7 Steps To Buying A Home Thru Closing Day

7 Steps To Buying A Home Thru Closing Day

You and your family have decided to buy a house. Now what?

Buying a home takes about six months from your search to the closing day at a minimum. There is a lot to consider when likely making the biggest purchase of your life. So you will need to make some effort to get things in order.

Pay special attention to the steps we outlined below. You will be working with key professionals—real estate agent, banker, title insurer, attorney, inspector—that will be part of this process. Mortgage rates happen to be at record lows.

However, Don’t Hurry!  Ok, ready?

Step 1: Get your finances in order.

You will likely need a loan unless you have loads of cash to pay for your house. Hopefully, you have been budgeting and saving for a house purchase.

Review Your Credit Report

Review your credit file to make sure it is in good shape. You will need to check with the credit bureaus, Equifax, Experian, and TransUnion credit reports. Make sure your credit report is accurate. If not, make corrections to clean up your credit file. At the same time, look up your credit scores and see if there are ways you can raise your score.

You need a working estimate of what your ongoing monthly costs for your new home will be. The budget for your home will include the mortgage principal and interest cost, real estate property taxes, homeowner’s insurance, and mortgage insurance.

These costs could be at least 50% higher than what your current home costs are. You should look at current mortgage interest rate levels at www.bankrate.com. There are calculator apps to help you estimate your monthly payments. Look for a conventional fixed loan and consider a shorter term of 15 years versus 30 years. Your interest costs, and therefore your total home costs, will be lower. See our post on Making Better Money Tradeoffs, such as shorter-term loans.

Also, you are likely moving to a larger space. If so, you will need to calculate incremental utility costs (heating,  A/C, electric, and water).  These costs are different than the one-time costs associated with buying a house, which I will discuss below.

 Step 2: Prequalify For A Mortgage – Takes About One Month.

Before you actively go house-hunting, it is a good idea to get preapproved for a mortgage. It will help to narrow your search. By doing so, it will save you some angst from the disappointment of finding a dream home out of your price range. The pre-approval letter may expire between 90 days and 120 days, giving you an idea about how long you should time your house search.

Many online mortgage providers, such as LendingTree, Lending Club, or Rocket Mortgage by Quicken Loans, streamline the process. Find three lenders in addition to your banker in your local area to speak to at this point.

Pre-Approved Letters Reflect Motivation

Keep in mind, getting prequalified does not guarantee a loan. However, it does help to have a preapproved letter for a mortgage. Lenders want to see motivated buyers who have made an offer with a pre-approval letter from a lender or mortgage broker in hand. The sellers expect this and even demand it, so this step is a must.

Go to a lender, either in person or online, complete a form, provide your financial information to the most minute detail. They are looking for a good income and good credit history to pre-qualify you. When you decide that you are ready to purchase a house, what do you do? Location.

You’ve narrowed down the locale, the state, and the city or town. Now what?

Step 3: Search for your home online and in-person*. This process can take two months or longer.

Early in this process, you may what to explore desirable areas. Driving around can be a fun part of the process or emotional as you move to the next stage of your life. You will need to consider your budget. Brace yourself from making an impulsive buy of a too big or too perfect a home that will be difficult to afford.

Check on Zillow.com  to get an idea of what you get for your budget in terms of floor plans, features, square footage. You may want to go to a couple of Open Houses.

*During the pandemic, it is likely you will see homes virtually.

Should I Get A Real Estate Agent?

You may have started thinking that you will do your search without a real estate agent and deal directly with the listing real estate agent. As you probably know, the seller usually pays the real estate agent. Still, engaging a real estate agent is very important.

The search can be overwhelming. Ultimately, you may decide to grab an excellent real estate agent after all.  There are many pluses to this as a real estate agent likely knows the neighborhoods you are exploring. I recommend you interview a few real estate agents, so there is good chemistry. There is a lot at stake here for the buyers and agents.

Respect Your Agent

Once you have a real estate agent, make sure to understand the ground rules for working with your agent. You want your relationship to go smoothly. We hear some stories where the buyers are late to appointments or call the listing agent without their agent. Being late is a no-no. Respect your agent.

Unlike a rental arrangement, the seller pays both buyer’s and seller’s real estate agents. The agents split the commission per a written agreement. You should sign a representation letter so that you can be sure that the broker is representing your interests as the buyer, not his or her pocketbook.

