Introduction to How Buying a House Works

On average, people who live in the United State­s move to new homes about every seven years. That means that every seven years, people just like you are driving around neighborhoods, checking out schools, walking through complete strangers' homes, talking with bankers, and spending large amounts of money (i.e., keeping the economy rolling). The process is a long and sometimes difficult one, but also one that can bring with it a lot of excitement and joy if you find your dream home and can afford it.

­In this article, we're going to go through the steps involved in a search for the perfect home. For instance, do you really need a real estate agent? Why do you need to be pre-approved by a bank? How do you negotiate the deal? And, how do you keep from getting a lemon?

Preparing for House Buying

Probably the most important step, and certainly the step you should take first, is to figure out how much you can afford to spend on a new home. If you haven't set up a budget that shows you how much you're spending on everyday things, now is the time to do it.

A good budget will help guide you to the right price range of homes as well as prevent you from spending more than you should on your house. This can happen when the bank says you can afford a certain price range of homes based on your income and debt, but they haven't taken into consideration all of your expensive hobbies, your monthly child care expenses, the fact that your car could die at any moment or your love of international travel. You probably don't want to have to change your lifestyle in order to buy a more expensive home.

By having a handle on your personal budget, you can compare your own numbers with what the bank is willing to lend you to come up with a very manageable mortgage payment that will let you continue the same lifestyle you currently have. Try out this cash flow calculator to help set up your budget.

Getting Pre-approved for a Mortgage

In our article on How Mortgages Work, we talk about the difference in getting pre-qualified and getting pre-approved. Getting pre-qualified just means that you have told a lender your income level and your debt and credit information, and the lender has estimated what you can afford.

Pre-approval, however, puts you much closer to the actual loan and means that the lender has done the legwork of pulling your credit report, checking your debt-to-income ratio, and has done a more in-depth analysis of your financial situation. In most cases, you're much better off getting pre-approved so you don't have any surprises when a lender checks your credit report -- particularly if you haven't checked the report yourself first.

The Importance of Pre-approval

In the house-buying process, the benefit of being pre-qualified or pre-approved is twofold. Not only do you have the added comfort of knowing what you can afford, the seller may also accept your offer over another if you are pre-approved and the other party is not.

The logic here is that a pre-approved offer is more likely to result in a completed sale, while an offer by a buyer that has not been pre-approved is not such a sure thing. The seller often doesn't want to take the chance of losing the sale -- even if your pre-approved offer is slightly lower.

Other House Buying Costs

In addition to the mortgage itself, you'll also have to add property tax and insurance to your monthly payment. And, if you don't make at least a 20% down payment, you'll also have to add Private Mortgage Insurance. Also, don't forget the expense of closing costs. It can eat into the cash you have available for the down payment.

All of these additional costs add up, so make sure you are comfortable with the total amount of your monthly payment and know how much you can put into a down payment before you begin your search and fall in love with a house you can't really afford.

Read How Mortgages Work for an in-depth review of the whole home financing process.

House Buying: Need vs. Want

Armed with a realistic price range, you can now start the process of finding that perfect home. Here is also where you have to keep a level head and think about what you "need" versus what you "want" in a home. Hopefully you can get both, but be prepared to give a little on some things that you don't really need. Keep in mind that finding the perfect home isn't always possible simply because it may not exist.

Make a list of things you absolutely need, like three bedrooms, a backyard, a good school district, etc., as well as a list of the things you want, like hardwood floors, skylights, a "smart" house or a large foyer. Then prioritize those things. If you find a house that comes close to having all of your NEEDS but doesn't have everything you WANT, give it a second look. By keeping these distinctions in mind, you'll prevent yourself from prematurely ruling out certain houses without seeing them first.

Types of Homes

When thinking about what you need, don't forget to think about other types of homes such as condos, cluster homes, and so on. Depending on the stage of your life, a condo may actually be a better fit for you. Think about it -- no lawn maintenance, pool/clubhouse amenities, and often lower costs and better security. For example, someone who is single and travels a lot for work probably doesn't need as much space and doesn't have the time to keep up a lawn. In this case, a condo may be the perfect home. The same argument goes for retirees who may travel more or simply don't want the upkeep involved with owning a single-family home.

If you really want to get specific (although it will shorten your list of potential properties) you can even think about the style of home you want. 

Once you know what you want and/or need, it's time to determine where it needs to be. Read on...

House Buying: Location

Location, location, location. We've all heard that the most important thing to look for in a home is its location. It's true -- location is very important, even if you don't plan to be there many years. What to look for in the location of your home may also tie in with the list of priorities we discussed in the previous section. For instance, are you looking for someplace close enough to town that you could walk to shops and restaurants, or do you want the seclusion of a more quiet, rural setting? Do you want your kids to be able to walk to school, or is riding the bus okay? Even if some of these things aren't important to you, when it comes time to sell, the location of the home will always have an impact.

