The selection process in the housing market has developed a number of options that have more to do with the legal rights you possess as a homeowner than with the physical style of the building. Since your ownership interest can be important in determining your satisfaction with the home and the investment rewards of the purchase, try to focus on the legal ramification of the type of dwelling you prefer before you start your housing search.
The single-family detached unit, which is the most common type of housing structure, is what most people have in mind when they think of buying a home. It is simply a house designed for use by one household that sits on its own plot of land without being connected to a neighboring structure. When you buy a single-family detached home, you own the house and land and are solely responsible for their upkeep. You are free to modify the structure and landscape or build outbuildings as long as you comply with local ordinances and codes and any deed restrictions.
In large cities and areas where space is limited, several housing units may be combined into one structure. These attached or cluster housing units are separated by party walls and have individual entrance ways. They may also have small lawns or courtyards in front and/or in back. In some areas, these units are called row houses or brownstones, but can also be referred to as townhouses. Some townhouse complexes are set up as condominiums, which are described in the next section. However, many townhouses, particularly older units, are individually owned. In these cases, the homeowner shares ownership of the party wall with each neighbor having an easement legally protecting the integrity of the wall.
In some newer subdivisions, housing units are clustered together to provide additional open space. These may be called patio homes or zero lot line homes. The arrangement often involves some type of shared wall, driveway or common grounds which are protected by easements as in townhouse units. The practical meaning of any of these types of housing arrangements is that the owner may be restricted in how he or she uses the component covered by the easement. The prospective buyer should become familiar with the specific restrictions that may apply.
The term condominium, which describes joint sovereignty, refers to the way individual property rights are exercised among the participating homeowners. Condominiums are made up of a number of dwelling units combined in a single building, complex, or subdivision. In a strict sense, the individual homeowner has ownership of only the interior of the dwelling unit. The structure of the buildings, the grounds, and any facilities on the grounds are common areas controlled by the homeowners' association. Every owner is a member of the association, paying periodic fees and having a vote in deciding its actions. The association generally maintains the common areas and sets rules for their use. In practical terms this means that the homeowner can enjoy common facilities, such as a swimming pool, at a fraction of the cost of providing one for individual use. It also means that the homeowner may be much more restricted in what can be done with his or her home than the owner of a single-family detached home. If you are considering a condominium, you should examine the association by-laws prior to making an offer. Some associations prohibit pets or even children.
Condominiums can be large or small, can be part of complexes with hundreds of units or a few units, and can be in the form of high-rise buildings, garden apartments, townhouses, or detached homes. Some units will be among the lowest priced housing available, while others are among the highest priced. The more inexpensive units are usually designed to take advantage of the lower land costs associated with high density development. The high priced units are usually located in highly desirable areas and include many luxury features. Condominiums appeal to people who don't care to do home maintenance chores.
Like condominiums, cooperatives involve sharing ownership of property with other homeowners. The cooperative buyer purchases shares in a corporation holding title to the building. The shares give the owner the right to occupy an apartment in the building. Each shareholder pays a portion of all financing, tax, and operating expenses associated with the building. The important differences between a cooperative and a condominium are related to mortgage financing and resales. In a cooperative a single mortgage loan is taken out by the corporation; in a condominium individual loans are obtained by each tenant. The cooperative arrangement may prove advantageous during periods of high interest rates as the new purchaser does not have to obtain new financing. However, failure of some cooperative shareholders to pay their share of expenses places a burden on all other owners to avoid foreclosure of the loan. Regarding resales, cooperative owners are free to offer their shares on the market, but transferring their right to occupy a unit must be approved by the other shareholders. In most cases, this procedure causes no problem, but does present one potential snag to reselling the unit.
Homes designed to accommodate two households are called duplexes. There are also triplexes and quadraplexes for three and four households. The building is divided into separate living areas, each with its own bath and kitchen facilities, as well as outside entrance. A duplex can often be purchased for little more than a single-family home and offers the opportunity to generate rental income. The owner may live in one half and rent the other to help defray housing expenses. If you like the idea of being a homeowner and landlord at the same time, a duplex may be for you.
Once referred to as mobile homes, manufactured homes are usually sold without a lot and can be moved to a site that is owned or leased by the buyer. These homes can be as large and luxurious as many site-built homes but cost substantially less. However, the market for used manufactured homes is not as broad as that for site-built homes. This means that a manufactured home will probably have no real appreciation in value. Many communities severely restrict where manufactured homes may be placed, so before you consider this alternative, check on where such homes are permitted.
