now, you might assume that you would have to pay more for monthly mortgage payments than you currently pay for monthly rent. What you pay each month for rent will give you some idea of what you can afford to pay for monthly mortgage payments. But you need to factor in the tax benets of owning your own home before you can have a clear understanding of what you will actually pay each month if you have a mortgage. Its important to keep in mind that homeowners can deduct most of their monthly mortgage paymentsthe portion that represents interest on the mortgage loan from their taxable income. This often results in savingsthrough tax benets of 25 to 40 percent. For example, if youre paying $500 in rent, after factoring in the tax benets of owning your own home, you may be able to afford a monthly mortgage payment of $625 to $700. Many Web sites offer online mortgage calculators to help you determine how much you can afford. Go to your favorite search engine and search for mortgage calculator, or look at Fannie Maes calculator at www.homepath.com, Mortgage-nets at www.mortgage-net.com/calculators, or Yahoo! Finances at loan.yahoo.com/m/mortcalc.html.

Condominium and co-op fees


If youre considering a condo or co-op, nd out if you will need to pay extra fees such as homeowners association dues or if you will need to buy additional insurance. Condominium associations, for example, often include homeowners insurance in their fees, but encourage additional insurance to cover personal belongings.

Maintenance costs
Estimating maintenance costs can be difficult, but its a good idea to assume that at some point you will have to x a leaky roof, repair the garage door, or replace the furnace. When estimating how much you can afford for monthly mortgage payments, make sure you leave yourself enough room to pay for emergency repairs.

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Assessing your nancial and life goals

Now that you have an idea of how much a mortgage could cost you every month, you can examine how buying a home ts in with your long-term and short-term nancial and life goals.

Assessing your nancial situation


It can clarify your thinking to write down your nancial goals. For example, is one of your goals to save for retirement? Are you planning to go back to college? To attend graduate school? If you are, does it make more sense to defer the costs and responsibilities of owning a home until youve completed your degree? Is paying off credit card debt or educational loans important to you? Do you need to buy a new car soon? Are you saving for a wedding? Try describing your nancial goals on the following worksheet. It can help you keep your priorities in mind.

FINANCIAL GOALS WORKSHEET

TIME FRAME
Goal 1

Goal 2

Goal 3

Goal 4

Goal 5

Goal 6

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Assessing other life goals


Its important to think about other life goals, too. For example, do you plan to move any time soon? Most nancial experts agree that in order to get a return on your investment, its best to own your home for a minimum of three to ve years before you sell it. Are you planning to start a family? To have another child? Do you hope to have room to allow an older relative to live with you? You may want to try describing your life goals on the following worksheet.

LIFE GOALS WORKSHEET

TIME FRAME
Goal 1

Goal 2

Goal 3

Goal 4

Goal 5

Goal 6

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WHAT IS APPRECIATION?

Appreciation is the increase in the value of a home over time. When the housing market is strong, houses sell easily and resale values go up in a relatively short period of time. Of course, no one can predict what the economy or the housing market will do. Typically, though, houses do appreciate over time. Heres an example: Assuming an average 4 percent annual appreciation rate: If you invested a $10,000 down payment in a $100,000 home, your mortgage would be $90,000. With a 30-year xed-rate mortgage at 7.75 percent interest, your homes value would have increased to $136,860 after 8 years. If you subtract the balance of what you still owe on the mortgage $81,585youll see that your original investment of $10,000 has grown to a whopping $55,275 in home equity. After taxes, this translates to a 24 percent annual growth rate.
If your cash is limited

Even if youre low on cash, buying a home may not be an unrealistic goal. You might want to

Consider low-down-payment loans. The Federal Home Administration, the Veterans Administration, the Farmers Home Administration, and some private lenders offer loans to qualied borrowers with down payments as low as 3 percent. To qualify, borrowers usually need to obtain private mortgage insurance and have excellent credit histories. Local state and housing nance agencies can also be a source of lowdown-payment loans. Look for a less expensive home. If you have your eye on a $150,000 home, but only have $15,000 (or 10 percent) saved for a down payment, consider lowering your expectations and looking for a lower-priced home. Instead of scraping together more money to make a 20 percent down payment, or buying the private mortgage insurance youll need for a down payment of less than 20 percent, rethink what you really need in your rst home. If you nd a home for $100,000, for example, you only need to save another $5,000 to contribute the 20 percent down payment. Check into HUD homes. If you buy a home from the U.S. Department of Housing and Urban Development, HUD will sometimes contribute to the closing costsup to 6 percent of the cost of the home. See HUDs Web site at www.hud.gov for more information or search for a HUD home near you at www.hud.org.

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Consider low- or no-point loans. The tradeoff is usually a higher interest rate, but if youre short on cash, sometimes larger monthly payments can be a good option. Think about asking your family for help. Sometimes parents, grandparents, or other relatives of rst-time homebuyers are in a position to contribute to a down payment or closing costs for a rst home. In some cases it can benet them nancially, too. Access retirement accounts. First-time homebuyers are allowed to make penalty-free withdrawals from their Individual Retirement Accounts (IRAs) for a rst-time home purchaseup to a lifetime maximum of $10,000. But be aware that even though the withdrawals are penalty free, withdrawals from a traditional IRA are taxable to you as income. Withdrawals from Roth IRAs are not, so long as the account is at least ve years old. You may also be able to access funds in 401(k) accounts. Check with your plan administrator to see if you are eligible for loans or withdrawals. Look into seller-paid points. In exchange for a higher purchase price, sellers will sometimes pay points or part of your closing costs. If youre low on cash, having higher monthly payments may be a good option. Make an aggressive savings plan. Look for ways to cut down on spending and save more money. Think about setting up a direct deposit from your paycheck into your savings account. Talk with a nancial adviser about short-term investing options like mutual funds.

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TALKING TO FRIENDS AND FAMILY ABOUT YOUR DECISION TO BUY

Most of the time, friends and family are happy when youre able to buy a home of your own. But what if youre single and your family thinks you shouldnt buy until youre married? Or friends say youre too young to make such a big investment? If your family or friends are less than supportive, remind yourself of the reasons you have decided to buy so you can discuss them condently. Let your parents or friends know that youve done your research and understand the benets and obligations of home ownership. It can go a long way to reduce friction and ease everyones minds. If youre meeting resistance because youre single and family members think you shouldnt buy unless youre married, remind them of your earning power and that youre building equity as well as nancial independence.

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Mortgage basics
Once youve assessed your nancial situation, decided how much you can spend on up-front costs, and settled on a price range for a home, you need to think about the kind of loan that will nance the rest of your purchase. Its important to understand how a lender determines the amount you can pay each month. Its also important to understand the differences between xed-rate and adjustable-rate mortgages, the relative advantages and disadvantages of 15- and 30-year mortgages, and what a lender will look at when deciding whether youre eligible for the mortgage you may want.