Now you are ready to search for that new dream home. After seeing a “zillion” houses, you finally found the one for you and your family. The search can take two months or longer depending on the buyers, frankly.

Step 4: Always Negotiate  With The Seller

This step is complicated with some parallel tracks.

Now The Negotiations Begin

You can negotiate the price, the timing of the closing, the outdoor furniture, and other details.

Everything Is Up For  Negotiation,

Sometimes there are contingency clauses designed to protect the buyer in individual events. These clauses could be a down payment, usually between 3% and 10% of the house price. The down payment may be returned to the buyer if:

  • the buyer cannot get satisfactory financing;
  • the appraisal value done by the buyer’s lender comes in below the agreed-upon price, or
  • the home fails inspection.

Make a written offer for the purchase of the home.

Before accepting an offer, there usually is a counteroffer. The agent will submit a written offer once you are comfortable with a price. That offer should be subject to a formal contract review and approval by your attorney (more to come on that).  Your bid is also subject to home inspections by a qualified professional.

Home Inspection Is Needed

Once your offer is accepted, you will want to have a home inspection before signing a contract. 

Your broker should have a list of competent licensed home inspectors. They are usually civil engineers, retired building inspectors or experienced contractors. 

You should expect a DETAILED report of the inspector’s inspection of the house, from the roof to the basement. The information should highlight the defects and deficiencies that the inspector discovers throughout the house. Ask the inspector for repair estimates and how they would rank the repairs based on their urgency. This report should be written and delivered to you in a few days.

The home inspection could be a means to negotiate the price downward

The findings can help you negotiate preclosing repairs the seller will pay for or get a price reduction. It also gives you an idea of the work that you will need to address in the future. The inspector should also conduct a termite inspection and provide you with a wood-boring insect certificate. Your lender will require this certificate.

Depending on where you live, you will want a radon gas test. Radon is a dangerous, odorless gas that tends to get trapped in basements and crawl spaces. It quickly breaks up, but you first have to discover it. An older house, pre-1978, may have lead paint residue. After 1978 lead paint was no longer in use in the US.

Ask your inspector to check for lead paint. Buyers can move forward with a satisfactory inspection and an agreed price for the house. The next stage is the transaction deal memorandum or “The Deal Sheet”.

While this is all happening, the agents are generating a transaction deal memorandum for the parties.

Step 5: Hire An Attorney And Formally Apply For A Mortgage Loan

Once you make an offer for the house, you will want to hire an attorney. Their role is to write a contract of sale through the home’s closing. 

Typically the seller’s attorney will draft and present a printed form of a contract of sale, a seller’s rider, and a lead paint disclosure. Your attorney will then provide a purchaser’s rider in response. Riders are common additions for most purchase agreements containing provisions such as a buyer’s obligations and special conditions relevant to the deal.

The purchaser provides the down payment, which is a show of earnest money or good faith deposit. Attorneys review many of the documents in an exchange between the buyers and sellers.

Among those key documents that will need to be reviewed by your attorney are:

  • mortgage loan estimate
  • title documents
  • closing disclosure
  • title or uniform settlement statement
  • closing costs.

After you sign the purchase contract, you will formally apply for a mortgage loan.

Mortgage Loan

Getting a mortgage loan can take time, even though you have preapproval from a lender. That preapproval letter speeds up the process for getting a formal loan but could expire before you found your desired home.  It is a good idea to consider more than one lender. You will likely want a lock-in agreement for your mortgage, especially if the interest rate is changing. These agreements are usually for 30-60 days.    

Step 6: Prepare For The Closing

Once you have made an offer, you will need to engage an attorney to represent you in the title’s negotiations and the closing. With that in mind, we will explore the contract process through the eyes of a  New York residential deal.  In many states, attorneys are minimally involved, if at all. A contract is a fill-in-the-blank form prepared by the brokers and a title company. This step takes place within one month of the closing.  

Step 7: The Closing

Who attends?

There is some nervous excitement when you reach this step. Several key people attend the closing. They are the buyers and sellers, their respective attorneys, the buyer’s and seller’s real estate agent, the lender’s representative (either a paralegal or an attorney), and the title company’s representative, usually called a closer.

At the closing, the buyer signs the mortgage documents, the seller signs the deed, transferring the title to the buyer. The buyer writes big checks in exchange for the keys to the buyers’ new home.