Sometimes it is possible to try out a home before committing to a purchase. A lease option is a lease with an option to buy within some time period. The tenant may be asked to pay a few for the option. This fee will be applied toward the purchase price if the option is exercised, but forfeited if it is not. In markets where homes are hard to sell, however, option fees are usually not charged. In addition, the seller may be willing to apply some of the rent toward the purchase price. Lease options are good ways to find out about a home before buying, and may provide a way to save a down payment for a home.
One way to buy a home when cash for a down payment is short is to arrange to co-purchase the home with an investor. The investor contributes a large portion of the down payment and you live in the home. Generally you must pay some form of rent on the investor's interest in the home. When the home is sold, you and the investor share in the proceeds. Before entering into an equity-sharing arrangement, it is essential to have in writing exactly what your rights and responsibilities are and the conditions under which the home can be sold.
Finding a new home can be a long and trying process. Fortunately, there are experienced professionals who can help in the search. Licensed real estate brokers can show you homes that are on the market, suggest sources of financing and help you in other aspects of the home purchase. Even with this assistance, however, you will find the process less confusing if you know a few basics. You will find it helpful if you know how to estimate the highest price you can afford to pay, how to size up the market, and how to make an offer.
By far the biggest hurdle in buying a home is getting a loan. To qualify for a free loan, you must have enough cash for the down payment and other closing costs and enough income to handle the loan payments. By comparing these requirements to your income and cash on hand, you may figure out how much you can afford.
The first step is to put together an accounting of current income and debts. The lender will want to see these items when you apply for the loan. It is a good idea to do this before you look at homes, so you don't waste your time with homes you can't afford.
Salaries. Include what you make from your regular job. You may also include a spouse's salary if the job is steady and you can show that the income is dependable. The same goes for second jobs, bonuses and overtime pay. Are they a dependable source of income or just a temporary arrangement? If you are self-employed or work on commission, you should average the income received over the last several years. The object is to total the income you expect to make on a continuing basis.
Investments. The money you get from your investments may be included if it is large enough to be meaningful (in most cases, $100 per month). This income includes interest from bank accounts, bonds and mutual funds, and dividends from stock and bonds. You should not include assets you intend to sell to raise cash to purchase the home. Once again, the idea is to include sources of income to be used for making the loan payments. If real estate is included, use net income after taking out routine expenses.
Alimony and child support. Include these sources of income if they are not subject to termination in the near future. For example, child support is generally terminated when the child reaches a certain age. If you expect to receive this income for only the next few years, it should not be included.
Liabilities. Now, make a list of your debts that require periodic payments. Include long term installment debt with a remaining term of more than ten months. Typically, this will include car loans, furniture loans, and other loans for major purchases. If you carry a balance on your credit cards, you should include the average monthly payment. Also include any other real estate mortgages you have, for example, the one on the rental property you listed in the income section. Finally, if you pay alimony or child support, you should include that payment.
Lenders have different ratios they apply to your income alone and to your income minus debt obligations. You can use these ratios to get an idea of the largest loan you can obtain. You should apply both ratios because you must qualify under both criteria.
The most common loan is the conventional mortgage loan. This is one with no government insurance or guarantee to cover the lender's risk that you may fail to keep up the payments. Most lenders require the ratios that are required to sell the loan in the secondary market. Currently, the Federal National Mortgage Association, a major investor in home mortgages, requires that total mortgage payments plus insurance and taxes be no more than 28 percent of gross monthly income. Also, these expenses plus other debt payments can be no more than 36 percent of gross monthly income.
An example will show how these ratios can be used to estimate the maximum affordable loan. Mr. And Mrs. Fenimore receive $3,500 per month salary plus an average of $500 per month from investments. Their total monthly income is $4,000. Their mortgage payment may be no more than 28 percent of this income, or $1,120. An approximation of monthly escrow payments is one-fifth of the total payment. In the example, that would be $224, leaving $896 for principal and interest. They find that a mortgage loan can be obtained at 10 percent interest for 30 years. They look at a mortgage loan payment table and find that the largest loan they could afford is for $102,100.
The Fenimores also pay an average of $400 per month on their credit cards and car loan payments. Using the 36 percent ratio, they have $1,440 to use for all debt payments. Taking out the $400 they spend on current debts leaves them with $1,040 a month for mortgage expenses. After deducting one-fifth for taxes and insurance, the remainder for principal and interest is $832. This payment would support a loan of $94,800 at 10 percent interest. Since this is less than the amount indicated by the simple income ratio, it represents the effective maximum loan obtainable. With a 20 percent down payment, they could afford a home priced at $118,500. Such a purchase would require a down payment of $23,700 plus closing costs of approximately $3,000, depending on how much the seller is willing to pay toward closing costs.
Source: Barron's Real Estate Handbook, Third Edition
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