The Transaction Mechanics
July 27th, 2005 - No Comments
This is a guest post by Owen Johnson.
Part 3 in a series of 7 on real estate.
THE WEEKLONG SERIES OF REAL ESTATE BASICS
1. The Real Scoop on Real Estate
2. Starting Down the Real Estate Investment Path
3. The Transaction Mechanics
4. A Primer on Real Estate Agency
5. Leveraging Yourself to Grow Your Wealth
6. Management Infrastructure
7. The Week in Review
A financed real estate transaction has a good number of moving pieces and steps that need to happen in order to for things to work. Here’s a rough overview of the buying process.
1. Obtain “proof” that you can purchase
This is typically in the form of a pre-qualification or pre-approval letter from a lender. Keep in mind that typically, the lender has not verified anything except your credit score, so this letter doesn’t really prove very much. It really just shows that you’ve had a discussion with a mortgage broker and that you are more likely in the frame of mind to buy than someone who hasn’t. One of these letters is typically necessary for a seller to accept an offer.
Going through this process will also give you an idea of the mortgage rate that you will get, which you’ll need to evaluate potential investments.
2. Find a property to buy
Simple to understand, sometimes hard to accomplish. Search, search, search. Let people know you are looking, they may know about something that fits what you are looking for. When you find a potential investment property, do the financial analysis. I use the OpenOffice.org spreadsheet application, which has all the financial functions you’ll need to calculate loan payments, etc.
Don’t forget to include taxes, insurance, and condo/association fees in your analysis! Also consider adding rental vacancy rate and maintenance costs variables. A place to start would be 10% vacancy rate and 10% maintenance costs, but these numbers vary dramatically from area to area, so you will have to do some research to find more accurate numbers for your purchase.
3. Make an offer, sign a purchase and sale agreement, and inspect the property
The order of these steps varies from state to state. Some states don’t distinguish between offers and purchase and sale agreements, some do. In some states the inspection is completed between the offer and purchase and sale agreement, in others after both documents are signed. Every locale has its own standards, but the gist of this piece of the transaction is:
Figure out the value of the property and make an offer, negotiate that offer, and make sure you are aware of any potential problems with the property. Use common sense and hire an outside inspector.
4. Apply for a mortgage
Formally apply for a mortgage. Be prepared to show proof of income with W-2′s, tax returns, and pay stubs. There are loans where this isn’t necessary, but the interest rates will be higher, so discuss what you can and can’t show with your mortgage broker during the pre-qualification stage. You don’t want an early rate quote that is low, only to discover after locking yourself into a deal that you can’t get that type of loan.
Once the application is complete, a short period of time should pass and you will receive a commitment letter. This commitment letter is a letter that states the bank will give you a specific type of mortgage assuming certain things are provided(appraisal, proof of earnings, etc.). Make sure that this letter is for the type of loan you are expecting and make sure the rates are correct.
5. Sit and wait for the appraisal
Depending on the location and the season, you’ll probably sit and wait for about one to four weeks for the appraisal to happen. The appraisal is done by a licensed appraiser. The appraisal protects the banks interest and in many cases yours as well. If the house doesn’t appraise for the agreed upon purchase price, there are four probable outcomes: you pay the difference in cash, the seller drops their price, some combination of the two, or assuming your mortgage contingency clause in your purchase and sale agreement is still valid, you walk. Let’s assume things work out, and everything appraises well, which is typically the case when dealing with good Realtors.
This waiting time is good for planning moves, lining up work that might need to be done on the property, and even starting to search for tenants if the property is vacant.
If the inspection negotiations resulted in work being performed, now is also the time to evaluate that the work has been done to your satisfaction. This might require bringing the inspector back in, usually at a reduced cost.
This is also the time to find a hazard insurance provider. Call several vendors to get comparisons. This process typically takes a day or two for a residential transaction.
6. Closing Time Approaches
Eventually, the mortgage company gets the appraisal, approves the loan, any necessary work is completed and inspected, and you are ready to close. You’ll be given the opportunity to walk through and inspect the property the day of closing. If anything seems different at this point than what you expect, bring it up, because you aren’t going to have much recourse after the closing. Things to watch out for range from tenants still living in the building when you agreed to have the building delivered vacant to a window being broken that wasn’t broken at the inspection.
A few hours before the closing, have your attorney fax you a copy of the HUD/settlement statement so that you can review it before sitting at the closing table.
You may have to bring money to the closing, if the amount is not clear on the HUD, have the settlement agent(your lawyer) let you know what you need to bring, and make sure you understand why. You’ll most likely provide a bank check at closing or wire the funds to them the day before.
7. The Closing Table
The settlement statement is the document that outlines your costs and the sellers costs. It shows where all the money is coming from and going to. Sounds simple right? Unfortunately, it isn’t. There are all kinds of fees, charges, incoming monies(especially with two mortgages) and outgoing funds.
Make sure that your mortgage is the mortgage that you really applied for(closing costs, rates, duration, prepay options, etc. are correct). Confirm that your insurance and tax escrows are what you expected, and also, make sure you understand what each and every item on the settlement statement is. If you don’t understand a number on the document or where it came from, have your lawyer explain it to you.
Unfortunately, even with the best players involved, errors creep into this very important document, and it can cost folks real money, so when it comes to the settlement statement, be detail oriented.
Have any friends who recently purchased a house? If so, call or write them now and tell them you are looking to buy and see if they’d be willing to walk through their settlement statement with you to help prepare. Keep in mind that the settlement statement is a financially sensitive document that includes information about their financial situation, so make sure you pick someone whom you think will be comfortable sharing this information with you. Recently moved parents are good candidates as well.
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