Are you ready to expand some more your home buyer vocabulary? Host David Sidoni is back to talk about the different home buyer terms and definitions. This time, he dives deep into the letter “I.” Get to understand the different lingo and terms as you learn the language of home buying—from Inspection Certificate to Investment Property and everything in between. Tune in to know more!
First Time Home Buyers Terms And Definitions from A-Z – “I”
Explaining The Important Terms In Buying Your First Home
First-time home buying can be Uber confusing. It’s like you need a Master’s degree in the terminology to feel like you are making the right decision. We are going to continue your first-time home buyer education with terms and definitions for the letter I, as in, I know you can do this. Let’s go.
What is the hippity hops my How to Buy a Homies? I’m recording this episode near the end of June 2022. To all you people reading this in the future, remember how freaked out everybody was this summer of news has led with the economy. That is usually not a good thing. Not because bad economic news is always bad for you. I’ve said it before, thanks to my friends at Run-DMC, “It’s not bad, meaning bad. It’s bad, meaning good.” Yes.
Read episode 108 if you want details on what’s going on with all the bad stuff in the economy and how it might be good for you. Now we are going to have a nice little educational lesson. We are going to dive right into the terms and definitions for the letter I. Let’s move on to the next Is. We are going to go into the Inspection certificate. An inspection certificate is a document that verifies a property as inspected and completed for whatever are the individual rules and guidelines for individual cities and counties.
The inspection is usually performed by a designated agent of the county. It has to be accepted and put in before the transfer of the property can happen. This doesn’t happen everywhere. Sometimes, the inspection report is purely a buyer beware and something to be used to negotiate for any changes and upkeep that the buyer didn’t see as obvious when they put the offer in on the house.
One thing I must explain to my buyers all the time is, “Depending on what state you live in. If you don’t have an inspection certificate that’s part of your home purchase process, the buyer is not obligated to bring anything up to code if you don’t have an inspection certificate in most parts of the country.” This is a huge common myth.
In California, most cities don’t need an inspection certificate, so to transfer the ownership of the property in one of the biggest states in the country, all sales are as-is, and the buyer beware. The seller only has to do three things. They have to install a carbon monoxide detector and smoke detectors and make sure the water heater is earthquake strapped. That’s all that the sellers are obligated to do. Don’t go in thinking that after the inspection, they are going to have to bring everything up to code. The inspection is for your benefit to understand what things need to be done on the property.
Next on the Is is an Income property. It is real estate developed or purchased to produce income, such as a rental unit. Next, we are going to get into some fancy math terms, Index. The index is a benchmark interest rate that reflects general market conditions. That index it’s going to change based on the market. It changes in the index along with your loan margin and determines the changes to your interest rate if you are using an ARM, Adjustable Rate Mortgage.
The index is a published number or percentage, such as an average interest rate or yield on US Treasury Bills, and a margin is added to the index to determine the interest rate that will be charged on your ARM. Do you understand that? Cool. If you didn’t, don’t even think about getting an adjustable-rate mortgage. Don’t touch an ARM if you don’t know what the index at the margin and how they combine to make your interest rate means. End of that eLesson.
Next I is an IRA. That’s an Individual Retirement Account. This is a tax-deferred plan that can help you build your retirement. When it comes to buying a home, I mentioned IRAs because, as of now, Tax Laws could change in the next twenty seconds if they feel like it. You can use your IRA for purchasing your home. $10,000 is the maximum that you can use towards a primary principal purchase. That’s what we call it.
Our next I is Inflation. If you read the other episodes, I talked about inflation a lot but if you are looking for a detailed analysis, it’s all the way back to episode 67. Some of that stuff will have changed, mostly the rate of inflation but the general concept is all there. If you want the Google definition of inflation, one of the economic neuro definitions is that it’s the number of dollars in circulation. When it exceeds the amount of goods and services available for purchasing, causing the prices of those goods and services to increase, inflation results in a decrease in the value of the dollar.
