Buying a House or a Condo

Disclaimer: The information below is provided for informational purposes. Author is not a real-estate expert. Information does not apply to all cases, may be found to be incorrect, and is subject to change without warning. Buying a house is a big investment and should be studied carefully using several sources of information.

Mini-lexicon:

Condo: A unit (usually an appartment) of a housing complex where parking space, if any, is not attached to the individual units. There are usually regulations that limit owners' ability to modify the exterior of their unit and that pay for common expenses through the collection of monthly condo fees.

Condo fees: Monthly fee imposed by the homeowner's association of a condo or townhouse to pay for common expenses through the collection of monthly condo fees.

Escrow: the legal process of transfer of ownership, which legally must be done by an escrow company. Essentially, it entails verifying that all the paperwork is in and genuine from both seller and buyer.

Points: a percentage of the total amount of a loan that buyer pays upfront to the lender as extra payment for the loan. Each point is equivalent to one percent of the loan amount. Loans can be chosen to have from negative (buyer gets a discount upfront for the first payment) to positive, including zero. The higher the points, the lower the interest rate for every subsequent period will be.

Single-unit: A stand-alone house, usually with no association involved in owning it.

Townhouse: A unit (house, duplex or appartment) of a housing complex where parking space is private and attached to the individual units. There are usually regulations that limit owners' ability to modify the exterior of their unit and that pay for common expenses through the collection of monthly condo fees.

Getting a loan

The first assumption of this article is that you will get a loan to help pay for the house. First of all, buying a house in a lumpsum payment is extremely rare, especially for Caltech students and postdocs. Secondly, there are tax advantages if you borrow money to buy a house which usually make it to your advantage to do so. Obtaining a loan in the U.S. is easier and cheaper than in some other countries, and the rates in the last few years have been particularly low, although there is an upward trend in the rates, fueled by the Fed's recent increases, in turn fueled by inflation concerns. To qualify for a loan, you need to have a satisfactory credit history, as reported by three national credit bureaus. This involves essentially two things: a) having had a sufficiently long history of credit in the U.S., as evidenced by previous loans, credit cards and other creditors; b) having had a sufficiently good history of credit in the U.S., as evidenced by lack of negative notes (non-payments, and to a lesser extent late payments) on your credit history. One thing that's nice to know is that for most purposes, credit ratings are discrete, not continuous, and thus if you have a reasonable credit history you will qualify for an A rating, and minor blemishes on your record do not affect your interest rates at all in that case.

The economics of buying vs. renting

The first and perhaps most important aspect of the house-buying process for a Caltech person is deciding whether it's best to buy or to rent given the length of time that you expect to stay at Caltech. The length of time is a factor because of the expenses and hassle associated with buying a house (somewhat over 7% of the value of the house). Speaking very very generally, if you can afford a downpayment large enough (e.g. 20%) to afford you a low interest rate, it is usually financially more attractive to buy than to rent if you plan not to sell the house (whether because you will live in it for that long or because you will rent it out after you move out) for at least 3-4 years. These are among the factors to consider when making your calculation:

Costs of buying:

a) The brokers' commission for the sale is usually 3% each (agreed beforehand), payable by the seller.

b) Other transaction costs include escrow costs and lender costs. Reasonable numbers for these are about a 10% of the value of the property (possibly more percentagewise for lower-valued properties, since there are some fixed costs), including escrow fees, title insurance, loan underwriting & document preparation, appraisal and loan tie-in, in approximate decreasing order of magnitude.

c) Condo fees, which can vary from ~$150 to ~$500/month for garbage collection, gardeners, exterior repairs, sometimes insurance, pool maintenance, ...

d) The opportunity cost of investing your downpayment and monthly payments in the stock market or elsewhere. This depends on how well other investments are paying currently and how they will perform in the future.

e) The interest on your loan.

f) Property tax: ~1.25% of the value at which you bought your house annually.

g) Cost, time and hassle of maintaining the house. Just think of everything you used to call the landlord for.

Note that unless there's depreciation, your money is not lost, so your downpayment and principal payments are not a cost: you are just transferring your wealth from liquid assets into real estate.

