Your Money_ The Missing Manual Part 15

Believe it or not, you can often negotiate on rent before you sign the paperwork. Wait until you and the landlord seem to have made a connection. (Here's a list of tips for knocking the socks off your next landlord: http://tinyurl.com/GRS-renttips.) Once he likes you, it's okay to ask whether he can do things like include the cost of your Internet service in the price or let you have a dog: "Well, it's a great place, but I don't know. You don't allow pets. My next stop is with somebody who'll let me keep a dog. Is there anything you could do to help?" (See the box on Close the deal Close the deal for tips on negotiating.) for tips on negotiating.) Remember to read (and understand) the contract before you sign it. Pay special attention to costs and dates, and don't be afraid to ask questions: What does it take to get your security deposit back? How much notice do you have to give before moving out or when does the lease end? Negotiate any details you don't like.

Be sure to doc.u.ment everything-even before you move in. To prevent future misunderstandings, record a video tour or take photos of the unit before you fill it with your stuff. If your landlord is there for the tour, that's even better.

Once you move in, live up to your end of the deal. The best way to stay on your landlord's good side is to pay the rent on time. If your check will be late, contact your landlord right away and explain the situation. Offer to pay as much as you can immediately, and give a firm date by which you'll pay the rest.

TipDon't forget to get renters insurance. Renters are 50% more likely to be burglarized than homeowners, and just as subject to fires and floods. Your landlord has insurance on the property and the things he owns-but not on your your stuff. Plus, renters insurance protects you from liability lawsuits in case somebody gets hurt in your home and sues you. For about 10 bucks a month, renters insurance can give you peace of mind. (For more info, head to stuff. Plus, renters insurance protects you from liability lawsuits in case somebody gets hurt in your home and sues you. For about 10 bucks a month, renters insurance can give you peace of mind. (For more info, head to http://tinyurl.com/GRS-renters.) When you're renting, it's vital to have good communication with your landlord to prevent misunderstandings, so don't rent from someone who's slow to return your calls and emails. To avoid disputes, put everything in writing-and ask your landlord to do the same. Try to stay on your landlord's good side; it can pay off in lots of ways. If he likes you, he'll be more likely to reduce rent if you ask, respond quickly to your maintenance requests, and maybe make other concessions.

If you have roommates, choose them carefully. Everyone on the lease or rental agreement is responsible for living by the rules. If your roommate leaves with no warning, you still have to pay the rent in full. (Here's some advice on what to do if you're frugal but your roommates aren't: http://tinyurl.com/GRS-roommates.) Before you move out, find out exactly what you have to do to get your deposit back. (You and your landlord may have different definitions of "clean.") Just as you toured and photographed or videotaped the apartment with your landlord before moving in, do so again for the move-out inspection.

If you run into a sticky situation while renting (or after you move out), check your local laws. The U.S. Department of Housing and Urban Development has collected links about tenant rights for every state here: http://tinyurl.com/tenant-laws. RentLaw.com is another good resource.

TipSpend some time researching tenancy laws in your state by picking up a book like Renters' Rights (Nolo, 2002) by Janet Portman and Marcia Stewart. A few hours spent reading can save you a lot of grief.

Buying a Home Generally, once you've saved 20% for a down payment and you can afford monthly mortgage payments, you're ready to start looking for a home. Yes, you can buy a home with a smaller down payment, but it'll cost you in the long run. You'll need to carry private mortgage insurance (Private Mortgage Insurance), you'll pay more interest, and you could put yourself in a position where you can't afford to sell your home! For more info, check out the Mortgage Professor's down-payment calculator: http://tinyurl.com/MP-dpcalc.

If you think you're ready to buy a house, take a few months to do a trial run. In The Money Book for the Young The Money Book for the Young, Fabulous & Broke Fabulous & Broke (Riverhead, 2007), Suze Orman says that you should "play house before you buy a house." Here's how: (Riverhead, 2007), Suze Orman says that you should "play house before you buy a house." Here's how: 1. Figure out how much you think you can afford to pay for a home every month, including mortgage and maintenance. This might be $1,750, for example.