You did it! Time to celebrate!

Final Thoughts 

 

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If you own your own home, how was your home buying experience? Please share your thoughts with us. We want to hear from you!

 

13 Money Lessons From Warren Buffett’s 2020 Letter to Shareholders

13 Money Lessons From Warren Buffett’s 2020 Letter to Shareholders

Each year I read Chairman and CEO Warren Buffett’s annual letter to Berkshire Hathaway’s shareholders upon its release. For many reasons, I do so as a shareholder, an investor, a former equity analyst, and a professor. Teaching finance to college students the letters are a treasure trove and better than many textbooks.  They are enjoyable to read, and I learn a ton from them.

The 2020 letter provides insights into the company’s diverse businesses. These businesses represent a proxy for our economy. What makes the letter so special is that Buffett writes it himself, sharing money and investing lessons with his memorable wit and humor. Each year, Buffet aims his words at investors at every level.  He pretends he is writing to his two sisters, Doris and Bertie. They have a significant amount of shares.

This year’s letter had several new aspects, which contained some soul searching but no major surprises. Buffett and his partner in crime, Charlie Munger, are the oldest leadership team of Fortune 500 companies at ages 90 and 96, respectively. They recognize the need to be candid with shareholders about the company’s future without them.

13 Key Takeaways:

 

1. 2019 Was Not A Stellar Year For Berkshire’s Stock Performance

Berkshire’s stock underperformed the S& P 500 index, the market’s proxy, by 20.5 percentage points in a strong year for equities. This year’s performance was its biggest disappointment since 2009. Looking at its 55 years history, Berkshire compound annual return of 20.3% exceeded the S&P 500’s not too shabby 10%. While this is an excellent performance for any company, Wall Street’s “what have you done for me lately?” mentality raised many questions for Buffett. The company has been hurt by its lack of acquisitions, particularly in fast-growth areas like the technology sector.

The company’s operating earnings in 2019 were slightly down compared to a year ago. Berkshire Hathaway does not pay a dividend to shareholders who would have boosted returns to shareholders.

2. A Disciplined Acquisition Strategy

Acquisitions are a signature priority for the company. However, Buffett has had trouble finding an “elephant-sized” one. Buffett tried buying Tech Data, a technology distributor, but  Apollo Management bid higher and acquired the tech company.

Buffett uses three criteria for buying new businesses:

  • The business must earn good returns on the net tangible capital required for its operations.
  •  Berkshire’s unique acquisition strategy prefers to inherit strong and honest managers.
  • Buffett wants to pay a sensible price and will not enter into bidding wars.

Although they prefer to own 100% of the acquired company or at least a controlling interest, they have valuable non-controlling interests in many businesses. Those holdings are worth $248 billion based on the year-end 2019 market price. They represent long-term holdings of reliable companies include American Express, Apple, and Delta Airlines.

However, the accounting isn’t as favorable a contributor for their non-controlling stakes. Berkshire can only realize the dividends that Berkshire receives in operating earnings they report. However, they cannot include the proportionate retained earnings reported by these holdings. Dividend income from the ten largest holdings in 2019 amounted to $3.8 billion compared to its share of $8.3 billion for retained earnings.

 

3. Reinvestment In Diverse Productive Operational Assets Remains Top Priority

Berkshire Hathaway splits their controlling businesses into insurance and non-insurance operations. Together, they reflect diverse companies representing a tapestry of our economy. Buffett has acquired dozens of companies over the years. In the current letter, he analogizes acquisitions to marriages: “Joyful weddings — but then reality tends to diverge from prenuptial expectations. Sometimes, wonderfully, the new union delivers bliss beyond either party’s hopes. In other cases, disillusionment is swift.” Almost poetic!

Although Buffett does not explicitly cite the significant disappointments, his commentary pointed to the original one. That dates back to early 1965 when he acquired Berkshire’s textile business, which received most of the capital. Buffett began acquiring companies, which received more of the company’s money. The textile’s losses became a drag on growth and eventually lost financial support. Of course, without that business, there may not have been a Berkshire Hathaway today. Today, Berkshire designates most of its capital to their companies that achieve good-to-excellent returns and less for those that perform poorly.