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How a lender determines what you can pay

Before you shop for a mortgage, you need to know how much you can afford to pay every month. You dont want to default on your loan, and you dont want to end up with your dream home but no way to pay the electric bill. Mortgage lenders use debt-to-income ratios, or qualifying ratios, as guidelines to calculate what a borrower can afford to pay each month. A qualifying ratio is the maximum percentage your monthly housing costs can be in relation to your gross monthly income. Lenders usually use a second qualifying ratio if you have long-term debt paymentsthis ratio signies the maximum percentage that your monthly housing costs plus long-term debt expenses can be of your gross monthly income. Regardless of the kind of mortgage you obtain, the lender is likely to use a qualifying ratio to determine whether you are eligible for nancing. To estimate the size of the mortgage for which you may qualify, you need to look at

The percentage of your gross monthly income that you would need to spend on housing costs. Housing costs, which are usually combined into one monthly payment, include the monthly mortgage principal (the money you borrowed), the interest on that principal, real estate taxes, homeowners insurance, and private mortgage insurance if your down payment was less than 20 percent. The percentage of your gross monthly income that you would need to spend on housing costs plus monthly long-term debt payments, such as car payments, college loan payments, or other bank loans. Long-term debt usually includes any expense that extends over a period of 11 months or more. The three most common kinds of mortgage loans have their own qualifying standards:

Conventional bank loans. Conventional bank lenders usually limit monthly housing costs to 28 percent of your gross monthly income. Monthly housing costs plus longterm debt payments are usually limited to 36 percent of your gross monthly income. Government-insured (Federal Housing Administration) lenders limit monthly housing costs to 29 percent of your gross monthly income and 41 percent of monthly housing costs plus long-term debt. Special loans for low-income and moderate-income rst-time homebuyers have certain eligibility requirements established by either the state or federal government, but the qualifying ratios are usually 33 and 38 percent.

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Comparing types of mortgage loans

The chart below can help you estimate what your maximum monthly housing costs would be for each type of loan.
CONVENTIONAL LOANS ANNUAL GROSS INCOME
$25,000

FHA LOANS

LOW INCOME LOANS


41% 33% 38%

MONTHLY GROSS INCOME


$2,083

28%

36%

29%

$583

$750

$604

$854

$687

$792

$30,000

$2,500

$700

$900

$725

$1,025

$825

$950

$35,000

$2,917

$817

$1,050

$846

$1,196

$963

$1,108

$40,000

$3,333

$933

$1,200

$967

$1,367

$1,100

$1,267

$45,000

$3,750

$1,050

$1,350

$1,088

$1,538

$1,238

$1,425

$50,000

$4,167

$1,167

$1,500

$1,208

$1,708

$1,375

$1,583

$55,000

$4,584

$1,284

$1,650

$1,329

$1,879

$1,513

$1,742

$60,000

$5,000

$1,400

$1,800

$1,450

$2,050

$1,650

$1,900

$65,000

$5,417

$1,517

$1,950

$1,571

$2,221

$1,788

$2,058

$70,000

$5,833

$1,633

$2,100

$1,692

$2,392

$1,925

$2,217

$75,000

$6,250

$1,750

$2,250

$1,813

$2,563

$2,063

$2,375

$80,000

$6,666

$1,866

$2,400

$1,933

$2,733

$2,200

$2,533

$85,000

$7,083

$1,983

$2,550

$2,054

$2,904

$2,337

$2,692

$90,000

$7,500

$2,100

$2,700

$2,175

$3,075

$2,475

$2,850

$95,000

$7,917

$2,217

$2,850

$2,296

$3,246

$2,613

$3,008

$100,000

$8,333

$2,333

$3,000

$2,417

$3,417

$2,750

$3,167

$110,000

$9,167

$2,567

$3,300

$2,658

$3,758

$3,025

$3,484

$120,000

$10,000

$2,800

$3,600

$2,900

$4,100

$3,300

$3,800

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Fixed-rate versus adjustable-rate mortgages

For many years, homebuyers had only one decision to make when they obtained a mortgage: whether the mortgage would be a 15-year xed-rate mortgage or a 30-year xed-rate mortgage. Now adjustable-rate mortgages give homebuyers more choice when they shop for a mortgage, but they are slightly more complicated. The following can help you understand the benets and drawbacks of xed-rate and adjustable-rate mortgages. With a xed-rate mortgage, the interest rate on your loan never changes. You pay the same amount every month for the life of the loan. One advantage of a xed-rate mortgage is the emotional security of knowing what your monthly payment will be. Although you never experience the pleasure of watching your monthly payment decrease, you also never experience the disappointment of watching your monthly payment go up. The interest rates on adjustable-rate mortgages are variable, which means they change from time to time, usually in relation to an interest-rate index. If you have an adjustable-rate mortgage you can expect your required monthly payments to go up and down. Why would you choose an adjustable-rate mortgage? The immediate advantage is that they are usually offered at a lower initial interest rate than the rate at which xed-rate mortgages are offeredoften up to three percentage points lower. This can be appealing if you want lower initial monthly payments. It also means that some homebuyers may be eligible for a bigger loan, because lenders sometimes qualify borrowers on the basis of their income and the rst years payments (which would be lower than the payments on a xed-rate loan). If interest rates remain steady or go down, adjustable-rate mortgages can be less expensive than xed-rate mortgages. However, if interest rates go up, monthly payments go up, too. With an adjustable-rate mortgage, a lower initial rate means more risk. As a result, these mortgages tend to be better for homebuyers who are planning to stay in their homes for a shorter amount of timeusually fewer than ve years.

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How lenders determine adjustments


Interest-rate adjustments on adjustable-rate mortgages usually depend on an index value. When the index rate goes up or down, chances are your mortgage payments will follow suit. The most common indexes are

rates on one-, three-, or ve-year Treasury securities the national or regional average cost of funds to savings and loan associations The interest rate on an adjustable-rate mortgage is typically adjusted every six to twelve months, but you should always check with a lender about the specics. Ask your lender to provide you with the history of the index that is used to determine the adjustments on a mortgage in which you may be interested. You can keep an eye on mortgage rates and trends across the country at www.bankrate.com. When determining the interest rate on an adjustable-rate mortgage, lenders usually add percentage points, called the margin, to the index rate. The margin amount can differ from one lender to another, but it ordinarily stays the same throughout the life of the loan. When you compare adjustable-rate mortgages, be sure to consider both the index rate and the margin rate.

Caps on interest
If you are considering an adjustable-rate mortgage, its important to understand what the highest possible monthly payment could be, or the cap on the mortgage. There are two kinds of caps:

Periodic caps limit the interest rate increase from one adjustment period to the next. For example, the lender may agree not to raise the interest rate more than 2.5 percent at one adjustment, no matter what the index has done. Overall caps limit the overall increase during the life of the loan. For example, your lender may agree not to raise your overall interest rate more than 20 percent over the whole life of the loan, no matter what the index does during that time. Your lender can calculate what your highest monthly payment would be. If you can easily cover the highest possible monthly payment while paying for other necessary expenses, then an adjustable-rate mortgage might be something to consider.

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Negative amortization
Amortization means that your monthly payments are large enough to pay the interest on what you borrowed and to pay some of the principal (the borrowed money) itself. Thats the normal situation when you pay a mortgage. Each month, you owe the lender less than you did the month before. But if your monthly payment isnt enough to cover the interest, you can end up owing more, not less, as the months go by. How can that happen? If your adjustable-rate mortgage contains a payment cap, its possible for the interest rate to increase more than the lender is allowed to increase your monthly payment. For example, an increase in the interest rate might mean that your payment should increase by $100 a month. But the payment cap says it can only increase by $50 a month. In that case, the interest shortage is automatically added to your debt, and interest may be charged on that amount. In short, even though you keep making your payments, your debt is actually increasing, not decreasing. You will eventually have to repay the higher remaining loan balance at whatever adjustablerate mortgage rate is then in effect. When this happens, there may be a big increase in your monthly payment. What can you do about negative amortization?