2. Subtract the amount you're currently paying for rent. If your rent is $1,000 per month, you'd subtract this from the $1,750 to get $750 per month.

3. Open a new, named savings account (see Targeted Savings Accounts Targeted Savings Accounts). On the first day of each of the next 6 months, stick $750 into this account.

If you can't make this work financially, Orman says you need to wait: "If you miss one payment, or if you are consistently late in making the payments, you are not ready to buy a home. If you can handle the extra payments, then you've got the thumbs-up to start looking for a home to buy." But before you start looking, you need to know how much you can spend.

How Much House Can You Afford?

Housing is the largest expense in most families' budgets. But how much is too much to spend on shelter?

Economists have used decades of financial stats to create computer models that predict how much people can afford to spend on housing and debt. Traditionally, lenders have used what's called a debt-to-income ratio (or DTI ratio)-a measure of how much of your income goes toward debt every month-to estimate how much people can afford to borrow to pay for a home. To find this ratio, divide your monthly debt payments by your gross (pre-tax) income. For example, if you pay $300 toward debt every month on a $3,000 income, your DTI ratio is 10%. (The lower the number, the better.) Banks and mortgage brokers look at two numbers when deciding how much to loan you: - Front-end DTI ratios (sometimes called housing expense ratios), which include your total housing expenses: mortgage princ.i.p.al, interest, taxes, and insurance. These four factors are often called PITI. (Yes, the mortgage industry is filled with acronyms and abbreviations.) - Back-end DTI ratios (also known as total expense ratios), which include all of the above plus other debt payments like auto loans, student loans, and credit cards.

When you apply for a mortgage, a computer checks to be sure the amount of debt you want to take on falls within accepted ranges. This process is called automated underwriting. When the computer is finished, the loan application moves to manual underwriting, where an actual person uses industry-standard DTI ratios to decide whether to approve or deny the loan.

NoteThe key thing to understand about DTI ratios is that they're used to estimate the lender's risk, not yours. That is, your mortgage company uses them to check whether they think you can make the payments-not whether you can comfortably make the payments. So if you want to be able to dine out and take vacations and pursue other financial goals, the DTI ratio you use in your calculations should be lower than the one your lender uses.

During the 1970s (before credit-card debt became common), DTI wasn't split between front-end and back-end. There was only one ratio, and it was 25%. If your mortgage, taxes, and insurance costs were less than 25% of your income, people a.s.sumed you could afford the payment. (This is still an excellent rule of thumb.) Debt-to-income guidelines have relaxed over the years. When my wife and I bought our first home in 1994, our mortgage broker told us our front-end DTI ratio had to be 28% or less, meaning we couldn't pay any more than 28% of our gross income toward housing. The back-end DTI ratio was capped at 36%, which meant that our housing expenses and other debt payments combined couldn't be more than 36% of our income.

When we bought our new home in 2004, the accepted DTI ratios had grown by 5%. "That 28% figure is old," we were told. "Most people can go as high as 33%." The back-end ratio had been raised to 38%41% in some cases. (During the housing bubble, some lenders went still higher, even above 50%!) A 5% increase may not seem like a big deal, but when you're talking about a house payment, it's huge. If you're earning $60,000 per year, 5% is $3,000, or $250 a month. Many people have lost their homes because they took on mortgage payments that were just $250 more than they could afford each month.

Generally, banks are happy to lend you as much money as you want. (Within reason, of course, and if your credit is good.) The recent credit crisis has certainly made lenders more cautious, but they're still not going to stop you from digging a hole for yourself if that's what you want to do. In The Automatic Millionaire Homeowner The Automatic Millionaire Homeowner (Broadway, 2008), David Bach writes: (Broadway, 2008), David Bach writes: You should generally a.s.sume that the amount the bank or mortgage company is willing to loan you is more than you should borrow. [...] Don't fool around with this. Do the math. Be realistic about your situation. Don't pretend you're in better shape than you are.

