Buy The Book
- In 2005 David
Bach wrote one of the very best books ever written for first-time
homebuyers. You're probably aware of the book called The Automatic
Millionaire Homeowner. First-time homebuyers would do well to read
this book from cover to cover. The book are some great lessons for
every aspiring homeowner. I thoroughly enjoyed the book and most
highly recommend it to my clients. On my web site, this is the one
book listed on the site that has my highest recommendation to buy.
As good as the book is, there are definitely some additions that
could be made to the book to make it more applicable for higher
priced markets like San Diego. Before I cover what additions I would
recommend for this valuable book, let's do a quick recap of the
major (and very wise) points that David Bach makes in his book:
Don't try to buy a dream house on
your first purchase.
Creating an automated system of paying your bills
and mortgage is
really the only effective way to guarantee that you'll pay down the
Don't stretch too much to buy your
Don't sell your home when you buy a
When you buy your 2nd home and subsequent homes after that, try to
hold on to your previous homes and rent them out. This is one of
David's major keys to wealth building. It takes planning to purchase
a property that you will someday rent out profitably.
Use a bi-weekly payment plan
to pay off your mortgage early and save a lot on interest.
You need to adopt the proper
to believe that
all of this is possible.
Consider your home a long-term
Make sure that the money you are investing in your primary residence
is a long-term commitment and not based on short-term speculation.
Use the older, more stringent (lower)
"back-end" debt ratios
to determine the maximum that you should borrower.
Buy less than you can.
Whatever your debt-to-income calculation says that you can afford,
knock 10% to 20% off of this. Doing so gives you an income cushion.
Keep making the same payments
after a debt is paid off.
If you pay off a large debt during or shortly before you become a
homeowner, continue to make the same payments except directed toward
the mortgage or down payment fund.
Automate saving the down payment
- To acquire funds for down payment, set up an automatic
transfer from your paycheck into a savings account that has no ATM
card or check-writing privileges attached to it.
Get rid of your "Latte Factor."
down payment, change your spending habits for one year.
Take care of the loan first
- Before you look at homes, get all questions related to the future
mortgage and your desired monthly payment limits and qualifying
ability resolved to your satisfaction first.
Don't let the lender determine the
max you will borrow
- Always keep in
mind that most lenders are willing to lend you more money than you
The above points
are great advice. Had the majority of homeowners who purchased over
the last five years followed such advice, there would be no subprime
crisis and foreclosure spike today.
To Become An Automatic Millionaire in
Higher Priced Neighborhoods
Here are some
ways that David's book could be updated to create Automatic
Millionaire Homeowners in high-priced home markets:
Work as hard as you can to save up a
You need to do more than just automate this process. You need to
automate it and then add additional to the fund every month. In a
higher priced market, a 10% down payment will normally be between
$25,000 and $45,000. It would be difficult to gather this sum by
simply automating an allocation of some percentage of your paycheck
to your down payment fund. You will have to come up with additional
measures to gather the large sum. Your down payment is your cushion
against property value decline. You need this in the volatile,
Avoid purchasing in areas that have a
lot of recent short sales.
A spate of short sales within an area indicates that prices have
recently dropped significantly in that area. Try not to buy in areas
that have falling prices. Wait at least until prices have
Try to get the seller to buy down
your interest rate.
A 1% reduction in rate can reduce the total interest paid on a
$400,000 loan by $20,000 in the first five years. Also, a 1% rate
reduction will lower the monthly payment of a $400,000 by
approximately $300. As far as monthly payment goes, it is a much
better deal for the buyer if the seller buys the rate down by 1%
than if the seller covers all other closing costs. The loan amount
needed by the buyer is typically reduced by the amount of the
closing costs that the seller covers. If a seller covers $10,000 of
closing costs, the buyer's monthly payments would be reduced by
approximately $50. If the seller agrees to pay to buy down the
buyer's rate, a 0.5% reduction in rate will reduce the monthly
payment on a $400,000 loan by approximately $150. Buying down the
rate is usually a better deal for the buyer than having closing
Try not to borrow from your
Question - Why did you set up a retirement fund in the first place?
