First-Time Real Estate Questions You Were Afraid To Ask
Let’s start with the absolute basics: you want to own property. You’ve heard a dizzying array of real estate terminology over the years, but now that it’s time to get serious. You want to know your agent from your broker, your deposit from your down payment.
Fear not. In this post, we will correct common misconceptions about the real estate industry, real estate transactions, and most of all real estate jargon, helping you enter your first deal with confidence.
Who and what is a realtor? How do they differ from a broker or an agent?
“Realtor” is actually a trademarked term that refers to a registered real estate agent or broker with the National Association of Realtors (NAR), a US organization.
Although people often interchange the terms “real estate agent” and “real estate broker”, they are actually separate licenses, with the latter being more extensive. In fact, agents must work on behalf of a broker. Both have access to an MLS or multiple listing service, NAR’s approximately 700 regional databases accessed exclusively by realtors. Some of this database is accessible secondhand to consumers through websites like Zillow, Trulia, Redfin, and many others.
Why do I need an agent or broker at all?
While there’s no legal requirement to use a realtor when you buy or sell a home, there are a few good reasons people nearly always do.
Because the seller typically pays for the buyer agent’s commission, the buyer essentially gets an agent for free. A good agent is an expert in the local market, can negotiate on your behalf, and makes you aware of options you hadn’t considered—all essentially for free to you.
For the seller, an agent’s marketplace expertise coupled with their experience and financial incentive to get the best price possible are the main selling points. When you’re parting with something as personal as a home, having someone outside the transaction with experience working on your behalf can provide valuable objectivity.
What exactly is a mortgage and why do I seem to need one?
Since most people don’t have enough money in the bank to buy property outright, they typically need a loan. Given the size of the loan required to buy a house, it needs to secured by something—the property—so that the bank has recourse if you stop making payments (i.e. they seize the house). Thankfully, the security and background checks homebuyers undergo allow banks to offer better interest rates to homebuyers than other loan types (i.e. credit cards).
What’s the deal with down payments, and how much should I pay?
Not to be confused with a deposit, a down payment (sometimes spelled downpayment) is the amount you pay at the time you buy a property. While 20% is still considered ideal—some even refer to it as the 20% rule—the truth is that more than half of homebuyers and over 70% of first-time buyers pay less than that. FHA loans, which are secured by the Federal Housing Authority and specifically intended for first-time buyers, allow for as little as 3.5% down. However, paying less than 20% usually involves paying for Private Mortgage Insurance (PMI) along with your monthly mortgage payments, which offsets some of the bank’s risk. Once you’ve pay off about 20% of your loan—or put another way, have a 20% equity stake in the property—PMI should no longer be required.
In short, the more you can scrounge up for your deposit, the less you will need to pay monthly—but many options exist to help you get into the homeownership market.
Who or what is a lender, mortgage broker, mortgage planner, loan officer, etc?
When you book a trip, you can either buy a ticket through the airline directly, or through a third-party service like Expedia. When taking out a loan, you have similar options. If you work directly with the bank, you will be working with a loan officer—you won’t pay any referring commission, but you will be limited by the options of that particular bank. If you work with a mortgage broker or mortgage planner—roughly equivalent to a real estate broker and real estate agent—your options expand exponentially, as they will have knowledge of programs available through many financial institutions.
While the term “lender” may refer to any of the above, the true lender is the financial institution providing the loan.
I’ve heard that I’m supposed to get pre-approved (or pre-qualified) for a mortgage. What exactly does that mean?
Getting pre-approved is the process of verifying the relevant information—primarily your income and credit—with your potential lender before they issue a loan. The resulting letter then becomes the seller’s verification that you are a serious buyer and have done your homework.
Pre-approval is the first step in the origination process, a funky term that simply refers to the buyer officially taking out a loan from the bank.
What is a title company, and why do I need one?
Like cars, properties have titles (and deeds, more on that later) that indicate the legal owner of that property. To ensure that a false title isn’t put forward as the real thing, title companies perform a title search to identify any relevant property records: other parties who may have a claim on the house (e.g. if the house was bequeathed in a will), any liens on the home (see below), the status of any easements on the property (i.e. a neighbor’s right to access the property), etc.
As you can see, titles can easily become messy affairs, which is why title insurance exists. Title insurance protects homeowners and lenders financially by stipulating that if someone else comes forward with a claim on the property, the new homeowner won’t get stuck with the legal bills while it’s resolved. In the worst case scenario—someone comes forward and does have a legitimate claim on the house—title insurance should compensate you the value of the home.
What is a lien, and why does it affect me if I want to buy a house that has one?
In a real estate transaction, a lien is a debt incurred by the seller that prevents the property from being sold until the debt is resolved. There are a few varieties of lien arising from different kinds of debt, but the consequences to the buyer are the same: ”no go” until the lien is paid off.