Some mortgages contain a cap on negative amortization. The cap typically limits the total amount the borrower can owe to 125 percent of the original loan amount. When that point is reached, monthly payments may be set to fully repay the loan over the remaining term, and the payment cap may not apply. You may limit negative amortization by voluntarily increasing your monthly payment. Remember that an increase in the value of your home may make up for the increase in what you owe. Be sure to discuss negative amortization with the lender to understand how it would apply to any loan you are considering.

Some mortgage lenders give you different mortgage payment options. For example, I opted to pay my mortgage in two payments each month instead of one. Im still paying the same amount each month, but because Im paying more frequently I end up saving a lot in interest.

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Combination xed-rate/adjustable-rate loans


Its possible to get a loan that is a combination of a xed-rate and adjustable-rate mortgage. Mortgages like these, which are sometimes called hybrid loans or intermediate adjustable-rate mortgages, can make sense for homebuyers planning to stay in their homes for an average of, but no more than, 5 to 10 years. Ordinarily a hybrid loan will start out as a xed-rate loan for a specied number of years, then convert to an adjustable-rate loan for the remainder of the life of the loan. Hybrid loans usually offer a xed-rate interest rate lower than that of a 30-year xed-rate mortgage, but higher than a traditional adjustable-rate mortgage loan. If you are considering a hybrid loan, try to evaluate how long you expect to own your home. Will you move before the initial interest rate changes to an adjustable rate? If the answer is yes, then you stand to save money on the lower initial interest rate of a hybrid. If the answer is no, then you may consider a xed-rate mortgage a safer bet.

Balloon loans
Similar to a hybrid loan, a balloon loan offers an initial xed rate for a specic number of years. But once the time period is over, the entire balance of the loan is due. (It doesnt convert into an adjustable-rate loan.) You must either pay the balance of the loan or renance the mortgage. Because nancing is never a sure thing, it is important to be cautious of balloon loans.
Deciding between a xed-rate mortgage and an adjustable-rate mortgage

Think about the following questions if you are trying to decide between a xed-rate mortgage and an adjustable-rate mortgage:

If interest rates go up, is your income likely to increase enough to cover higher mortgage payments? Will you be taking on other sizable debts in the near future, such as a loan for a car or school tuition? How long do you plan to own this home? (If you plan to sell soon, you may not need to worry about where interest rates will go years from now. But if you plan to own the home for a long time, future interest rates will be very important.) Its important to know how any adjustable-rate mortgage you are considering compares with a xed-rate mortgage. You can make photocopies of the chart on the facing page to help you keep track of and compare information from each lender.

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Comparing xed-rate and adjustable-rate mortgages

MORTGAGE A adjustable rate Amount of mortgage Annual percentage rate Initial fees and charges $ % $

MORTGAGE B xed rate $ % $

For adjustable-rate mortgages only

Adjustment period Index used and current rate Margin Initial payment without discount Initial payment with discount How long will discount last? Interest-rate caps Periodic Overall Payment caps Negative amortization Convertibility or prepayment privilege
Monthly payment amounts

$ $

% % $

What will my monthly payment be after 12 months if the index rate Stays the same Goes up 2% per year Goes down 2% per year What will my monthly payments be after three years if the index rate Stays the same Goes up 2% per year Goes down 2% per year

$ $ $

$ $ $

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Other considerations

The term of your mortgage Whatever mortgage you choose, you will need to decide how long a term works best for you. Typically, this means choosing between a 15-year or 30-year mortgage, although other options are sometimes available. Each has its own benets and drawbacks:

A 15-year mortgage means a higher monthly payment than a 30-year mortgage, but a lower interest rate. A 30-year mortgage means a lower monthly payment than a 15-year mortgage, but a slightly higher interest rate. Another signicant difference between a 15-year mortgage and a 30-year mortgage is the total amount you pay in interest over the life of the loan. As you can see from the chart on the following page, paying off a mortgage in 15 years can save you a lot of money in intereston this $200,000 mortgage it saves you $194,400. So if you can afford to make the payments on a 15-year mortgage, is there a reason you would opt for a 30-year mortgage? The answer depends on your other nancial goals. For the example given, what would you do with the extra $400 a month (the difference between the monthly payments on the 15- and 30-year mortgages)? Would you use some of it to prepay your mortgage? Would it go directly into a savings account for your retirement?

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Outstanding mortgage loan balances

30-YEAR M O RT G A G E AT 8 % Monthly payment


Balance at 5 years at 10 years at 15 years at 20 years at 30 years Total interest paid

15 -YEAR M O RT G A G E AT 7 . 5 % $1,854
$156,188 $95,523 $0 $0 $0 $133,720

$1,467
$190,122 $175,385 $153,507 $120,911 $0 $328,120

If youre the kind of person who could benet from the type of forced savings a workplace 401(k) plan can offer, for instance, and saving for retirement is one of your goals, then taking a 30-year mortgageeven though the interest rate is a little highermight be a smart option. It might work especially well for you if you can save for retirement and prepay a portion of your mortgage. Some homeowners just want the option of paying less each month. The decision is up to you, but be sure to explore each option carefully. And ask your mortgage lender any questions you may have until you feel condent that you can make a decision thats right for you.

Prepayment
Whether you decide on a xed-rate or adjustable-rate mortgage, if you are able to pay more than the required amount on your mortgage every month you can save yourself a considerable amount of money. In general, the longer you take to repay a loan, the more youll pay in interest. Be sure to check with your mortgage lender and read your loan documents carefully before you sign them to see if there are penalties for prepayment.

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Renancing

If you choose a xed-rate mortgage but interest rates drop signicantly (to at least 2 percentage points less than your current interest rate), and youre not planning to sell your home in the next 18 months, you may want to look into renancing. Keep in mind though, that renancing can mean paying certain closing costs and fees once more, as well as additional ones such as origination and loan application fees, and title insurance fees, too. If you do think about renancing, call your mortgage lender and ask if they agree that it makes sense for you to renance. Lenders can sometimes fold costs of the renancing into the amount of the loan so you dont have to come up with up-front cash. And with the lower interest rate, the money you save versus the money you spend to renance can make it worthwhile.
Looking for a mortgage lender

Banks, credit unions, mortgage companies, and savings and loan companies all offer mortgages. Check your local newspaper or Yellow Pages to see who your local lenders are. Often rates are listed in the newspaper, but remember that rates change frequently. There are also mortgage brokers, who do not make loans themselves, but act as intermediaries and shop around to help you find a loan that fits your needs. A broker can be especially helpful if you have a bad credit rating or low savings, and are concerned that your bank may turn you down. Brokers make their money by buying mortgages wholesale from lenders and marking them up slightly before selling to you (typically by .5 to 2 percent of the borrowed amount). If youre interested in hiring a mortgage broker, nd out how much commission he or she receives and dont be afraid to negotiate. You might also talk with the broker about contracting him or her to act as your agent; otherwise you may run the risk of working with a broker who is working on the sellers behalf.