Benefits of buying:

a) Property appreciation (historically on the order of 2-5% annually in Pasadena, but values can sometimes go down instead). There is a very important point to realize here: the appreciation is on the entire value of the house, despite the fact that you have only put money to pay for a fraction of it (the downpayment). Therefore, the rate of return for your investment (which is the relevant rate to compare with what you would get in Wall Street, for example) is much greater than the appreciation rate; in other words, while your debt to the bank remains constant, what you get when you sell the house does not. You may have realized that as the years go by and your investment in the house becomes a larger percentage of the value of the house, this advantage gets diluted; this is the reason why it is best to refinance a house after about 7 years, getting a new loan and investing the money you had put into the house elsewhere.

b) Interest payments are tax-deductible.

c) You save the cost of rent or, equivalently, earn rent income.

d) You don't get kicked out

Types of loans

Now the exact economics depend on the type of loan you get. There are fixed rate loans that do just that: keep your interest rate constant through the term of the loan, usually 30 years, but possibly 15 or 20. Variable rate loans have a floating interest rate that varies with the prime interest rate set by the Fed (Federal Reserve). These are not good if you suspect the rates will go up, or if you want to avoid the risk of that happening, but in return for you taking the risk as opposed to the lender doing it, the rate is lower initially. An interesting compromise is what is called 7/1 or 5/1 ARM loans, which keep the rate fixed for 7 or 5 years, respectively, at a value lower than that for fixed rate loans, and then jump to the floating value of variable-rate loans. I have a hearty recommendation for John Thompson of First Advantage Mortgage (888 265 2445 x343), who has shown to have very competitive pricing, integrity and excellent service. Most realtors will try to get you to use the lender associated with their real estate company, but you do not need to.

Realtors

OK, so you've gone through the economics, and you've decided you will buy. Now what? The first thing to do is to get a realtor. Lately, there's been a surge of internet house buying and selling sites. Since this is very new and I have never bought a house that way, this article will not deal with that way of doing it. My hunch is that online selling may be an excellent idea if you are selling a house, for three main reasons: because the seller pays most of the transaction costs and online selling reduces seller-buyer matching costs considerably, because the seller faces little risk once the check clears, and because the seller is only interested in the selling price and is not looking for a specific property, so an exhaustive search is not essential. The buyer, in contrast, faces great risk in buying a house, so the experience and liability of realtors is welcome; he/she wants the best match to the house of his/her dreams he can find & afford, so the larger the search the better, and does not pay for the cost of realtors, so there is really no reason not to use a realtor, which does not preclude him/her from expanding the search online as well on his own. But try to get a recommendation for a good realtor, because a bad one can be a real pain throughout the long buying process. I have received a recommendation for Kevin Gardner at Fred Sand's (626-431-2377).

What will a realtor do for you? First, he/she should make an exhaustive search of all properties that match the criteria you specify. Some realtors will not do a thorough checking of each property's properties before calling you to discard those that do not comply with your desires; if they do, that will be a big time-saver for them and you. Second, he/she will have the keys or make arrangements to be able to get into every property. Most properties on the market are vacant and require a realtor's keying system to get in; those occupied usually require appointments. Thirdly, the realtor will carry you through the whole paperwork process, from offer to the close of escrow.

Choosing the house

In deciding what house you can afford, bear in mind that payments will get smaller with time as more of the principal is paid, as inflation makes the fixed value of the loan smaller in real terms, and as your income increases (hopefully!). Decide on a (series of) neighborhood(s). Decide on the right number of rooms. Decide whether you want a condo or a townhouse. Private garages are more convenient and afford a lot of storage space, but cost more. And look, look, look.

Your offer

A few recommendations on making your offer. Look at a lot of properties, but when you see something you like, do not take long in making an offer, properties on the hot Pasadena market do not stay long on the market before they are sold, typically no more than a month, which means that by the time you see them you may have a week of time before a hot property goes into escrow. Ask for the seller to pay for a Home Warranty. This is standard, sellers almost always pay for them, and protects you in case something wrong is not detected during escrow or goes wrong in the following year. Demand that the seller check the boxes for seller warrants that all appliances are working, etc.: this means that if you find something not working during escrow, the seller will have to fix it. Don't be afraid to offer below the asking price, but do not expect to get a seller to agree to something below 5% of his asking price unless the property has been on the market for a long time. Get a professional inspector to perform a thorough inspection of the property during escrow, but do not have that replace your own inspection, trying every appliance, inspecting faucets and sinks for leaks, etc.

Happy buying!

Acknowledgements: Thanks to Eric Slimko for contributing some of the knowledge expressed herein, and to Eva Peral for constructive comments.

This page is moving soon to Buying a House Guide. This page has been visited times since November 11, 2003.