A deal that some refuse

Why are so few people buying houses? One of the key reasons is falling prices.

Although lower prices encourage true bargain hunters to look for deals, they can also scare off homebuyers who fear the bottom has yet to come. And, between the two, anxiety is winning.

This spring, home prices in major cities were back to the same levels reported in the summer of 2003. Although prices in several locations are beginning to rise again, even with the increases, housing remains the weakest part of the U.S. economy. Prices won’t fully recover until the glut of foreclosures for sale is reduced, companies start hiring in greater numbers, banks ease lending rules and more people get comfortable again with buying a house.

Laura Young and her husband, Andre Gjerde, wrestled with whether a weak housing market was a great opportunity or a serious risk.

“We were keeping an eye on prices hoping to hold out a couple of years to see if they hit bottom,” says Young. They were particularly cautious after seeing a relative buy a condo in 2008 only to see its value drop by $100,000.

After sitting on the sidelines, the Seattle-area couple took stock of their financial situation: Gjerde, a freelance foreign-language translator, was able to maintain a consistent income during the recession; and Young’s job at a public relations agency remained secure. They decided a few months ago to meet with a mortgage banker and start the process.

Ultimately, the couple settled on a newly built home in Bothell, Wash., a suburb about 15 miles northeast of Seattle.

They were impressed by the 3-bedroom, 2 1/2-bath home on a corner lot. There had been an outstanding offer on the home, but, in a sign of the times, the financing fell through. Young and Gjerde then jumped at the opportunity to make an offer of $325,000, about $5,000 lower than the home’s appraised value.

Buyers who are ready to enter the market are likely to be hard-pressed to find a better time. The national median existing-home price for all housing types was $166,500 in May, which was almost 5 percent below the comparable price in May 2010, according to the National Association of Realtors.

Financing is cheap: The average interest rate for a 30-year fixed-rate mortgage is 4.5 percent, slightly above the four-decade low of 4.17 percent reached in November.

What’s more, the number of existing homes available for sale remains high with 3.72 million homes on the market in May. A large inventory of homes tends to suppress prices.

Here are some factors you need to think about as you ponder taking the leap:

1. DO THE MATH

The market conditions all favor the buyer in closing a deal, so it seems like they would be clamoring to find an ideal home.

But an uncertain economy has complicated matters. A banker who specializes in working with first-time buyers, Justin Lopatin of Baytree National Bank and Trust in Chicago, says clients are appropriately cautious.

“Some people fear the financial commitment, while others may be hesitant because they don’t have the certainty of job security,” Lopatin says. “For the rest it’s just mustering up the down payment.”

Whatever the condition of your local housing market, as a potential homebuyer you need to start with the threshold question of whether buying makes financial sense.

Recognize that if you buy it typically takes four to five years before your annual expenses fall below the cost of renting. Although homeowners get the benefit of deducting mortgage interest from income taxes, precisely when they will be able to realize that benefit is influenced by the direction of rents and home prices in the area.

Gather all of the financial information that will influence your decision, such as the amount you have to put toward a down payment, a reasonable price estimate of the home you want to buy and the property tax rates for the location. There are several online calculators that can help you gauge at what point buying a home may begin to save you money, Ginnie Mae offers one at: http://tinyurl.com/3rt5n37.

Negotiating with motivated sellers and brokers looking to make a deal can help you control some of your costs.

2. KNOW WHAT’S AFFORDABLE

Real estate website Trulia.com found that buying a home is increasingly more affordable in most major cities because of falling home prices and stable interest rates that remain near record lows. The site defines affordability as being within reach of households earning the national median income of $64,400.

You’ll want to get preapproval for a mortgage to determine how large a loan you might qualify for, and at what interest rate.

With a projected mortgage payment in mind, add in the cost of property taxes and homeowner’s insurance. Banks will hesitate to approve a loan if these costs exceed 28 percent of your income before taxes.

To provide plenty of breathing room in your budget, calculate your housing costs based on your take-home pay. Let’s say you bring home $5,000 a month. Multiply that by 28 percent and you find that you should keep your monthly housing expenses below $1,400.

You should also figure out your debt-to-asset ratio, which will give you some insight into your total debt load. Add up your monthly payments for auto loans, student loans, credit cards and the home mortgage. Total debts shouldn’t exceed 36 percent of your gross income.

Try the calculator at Bankrate.com: http://tinyurl.com/yjgnoxf.

3. EVALUATE YOUR FINANCING OPTIONS

Many potential homebuyers are needlessly assuming they won’t qualify for a loan, so they don’t try, says Jeff Hansen, a real estate agent in Littleton, Colo. Even those with an average credit score can get a competitive mortgage rate, says Greg McBride, senior financial analyst at Bankrate.com.

“The idea that banks don’t want to lend money is like saying fast food chains don’t want to sell hamburgers,” McBride says.

Buyers with a credit score of 680, which is close to the national average credit score, should be able to get a loan at a competitive rate, according to McBride. The minimum score requirement varies depending on the bank.

Still, the biggest financial obstacle for many potential buyers is coming up with the down payment. A typical conventional bank mortgage requires 20 percent. On a $200,000 home that’s $40,000. Some lenders may allow less but will require a home mortgage insurance policy. The premium will be added to the mortgage payment, pushing the monthly payment higher.

Loans through the government FHA program allow down payments for as little as 3.5 percent for borrowers with good credit.

4. FOCUS ON LOCAL CONDITIONS

Keep in mind you shouldn’t view your home as an investment in the traditional sense. It’s your home, not a liquid asset that you can easily sell and cash out as soon as prices rise. Many areas of the country are still struggling with depressed housing prices.

In Seattle, where Young and Gjerde purchased, the local home price index is down 6.9 percent from a year earlier.

If you’re looking to buy, do your homework, consult a banker and look only at homes you can comfortably afford. If it’s your first, remember it doesn’t need to be your dream home. A good strategy is to buy a starter, build equity and trade up.