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Finding the right mortgage lender is much the same as nding a good real estate agent. You want to nd someone youre comfortable with and feel you can trust. Ask a real estate agent, friends, family members, or co-workers for recommendations. Then do some legwork. Visit a few lenders and see what kinds of mortgages they can offer you. Dont be afraid to negotiate. For example, there is nothing inappropriate about asking your lender to waive or reduce some of the closing costs, or to reduce the number of points you need to pay. You should also check with your own bank to see what it can offer.
Qualifying for a mortgage

Once youve decided what kind of mortgage will work best for you, its time to work on the application process. It will help if you understand what lenders are looking for in applicants, and what terms like pre-approval and pre-qualication mean.

What counts when youre applying for a mortgage?


Lenders look to factors like these when they evaluate your application:

Credit history. Contact your local credit bureau or a national credit repository like TransUnion (www.transunion.com), Experian (www.experian.com), or Equifax (www.equifax.com) to obtain a copy of your credit report. Depending on where you live, you may be eligible for a free report, or you may have to pay a small fee. Examine it carefully and let the credit bureau know immediately if there are inaccuracies. Bad credit could cause you delays or denials in the mortgage process. Money saved. This includes investments, checking accounts, and savings accounts. Your income, including its stability and potential. Lenders want to know what you can afford, and also that youre going to continue to be able to afford it. Bills, debts, and expenses. This includes credit card debt, outstanding educational loans and car loans, and any other regular expense. Your net worth. Net worth is the sum of all your assets minus your liabilities.

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Pre-qualication and pre-approval

Two processes can help you get ready to bid on a home: pre-qualication and pre-approval. Here are the differences:

Pre-qualication usually takes place based on an informal conversation with a lender. The lender asks you for information about your income and savings, and tells you the amount and kind of mortgage for which she thinks you might qualify. The lender doesnt require verication of the information you provide. If you pre-qualify, the lender isnt under any obligation to provide you with a loan for that amount. Lenders dont usually charge for pre-qualication. Pre-approval is a more detailed and time-consuming process, but it ordinarily guarantees you a loan through a particular lender. The lender veries your nancial information, and also considers factors such as the likelihood that you will continue to be employed. If you are pre-approved, the lender guarantees you a loan of a certain amount at a certain interest rate. This guarantee applies only to the lender who has pre-approved you. Because some lenders charge for pre-approval, it is important to ask up front about any charges. A pre-approval doesnt require you to work with a particular lender, but the lender may expect you to. If the lender quotes you a higher interest rate or lower loan amount than you expected, dont be afraid to ask for an explanation or to go somewhere else to see if you can get a better deal. Knowing that you are pre-approved by your lender means more to a seller than knowing that you are pre-qualied. In fact, in a situation where a seller receives multiple bids, having a pre-approval letter is likely to give you an advantage over other bidders who dont have pre-approval or who have only been pre-qualied for a loan. When the sellers market is particularly strong, some sellers wont even accept bids from buyers who havent been pre-approved.

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What you can afford

How much you can afford to spend and how much youre eligible to borrow can be two very different things. Even if a lender has approved you for a $200,000 loan, the debt may be too much for you to take on given your other nancial and life goals. When youre deciding how much to borrow, its important to do the math before you start looking at property. Take a look at your nances, your short-term and long-term goals, and your comfort level with debt before you come up with an amount that seems reasonable for you to take on. Remember too, that maintenance on a home of your own can put a fair amount of pressure on your pocketbook.

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Your home search

Once you have an understanding of what you can afford to pay and how mortgages generally work, its time to begin your search for the right home. You will want to look through newspaper real estate listings to get a general feel for the market in the area where you think you may buy. You will probably want to visit a variety of neighborhoods and imagine yourself living there. You will also want to understand what a real estate agent does and how to nd an agent whos right for you.

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Choosing a real estate agent

A real estate agent or broker is licensed by a state licensing body to represent sellers or buyers of real estate. (If a real estate agent isnt operating as an independent broker, then he or she reports to one. An agent has a salespersons license, which requires working for a broker. A brokers license allows you to choose between operating independently or working for another broker.) Licensed real estate agents must adhere to a code of ethics and certain professional standards. Your real estate agent is the person who is going to help you nd the home you want and work to negotiate a deal on your behalf. You want someone who is honest, reliable, and has your best interests in mind. There are several ways to go about nding an agent. You can

Get referrals from friends or relatives. Check to see if your employer has a relocation service that you might be able to consult for recommendations. Talk to agents working at open houses. This can be especially helpful if the open houses are in the neighborhoods youre interested in. You want to feel as comfortable as you can about your agents experience, skills, and way of dealing with people. Before you settle on an agent, interview several, and keep the following in mind:

Ask for references from buyers, not sellers. Call buyers who during the past year bought homes similar to the one you want. Find out whom your agent is representing. Is it you? The seller? Both? Its important to clarify this from the beginning. Make sure you agree with and understand any document your agent asks you to sign. After youve discussed what youre looking for, ask a prospective agent to sum up what your needs are. Find out how many clients an agent is serving and if the agent will have enough time to t you into his or her schedule. You want to make sure your business is a priority. Ask yourself if you feel comfortable with the agent. Is the agent pushy? Did you feel intimidated or uncomfortable asking questions?

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In addition to being helpful, informative, and friendly, your agent should listen to you and be proactive about nding what youre looking for. Good agents will screen listings and weed out ones that dont fall within your price range or dont offer what you want or need in a home. Good agents will also follow through with details, keep you informed of next steps, and keep the whole process running smoothly. Instead of just asking you what kind of home or neighborhood youre looking for, an agent should be willing to help you prioritize and to work through the decision-making process with you. Having an agent doesnt mean you should stop educating yourself or looking for homes on your own. Read the real estate section of your local paper. Dont just look at the listingsread the articles, too. This is often a good way to nd out about any local programs or subsidies your city or state might offer to homebuyers. Be sure to keep your eye out for open houses you might be interested in, and let your agent know if you nd something youd like to see.

Our broker was great and supplied us with listings of new homes every week. But it got really overwhelming. So my partner and I decided to take turns so we could give each other a break. One week it was her turn to check out the listingsthe next it was mine. If we found something we really liked, wed go back together.

Types of agents
If you nd an agent you like, make sure you understand if he or she is a

Buyers agent, who works only for the buyer Sellers agent, who works only for the person selling the home, even though the agents commission may come out of your pocket. Keep in mind that because they are working for the seller, sellers agents arent obligated to get you the best deal. Dual agent, working with a dual agency that represents both buyers and sellers. Working with a dual agency doesnt necessarily mean that the same agent will represent the buyer and seller at the same time, but it does mean that both agents work for the same company. Dual agency can create a conict of interest for the agents, and you should be clear about whom your agent is working for from the beginning.

