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OUTLOOK
Steps to Home Ownership
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This article is specific to US markets
Buying a home is a significant investment, but it’s one that can come with many benefits. You’ll build equity as you make monthly payments and pay down your mortgage loan, make renovations or design the home to meet your lifestyle and needs, benefit from a rising property market, and transfer wealth effectively.
While you might be able to fund your entire investment in cash, there are advantages to home loans. Mortgages are a source of long-term and cost-effective financing, and borrowing is an important part of overall balance sheet management.
Key considerations for choosing a home
The first thing you need to decide on is what type of property you want – and you have some options to choose from. First up: co-ops and condos. While both are technically apartments, there are some important differences between the two.
When you purchase a co-op, you’re buying shares in a corporation that owns the residential building. As a shareholder, you receive a proprietary lease to an apartment. When you purchase a condo, on the other hand, you own real property: an apartment, plus a percentage of the building’s common areas. In both cases, you pay monthly fees to cover the building’s upkeep – but in a co-op, the monthly fee can also include payments for the building’s underlying mortgage and property taxes.
Next, you have single-family homes. These are detached, free-standing homes occupied by one family. They provide owners with the most privacy, space, and freedom compared to other home types, but often involve higher maintenance costs.
Then you have townhouses. These are multi-floor homes that may share one to two walls with the adjacent properties, but each one has its own entrance. Compared to single-family homes, townhouses are generally more affordable – but they offer less space and privacy. Compared to an apartment, though, they have more of both.
As well as property type, there are other important considerations to make when choosing a home. These include location, condition (new-build vs. “fixer-upper”), and occupancy type – that is, whether you’re buying the home as a primary residence, secondary residence, or investment property. Your occupancy type may impact down payment requirements and the cost of the loan.
Types of home loans
When you take out a home loan, it will be set up in one of two main ways: as a fixed-rate mortgage (FRM) or as an adjustable-rate mortgage (ARM).
FRMs come in terms of 10, 15, 20, and 30 years, and your interest rate stays the same over the life of the loan. FRMs usually don’t have prepayment penalties, so you can pay off the entire loan before the scheduled term – or pay off part of it to reduce your future monthly mortgage payments.
ARMs typically have an introductory-rate period of 3, 5, 7, or 10 years where your interest rate is fixed, but that changes to a variable rate for the remainder of the term. Some ARMs have prepayment penalties – especially if the introductory rate is low.
Both fixed- and adjustable-rate loans can be amortizing or interest-only. With an amortizing loan, your monthly payments include both interest and principal (paying back the loan itself). The interest portion of the payment is higher during the early years of the loan and gradually decreases with each subsequent payment.
| Payment Number | Monthly Payment | … of which is interest | … of which is principal | Remaining principal |
|---|---|---|---|---|
| 1 | $2,121 | $833 | $1,288 | $198,712 |
| 2 | $2,121 | $828 | $1,293 | $197,418 |
| 3 | $2,121 | $823 | $1,298 | $196,120 |
| 4 | $2,121 | $817 | $1,304 | $194,816 |
| 5 | $2,121 | $812 | $1,309 | $193,506 |
| … | … | … | … | … |
| 116 | $2,121 | $44 | $2,078 | $8,398 |
| 117 | $2,121 | $35 | $2,086 | $6,312 |
| 118 | $2,121 | $26 | $2,095 | $4,216 |
| 119 | $2,121 | $18 | $2,103 | $2,113 |
| 120 | $2,121 | $9 | $2,113 | $0 |
With an interest-only loan, your monthly payments are going solely towards interest, and that can be the case for up to 10 years. After the interest-only period ends, your monthly payments will include principal and interest for the remaining term of the loan.
How to take out a mortgage and purchase a home
“Purchasing a home is a large transaction. It's important you engage with industry professionals that have only your best interest at heart. This includes the realtor, lender, home inspector/engineer, attorney, and title company. You are paying for these services and, collectively, their number one objective should be to ensure you have the information you need to make informed decisions. Don’t settle, get the best.”
– Jeffrey Arestivo, Head of Residential Real Estate Sales, North America for Citi Private Bank
Once you’ve considered property type, occupancy, and location, and settled on what you want in a home, your next step is to speak with a qualified mortgage professional to obtain a pre-qualification. It’s a quick process that requires you to provide lenders with some information about your financial situation. Importantly, this gives you an opportunity to learn about your mortgage options and the different products available, as well as how much you can borrow and at what approximate rates and fees.
If you like the terms from a particular lender, you can apply for a mortgage pre-approval, which is a much more involved process than a pre-qualification. It requires you to fully complete a mortgage application and provide the last 2 years of income and asset documentation, since this request will be reviewed by a mortgage underwriter. Based on the information you provide and having a satisfactory a credit score, you’ll receive a commitment to lend you a specific amount based on the product selected and that days current rate. It is valid for up to 90 days from the approval date.
It’s worth knowing that getting pre-approved will make purchasing a home much easier as you already have a commitment from the bank for a loan and all you need is an executed sales contract. The home must be appraised to determine the value.
With that in hand, your next step is to select a real estate agent: they’ll help you find a home and navigate the whole buying process. Agents are an extremely valuable source of information – especially the expert kind that’s not available online. Work with your agent to determine a purchase price you’re comfortable with and shop around for homes in the market you’ve chosen.
Once you’ve found a home, it’s time to submit an offer. If your offer is accepted, you’ll need to arrange for a home inspection and appraisal. If the home inspection reveals no serious defects and the appraisal shows the house’s value to be in-line with the purchase price, then you can officially apply for and close your mortgage.
All that’s left to do then is finalize the sale – and celebrate.
Understanding your mortgage payments
Once your sale is final, you’ll need to make monthly mortgage payments, which are made up of four parts: principal, interest, taxes, and insurance (PITI). To recap, the principal component is paying back the loan itself, while interest is the cost of borrowing money.
The taxes part of your payment is made up of property taxes paid to local governments. It’s usually calculated as a percentage of the property’s value. And the insurance component is made up of homeowners insurance and mortgage insurance (if you need it). The former protects the home and its contents from fires, disasters, theft, and so on, while the latter is required if you’ve bought a home with a down payment of less than 20%.
Note that taxes and insurance are collected by your lender every month and held in an escrow account until your annual tax and insurance bills are due.
KEY TAKEAWAYS:
Residential real estate is a significant investment with many benefits. When you’re choosing a home, consider property and occupancy types, school district, commute to work, as well as the location and condition of the home.
Home loans can be fixed- or adjustable-rate mortgages, and payments are structured as amortizing or as interest-only.
The first step to home ownership is mortgage pre-qualification or pre-approval. With the help of a real estate agent, you can shop around for homes, make an offer, arrange for a home inspection and appraisal, finalize the mortgage, and close the deal.