Remember, n.o.body cares more about you than you. Your real-estate agent, mortgage broker, and bank all have a vested interest in encouraging you to buy as much house as possible-their incomes depend on it. Listen to what they have to say, but make your decisions based on what's best for you.

Homebuyers are often told to "buy as much house as you can afford." But the problem with following this advice is that you're left without a buffer. What if you lose your job? Or what if you're forced to sell your home, but housing prices have dropped? (Many Americans are facing this problem in the aftermath of the housing bubble.) Instead of buying as much house as you can afford, it makes more sense to buy as much house as you need, keeping conventional DTI ratios as ceilings. (The box on Choosing a Home Choosing a Home tells the story of a couple who bought more house than they ended up needing.) tells the story of a couple who bought more house than they ended up needing.) Ultimately, it doesn't matter what the guidelines are. It all comes down to what you're comfortable paying. Just because conventional wisdom says you can afford a $1,650 housing payment on your $60,000 annual income doesn't mean you should do it.

Give yourself a margin for error. Instead of basing your home-buying budget on a 33% front-end DTI ratio, consider dropping that to 28% or, better yet, 25%. Another way to create a buffer is to base your estimates on your net (take-home) pay instead of your gross pay. You won't be able to afford as big of a mortgage, but you won't feel pinched by the payments, either.

Your Money And Your Life: Movin' on DownWhen they got married, Sierra Black and her husband Martin bought a home near Boston, Ma.s.sachusetts. "We found an old Victorian with gables and staircases and a finished attic." The 2,200 square-foot house was beautiful, and they loved it-but it was a nightmare to maintain that much s.p.a.ce. "Buying that house meant buying a piece of the American Dream-but we both figured out pretty quickly that it wasn't our our dream." dream."There was the $2,200 monthly mortgage payment and the $600 monthly cost of their combined commutes (which totaled 160 miles every day every day). Sierra tried to boost their cash flow by making the sorts of frugal choices described in Chapter5 Chapter5, but she says, "It felt like I was bailing out a leaky boat with a teaspoon."After 2 years of struggling to make ends meet, Sierra and Martin moved to a 1,500-square-foot colonial-style duplex closer to his office. "The new house feels small but not cramped," says Sierra. "We gave up a lot of square footage, but we didn't lose any functionality. It turns out we didn't need all that s.p.a.ce."They now pay about $1,600 each month for their mortgage. But that's not the only savings: "All of our utility bills are lower than they were," says Sierra, "and our commuting costs are nonexistent." Martin used to drive 40 miles to work every day; now it's a four-block walk. And Sierra does a lot of her errands on foot. "The great thing about this is that it's saved a ton of money and and a ton of time." a ton of time."As Sierra and Martin have learned, it's not material things that bring happiness, but finding ways to align your spending with your values (see Chapter2 Chapter2): "Every single day that goes by since we moved, we tell each other this is the best decision we ever made. This improved our quality of life so much so much."

Choosing a Home Buying a home is an emotional process. It's probably the biggest financial decision you'll ever make, and there's a lot of pressure to get it right: You don't want to overpay, make any legal mistakes, or discover you've bought a house you hate. But you'll be happier in the long run-not to mention more financially secure-if you do your best to take emotions out of the process.

That's not to say that you should buy a house using detached, Spock-like logic; even with preparation, the decision will be emotional. But before you start looking, you can take steps to keep from spending too much. Let's look at three of the most important.

Getting pre-approved Once you've figured out how much home you think you can afford (see How Much House Can You Afford? How Much House Can You Afford?), it's time to talk to the banks. You need to know how much a mortgage company will loan you before you start shopping.