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Working directly with a sellers agent

What happens if you find a home on your own and not through your agent? Can you approach the sellers agent directly with a bid? This is an option, and one that some sellers agents prefer because if the deal goes through they dont have to share their commission with a buyers agent. But keep in mind that the sellers agent works in the best interests of the seller, not the buyer. It may seem to be, and can end up being, a less complicated way to buy, since youre streamlining the process by involving only one broker. But make sure you look out for your own interests, and ask questions if you dont understand something. Since you dont have an agent representing your best interests, you have to make sure youre doing that on your own.
How your real estate agent gets paid

An agents commission can range from 3 to 7 percent of a homes sale price. This percentage is negotiated ahead of time between the seller and the sellers agent. Technically, the seller pays an agents commission. But since the commission is usually factored in as part of the sales price of the home, the funds end up coming out of both the buyers and sellers pockets. Usually, your agent and the sellers agent will split the commission. If you work directly with the sellers agent for the home you end up buying, the sellers agent receives the entire commission. (Agents who work for brokers split a portion of the commission with the broker.) The bottom line is this: if the home doesnt sell, the agents dont make any money. Beware of agents who try to rush you or who pressure you to close the sale as fast as possible. They are looking out for their own pockets, and not your best interests.
Buying without an agent

You may know a homeowner who purchased a home directly from an owner without using an agent. A home for sale by owner (FSBO) may be offered at a considerably lower price, since the owner doesnt have to pay a commission to an agent. But there are risks involved when buying directly from an owneryou are responsible for details that an agent usually takes care of. These can include

estimating the market value of the home negotiations of the sale price and contingencies seller disclosures, including any hidden defects establishing escrow accounts

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Consider the risks carefully. Even if you save money initially by negotiating to split the unpaid commission with the seller, there may be other fees and tasks you havent anticipated such as securing homeowners insurance. If you do decide to buy without an agent, its always a good idea to hire a lawyer to review any documents before you go through with the transaction.
Investigating neighborhoods

Now that youve done your research, youre ready to start looking for a home. Where do you start? There is a range of starting points:

Get on the multiple listing service (MLS). You can usually do this through a real estate agent. It allows you to receive daily listings via fax or e-mail of homes that t your specied criteria. Or you can log on and browse the MLS site yourself at any time. (Youll need a user name and password, which your agent can give you.) Take tours. Your real estate agent should set up home viewings for you. But you should also keep your eye out for open houses, which are usually held on the weekends. Take notes on each home. Save the sell sheet youre given. It will include details like the sales price, interior and exterior features, and property tax information. Check online and in the newspaper. Many Web sites offer real estate listings. Get into the habit of checking out daily or weekly newspapers in your community or neighboring communities youd like to explore.

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Narrowing your search

Its important to think about the inuence that your choice of neighborhood will have on your lifeand your familys life, too.

For each neighborhood you consider, think about what your commute will be like. Will you need to spend more to get to work? Think about the costs of gas, wear and tear on your car, or the costs of monthly train or bus passes. How much are the taxes? State and local taxes differ. You can check with your local county tax assessor for tax information on a particular property, often for free. You can also contact an attorney to nd out how much youd be paying in your new neighborhood. What kind of neighborhood do you want? Are you looking in a rural or urban area? Does proximity to places like work, religious organizations or cultural centers, shopping, or major highways or streets matter to you? Are you looking for somewhere quiet or lively? Do you want a neighborhood that has lots of young people or young families, or a more mixed group of residents? If safety is a concern, you can contact the local authorities and ask for safety statistics. If you already have a neighborhood in mind, the local planning and development department can provide information about intended developments in that neighborhood. This can be a helpful way to learn about plans to build additional homes, and can also alert you to any upcoming development projects that may alter a neighborhoods personality. Should you consider school systems? If you already have children, or are planning to start a family in the home you will buy, this will probably be a big inuence on your choice of town or neighborhood. A good school system will often help the resale value of a home, too. Do you want a xer-upper or a newer home? If youre seriously considering a xerupper, its probably worthwhile for you to hire an architect or general contractor to give you a home inspection. (You can read more about the home inspection process on page 47.)

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If youre thinking about a condominium

In some parts of the country, condominiums can be a good way to get into the housing market. Condominiums are a form of shared ownership. You own an individual unit in a building, but you share the maintenance of the entire building and property with the other unit owners. You also pay an additional regular fee usually monthlyto the condominium homeowners association. Because youre sharing certain expenses with other co-owners of the property, condos can often be more affordable than other kinds of homes. If you are thinking about buying a condominium, try to keep the following points in mind:

You are automatically made part of a homeowners association when you buy your condominium. You can tell a good deal about a condominium complex from the homeowners association meetings. Ask to review notes from the last meeting. Look for any complaints by residents or reports of upcoming projects. Ask what your homeowners association dues cover. In addition to normal maintenance fees, a portion of the dues should be put into reserve for repairs and replacements, like xing a leaky roof or a new exterior paint job. You should receive the complexs operating budget to review as part of the purchase process. Review this document carefully before you make an offer. Experts recommend that 3 to 5 percent of the total operating budget be set aside for predictable repairs and replacements. If the reserve fund is too low, you could be hit with additional expenses in the future. Find out what the required homeowners insurance covers. Ordinarily, the insurance covers the exterior of the complex such as the roof, foundation, and grounds. If this is the case, you may want to consider additional insurance to cover your personal belongings. Your condominium could offer less privacy than a detached house. Ask to view the condo in the evening or on a weekend, when more people are likely to be in the building. Are the walls solid enough to baffle noise?

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Some condominium associations can be extremely restrictive. The restrictions can range from what kind of window treatments you can use, to what kind of pets you may have, to the conditions under which you may be allowed to rent out your unit. Carefully examine the associations Declaration of Covenants, Conditions, and Restrictions (CC&R) and bylaws before you buy. If you dont understand something, ask a real estate lawyer to review it with you. In some cases, multi-family homes are sold as condo units. Because there are usually a smaller number of units involved, this is sometimes a more informal kind of arrangement than participating in a large condominium complex. Nevertheless, you still need to do your homework ahead of time. If you are considering buying a half house or one unit of a multi-family unit, talk to the renters or owners with whom youll be sharing the home. Find out how long theyve lived there, if theyre planning to stay, and if they have any plans for the home or grounds like an external paint job or landscaping. Be sure to agree ahead of time how youll divide up the expenses. For example, you may agree that instead of establishing a reserve fund, you will split the cost of the repairs as they happen. Agreements like these should, of course, always be in writing.

BUYING REAL ESTATE WITH LIVE-IN PARTNERS

If youre unmarried and thinking about buying real estate with a live-in partnera signicant other, relative, or friendits important to get advice from a lawyer familiar with residential real estate partnerships before you put an offer on a home. Your lawyer can help you create a document that lets you and your live-in partner or partners clarify details such as the appropriate legal form of joint ownership who is responsible for what portions of the down payment, closing costs, and mortgage payments any limits or spending requirements related to home maintenance and appliance purchases how any prots from a sale would be divided A lawyer will also help you prepare for the unexpectedfor example, what would happen if your relationship ends, one of you takes work elsewhere and needs to move, or if one of you dies?

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Making an offer and closing the sale


Once you nd a home you want, with an asking price that falls within your price range, the next step is to make a bid (also called a purchase offer). But before you make your official offer, youll want to make sure that its reasonable and smart. Doing some research before you make your purchase offer, hiring a lawyer to help you with the contract and paperwork related to the offer and the closing, and arranging for a home inspection are all necessary steps to take as you approach a closing date.