If you dip into your retirement fund every time you need money, how
much money will you have at the time of your retirement? If you
borrow from your retirement fund, this borrower money typically has
to be repaid in 5 to 10 years. If you don't repay this or you get a
new job, you might have to pay the IRS a 10% penalty on the borrowed
money. . Do remember though that you are able to take out $10,000
from your IRA for the purchase of your first home without penalty.
Set up a separate account to save up for down payment. Don't touch
your retirement fund if possible.
Eliminating the "Latte Factor" is
David Bach provides an important discussion about the changes that a
typical person must make in their lifestyle to accumulate a
sufficient down payment. I believe that a much more detailed
discussion of budgeting is warranted. Eliminating the "Latte Factor"
is one thing, but probably not enough. Only through effective,
disciplined, proactive, continuous budgeting will a person save up
enough for a down payment in a high priced market.
Earning more is better than spending
- In addition to establishing a budget and thus enforcing frugality
upon one's lifestyle. a person should make efforts toward earning
more money as well. There are two schools of thought regarding
saving up a down payment. One school of thought proposes that the
best way is to reduce expenses and direct the savings to an account
that is solely dedicated to acquiring down payment. The other school
of thought asks, "Instead of emphasizing reducing expenses, why not
work harder to earn more money?" The is a real and finite limit to
the amount of money that can be accumulated through reducing
expenses. A person will always have a certain fixed level of
expenses. In a high priced market, this method can take quite a long
time to accumulate a 10% down payment for a $400,000 home. On the
flip side, a person's ability to increase income is unlimited.
Knowledge, creativity, and drive are the factors that determine how
much a person can increase his or her income. I would much rather
accumulate my down payment by earning a lot more than by starving a
lot more. Wouldn't you?
Don't do interest-only payments.
Opt for the fully-amortized (principal and interest) payments.
Interest-only payments pay no principal down. You will accumulate no
equity unless the underlying home value goes up, and stays up. Many
of the high priced markets might see long periods of time before
prices rise again. In this situation, renting would be the better
alternative for the person who cannot afford to pay any principal
down. You accumulate equity by one of two ways: paying off the
balance on the mortgage or through property appreciation. If you are
not paying down the mortgage, the property is not appreciating, and
rent for a comparable property is cheaper, you're might be better
off renting. Don't buy a home unless you can afford a fully
amortized, fixed loan.
Only buy a property if you expect to
live in it for at least five years.
The transaction costs of purchasing a home are high enough that you
don't recoup them unless you are in a home for at least five years.
Appreciation is not something to count on. The higher priced markets
are the most volatile and the levels of appreciation in these
markets in five or even in three years will likely be completely
different than what they are today. Short and medium-term
appreciation is not something to count on a high priced and volatile
market, no matter what a real estate agent or loan officer tries to
Determine what payment you can
One general rule-of-thumb is that homeowners can often afford to
pay up to 50% more on monthly home expenses than they were paying
while renting. The tax benefit that homeowners get makes this
possible. The immediate write-off of mortgage interest and property
taxes will result in either a large refund at the end of the tax
year or an increase of several hundred dollars of monthly take-home
pay as a result of reduced income tax withholding with the employer.
Evaluate the worst-case future loan
Only take a loan if you are sure that you can handle the worst thing
that happen in the future. For example, if you are out of work for
three or six months, will you wind up in foreclosure? If rates
adjust two points up by the time an adjustable mortgage becomes
adjustable, can you afford it? If home prices in your area drop 5
percent and you have to sell for some reason, will you wind up in
foreclosure because the mortgage balance would not be covered by the
sale price or your reserves? How close are you to the edge? What
reserves do you have available? You'll need to answer these
questions before taking on a home purchase. Most of those in
foreclosure or heading toward foreclosure today did not think these
issues through before they purchased.
Avoid certain mortgage folks.
You only want to deal with mortgage loan officers that have your
interests in mind. Here are some red flags that tell you that you
are not dealing with a loan officer that has your interests in mind.
Know unsafe loans and avoid them.
The loan officer is suggesting that you get into an unsafe loan like
an option ARM or a short-term adjustable rate. Loan officers like
this are to be avoided with no exceptions. Run for your life!
Ask the loan officer to guarantee the
non-recurring closing costs
that appear on the Good Faith Estimate within $200. You'll need to
get this guarantee in writing. If the loan officer won't do this,
get a new loan officer.