The other thing to keep in mind about location is that your preferences will change over the years. What's important to you right now may not be so important in 10 years and vice versa. For example, having no kids might make you ignore looking into the school district the home is in. Later on, if you do have kids, that will be an important consideration and can also mean moving from a home you love in order for your children to attend better schools.

Good Home Locations

There are many reasons why a home's location is so important. As you're shopping for your new home, you may want to consider the following:

• Proximity to town: How convenient will quick trips to the grocery store be? Do you care?
• Proximity to schools: Is the school district a good one? Do you like the school your kids would attend? This is important for resale, even if you don't have kids yourself.
• Proximity to work: How long will your commute to work be?
• Proximity to other amenities: If you have kids, will you be driving all over the county to take them to sports events and school functions? Would that bother you?
• Crime rate: Does the area have a high rate of crime compared to other areas of town?
• Tax rate: Do you have to pay both city and county property taxes?
• Zoning: What's going to be built next to you in the future? Or, what restrictions might there be on what you can do in your home? Some home businesses can be affected by zoning issues.
• Restrictive covenants: Does the neighborhood have restrictive covenants, or will you have a chicken farm pop up on the property next to yours? If you want a chicken farm yourself, does the neighborhood allow it?!
• Homeowners association: Is there an active neighborhood organization that will help maintain and improve the area?
• Public transportation: Do you have transportation options? Is that important to you?
• Noise: Go to the property at various times of the day. Is there a lot of noise from traffic? Are you in a flight pattern from the local airport?
• Safety issues: Are you near a nuclear or other potentially dangerous facility? Is there a landfill nearby that lowers the property value?
• Neighbors: Do the neighbors have similar values to yours? Go to the neighborhood at night and on weekends to get a taste of the types of activities that go on.

Do you need a realtor?

When you begin the search for your home you have three choices:

• You can go it alone and do all of the legwork of finding homes by looking in the newspaper, searching online, or simply asking around.
• You can call a real estate agent and ask them to show you homes.
• Or, you can sign a contract with a buyer's agent.

If you're like most people, you probably weren't even aware of that third option.

There are some very fundamental differences in these three options. In the first instance, going it alone, you may miss out on a lot of potentially great properties. You will also find that you're not saving any money because the seller pays the commission to the agent based on a percentage of the sales price. In the next section we'll discuss finding a real estate agent.

Real Estate Agent

When you call an agent and ask them to show you some properties, you have to remember that they are always working for the seller -- not you -- even if they are not the listing agent! (The listing agent is the agent who was hired by the sellers to list their home.) This ties in with the fact that the agent is paid a commission based on the selling price of the house. (Usually a 5-7% split between both agents involved.) So, the higher the sales price, the more money the agent makes.

It may be hard to keep this in mind as you spend time with the agent and feel you know and have a relationship with that person. Even though you trust the agent, it is very important never to reveal the highest price you are willing to pay, or other concessions you know you would be willing to make. Because the agent represents the seller, he/she must relay this type of information to the seller.

The flip side of this is also true. Again because the agent is representing the seller, he/she is not allowed to divulge anything that would tip the scales in your favor -- like why the seller is selling or how low the seller will probably go regarding the selling price. Remember, the agent is bound by contract to work to get the best possible deal for the seller. In the next section, we'll discuss your third option, buyer's agents.

Buyer's Agent

Your third option, using a buyer's agency, means the agent is working with your best interests (and wallet) in mind. A buyer's agent will work to negotiate the best price, ensure the property is inspected, and make sure you have the representation you need. Things you tell a buyer's agent remain confidential. Using a buyer's agent also means that you will be shown homes that are For Sale By Owner (FSBO). It might seem like using a buyer's agency means you are going to pay more -- but that's not always the case. Although there are situations where agents charge an hourly fee or a flat fee for the service, in most situations they are simply working for the same commission that is paid by the seller and split it with the seller's listing agent. While there is still some argument that this method leaves the incentive for a higher sales price, buyer's agencies counter by pointing out that a $10,000 savings for the buyer only amounts to a $150 difference in commission for the buyer agent. They feel that the benefit of your satisfaction with their service and the word of mouth promotion they will get outweigh the loss of this small amount of money.