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A reasonable price

Lets say you have your eye on a particular home and want to make an offer. How do you know if the seller is asking a reasonable price? You can

Ask your real estate agent for a comparable market analysis (CMA) of homes in the surrounding neighborhood. Your agent should prepare one of these for you before you make an offer. A good CMA includes information about all recent sales (usually within the past six months) in the neighborhood as well as all homes currently for sale that are similar to the one you want in price, size, and condition. For each home, it should include information such as the sale price (including price per square foot) and the condition of the home. Look at the homes selling history, which usually includes the dates of previous transfers of title, the prices at which the house sold, and how long the home has currently been on the market. Your agent can provide you with this information. Remember that a sellers price is usually slightly inated to allow for negotiation. Take a careful look at the house youre considering as well as others on the market in the same area. Compare how the homes are laid out, their overall condition, and details like ceiling height and closet space.

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The purchase offer

Once youre condent that the sales price is reasonable, its time to start the negotiation process. Keep in mind that everything is negotiable: the price, how it is paid, the closing costs and points, the timing of the closing, and the items included (such as xtures and appliances) with the house. Once you make an offer, the seller will accept or reject itusually within days. Sometimes a seller comes back with a counter-offer. If this happens, review your budget and goals carefully. If the price is simply too high, dont be afraid to say no and keep on looking, or make a counter-offer of your own. Your purchase offer is documented by a preliminary agreement, usually called a binder or an offer to purchase. As the prospective buyer, you will be expected to secure the offer with a payment of earnest moneya good-faith deposit. This money usually is placed in a protected account called an escrow account. Both you and the seller sign this document, which grants you, the buyer, the right to purchase the property at the agreed price and on agreed terms for a limited period of time while you apply for a mortgage, have the property inspected, check title to the property, and take other necessary steps. It is important to pay careful attention to this document. If you change your mind or are unable to purchase the property, you forfeit the earnest money you have paid unless the binder clearly states that it will be refunded.

Protecting yourself with contingencies


A well-constructed buyers offer will contain contingencies that must be satised in order for the sale of the home to go through. Two important contingencies that protect the buyer are contingencies related to nancing and to property inspections. These contingencies should be drafted to allow a buyer out of the sale (and recovery of the earnest money) if the buyer cant obtain nancing or if the property doesnt pass a property inspectionfor example, if there are structural or mechanical-system defects.

We found our attorney by taking a rst-time homebuyers class through our local adult education center. Since he was teaching the class, we got a chance to get to know him while learning a lot about the process of buying a home.

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HOME INSPECTIONS

Arranging for a home inspection is one of the most important steps in the home-buying process. The most common kinds of home inspections are Pre-purchase interior and exterior components inspection. This covers electrical work, plumbing, heating and cooling systems, roof and gutters, smoke detectors, kitchen, bathroom, foundation, and insulation. Pest-control inspection. These inspectors will check for property damaged by insects and organisms such as termites and dry rot. Pest-control inspections are usually done in addition to pre-purchase interior and exterior components inspections. Architect or general contractors inspection. This is particularly important if youre buying a home you plan to x up. This inspector can give you information on local planning codes and will tell you if what youre planning to do is structurally possible. How do you nd a home inspector? Ask friends, relatives, co-workers, or neighbors for recommendations Check the Yellow Pages or local newspapers Search for inspectors in your area through the American Society of Home Inspectors (ASHI) at their Web site, www.ashi.org Check to see if your home inspector carries errors and omissions insurance coverage for mistakes an inspector may make, such as missing a aw in the home. Such errors can result in costly repairs for the new homeowner. Inspector licensing and insurance requirements vary from state to state. You can contact county government offices for local regulations.
Preparing for the closing

The busiest time for homebuyers is the time between when an offer has been accepted and the closingthe day when papers pass and title to the property officially passes to the buyer. You will be working closely with your real estate agent, your lawyer, and your loan officer to complete a number of steps:

Signing the agreement of sale


If the seller accepts your original offer or if you accept a counter-offer, you and the seller will negotiate and sign an agreement of salealso called a purchase and sale agreement, purchase agreement, or sales agreement, depending on where you live. This agreement spells out the terms and conditions under which the seller agrees to sell and the buyer agrees to buy. Like the offer to purchase, it is an important document, and you should make certain that it is written and negotiated in a way that allows you to opt out of the purchase without penalty if certain contingencies

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such as obtaining nancing, or that the house passes inspectionarent met. You should make sure that you understand the terms of this agreement and you should make sure that your lawyer reviews it for you.

Applying for the mortgage


If you havent been pre-approved for a mortgage you will have to apply for and secure your nancing. By this time, you will have also received an estimate of closing costs in writing.

Ordering title, appraisal, and insurance


Your closing agentyour lawyer and/or your real estate agentwill order title insurance to protect against other claims on the property. Most mortgage companies require you to get homeowners insurance, which protects their investment against re, theft, and other accidents. Ask your friends, relatives, lawyer, or real estate agent for recommendations of insurance brokers, and be sure to compare rates and policies before deciding on a policy. Your mortgage lender will also order an appraisal an expert estimate of the value of the propertyto make sure the house is worth what youre paying for it.

Receiving a mortgage commitment


If youve already been pre-approved for a loan, having the nal documents in hand could take as little as 48 hours from the time the nal paperwork on the home is submitted to the lender. Otherwise, you may need to wait as long as a few months for the paperwork to be ready. A commitment means your mortgage application has been formally approved. Be sure to review it with your real estate agent and lawyer, sign it, and return it to the lender for nal processing.

Transferring utilities
Youll need to notify gas, electric, water, and other utility companies that youll be moving into your home after the closing date. Be sure to cancel utilities in your current home and notify the landlord of your departure, as specied in your lease.

When I bought my home, the seller offered the results from the home inspection shed had a few months earlier. Luckily, I chose to have my own home inspection. Several problems were identied and I was able to negotiate $1,000 off the asking price!

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CHOOSING A LAWYER

Although some attorneys are also real estate brokers, most real estate brokers are not attorneys and are not permitted to provide legal advice. It is important to consult a lawyer experienced in real estate transactions when you buy a home for advice about your particular situation and the real estate laws in your state. A real estate lawyer will also help you with the nal details such as the purchasing agreement, which is a legally binding contract. To nd a lawyer you can often ask your mortgage lender for a recommendation. You can also ask friends or relatives for recommendations of lawyers who have handled residential real estate transactions for them, or contact your city or county bar association for listings.

The closing

The closing day and time will be scheduled several weeks in advance. You may want to consider taking a vacation or personal day that day or rearranging your schedule to allow you some time off. You may also want to take one last walk through the property before the closing to make sure everything is as it should be. For example, if youve arranged with the seller for some corrective work to be done before the closing, youll want to inspect and make sure its been completed. At the closing, youll need to pay any nal closing fees: your costs minus the amount already in escrow. Your agent will tell you the exact amount to bring in the form of a bank check. The closing or settlementthe legal transfer of the house to you may take place at the office of the escrow agent, the lawyer, or the real estate agent. It may include a representative from the title company, the mortgage broker, escrow agent, real estate agents representing both you and the seller, your lawyer, the sellers lawyer, a conveyancer who prepares the documents, and the seller. Be prepared to sign a lot of papers and to ask lots of questions. You may feel pressure to complete the necessary paperwork as soon as possible, but its important to take as much time as you need. It may be helpful to ask to see sample documents before the closing, which you can review at your own pace. Once youve paid the remaining fees, signed all the papers, and closed the escrow account, youre nally on the way to your new address!