One option is to get pre-qualified for a loan. To do that, you give your basic financial info to a lender, who then does a quick calculation to give you a rough estimate of how much you can afford to spend on a house. Bear in mind that the bank isn't actually agreeing to loan you this amount; they're simply saying, "We think you can afford this much house-we'll work out the exact numbers later."

You're usually better off getting pre-approved for a loan instead. Pre-approval is more formal than pre-qualifying, and it takes days instead of minutes. The lender will pull your credit report, review your financial info, and check your employment history before giving you a pre-approval letter. This process may actually cost you money, but pre-approval gives you the confidence that you can actually afford the homes you're looking at, and gives sellers confidence that you'll be able to get a loan.

NoteNeither pre-qualification nor pre-approval is binding on you or the lender. If you buy a house, you're not required to use the bank you talked to, and they're not required to lend you money (but if you're pre-approved, they probably will).

Be careful: Even after the recent mortgage crisis, lenders can and do approve loans for more than people should borrow. Run the numbers yourself and be willing to put on the brakes. Don't spend $500,000 on a house just because a bank will lend you that much.

Making a list While you're waiting for the pre-approval process to finish, put all your hopes and dreams down on paper. Having a list of wants and needs can help you avoid making an emotional buying decision.

First, list all the things your family wants in a house. This is a time to brainstorm, not be judgmental. Your aim here is to make a list of features in your ideal home. Do you want a laundry room? A large garage? A yard for the kids to play in? And what sort of neighborhood are you looking for?

Once you've made your list, prioritize it. Sort the things you want from most important to least important based on your family's goals. What makes you happy? Maybe you love to spend time outdoors gardening and entertaining, so a big yard is a necessity. But if your family spends a lot of time together watching TV, the size of the family room might be more important.

This list will help ground you when you think you've found the "perfect" house: It can remind you that you need a laundry room, and that you swore you didn't want a place where you'd have to remove asbestos ceiling tiles. As you search for homes, update your list as you discover new wants and needs.

On The Money: Does Size Matter?A book on smart money management isn't the place to tell you what to look for when choosing a home. (So check out other great books on this subject, like Buying a Home: The Missing Manual Buying a Home: The Missing Manual.) But some parts of the decision can have a big impact on your bottom line. One of these is home size.According to the U.S. Census Bureau, the average new home was 2,349 square feet in 2004, up from 1,695 square feet in 1974. During those 30 years, kitchen sizes doubled, ceilings rose more than a foot, and bedrooms grew by more than 50 square feet. But home sizes are ballooning even while our families are getting smaller: The average family had 3.1 people in 1974; it had shrunk to 2.6 people in 2004. (For the stats geeks out there, that means we've gone from having 547 square feet of home s.p.a.ce per person to 903 square feet per person.)But bigger isn't always better. The larger your house, the more it costs to buy, maintain, heat, light, paint, furnish, and repair. That's not to say you should live in a shack, but as you shop for a house, remember that size comes with a price. If you need the s.p.a.ce, buy it. If you don't, you're better off saving your money for something else.

Shopping smart Once you have your wish list and your pre-approval letter, it's time to start house hunting. Here's the last (and most important) way to outsmart yourself and help take emotion out of the buying process: Don't look at homes outside your price range.

This seems simple, but it's not as easy as it sounds. Your real-estate agent will want to show you houses that are at the very top of your budget-or maybe cost a little bit beyond it. If she tries to push you out of your price range, politely refuse. If you don't look, you can't be tempted.

Stick to your budget and be patient. It can be tempting to s.n.a.t.c.h up the first good house that comes along because you're afraid of missing out. But the more you look, the better you'll know the market. You'll learn what features are typical for your area and be able to spot good deals.

Do what you can to prevent emotion from carrying you away. Set priorities, try not to compromise, and take your time. And remember that buying a home is a purchase, not an investment, so treat it like any other shopping decision: Do your research, shop for quality, negotiate a good price, and then keep it for a long time.