The type of agreement you sign with a buyer's agent will dictate how the arrangement works. A limited agency agreement may stipulate, specifically, for what the agent will be paid. For instance, the agreement might state that if you find a home on your own, then no commission will be paid. Basically, you can negotiate the terms of the agreement up front so both you and the agent know what to expect and are comfortable with the relationship. Typically, however, if the agent has been otherwise very helpful and attentive, most buyers still pay some type of commission even if the agent was not involved in finding the home they end up purchasing. If you do decide to use a buyer's agent, be sure to read the next section.

House Buying Tricks

If you decide to use a buyer's agent be on the lookout for:

• Dual agency: This means the agent or agents are working on both sides of the fence. For example, an agent with XYZ Realty may represent the seller, while another agent (or the same agent) also with XYZ Realty represents the buyer. There are obviously arguments against this arrangement because of conflicts of interest, but nonetheless, it is still a common practice. In the dual agency situation, both the buyer (you) and the seller must be made aware of the arrangement and privileged information can't be shared unless you agree to it.
• Neglecting to specify: If you begin working with an agent and forget to ask for or sign a buyer's agency agreement then the agent automatically represents the seller. In most cases, the agent will bring this up and offer you the choice. If, however, the agent is the listing agent for a house you are interested in, then the relationship automatically becomes that of a "dual agency."
• Buyer's Agency Clause: One potential problem with signing a buyer's agency agreement may come with a blanket clause stating that the agent gets a commission on any home purchase. If you think it is likely that you will find something without the help of the agent, then you may want to specify in the agreement that a home you find on your own (an FSBO, for example) will not require payment of the standard commission.
• "In-house" Listings: If you're working with a traditional agent (or listing agent) rather than an exclusive buyer's agent, be aware that you might get a little harder sales pitch for their own listings, or the listings held by their brokerage firm, simply because they make more money that way.
• Release Clause: Make sure you have a "release clause" in your buyer's agency agreement just in case you find out you just don't like your agent. This will allow you to sever ties without any future problems. You may need to take advantage of this clause BEFORE you see any houses -- or at least any houses you think you are interested in.

You can find more information on selecting the best agent at Nolo's: Law for all Web site.

House Hunting

Once you've made the agent decision, you are ready to start house hunting. The agent will search the Multiple Listing Service (MLS) and give you a printout of houses that meet the criteria for your ideal home. If you are using a buyer's agent, you may also get a list of For-Sale-by-Owner (FSBO) homes to look at in addition to the MLS list. Don't forget to do some looking around of your own just in case the agent misses something. This is where your communication with the agent is critical. The agent needs to have a really good idea of what you want in order to make your search as efficient as possible.

After you comb through the MLS printouts and FSBO lists, appointments are made to see the homes that you think may best meet your needs. When you visit homes with your agent, the homeowners are typically absent. This gives you and your agent the opportunity to discuss the home freely (if you're using a buyer's agent) and inspect things a little more thoroughly than you would if the proud homeowner is right there the entire time.

House Buying Notes

Take note of things you like and dislike about each home. It is also a good idea to make a house comparison chart to jot down information as you go through the house (or immediately after). This should be done for every home you see and attached to the listing sheet.

Sketching the floor plan is also a good idea because it doesn't take long at all for all of those houses you've seen to start running together. You'll quickly forget which house had that beautiful staircase and which house had the second story loft you liked so much. Probably more importantly, though, you may also forget which one had that leaky shower drain in the upstairs bathroom.

Since you really need to see at least a dozen or more homes in order to get a good feel for what you can get for your money, having a system to help you keep everything straight is all the more important. Taking photos is also a good idea to help keep things straight in your head as far as which house had which feature (prior to picture-taking, you'll want to make sure this is OK with the homeowner).

If you have found a house (or houses) you like, it's good to go for a walk-through several times and at different times of the day. You may find there are things that are apparent in the morning or at night that weren't when you saw it the first time. For example, the neighbor's dog likes to bark all night, the street is a teen drive-through scene and a hangout in the mornings before school -- anything that you might not necessarily want to live with.

Make sure you see a copy of the neighborhood restrictive covenants and know how much the homeowner association dues are. Also ask about other neighborhood expenses. For example, living in an equestrian neighborhood may be nice, but not if you don't own horses but still have to shell out money for fence and barn repairs.

House Buying Online

In addition to the traditional driving and searching routine for home buying, you also have, via the Internet, a number of tools to help you find a home. Sites like Realtor.com or HomeGain.com offer a lot of information as well as "sneak previews" for homes that might fit the bill. These sites seem to be particularly helpful if you are moving to an area with which you are not familiar, because they offer neighborhood information, school information, crime rates, cultural activities and other types of information to help you narrow down your search. They can even help match you up with a realtor, find a lender and sell your existing home.