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Once youve settled in

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Congratulationsyouve successfully navigated the exhilarating move from homebuyer to homeowner! But your work is far from over. In addition to packing and moving, deciding where you want your furniture to go, and changing your mailing address on all your magazine subscriptions, you have three important tasks to do:

Keep saving. Look at the worksheet at the beginning of this booklet where you described your long- and short-term goals. Make sure you havent stopped putting money into your 401(k) or IRA plans, for example. Is buying a new dining room set more important than saving for retirement? No doubt some of your goals will change. But its important to review them once more, re-establish your priorities, and nd a way to adjust your budget to reach the ones you feel are most important. Limit the money you spend on renovations and furnishings. Separate what you need to do from what youd like to do. Fixing a leaky roof is a need, while a new bed and dresser are usually a want. Leave yourself something to look forward to. Tackle each room one by one. Learn how to do simple repairs from a book or a continuing education course. Rebuild your emergency fund. More than likely, the down payment and closing costs of buying your rst home have drained any savings you may have reserved for emergencies. Its important to build this back up as quickly as possible. Waiting may cost you more money in the long run if you have to put unexpected car payments on a high-interest credit card. But for now, pull up a moving crate, grab a slice of pizza, and enjoy the fact that youve made a sound investment in your futureyour own home.

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Terms it helps to know


Abstract of title
A summary of the public records relating to the title to a particular piece of land. An attorney or title insurance company reviews an abstract of title to nd out whether there are any problems with the title (title defects) that must be cleared before the purchase. Problems with the title could prevent you from getting adequate insurance on the property, and could affect the value of the property and your ability to sell it later on.

Agreement of sale
A contract in which a seller agrees to sell and a buyer agrees to buy, under certain specic terms and conditions spelled out in writing and signed by both parties. It may also be called a contract of purchase, purchase and sale agreement, purchase agreement, or sales agreement, depending on where you live.

Amortization
A payment plan that enables you, as a borrower, to reduce your debt gradually through periodic (generally monthly) payments. When property is used for business, amortization also refers to the annual reduction in the propertys value for tax and business reporting purposes.

Appraisal
An expert estimate of the value of a piece of property. Mortgage lenders generally require an appraisal to ensure that the value of the property is greater than the loan they are considering.

Binder or offer to purchase


A preliminary agreement to purchase a piece of real estate. To be valid, a binder must be secured by the payment of earnest money, and must be signed by both the buyer and the seller. A binder grants you, as the buyer, the right to purchase the property at an agreed price and on agreed terms for a limited period of time (while you apply for a mortgage, have the property inspected, have the title checked, and take any other steps you may need to take before you complete the purchase). If you change your mind or are unable to purchase, you forfeit the earnest money unless the binder clearly states that it is to be refunded.

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Broker

(See real estate broker.)


Certicate of title

A certicate issued by a title company, or a written opinion from an attorney, stating that the seller has a clear title (good, marketable, and insurable) to the property being offered for sale. A certicate of title is not a guarantee to you, as a buyer, that there are no hidden problems with the title (hidden title defects) that would not be uncovered by a normal, careful examination of the title records. The title company or lawyer issuing the certicate of title is liable only for damages due to negligence for not noticing and pointing out a defect that is in the title records. You can get more comprehensive protection against a title problem by purchasing a title insurance policy.
Closing

The meeting at which documents are signed, payments are made, and ownership of the property is legally transferred from the seller to the buyer. The certicate of title, abstract, and deed are generally prepared for the closing by an attorney and this cost is charged to the buyer. The buyer signs the mortgage document and payment is made to cover the closing costs. The nal closing conrms the original agreement reached in the binder or agreement of sale.
Closing costs

The many small and large expenses that buyers and sellers normally incur to complete the sale of a piece of property. These costs are separate from the price of the property. Payment of closing costs is generally required at the closing. The agreement of sale negotiated between the buyer and the seller (the binder) may state in writing who will pay each of the various closing costs.

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Commission
Money paid to a real estate agent or brokermost commonly by the selleras compensation for nding a buyer and completing the sale of a piece of property. A commission is usually a percentage of the sale price6 to 7 percent on houses, 10 percent on land. While sellers have traditionally hired and paid commissions to real estate agents or brokers, more and more buyers are hiring buyers agents and paying them commissions to perform these services on their behalf.

Condominium
A form of property ownership that allows you, the buyer, to be the sole owner of an apartment or living unit and to share in the ownership of common areas and facilities in a multi-unit building or development.

Contract of purchase
(See agreement of sale.)

Contractor
In the construction industry, a contractor is someone who contracts to build buildings or portions of buildings. There are also contractors for each phase of construction: heating, electrical, plumbing, air conditioning, and so on.

Conventional mortgage
A mortgage loan that is not insured by the U.S. Department of Housing and Urban Development (HUD) or guaranteed by the Veterans Administration. Banks, mortgage companies, and other nancial institutions lend money for home purchases in the form of conventional mortgages.

Cooperative housing
An apartment building or a group of homes owned by a housing corporation whose stockholders are the people who live in the homes or apartments. The residents/stockholders elect a board of directors to oversee the management of the property. The corporation or association owns title to the property. While the residents do not own their specic apartments or units, they have an absolute right to live in their units for as long as they own stock in the corporation.

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Deed
A formal written instrument by which title to real property is transferred from one owner to another. The deed should contain an accurate description of the property being transferred, should be signed and witnessed according to the laws of the state where the property is located, and should be delivered to the purchaser at closing day. There are two parties to a deed: the grantor (the person giving up ownership of the property) and the grantee (the new owner of the property).

Default
Failure to make mortgage payments according to the terms of the mortgage or deed of trust. The borrower is responsible for making payments when they are due, without reminders from the lender. Generally, if payment is not received 30 days after the due date, the loan is in default. The loan may also be in default if the borrower fails to meet other conditions in the mortgage or deed of trust, such as timely payment of real estate taxes or maintaining adequate homeowners insurance. When a loan is in default, the mortgage or deed of trust may give the lender the right to accelerate payments, take possession of and rent the property, or start foreclosure (the forced sale of the property).

Depreciation
A decline in value of a home due to wear and tear, changes in the neighborhood, or any other reason. When property is used for business, depreciation also refers to the annual reduction in the propertys value for tax and business reporting purposes.

Down payment
The amount you, as the buyer, come up with from your own resources to purchase the property. The down payment is the difference between the sale price and amount to be borrowed under the mortgage or deed of trust. You pay the down payment amount to the seller when you both sign the agreement of sale. The agreement of sale species the down payment amount and acknowledges its receipt by the seller. If you do not follow through and complete the purchase of the property, you may forfeit the down payment. Because events outside of your control may keep you from completing the purchase, you should be sure the agreement of sale species the conditions under which the deposit will be refunded. If the seller cannot deliver good title, for example, or you make a reasonable effort and nd that you are unable to obtain the needed mortgage, the agreement of sale usually requires the seller to return the down payment.

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Earnest money
The deposit money that you give to the seller or to the sellers agent when you and the seller sign the binder or offer to purchase to show that you are serious about buying the house. If the sale goes through, the earnest money is applied against the down payment. If the sale does not go through, you may forfeit the earnest money unless the binder or offer to purchase expressly provides that it is refundable.

Easement rights
A right-of-way granted to a person or company, authorizing access to or over the owners land. A common example is when an electric company obtains a right-of-way across private property for a power line.

