Jagged Thoughts | Dr. John Linwood Griffin

We bought a house!  Or, as friend Brendan put it:

Grats on leveling up in the American Dream MMORPG!  Your character now has an improved credit score.

We are first-time homebuyers, so everything about the house feels surreal—everything from sitting in the yard (“this is our house?”) to reading mortgage documents that assert “Borrower has promised to…pay the debt in full not later than July 1, 2042.”  2042?

We moved to Boston in October 2011.  Our plan was to rent for a couple of years, decide whether we liked Boston, then maybe dip our toes in the housing market.  The plans changed when our landlord notified us that he would likely raise the rent when our lease renewed in Fall 2012.  Since we indeed like Boston, we decided to dip our toes in ahead of schedule.  And wow did things move fast at that point:

• April 4, 2012: Started researching potential neighborhoods in Boston, plus looking at online listings to get a feel for prices and availability.
• April 17: Met with a realtor, discussed what we were looking for, made an appointment to see houses two days later.
• April 19: Toured eight houses, fell in love with #8, did some quick research, put in an offer, received a counteroffer, sent a counter-counteroffer. (Paid $1,000 deposit.)
• April 20: Counter-counteroffer accepted by the seller!  At this point we’ve “bought” the house, so long as we are able to get a mortgage commitment, the inspection is satisfactory, and the bank’s appraisal is at least equal to the agreed sale price.
• April 23: Mortgage application submitted.
• April 24: Landlord (from whom we were renting) began looking for new tenants, in hopes of allowing us to break our lease early.
• April 27: Home inspection and radon test completed. ($525)  The inspection revealed concerns about the roof, leading the seller to offer a $2,500 closing credit towards roof repairs.
• May 1: Mortgage rate locked in with the bank.
• May 3: Bank’s appraisal of the property completed. ($350)
• May 4: Purchase and sale (P&S) agreement negotiated and signed. ($20,800 deposit.)
• May 5: Mortgage underwriting paperwork submitted.
• May 15: Moving company scheduled.
• May 23: Mortgage commitment received from the bank, one day before deadline.
• June 1: Homeowner’s insurance policy obtained.
• June 5: Landlord signed lease with new tenants to start July 1, saving us $5,200 in rent!
• June 8: Wire transfer to closing agent’s IOLTA of funds needed to close. ($74,000 deposit plus $20 wire fee.)
• June 15: Closing.  At this point we took possession of the house.
• June 20: Locksmith hired to change keys and replace some locks. ($190)
• June 22: Moved into the house.
• August 1: First mortgage payment due.

One of the secondary joys of house hunting was the chance to “geek out” and dig deeply into understanding how things like property assessments, securitizable mortgage loans, and purchase and sale agreements work.  For example:

It costs more to buy a house than the price of the house.

On the closing date (the date we signed all the documents and got the keys to the house, plus the date on which our deed to the house was recorded with the Suffolk County Registry of Deeds) we paid in full both the down payment ($87,200) plus a variety of miscellaneous loan-related fees, escrow and tax prepayments, and adjustments ($10,395.77).  Even if we had paid cash for the house we still would have paid at minimum $2,500 for legal representation, title insurance, inspection, appraisal, a homestead declaration, and government recording fees.

Of course, there’s also the interest paid on the mortgage over the life of the loan (we chose a 30-year fixed at 3.625% interest rate).  If we stick to our loan schedule—if we don’t refinance, make any principal prepayments, or sell the house—we will pay $223,853.59 in interest on the $348,800 loan.  (I’m not complaining, though.  Interest rates are at a historical low right now.  Five years ago the interest rate was 6.5%, which would have made the total interest paid $444,870.41.  However, if rates were that high then housing prices would probably be lower than they are now, in which case we could have gotten a smaller loan and owed less interest.)

Our loan requires us to make payments of about $225 monthly into an escrow account to cover property taxes and homeowner’s insurance.  (You may apply for a loan that doesn’t have an escrow requirement, but such loans are more expensive because of the risk to the lender that you won’t make the required payments.)  That amount, plus $1,590.71 monthly towards loan repayment, yields a housing cost of about $1,815/month—meaning that payments on a 4-bedroom house are less expensive than rent for 2-bedroom apartments where I lived in New York City, Arlington (VA), and Boston.  But mortgage interest is federally tax deductible:  In 2013 we will pay $12,436.27 in mortgage interest (netting a $290/month reduction in federal tax), so our effective monthly housing payment next year could be as low as $1,525—significantly cheaper than rent on equivalent detached single family houses in those locations.