Top businesses that get superstar status in Berkshire’s portfolio are insurance operations,  followed by BNSF railroad and BH Energy acquisitions. The rest are Clayton Homes, International Metalworking, Lubrizol, Marmon, Precision Castparts, Forest River, Johns Manville, MiTek, Shaw, and TTI. They also own many smaller businesses.

4. Wind As A Major Energy Accomplishment

Berkshire Hathaway Energy has been very successful in charging lower energy rates. They realized efficiencies from converting wind into electricity. The company expects to be wind self-sufficient for its Iowa customers in 2021, far ahead of the other Iowa utility. Berkshire’s move to the wind is potentially well ahead of other utilities in the US. Positively, Berkshire’s energy business may take on more utility projects.

5. Valuable Insurance Businesses With Conservative Risk Approach

Berkshire’s property/casualty insurance businesses provide a lot of capital by “float” or “free money.” Float is an attractive aspect of the insurance business. The insurers receive premiums upfront from the sale of insurance policies. They make payment of claims which can stretch out over decades. In the meantime, the company invests the float money in conservative high-grade bonds. Given our low-interest-rate environment, the returns have been low for these financial instruments in recent years. Had the float been invested in lower-quality bonds or stocks with higher returns, Berkshire and its shareholders would have been bigger beneficiaries but at far greater risk.

Instead, Berkshire is sticking with a conservative investment policy for the float. Insurance can be a risky business. There have been significant catastrophes in the past, such as asbestos, Katrina, earthquakes, and tsunami in Japan. When they occur, it can be tragically devastating for human lives and significantly impact businesses unexpectedly.

6. The Compounding Power Of Retained Earnings

Buffett discussed an economist, Edgar Lawrence Smith, who had written Common Stocks As Long Term Investments in 1924 in his letter. Smith argued that stocks would perform better than bonds when prices rise, and bonds would deliver better returns when prices decline. However, the author himself admitted that the studies he was using did not prove his theory.

Giving support to Smith’s insights, John Maynard Keynes wrote in his review of Smith’s book: “I have kept until last what is perhaps Mr. Smith’s most important, and is certainly his most novel, point. Well-managed industrial companies do not, as a rule, distribute to shareholders the whole of their earned profits. In good years, if not in all years, they retain a part of their profits and put them back into the business. Thus there is an element of compound interest (Keynes italics) operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from dividends paid out to shareholders.”

Before Smith’s book, stocks were considered speculative compared to bonds. Reading The Beautiful And Damned classic by F. Scott Fitzgerald written in 1922, the protagonist Anthony Patch had lived off his bonds, selling them off as his emergency fund as he had no other income. Stocks were not what gentlemen buy.

Think of the company’s retained earnings as its savings account compounding growth. This growth can be invested in new opportunities, whether to buy new companies or expand their holdings.

7. “If”

Buffett is a big fan of Rudyard Kipling’s poem “If and uses “If” when asked about predictions. When making forecasts, Buffett Cannot predict future interest rates, tax rates, or economic growth. Changes in these rates can cause stocks to have significant drops in the market of 50% or greater. That said, he remains an unflappable optimist about our country and the future of stocks for the long term. Equities are the better choice over fixed-rate debt securities assuming interest rates and corporate rates remain as they are now. Hard to predict significant “ ifs.

That said, equities perform better over the long term benefiting from compound growth. However,  you can do things to reduce your risk by not using borrowed money (e.g. buying on margin) to buy stocks. Control your emotions when the markets get rocky so that you don’t sell good stocks recklessly. Volatility in the markets happen regularly but weather the dips for the long term rather than sell out of nervousness. An emergency fund helps you maintain liquidity when the unexpected happens, such as a job loss.

8. Use Of Conservative Accounting Standards

Buffett and Munger refer to earnings as bottom-line net earnings, meaning after considering all income taxes, interest payments, management compensation, restructuring costs, depreciation and amortization, and home office overhead costs. Net earnings contrast to the often practiced adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is a much higher number than net earnings. However, Berkshire prefers net earnings, which is more conservative. Munger has often referred to the EBITDA profit metric as “BS earnings.”

High growth companies who are not year generating bottom-line earnings use EBITDA as a measurement. Wall Street bankers and analysts have endorsed EBITDA as alternative valuations for growth companies. Buffett is critical of companies that report earnings before “one-time events” such as restructuring and stock-based compensation costs. What he means is that these costs still need to be deducted from gross earnings. Some management doesn’t want to include these items as an expense, but as Buffett quips: “What else could it be–  a gift from shareholders?”