- Ask the loan officer to provide you with the rate lock
confirmation from the lender and also the initial loan approval from
the underwriter. If the loan officer won't do this, get a new loan
Ask the loan officer to show you the
rate sheet from which they are quoting your rate
and to explain to you in very clear terms how their yield spread
premium (the money that the lender pays them based upon how high of
a rate they can get the borrower to take) is calculated. If the loan
officer won't do this or can't do it in a way that you understand,
get a new loan officer.
Make sure the loan officer has been
in business for a while.
Get your credit squared away first.
One of the very first things a potential first time home buyer
should do is to obtain a copy of the credit report from each of the
three credit bureaus. This should be done well in advance of the
home purchase. There are often surprises on credit reports that can
take a long time to correct. The credit should be squared away
before applying for a mortgage.
Do not take a subprime loan.
Avoid loan officers that bill themselves as "subprime specialists."
These are the loan offices that made the majority of the bad loans
out there today. Subprime loans are loans that are designed for
people with credit issues. You should try to get your credit in good
standing before thinking about purchasing a home. A credit score
that is less than optimal will rise reasonably to a good rating if
all further payments are made on time. I've had clients that had
700+ FICO scores within two years of discharge from a bankruptcy.
Don't worry about the median home
price in an area.
First time home buyers nearly always purchase well below the median.
In San Diego, the median price is above $500,000. That really
doesn't matter at all for a first time home buyer. There are an
enormous number of excellent condos and house priced from $200,000
to $400,000. As a first-time home buyer specialist, I rarely ever
have to obtain financing for $500,000 homes. The median home price
means nothing to the first time buyer and should not in any way
deter a first time buyer from exploring the process.
Before you make an offer, get the
approval of an underwriter.
A mortgage broker or a direct lender can both obtain an underwriter
approval prior to an offer submission. I don't like to use the words
"prequalify" or "preapproval." The difference is kind of confusing
to people outside of the mortgage industry. The loan officer either
has an underwriter's full approval, or he or she doesn't. Ask to
obtain an underwriter's approval, and then ask to see the actual
approval. The approval should state the rate, type of loan, loan
conditions that you and the loan officer will have to satisfy, loan
terms, pre-payment penalty, and the loan officer's yield spread
premium. Go over all of the loan conditions to make sure that they
are realistic. You need to get all of this information in writing up
front from the loan officer. If he or she won't provide this, get a
new loan officer.
Don't worry about who services your
David Bach states that is is important that the original lender
remains the servicer of your loan. That is one of the few points
that David makes that I disagree with. It really doesn't matter at
all who the servicer of your loan will be. That should not have any
bearing on your home buying or mortgage decision. Most likely, your
loan will be sold between servicers at some point during its life.
One servicer may have better customer service than another, but the
loans terms won't change, just who you mail the check to should
Don't extend the loan term past 30
There are 40 and 50-year loans out today, but what is the point?
These loans were created so that people could qualify for home that
they could not otherwise afford. If you cannot qualify for a home
using a 30-year fixed loan with a principal and interest payment,
you are probably looking at a home that you can't afford and
shouldn't buy. One of the main reasons for buying your home is that
you will someday own your own home free-and-clear. You'll probably
never arrive there if you take on a 40 or 50-year mortgage.
A two-year prepayment penalty is
If you are going to be in the house over the long term, you are
definitely better off with a prepayment penalty because your rate
will be lower as a result. If you fully expect to be in the home for
a long time and are willing to take a two or three year prepayment
penalty, make sure that the loan officer is passing ALL of the lower
rate to you. You would need to look at the loan officer's rate sheet
and have him or her explain it to you in clear terms explaining what
the rate is with and without a prepayment penalty. A rate sheet is
not that hard to explain. If your loan officer cannot or will not
explain the rate sheet to you in a comprehendible way, get a new
Do your best to use a local lender.