…Of course, amortizing the roof (and other) repair/replacement costs will increase our effective monthly housing payment for a while.  As will amortizing the $10,395.77 mentioned above.

Speaking of finance:  By far the most informative resource I found about home buying is The Mortgage Professor.  I recommend you start by reading the “Questions by Topic” on that site; before you know it you’ll have spent days reading almost every article on the entire site.  The site also solicits new questions from readers; I sent the professor (Prof. Jack Guttentag) a query about the effectiveness of principal prepayment and received an informative answer just four hours later.  Another useful site for understanding the mortgage process is Bankrate.com.

Real estate agents make 2.5% commission on each sale.

That is, the agent representing the buyer makes 2.5% and the agent representing the seller makes 2.5%.  So our agents walked away with $10,837.50, and the seller’s agent walked away with $10,837.50.  (In other parts of the country, 3% is common.)

Several websites (especially the interesting but self-serving REALTOR.com blog) claim that you as a buyer shouldn’t worry about agent fees because the seller pays the real estate agents’ commissions.  That’s technically true, but it’s also technically true that I had to eat the cost regardless—as the seller likely hiked up his asking price by 5% to pay the real estate commission.

How can a percentage-based sales commission possibly be construed as ethical by the real estate industry or legitimate by government regulations?  Especially given that one of the agents’ primary tasks is to negotiate the sales price—a price in which the agents have a conflicting compensatory interest?  And, perhaps controversially, assuming that people purchasing $100,000 houses deserve equal agent representation/engagement/effort as people purchasing million dollar homes?

Note that I’m not saying that real estate agents don’t work hard to earn their pay.  Case in point: my first email exchange with my realtors took place after 8pm; later in the process I received messages from them as late as 11:03pm and as early as 7:07am.  Our agents provided excellent advice and guidance throughout the whole process, and we ended up with a great house; I would not hesitate to use them again.

Just as I can’t imagine driving a motorcycle without first taking the MSF RiderCourse, I can’t imagine buying or selling a house (at least for the first time) without agent representation.  Agents certainly deserve professional compensation that is commensurate with the effort and time they expend on behalf of their clients.

However, the other major parties involved in the purchase—the mortgage loan originator and the lawyer serving as the closing agent—both received fixed compensation for their services.  Why are real estate agents paid on commission?

Points on a mortgage—I’d heard of them but had never sat down to figure out what’s the point.

Points are a wager you place with the lender:  If you pay points you’re betting that you’re going to keep the mortgage for longer than 3 years.  The lender makes money either way, but makes more money if you bet wrong.

One point is 1% of the price of the mortgage.  Our mortgage is for $348,800, so one point is $3,488.

When you “pay points,” you are essentially giving extra money at closing to the entity loaning you the money.  As described above, we paid $10,395.77 at closing in miscellaneous fees, prepayments, and adjustments.  Part of that amount was $2,441.60 we paid (equal to 0.7 point) to reduce our interest rate by 0.25%.

The advantages of paying points are:

1. By paying points you reduce your interest rate.  In our case we could get a 30-year fixed mortgage at a 3.875% interest rate, or we could pay 0.7 point ($2,442) for a 3.625% interest rate, or we could pay 1.3 points ($4,482) for a 3.5% interest rate.
2. By paying points you also reduce your monthly payment.  In our case we could make loan service payments of $1,640 (at zero points), or $1,591 (0.7 point), or $1,566 (1.3 points).
3. Points you pay may be tax deductible. Our $2,441.60 payment of points effectively cost only $1,757.95 due to the reduction of our federal taxes.

The disadvantage is:

The money you spend on points doesn’t increase your equity in the house; it’s basically free money for the lender.  It takes 3 to 5 years to “break even” when you pay points [for the reduction in monthly payments to catch up to the amount spent on points]—for example, if we were to pay three points (~$10K) this year, and if we sell the house next year [or if we refinance next year at a lower interest rate] then we’ve effectively flushed $9K down the toilet.

With the 0.7 point we paid, if we sell or refinance the house in three years it’s a wash.  Beyond 3 years we save money; if we keep the loan for 30 years then we will save $17,812.50 in interest payments.

The legal definition of a point is “prepaid interest.”  (That’s why it lowers the interest rate—you’ve already given the lender a guaranteed return on investment.)

There is also a concept of negative points where the lender pays some of your closing costs in exchange for a higher interest rate on the loan (and therefore higher monthly payments).  According to our loan originator at the bank, one scenario where you might agree to negative points is if you believe interest rates will fall in the near future—such that you will be able to refinance soon, at a lower rate, without “flushing” any money as described above.