While a lien has to do with actions on the part of the seller—typically failure to make mortgage or legal payments—the home gets drawn into the picture because, like your mortgage, the property acts as insurance that the loan will be repaid. If the seller’s home is sold while he or she still owes debt, the collector of the seller’s debt no longer has leverage—not good.
Unfortunately, you can’t proceed with the transaction (unless it’s a cash transaction) until either you, the seller, or some third party pays off the lien. If a seller has advanced the transaction to the point that a lien is uncovered by the title company, it probably means they were unaware of the lien or believe they can swiftly contest it or pay it off.
If this happens to you and the transaction grinds to a standstill—i.e. the seller needs months or years to pay off the lien or handle litigation—all is not lost: you may be able to get your deposit back by claiming breach of contract.
Is there a difference between “earnest money”, “escrow deposit” and a plain old “deposit”?
Short answer: no.
What is a deposit, and how much should I pay?
If you make an offer and the seller accepts it, it’s time to make a deposit. The deposit shows that you’re serious about this property, and aren’t simultaneously cruising other properties around town.
How much you should pay depends. The NAR says that 1-3% of the purchase price is typical, but it varies depending on location and circumstance, and will be specified by your contract. This money will go into escrow—not directly to the seller—and ultimately counts toward your down payment.
What is escrow, and why do people talk about “title and escrow”?
Zillow defines escrow as “when an impartial third party holds on to something of value during a transaction”. In a typical real estate transaction, your deposit and down payment will both be placed in escrow until the contract is final and “executed”, at which point the funds will be released to the seller. Put another way, escrow is a safeguard to ensure that money changing hands between two negotiating parties is released to the right party at the right time, so no one gets burned.
Title companies often perform this function, which is why the phrase “title & escrow” will sound familiar. While the buyer or seller’s agent will likely recommend a company, the choice of company is the mutual decision of the buyer and seller.
What’s this I hear about closing costs?
As you might guess, closing costs are fees paid at the close of a real estate transaction. Zillow maintains a long list of what these could be for a given transaction, but what’s more important to understand is how much they cost: about 2-5% of your home purchase price. At the most, closing costs could potentially rival your deposit; at the least, it’s still a significant payment you will need to account for as you approach the transaction.
Many of these closing costs come from the loan and the lender administering it, so it’s important to weigh these fees in your choice of lender.
Let’s talk home inspections: what are they, when should I get one, and why?
If you’ve toured a house and feel ready to make an offer, setting up a home inspection is a logical next step. Your agent can likely recommend a reputable inspector who knows the area and any common problems associated with it. Because the benefit is primarily to the buyer, it is traditionally your role to pay for it.
Can just anyone be a home inspector? That depends where you live. In California, for instance, no license is required.
What will an inspector uncover? Water damage—leading to rot or mold—is one of the most problematic issues, but there are many others you could face depending on the property’s age and history. The disclosure forms provided by the seller can be useful in pointing your inspector toward likely issues.
How do appraisals work?
For both you and your lender, it’s important that you pay a competitive price for the property—that it’s worth what it appears to be. That’s why your lender will want a professional appraisal to take place.
Similar to an inspection, an appraisal involves an on-site tour of the property by a professional, but with a focus on the property’s value. That means they will assess the neighborhood in addition to the property, with less emphasis on the nitty gritty of the home. This is typically either paid as a part of your loan application, or rolled into your closing costs.
What’s a deed, and how is it different from a title?
A deed is the document that proves legal ownership of a property, filed with the local court. As a buyer, you should receive this at closing—it’s proof that the home is yours. Title, on the other hand, is more of a synonym for ownership. In effect, the deed conveys who “has title” over a particular property, which might be divided among several people. It’s confusing terminology—with cars, the title is the documentation itself—but when it comes to your home, it’s the deed that matters most.
What is the principal of a loan?
The principal is the value of your mortgage (or any other type of loan) before interest is taken into account. Ultimately, this is what you want to pay down; the lower the principal, the less you pay over and above it in interest.
In a nutshell, how does interest work on a mortgage?
Most people are familiar with the basic concept of interest: a creditor loans you money, and in addition to paying back the principal, you are obliged to pay back the loan, plus a percentage of the loan’s balance—the interest—calculated at some regular interval. You might say interest is “the cost of using somebody else’s money.”
How the interest on your mortgage accrues falls into two main categories: fixed-rate, or adjustable-rate. As you might guess, the former means that the rate you pay does not change over the term of the loan, while with the latter, it does—usually after a set period.
Each monthly payment will go toward a combination of interest and the principal, shifting over time toward the principal as the total interest decreases. This process is called amortization.