If you are a first-time homebuyer, you will need more hand-holding
than the average buyer. You will likely want to meet your loan
officer at some point. I've done plenty of loans that I did not ever
meet the borrowers personally. However, if I were a first-time
homebuyer, I would opt only for a local lender. Under no
circumstances use a lender such as Eloan.com to help with the
purchase of your first home. You definitely will not get a local
lender. You will probably not even get a loan officer in your own
state. Out-of-state loan officers are not subject to the department
of real estate in your state. They can get away with a lot more
mischief than a local loan officer could. Using an Internet lender
on your first home purchase is a complete crap shoot. I have on
several occasions contacted Internet lenders posing as a first-time
homebuyer. In each case, I was appalled by the incorrect information
and flat-out incompetence of the person who was trying to get my
business. Repeat buyers who have excellent credit, lots of income
and assets, and experience buying homes can often get a good deal
with Internet lenders. A first-time homebuyer's situation is usually
quite a bit different. A local loan expert recommended by your
Realtor is the best bet.
Use a Realtor to act as your buyer's
A person with merely a real estate license is not a Realtor and is
not qualified to represent you. Your buddy who recently got his real
estate license should not be your buyer's agent.
Never use Option ARM loans.
David Bach states that the option ARM is appropriate for some buyers
on their primary residences. Not a chance. No way. Never on a
primary residence. Ever.
Get in touch with a loan officer than
is a specialist in first-time homebuyer programs.
If you're a first-time homebuyer and your loan officer is not
familiar with the first-time homebuyer assistance programs in your
county, get a new loan officer. You might be leaving a lot of money
on the table otherwise.
If you set up a bi-weekly payment
plan, have it set up and run by a company.
Don't tell yourself that you'll make the extra payments. You won't.
This is one thing that needs to be automated even though it will
probably cost a few hundred dollars to set up with a company.
If you get a bi-weekly payment plan
set up, make that that you are able to make at least 3 half-month
payments during any month
if necessary. This event will occur once or several times during the
year if you are using the bi-weekly payment plan. Make sure you have
sufficient reserves to cover it when it happens.
Plan to rent the property out later.
While you're in your new property, do what you can to make the
property more attractive to renters.
Consider a 1031 exchange
- When you move out of your property and it doesn't have positive
cashflow from the rental income, rent it long enough that you will
be eligible to 1031 exchange it for a property elsewhere that does
have positive cashflow.
Always maintain 6 months of income as
reserve in the bank.
You should not buy a home if you are living on the edge financially.
You need to have a little breathing room before you get yourself
into a mortgage. Many people buy a home and have almost no money
left in the bank after the transaction. That is not a good place to
In lending, if something looks too
good be true, it is.
Be careful about choosing the loan offer that has a significantly
lower rate and fee structure for a similar type of loan than all
other loan offers.
Expect to pay the Realtor and loan
David Bach mentions that you should negotiate fees with the lender.
With exception of the points of orientation and discount that the
loan officer charges, all of the other fees on a Good Faith Estimate
must be paid to third parties (provided that the loan officer has
not padded the Good Faith Estimate with any junk fees that do not
cover any services). All of these fees do have to get paid to
someone by someone. If you are negotiating fees with the loan
officer, you are asking him or her to pay your fees to third parties
out of his or her commission. Just like you, the loan officer has to
earn a living, If the loan officer has charged you a fair price in
the beginning, he or she will have to charge you a higher rate in
order to have those fees covered by the bank. The higher the rate
the loan officer can get you to take, the higher will be the loan
officer's commission from the bank, normally called the Yield Spread
Premium. If you are asking the loan officer to pay your closing
costs, he or she will have to charge you a higher rate to get a
larger Yield Spread Premium from the bank. A higher rate is exactly
what you don't want. As a loan officer, I can tell that most loan
officers establish a minimum amount that they need to make on each
loan. If the borrower demands that additional closing costs be
covered by the loan officer, the loan officer has to pass the
charges back to the borrower by charging a higher rate. This is
exactly what you, the borrower, do not want. It is definitely in
your long-term best interest to get the lowest rate possible on a
loan. That won't happen if you demand that the loan officer pay
closing costs that will be charged by third parties.
Instead of asking the loan
officer to cover closing costs, try to persuade the seller to cover
If the seller will make a large profit and the home has been on the
market for a long time without many offers, the seller might be
willing to acquiesce and cover your closing costs. From a previous
point however, remember that it is your better long-term interest to
get the seller to buy your rate down and get you the lowest possible
rate rather than for the seller to pay closing costs.