Real estate case law can be fascinating.

See for example this case about adverse possession, and many of the other articles at that site.

Overall we found it really helpful to solicit advice from our friends who are homeowners.  Some of the best advice:

• If you think you might buy a house in the next couple of years, go ahead and get your financial ducks in a row now.  I didn’t do this; instead I made a couple of rookie mistakes that could have ended up costing us extra money.  The first mistake was that I (unnecessarily) asked one of my credit card companies to increase my credit limit last fall, which caused an Inquiry to show up on my credit report, which reduced my credit score.  Lower credit scores can result in higher interest rates for mortgage loans.  The second mistake was that I kept some of our down-payment money in an “aggressive strategy” mutual fund until after our offer was accepted.  As a result I had to sell those fund shares immediately, at whatever the current price was, instead of (for example) setting up a systematic withdrawal plan over several months or trying to time the market for a favorable sale.  Also as a result we had to provide extra documentation to the mortgage underwriter to explain why all of this extra money suddenly showed up in our checking account right before we submitted our loan application.
  
• Pay close attention to the recommendations and referrals made by your real estate agents.  We expected the house-hunting & offer & sale process to be long and arduous.  It turned out to be very easy because our agents did a lot of the “heavy lifting” for us—for example, instead of just advising us to search building permits before making an offer (to ensure all previous work was permitted and performed to code), our agents performed the search for us while showing us how we could repeat the search when we needed to.  We found our agents by lucky happenstance: They were the listing agents for one of the properties we found listed online, and when we contacted them (by that point the property was “under agreement” and no longer available) we were so impressed by their prompt and helpful responses—this was the after-8pm email exchange—that we asked if they also represented buyers.  Yes.  Soon thereafter we found ourselves putting in the offer on this house.
• Once you have a signed offer, you don’t have to worry about the seller backing out.  For several weeks I expected someone to call us up with the grim news that the seller had decided that he didn’t want to sell the house after all.  It turns out I needn’t have worried; our lawyer explained that once an offer was signed by both parties, the buyer can sue for specific performance if the seller tries to back out of the deal.  There were also a few deadlines that felt unnecessarily nail-biting; for example, we only had seven days to inspect the house, but the inspectors we tried were all booked more than 7 days in advance.  (In the end our recommended inspector had someone else cancel on him, so we were able to squeeze the inspection in just in time.)  Also our mortgage underwriter waited until the last moment to approve our loan even though we’d submitted all required documents (multiple times for some documents) well before the deadline.
  
• “Don’t get freaked out by the home inspection,” advises my colleague Jeremy.  He notes that it’s the inspector’s job to nitpick every small thing they find; during the inspection you’ll likely become afraid that the whole house is going to collapse around you any moment.  Listen for big-picture items and for the inspector’s overall assessment of the house at the end of the inspection.  Our inspector asked if we wanted to perform a $50 radon test; we weren’t sure at first whether we should, but in the end we were glad we chose to run the test.  (2 pCi/L: nothing to worry about.)
• When you buy a condominium, understand that you’re entering into a business contract with the other condo owners—make very sure they’re the kind of people with whom you’re comfortable being in business.  Prior to this year I’d never wondered how condo associations work, although we got a taste of it last year watching our landlord argue with his condo association over who should pay for a plumber to track down a mystery leak in the building.  (After three plumbers in as many months, it was discovered that the overflow valve on our bathtub had rusted through…so our landlord ate the cost.)  As we looked at condo listings in our neighborhood I came across several articles warning about dysfunctional condo associations or despotic homeowners associations.  In the end we were happy to have found a place subject to neither type of association.
• Understand your basis and other tax implications.  Basically, read IRS publications 530, 936, and 523, and possibly some other ones I haven’t quite gotten around to reading.  I was surprised to find some key differences between federal and state laws; for example, there is no deduction for mortgage interest on Massachusetts state taxes.
• Don’t sweat the small stuff.  Our closing agent made a $15.67 error in the seller’s favor.  (Earlier this year the seller had paid the quarterly real estate taxes covering April 1 through June 30, so part of our closing costs on June 15 were an apportioned refund to the seller for June 15-30.  The closing agent miscalculated this amount.)  But so what?  The seller negotiated with us in good faith, he maintained the house in excellent condition, he gave us a few extra items for free (including a $500 portable air conditioner), and he even left us a nice bottle of wine for us to celebrate our new house!  We got a good deal on a house we already adore; we couldn’t be happier.