TipBefore you make an offer on a house, ask whether you'll have to join a homeowners a.s.sociation (HOA). Some people like them-some don't. If you like uniformity and standards, an HOA might be just your style. But be aware that HOAs usually charge a monthly fee, which could be a deal breaker if you can't afford it.

Picking a Mortgage Once you've found a home and made an offer, it's time to select a mortgage. Happily, because you've been pre-approved and stayed within your budget (right?), financing shouldn't be too tough.

TipThe best thing you can do when shopping for a mortgage is to learn more about them. Start by spending a few hours reading the archives at The Mortgage Professor (www.mtgprofessor.com).

One easy way to research mortgage interest rates is to go online. Sites like BankRate.com, ShopRate.com, and Money-Rates.com can help you find the best rates from around the country. If you'd rather shop locally, your credit union or community bank is likely to have good rates, too. But perhaps the best way to find a good lender is to ask family and friends (not your real-estate agent). Personal recommendations offer color and nuance you can't get from a website.

TipYou may also want to check out the Up-Front Mortgage Brokers a.s.sociation (www.upfrontmortgagebrokers.org), whose members pledge to be clear about their fees and give objective advice.

When shopping for a mortgage, consider these factors: - Good rates. Many first-time homebuyers don't realize that even a small change in interest can make an enormous difference in their monthly mortgage payment-and in the total cost of the loan (see the table on Picking a Mortgage Picking a Mortgage).

- Low fees. Find out what sorts of fees each lender charges. Closing costs (like those listed here: http://tinyurl.com/FR-closing) can have a big impact on the total cost of the mortgage, but many people ignore them, probably because the cost of the mortgage is so huge that these charges seem small by comparison. Be sure to get a good-faith estimate (http://tinyurl.com/wiki-gfe) whenever a lender or broker gives you a quote.

- Gut feeling. If the broker seems shady, find someone else.

Your goal is to find the lowest total cost for your loan. In most cases, this means focusing on the best interest rates, but if you expect to have your mortgage for only a couple of years, you might be better off paying a higher rate to get lower fees. Always run the numbers for your situation, using a mortgage-comparison calculator like this one from LendingTree: http://tinyurl.com/LT-mtgcalc.

Once you find a lender you think you can work with, ask lots of questions. When they "lock" your rate, how much time do you have to close the deal? What's the mortgage's annual percentage rate (APR)? (The APR doesn't just take into account the loan's interest rate; it factors in other fees and payments, too.) Are there any penalties if you pay the mortgage off early? And if you're dealing with a broker, how is he paid?

Remember that you'll get few chances in your life to have this kind of impact on your budget, so take the time to do things right. Four fundamental things reduce the cost of a mortgage: - Having a good credit score (see Chapter8 Chapter8). In the fallout of the mortgage crisis, qualifying for a loan can be tough. Lenders have tightened their standards so that their best rates are only available if you have solid credit.

- Buying a cheaper house. The lower the purchase price, the lower the mortgage. This is obvious but important (and a lot of people seem to forget it). It's the reason you need to set a budget before you start shopping for a house.

- Making a bigger down payment. The less you finance, the less you pay each month. And if you don't put 20% down, you'll have to pay for private mortgage insurance, which can cost you hundreds of dollars a year (see Private Mortgage Insurance Private Mortgage Insurance).

- Finding a better interest rate. Interest rates have a huge impact on your monthly payments. As you can see in the following table, even one-half of a percent can make a difference of tens of thousands of dollars.

Table10-1.Monthly mortgage payments on a $250,000 loan

Interest Rate .

Length of Loan .

10 years .

15 years .

20 years .

25 years .

30 years .

5.00%.

$2,653.

$1,978.

$1,650.

$1,463.

$1,343.

5.50%.

$2,715.

$2,046.

$1,720.

$1,538.

$1,420.

6.00%.

$2,778.

$2,110.

$1,793.

$1,613.