Initial Escrow Deposit
The next one is the Initial escrow deposit. Sometimes this is called the Earnest Money Deposit, the EMD. That’s the money that you are going to put in to open up your contract. Another initial that we have is the Initial Interest rate. This is the first-rate that you get when you are doing an adjustable-rate mortgage. That’s the ARM. Sometimes this is known as the start rate. What do you need to know about the initial interest rate of an adjustable mortgage? It adjusts.
Initial Adjustment Cap
The Initial adjustment cap is our next I, and that is associated with these ARMs. The cap determines how much the interest rate can increase the first time it adjusts after the first period. It’s common for this cap to be either 2% or 5%, meaning that at the first-rate change, the rate can’t be more than 2 or 5 percentage points higher than the initial fixed rate. That way, if you get something to 3% now and suddenly rates go up to 15%, you can’t go higher than 5% or maybe 10%.
This is a word we hear a lot when we are talking about credit scores. It’s a request for your credit report by a lender or another business. Of course, that happens when you are filling out an application to request more credit. As you know, hopefully, too many inquiries on a credit report can hurt your credit score. However, I will say again two things about inquiries.
Number one, you can do as many as you want if you are doing automotive or mortgage within anywhere from 3 to 6 weeks, depending on who you talk to. That means you can shop around or shop lenders. You only get one inquiry hit. The other thing about inquiries is I have never seen someone pull their credit a year before buying a home, and that is the reason they couldn’t buy a home.
I have seen people say, “I don’t want to pull my credit. I can’t do an inquiry.” They wait until they are ready to buy a home and pull their credit before they buy a home. Something in there causes them not to buy the home. The moral of the story is don’t wait to pull your credit and get the inquiry. Get it done early. It’s a few points. If you do it twelve months early, you’ve got nothing but time to jack it back up.
The next I is an Installment. This is the regular periodic payment that our borrower pays to a lender. They are used in the next I, Installment debt. This is important to understand for your credit score. This loan is repaid in accordance with the schedule of payments for a specified term. It has an end date like an auto loan.
These are much less of a hit on your credit score than your revolving credit lines because if you go out and shopping on your Visa or your Mastercard, it can stay there forever and doesn’t have an end date. You get a bigger hit on your credit score. In episode 56, I talked about the potential of using an installment loan, using installment debt versus revolving debt to pump your credit score up.
The next I is Interest. That’s the cost that you pay to borrow money. It’s the payment that you make to the lender, whoever the lender is, for the money that’s the loan to you. That goes through our next I, the Interest rate, the amount of interest charged on a monthly loan payment, and it’s usually expressed as a percentage. It’s the cost that you are going to pay each year to borrow the money. It does not reflect any fees or other charges that you have to pay for the loan. In a simple example, on a $100,000, if you have an interest rate of 5%, you’ve agreed to pay $5,000 each year that you borrow that amount.
The next interest is an interest-only loan. This falls under the category of the ARMs. This is a loan you best know what you are doing if you are going to get into it. It has scheduled payments that require you to only pay the interest for a specified amount of time. Sometimes it’s called an IO. It’s because you are just paying the interest, they are a lot lower than anybody who’s paying interest in principal.
I recommend this should only be used by savvy buyers who can handle things with the market changes and if your plans change. If you need to stay in that property because of a highly inflated new payment, once that IO period ends, you have to be ready to handle it. Not to mention a lot of these IOs will end with a balloon payment where you got to pay everything. The moral of the story is don’t touch ARMs and IOs unless you know what you are doing.
Interest Rate Cap
A couple more definitions that go with the ARMs are the interest rate cap or the interest rate ceiling. You are going to read that. You’re going to read the interest rate floor. It’s the cap or the ceiling for an ARM. That’s a limitation on the amount the interest rate can change per the adjustment over the lifetime of the loan. That will be stated in what they call your note, which is your original loan agreement. It also will have a floor. Don’t think they are going to let you, “Everything dropped. I should be able to go to nothing.” No, you are going to have a minimum interest rate as specified in the note.