Encumbrance
A legal right or interest in land that affects a good or clear title, and diminishes the lands value. This can take numerous forms, such as zoning ordinances, easement rights, claims, mortgages, liens, charges, a pending legal action, unpaid taxes, or restrictive covenants. An encumbrance does not legally prevent transfer of the property to another. A title search is all that is usually done to reveal the existence of such encumbrances. It is up to the buyer to determine whether he or she wants to purchase the property with the encumbrance, or what can be done to remove it.

Equity
The value of a homeowners unencumbered interest in real estate. Equity is computed by taking the propertys fair market value and subtracting the total of the unpaid mortgage balance and any outstanding liens or other debts against the property. A homeowners equity increases as he or she pays off his or her mortgage or as the property appreciates in value. When the mortgage and all other debts against the property are paid in full, the homeowner has 100 percent equity in the property.

Escrow
Money the property owner pays to the lender to be held in a special, protected account (an escrow account) to be used to pay mortgage insurance premiums, real estate taxes, and other regular expenses required to ensure the continued value of the property. The money in the escrow account belongs to the buyer, and can only be used to pay for certain expenses related to the property, as specied in the mortgage or deed of trust.

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Foreclosure

A legal term for any of the various methods of enforcing payment of the debt secured by a mortgage or deed of trust. Foreclosure methods include taking and selling the mortgaged property, and evicting the borrower from the property and renting it until the mortgage is paid.
Hazard insurance

Protects against damages caused to property by re, windstorms, and other common hazards.
HUD

The U.S. Department of Housing and Urban Development. The Office of Housing/Federal Housing Administration within HUD insures home mortgage loans made by lenders and sets minimum standards for such homes.
Interest

A charge paid for borrowing money.


Lien

A claim by one person or party on the property of another as security for money owed. A lien may be applied to guarantee the payment of unpaid taxes, money due to a contractor, or any other debt. A lien prevents the property from being sold without rst paying the money owed. (See also special lien.)
Mortgage

A lien or claim against real property given by the buyer (or borrower) to the lender as a security for money borrowed. Under the terms of a mortgage, the borrower grants the lender certain rights to the property in the event that the borrower defaults on the mortgage (fails to make regular mortgage payments or does not fulll other conditions of the loan). The lender has the right to force the property to be sold to repay the loan, for example, or to evict the borrower from the home in order to rent it and earn money toward the loans repayment. Mortgages generally run from 10 to 30 years. The borrower makes regular (generally monthly) payments of interest and principal until the loan is completely repaid.

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Mortgage broker
An intermediary between the buyer and a mortgage lender. Brokers often shop around to help you nd a loan that ts your needs. A broker can be especially helpful if the buyer has a bad credit rating or low savings, and is concerned a bank may turn him or her down. Brokers make their money by buying mortgages wholesale from lenders and marking them up slightly (typically by .5 to 2 percent of the borrowed amount) before selling resale.

Mortgage commitment
A written notice from the bank or other lending institution saying it agrees to make a mortgage loan to the buyer, and will advance mortgage funds in a specied amount to enable a buyer to purchase a house.

Mortgage insurance (also called private mortgage insurance or PMI)


A government insurance program, administered by the Federal Housing Administration (FHA), that protects mortgage lenders against loss when borrowers default on mortgage loans. A mortgage lender may require you, as a borrower, to buy mortgage insurance. When this happens, the lender generally adds the mortgage insurance premiums to the amount you pay with your regular mortgage payment. The lender then forwards the premium portion of your payment to the government to help defray the cost of the FHA mortgage insurance program.

Mortgage note
A written agreement to repay a loan. The agreement is secured by a mortgage, serves as proof of the debt, and species how the loan will be repaid. The note states the actual amount of the debt that the mortgage secures and renders the borrower (or mortgagor) personally responsible for repayment.

Mortgage (open-end)
A mortgage with a provision that permits borrowing additional money in the future without renancing the loan or paying additional nancing charges. Open-end provisions often limit borrowing to no more than the balance of the original loan gure.

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Mortgagee
The lender in a mortgage agreement.

Mortgagor
The borrower in a mortgage agreement.

Plat
A map or chart of a lot, subdivision, or community drawn by a surveyor showing boundary lines, buildings, improvements on the land, and easements.

Points
Sometimes called discount points. A point is 1 percent of the amount of the mortgage loan. For example, if a loan is for $25,000, one point is $250. Lenders charge points to raise their returns on loans at times when money is tight, interest rates are high, and there is a legal limit to the interest rate that can be charged on a mortgage. Buyers are prohibited from paying points on HUD or Veterans Administration guaranteed loans. (Sellers can pay, however.) On a conventional mortgage, either buyer or seller or a combination of the two may pay the points.

Prepayment
Payment of the mortgage loan, or part of it, before the due date. Mortgage agreements often restrict the right of prepayment either by limiting the amount that can be prepaid in any one year or charging a penalty for prepayment. No restrictions on prepayments are allowed in FHA-insured mortgages.

Principal
The amount of money borrowed under a mortgage loanas distinguished from additional money that may be paid over the course of the loan, such as interest and mortgage insurance premiums. In other words, principal is the amount upon which interest is paid.

Purchase agreement
(See agreement of sale.)

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Real estate broker


An agent who buys and sells real estate for someone else on a commissioned basis. The broker does not have title to the property, but generally represents the owner or seller. Buyers may also arrange for brokers to represent them in their search for property and negotiations for its purchase.

Renancing
The process of replacing one mortgage loan with another, generally at a lower rate. Renancing is done by obtaining a new mortgage (from the same mortgage lender or from a different lender) and using the money borrowed in the new loan to pay off the outstanding balance on the old loan.

Sales agreement
(See agreement of sale.)

Special assessments
A special tax imposed on property, individual lots, or all property in the immediate area, for road construction, sidewalks, sewers, street lights, and so on.

Special lien
A lien that binds a specied piece of property (as opposed to a general lien, which is levied against all of an individuals assets). A special lien gives one person certain ownership rights to another persons property as a way to collect money that is owed for work or materials or money spent on the property. In some places it is called a particular or specic lien. (See also lien.)

Survey
A map or plat made by a licensed surveyor showing the elevations, improvements, and boundaries of the land, as well as its relationship to surrounding pieces of property. A survey is often required by the lender as assurance that a building is actually located on the land according to its legal description.

Title
The rights of ownership and possession of particular property. In real estate transactions, title has two meanings: it may refer to the instruments or documents by which a right of ownership is established (title documents), or it may refer to the ownership interest an individual has in the real estate.

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Title insurance
Insurance that protects homeowners or lenders from loss due to problems with the title to a piece of property. Title insurance may be issued to either the homeowner, as an owners title policy, or to the mortgage lender, as a mortgagees title policy. Since payment is made only to the party insured, if you want the full benet of a title insurance policy, be sure to purchase an owners title policy.

Title search or examination


A check of the title records, generally at the local courthouse, to make sure the buyer is purchasing a piece of property from the legal owner and there are no restrictions, claims, or liens on the property that would reduce its value or limit the buyers ability to resell.

Zoning ordinances
Acts carried out by an authorized local government, establishing building codes and setting regulations for proper land usage.

This glossary was adapted from Home Buyers Vocabulary, a brochure published by the U.S. Department of Housing and Urban Development, Washington, D.C.

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