9. Buy-Hold Investment Strategy is A Longstanding Trademark

Berkshire has a significant collection of equity holdings. This portfolio is separate from the companies Berkshire controls. Here, Berkshire has ownership typically about 5%-10%+ stakes in substantial companies that deliver dividends and stock appreciation. Berkshire holds about fifteen positions thoughtfully bought and intended for long term. At the end of the year, Berkshire’s portfolio of $248.0 billion market value, well over its $110.3 billion costs.

This portfolio does not include Berkshire’s more significant holding in Kraft Heinz because it is in a control group. Kraft Heinz is one of his acquisitions that Buffett believes the company overpaid. One of his few mistakes. Overall, Buffett often is praised for his buy-hold portfolio diversification.

10. Berkshire Share Repurchases

Buffett and Munger will buy back shares if they sell at prices below their intrinsic value estimate and have sufficient cash. Berkshire bought back $5 billion in shares for about 1% of the company. They are reluctant to buy back shares solely for the appearance of propping up the stock. They have been critical of other companies doing that.

The management of their constituent companies has also repurchased shares, using their retained earnings. Repurchased shares boost Berkshire’s ownership percentage from the lower outstanding share count.

11. Has An Ample Emergency Fund

Berkshire maintains a high level of cash-equivalent securities, invested in US Treasury bills of $125 billion at yearend. They use debt sparingly with $19.9 billion.  Buffett admits to making expensive mistakes along with missed opportunities. The company always maintains a minimum of $20 billion to guard against any potential calamities. Holding this money is like an emergency fund for the company so they can have liquidity readily accessible. Berkshire would never want to sell any of their businesses to raise capital.

12. Planned Exits For Buffett And Munger

Neither management is going anywhere in the immediate future. They remain energetic and optimistic about the company’s future. The company is well known for its strong corporate culture throughout its many companies. That said, in preparation for Buffett’s eventual exit, he discussed the details of his will’s directives. According to Buffett’s directions, fiduciaries–executors and trustees–cannot sell any Berkshire shares right away. Both the Mungers and Buffett have most of their wealth concentrated in Berkshire shares.

Over time, the trustees will convert A shares into B shares annually and distribute them to various foundations. The higher-priced B shares are the original Berkshire Hathaway stock and have never gone through a stock split. A recent stock price for Berkshire A (BRK.A) was $343,449.00, while the B shares (BRK.B) are $229.33, a more accessible price for the average investor.  It will likely take 12-15 years to distribute after Buffett’s passing.

Buffett feels confident in his strategy despite the concentration of that much wealth in one stock. His faith in the company outweighs his need for diversification. That is not good advice for the regular investor, but hey, he is Warren Buffett. Buffett is aware that Investment banks may approach the Berkshire Board of Directors to change Buffett’s strategy. However, Buffett has a strong belief in his board. He has been critical of overpaid directors at other companies who do not buy shares with their savings except through grants. The need for board independence for Buffett has been a constant topic well before Sarbanes-Oxley law’s requirements.

13. “We Are All Duds At One Thing Or Another”

In a jab at directors he met through the years, Buffett said he would not have chosen them to handle his money or business matters. Adding, “They, in turn would never have asked me for help in removing a tooth or improving their golf swing. Moreover, if I were ever scheduled to appear on Dancing With The Stars, I would immediately seek refuge in the Witness Protection Program. We are all duds at one thing or another.”

Ajit Jain And Greg Abel Will Have More Exposure At This Year’s Shareholders Meeting

Jain and Abel –two prominent operating managers–have been touted by Buffett in recent years. Jain heads the insurance business, while Abel is part of the Berkshire Hathaway energy business. Buffett and Munger have not named Abel and Jain as successors. Buffett turned 90 on his last birthday (August 30), so it is only reasonable that investors encourage the company to make their decision official soon.

Final Thoughts

Warren Buffett has long been an investment icon, teacher, and generous philanthropist. His folksy letters to shareholders provide personal finance lessons in a manner of common sense. They are informative about the company’s businesses.  Buffett’s refreshing optimism about the future can be contagious. He owns up to mistakes and is self-deprecating with his wonderful sense of humor.

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