In addition to having searchable databases of homes for sale in your area, these sites have "virtual tours" of many homes. These tours give you a panoramic view of several rooms in the home. This can give you an idea of the layout and condition of the home without having to take the time to make an appointment and actually visit the house. This is especially helpful if you're traveling to a different city to look at several homes and have limited time. View a sample virtual home tour at Homestore.com.

Even if you don't use the search features or realtor matching services, these sites provide a wealth of information about the home buying/selling process, great financial calculators to help you determine your price range, and tips to help you along each step of the way. Most also offer e-mail services that will notify you when a home that meets your specifications comes on the market in your area. Read on to learn about regional real estate sites.

Regional Real Estate Websites

Besides large, national sites there are many smaller regional sites. State multiple listing services and realty associations often have Web sites that offer more listings. A keyword search within a search engine using "multiple listing service" and your state will bring up a list of these types of Web sites. You may also find useful Web sites posted by individual realtors who have links into the regional MLS system.

For Sale By Owner (FSBO) Web sites

Salebyowner.com, Forsalebyowner.com, and a number of regional "for sale by owner" sites all offer another arena for your home search. With or without a realtor, you can search these sites for homes in your area. Owner contact information is provided for additional information or to schedule an appointment.

Virtual Real Estate Agents

These sites often offer the services of a real estate agent with lower commission fees for sellers and rebates for buyers. They can offer many of the same search functions as other online real estate pages, but for example also offer a $1500 payment to the buyer at escrow. They provide you with search tools and a tracking system to keep up with homes you are looking at and also provide live agents in your local area to help you out. The main benefit of these types of companies is primarily to the seller. They save money by paying lower commissions. With eHomes, they also have the choice of the level of marketing they want for their home (i.e., the amount they pay drops when less marketing is done).

Making an Offer on a House

When you've found the house and are ready to make an offer, there are several steps you need to take and contracts that need to be drawn up. Here is where your real estate attorney or agent really comes in handy.

The first thing that happens is your official offer, or bid. When you make the offer, you have to keep in mind that it could easily become a legally binding contract if the seller accepts it. Because of this, you need to make sure the offer includes all of the contingencies, concessions, and other details you need it to cover. In the next section we discuss the items your offer should include.

Your Offered Purchase Price

Here are some examples of things that should be included your offer:

• Your offered purchase price and the amount of earnest money you are putting down
• Home inspection contingencies: Since the inspection may take place after the offer is accepted, you need to state that the entire deal is contingent upon an acceptable inspection report. If the house is on a well and septic system rather than city water and sewer, these should also be inspected.
• Financing contingencies: You can also include a contingency for getting the mortgage you want (i.e., maximum interest rates, expected terms, etc.)
• Items included in the purchase: This list can include things like major appliances (often the refrigerator goes with the seller), lighting fixtures, shrubbery, basically anything that isn't nailed down and some things that are!
• Title contingencies: Your attorney will do a title search to make sure the property does not have any other legal claims against it and that the seller holds a clear title to it.
• Timeline: A deadline for responding so you know when to consider the offer rejected

There may also be other special considerations that your agent or attorney may recommend, so be sure to ask for their advice. The offered purchase price is, of course, the most important aspect of the offer. Here is where a buyer's agent really helps. A buyer's agent should be able to provide you with a comparative market analysis (CMA) that will show you what similar properties sold for in that particular neighborhood or the immediate surrounding area. This can also be used as ammunition if the seller counters your offered price. While the seller's agent probably provided them with a CMA before they listed the price, they may have chosen to price their home higher with the hope that buyers wouldn't have a similar document for comparison. Buyers who are using a traditional agent rather than a buyer's agent are pretty much on their own in deciding an appropriate offer.

­Armed with this comparative information, you might also make a quick drive by the other properties just to do your own comparison. Keep in mind that some of the amenities in the house may not increase the value of the home as much as the sellers might think. For instance, a backyard pool for some folks is a great advantage, while others may see it only as a liability and have immediate plans for filling it in with dirt and concrete!

Counteroffers

After your initial offer, the seller may counter with a price just slightly below their asking price.

This back and forth dickering can go on a couple of times until you come to an agreement, or someone else steps in and offers the asking price! Your agreement may not be only about the money, either; there may be other terms and demands that you have to deal with.

Just remember that until you have a signed contract, anyone else can step in and make another offer.

Negotiating Home Prices

It is a very infrequent occurrence that an initial offer is accepted. You can almost always expect some sort of counter to your offer and negotiations. It may be strictly related to price or it may be the fact that you want the porch swing and washer and dryer included in the deal. Be prepared for some haggling.

