First-Time Home Buyers' Guide

Luke Mullins

Everything you need to know about jumping into the real estate market this year

Why is everyone nagging you to buy a house these days?

When real estate values were crashing -- prices dropped nearly 33 percent from the second quarter of 2006 through April 2009 -- renting that apartment was darned savvy. And since home values are projected to drift lower in 2010, getting into the market now may seem like financial suicide. But the truth is, even the worst housing slump since the Great Depression can't remove the long-term benefits of homeownership.

Meanwhile, the combination of lower prices, cheap mortgage rates, and a special tax perk from Uncle Sam has produced some of the most favorable conditions for home buyers in years. And without the need to unload one property to purchase another, first-time home buyers will find themselves in a position of particular strength this year.

To assist those who are considering purchasing a house, U.S. News has created a 2010 first-time buyers' guide.

Although the real estate bust wiped out nearly $6 trillion of housing wealth through November 2009, the financial advantages of homeownership remain. "When you own a home, you are slowly but surely building strength in an asset that you can utilize to your great benefit at some point," says Keith Gumbinger of HSH.com. Homeowners who accumulate enough equity can borrow against the property to put Junior through college, or they can sell it down the road to purchase that retirement bungalow in Boca Raton, Fla. And federal tax breaks make home mortgages less costly than other forms of debt. "It is a long-term forced savings plan," Gumbinger says.

Meanwhile, the housing meltdown and the federal government's response have created some compelling reasons to consider jumping into the market this year. First, lower prices make buying more tempting. By late 2005, breezy credit and speculative fervor had pushed the national median home price to median household income ratio -- a key measure of real estate affordability -- to more than 2.3, according to Moody's Economy.com. That's significantly higher than the 1.9 average for the 15-year period that ended in 2003. But by the third quarter of 2009, plunging prices had dragged the ratio down to 1.67. And although Mark Zandi, the chief economist at Moody's Economy.com, expects an additional 10 percent decline before prices hit bottom late this year, the likelihood of a sizable drop is much smaller today than several years ago. "The risks to all homeowners are much lower now because house prices are a lot lower," Zandi says. "You're not going to see the kind of price declines that are really going to cause you problems."

Mortgage rates are sitting near all-time lows, with 30-year, fixed mortgage rates falling to an average of 4.88 percent in November from 6.09 percent a year earlier. And while they're likely to increase, rates should remain attractive throughout 2010, experts say. If that's not enough, Uncle Sam is handing out tax credits worth up to $8,000 for qualified first-time home buyers who close the purchase of a primary residence by the end of June. "You have got some of the best housing affordability conditions in many markets that [buyers] have seen certainly in their lifetimes -- and perhaps even their parents' lifetimes," says Mike Larson of Weiss Research. "If you are not encumbered by a previous home you are trying to sell, this is great for you."

Jobs first. Many Americans are taking advantage of these conditions to become homeowners, with first-time home buyers accounting for more than half of home sales in November. But as we learned during the housing bust, "because everybody's doing it" is a terrible reason to buy property. Instead, would-be buyers must first determine whether or not it's the right time for them. And that means they must take a critical look at their employment situation. Although the economy is showing signs of life, the national unemployment rate stood at 10 percent as the year began, and it is projected to move higher. Since a steady income stream is essential to homeownership, only those with sound job security should pursue a home purchase.

Second, remember that all those headlines about the national housing market aren't nearly as important as what's going on in the area you are looking to buy into. The trajectory of home prices will vary a great deal from one place to the next. Home values in Tacoma, Wash., for example, are expected to increase more than 40 percent over the next five years, while prices in Atlantic City are projected to fall more than 10 percent, according to Moody's Economy.com. Markets with a diversified economic base of faster-growing job providers -- like high-tech or business service firms -- are in a good position to experience growth in employment, population, and wages, says Celia Chen, the senior director of housing economics at Moody's Economy.com. Such factors will help stimulate housing demand and juice property values over the long term.

A market's current pricing trends are important as well. Although the housing bubble popped more than three years ago, prices in some markets remain significantly higher than fundamentals suggest they should be. Homes in Asheville, N.C., and Portland, Ore., are more than 20 percent overvalued, according to IHS Global Insight. To determine if buying today makes financial sense in a given market, check out the local rental stock. "If you can find houses in that market that are renting for considerably less [than what you would pay each month to buy a comparable property], then you are in a marketplace where it still makes more sense to rent," says real estate analyst Jack McCabe.