This I is an Investment property. People get excited about making money and building an empire. What’s the Google definition? It’s a property purchase to generate rental income, tax benefits or profitable resale rather than serve as the borrower’s primary residence. If you are seeking to buy an investment property before your primary residence, which a lot of people ask me about. I have a few things to ask you. First of all, are you savvy enough to predict the equity appreciation on that investment and understand that this is a smarter move for you than replacing your rent with your own primary investment that you would live in?
The next question I have is, have you included maintenance, property management or vacancy rates in your calculations? All of that is being part of a property owner being a landlord. I’m seeing a fascination with people reaching out to me by reading the blog. People want to buy an Airbnb first before they purchase their own home. I want to make sure I ask all these people, have you taken a route count all of this, and most importantly, have you done the math on buying an investment home first before you buy your own primary residence?
I would say use the same math that I tell people on rent versus buy. Is it better for me to buy or rent? You have to take that calculation and put that into the equation if you are thinking about buying an investment property first. For instance, if you cover all the costs that I mentioned in the investor’s property before you purchase the home and replace your own rent.
Let’s say that you can cover all of those things. You have the maintenance, the property management, and the vacancy racing. You are a genius, found a great deal, and going to gross $1,000 profit on a $2,000 mortgage on an investment. What that is, is you went out and bought a $350,000 home for 20% down. That’s $70,000 investment plus $15,000 in closing costs. You are full PITI is about $2,000, and you are going to have that home but it has to rent at $3,000 a month for you to gross $1,000 in profit.
If you take into account the things that I mentioned, the maintenance of property management, and the vacancy rates, you are going to net about $500 a month’s profit. That’s a $ 6,000-a-year profit. From an $85,000 investment, that’s a pretty damn good return, and I understand that, except here’s the thing. You are still paying rent every month.
I honestly don’t see how adding up the rent money that you are throwing away, which could be $2,000 a month or $24,000 a year. Is that the right call to not address that so you can make a $6,000 profit, even if you now have to resave up your own down payment for your house? How many years will it take you to do that, to replace your rent with an appreciating asset while we are in an upward-trending market with rising rates? The longer you wait, the more expensive that’s going to get.
I could get a little bit more into that but hopefully, that makes sense to you, and that information should suffice. I ask you this. If you understand all of that, do you still think that buying an investment home before you purchase your own home is a good idea? Who knows? Maybe you have some different factors, you are living at home for free or buying an investment property first while you live van life for four years.
I don’t know but in general, for most folks, I don’t see it’s a good idea for you if you’ve never purchased a home before in your life to decide that you are going to first purchase as an investor. Mathematically, it doesn’t make sense but philosophically, it can be rough for that to be your first home. Maybe it’s better for you to take care of your own house first. At least, I believe that’s a good idea. Speaking of good ideas, HowToBuyAHome.com has everything you ever need to get loads of free advice and guidance from me, a realtor with actual experience helping first-time buyers, not a badass TikTok account. Although mine is doing all right.
If you go to HowToBuyAHome.com, you are going to find links to the show, the YouTube page, the Instagram, the TikTok, and soon, if you are reading this past the summer of 2022, it’s probably there now. We are starting to get together due to the overwhelming response of people feeling overwhelmed. We are going to be launching the How To Buy A Home Starter Kit on the website because, after several years of doing this show, your number one question from the reader is, “Where do I start?” Help the show out if you can with five stars. Take 94 seconds and type me a review. That seems to be the only way people know that I am legit. That is the letter I, and I am going to leave you with one more thought, “You can do this.”
- Episode 67 – Past Episode
- Episode 56 – Past Episode
- YouTube – How To Buy A Home Podcast – David Sidoni
- Instagram – David Sidoni
- TikTok – How To Buy A Home Podcast
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