It's extremely important that you keep your financial state of affairs in mind and not let your heart make you house poor. (House poor is when you've overspent your budget on the mortgage and now can't afford to buy new drapes for the house or take your spouse out to dinner!)

Another helpful tidbit of information has to do with why the sellers are selling and how long the house has been on the market. Are they building a house and trying to meet a construction deadline? Have they already moved into another home and are now carrying two mortgages? Has the house been on and off the market for a year or more? All of these things can strengthen your negotiations in the deal.

Finally, be realistic in your offer for the house. Don't make a lowball offer on a house you really want. If your research has shown that the price is realistic, then offering a really low price is only going to annoy the sellers and potentially upset your chances of getting the house -- particularly if there are others folks making offers, too.

Professional House Inspections

Since the entire deal could be riding on the professional inspection of the home, don't cut corners when it comes to the house inspection -- and never skip it altogether. Even with new houses, there can be hidden problems that only a professional inspector may find. These inspections cost anywhere from $200-$500 and are well worth it.

If you are getting an FHA or VA loan, you will also have to have an additional inspection. (Don't let that one be the only inspection you get, however, because it may not be as thorough as a full-blown inspection.) Your offer should be contingent on the results of the professional inspection. This means that if the inspection turns up something like really bad termite infestation or cracks in the foundation, you can back out of the contract, OR you can have the seller repair the problem to your satisfaction.

When looking for an inspector, make sure you hire someone with experience who is certified by the American Society of Home Inspectors. Inspectors with this certification follow a standard of practice that will help let you know if the home you're buying is in the best shape possible or needs repair.

The types of things the inspector looks at are defects that affect the value of the home o make it unsafe or less livable for whatever reason. Leaky appliances, damp basements, plumbing problems and other defects are some of the problems that can be turned up by a good inspector. You should accompany the inspector when they go to inspect the house. Ask as many questions as you can and make sure you get a copy of the results.

Major Points of Home Inspection

Here is a list of some of the major areas inspectors will cover:

• Foundation: With either a basement or a crawl space, is it simply damp or are there outright water problems? Are there any cracks in the walls or floor that might indicate structural problems?
• Construction: Does the house have good quality construction? Is the flashing properly installed to protect wood, are there any rotting problems with the wood, is the roof in good shape or will it need replacing soon, etc.
• Plumbing: Has the plumbing been properly installed? Is it in good shape? Is there any evidence of leaks?
• Heating and cooling systems: Are the units in good shape? Will they need replacing soon? Are they rated for the amount of square footage they are heating?
• Electrical: Do there appear to be any electrical problems or code violations?
• Interior: Are the floors level? Do windows and doors function properly? Do the appliances in the kitchen function properly? Is there any evidence of leaks or mildew in the bathrooms?

The bottom line is, don't skip the inspection and make sure the inspector you hire is experienced and certified to do the job.

Closing Costs

Assuming the inspection turns out well, the financing is going through to your satisfaction, and all other contingencies are met, you're now in the home stretch. Your attorney will do due diligence, which includes a title search to determine if the seller does indeed hold the title to the property and there are no other legal claims against it. This along with the home inspection will complete the due diligence package

If everything is clear, then you're ready to sign what may seem like the largest stack of documents you've ever seen! It is at the closing that the title to the property will be transferred to your name, your homeowners' insurance (which you have to have already secured) begins coverage of the property and you are officially committed to your mortgage. It is, unfortunately, also time for you to plunk down your cash for the down payment and closing costs. You should be able to get a copy of the settlement statement that includes the amount of cash you'll need at closing from your lender a day or two prior to the closing. Knowing these costs is important since you'll need to pay your down payment (and usually your closing costs) with a certified check.

You'll be signing lots of papers, including:

• The settlement statement
• The sales contract
• Title insurance
• Homeowners' insurance
• The title or deed to the property
• The down payment and closing costs

There may be additional documents to sign depending on the complexity of the deal, so be prepared and block out appropriate time for everything.

For more information on buying a house, including credit reports and mortgage information, check out the links on the following page.

Lots More Information

Related HowStuffWorks Articles

• ­How Selling a House Works
• Real Estate Pictures
• How Realtors Work
• 5 Questions You Should Ask Your Realtor
• How Credit Reports Work
• How Credit Scores Work
• How Mortgages Work
• How House Construction Works
• How to Buy a Car
• How Rent To Own Homes Work
• How Housing Cooperatives Work
• How Real Estate Investment Clubs Work

More Great Links

• Smart Agreements.com
• HomeGain: Online home search
• EBASearch.com: Buyers Agency Search
• National Association of Exclusive Buyer Agents
• Nolo: Law for All: House buying articles