Staying put. In recent years, many homeowners got into trouble because they purchased properties that were more expensive than they could reasonably afford. To avoid this pitfall, first-time home buyers should plan to devote no more than 30 percent of their monthly household take-home pay to housing costs, which include principal, interest, taxes, and insurance combined, says Gail Cunningham of the National Foundation for Credit Counseling. Homeownership comes with a number of expenses that renters don't have to worry about. In addition to utilities and in some cases homeowners association fees, property owners are responsible for landscaping, servicing heating and cooling equipment, and taking care of any unexpected headaches that pop up. "It's essential to have that rainy-day fund for the leaky toilet or the leaky roof," Cunningham says. This conservative budget also gives homeowners additional flexibility to weather a job loss, illness, or other financial setback. And because home prices are still declining in many markets, would-be buyers should avoid purchasing property unless they plan to remain there for at least five years. This time horizon helps allow prices to recover even if they decline initially.

Although they should increase from last year's record lows, mortgage rates are expected to remain quite favorable in 2010. Rates on 30-year, fixed mortgages plunged after the Federal Reserve unveiled a program to buy up debt and mortgage-backed securities from Fannie Mae and Freddie Mac. But the asset-purchase program is slated to expire at the end of the first quarter. And if private investors don't step in, rates could move significantly higher. The unwinding of this Fed program, the slowly recovering economy, and mounting concern over government spending could boost mortgage rates to perhaps 5.5 percent by mid-2010 and nearly 6 percent by the end of the year, Larson says. But remember, even rates of 6 percent are extremely attractive compared with long-term historical averages.

Unfortunately, many first-time home buyers won't be able to obtain the lowest possible mortgage rates in 2010. Banks have raised lending standards in the face of soaring delinquencies. As a result, buyers will typically need a FICO score of around 720 and fully documented income and assets to get the best rates, Gumbinger says. Minimum down payments have also increased. Although the requirements will vary depending on the market, borrower, and property type, most buyers will need to put between 10 and 20 percent down. "That doesn't mean you can't get a mortgage if you have less of a down payment," says Guy Cecala, the publisher of Inside Mortgage Finance. "It just means that you are not going to get the best interest rates."

Borrowers who can't meet these requirements can turn to the Federal Housing Administration, a federal agency that guarantees home loans against default. Because of the agency's more liberal lending standards, the FHA is currently backing nearly 30 percent of new home-purchase loans. Such borrowers will typically get slightly above-market mortgage rates and pay into an insurance pool, which is used to reimburse lenders when a borrower defaults. Although most borrowers are required to put only 3.5 percent down, many housing experts encourage buyers to take a larger stake -- say, 10 percent -- as a buffer against price declines.

Go slow. Home prices should improve slowly if at all this year, so there is no reason for buyers to feel rushed or act impulsively. Before beginning your real estate search, establish your price range by getting preapproved by a mortgage lender. Next, click through online real estate search tools like Zillow, Realtor.com, and U.S. News partner Trulia to get a broad feel for the market. Consider reaching out to a real estate agent with experience in the local market, but don't let the agent do all of the work. "If you are going to invest this much money and take on this much risk, you shouldn't rely on just a Realtor to give you advice," McCabe says. "You owe it to yourself and your family to do all the research possible."

To dig deeper, find a couple of good blogs that cover local real estate, says Patrick Kitano of Domus Consulting Group. Signing up to receive bloggers' Twitter feeds is even better. "Twitter is a breaking-news channel," Kitano says. "And if you are a consumer stepping up to the plate as a first-time buyer, you want accurate, real-time information." In addition, buyers should hit as many open houses as possible, poke around neighborhoods, knock on doors, and chat with nearby homeowners about the community.

The foreclosure crisis will provide buyers with opportunities to get into the market at a discount this year. Foreclosed homes sell in three primary ways, says Sean O'Toole of ForeclosureRadar.com. A preforeclosure, or short sale, requires the approval of the lender and can sometimes drag on months longer than a traditional home sale. "Real estate owned" properties, which have been repossessed by banks, are usually listed and sold by third-party brokers, O'Toole says. Such transactions often generate aggressive interest from buyers but don't differ a great deal from a typical sale. Foreclosure auctions are the third type. Since laws vary from state to state, properties typically can't be inspected beforehand, and transactions are usually handled in cash, first-time home buyers should leave auctions to the experts, O'Toole says. He also recommends that anyone looking to purchase a foreclosed home find a real estate agent specializing in distressed sales. "If you were hiring an attorney, you wouldn't just use whoever had a pulse," O'Toole says.

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Real Estate - 2010 First-Time Home Buyers' Guide