Buying a house is tough. Coming up with enough money is a major issue, and once you do, it’s still way more complicated than you would expect. Around here, we call the number of steps needed to buy a home “the real estate monster.” We’re used to seamless, integrated and delightful products and services. The way housing works is neither seamless nor integrated — let alone delightful.
Part of the reason it’s tough is that for many of us, it’s the first time we’ve ever done a transaction like this. That newness in itself can be daunting. Paired with that are a number of confusing steps and many, many pieces of complex paperwork. In the end, this doesn’t make for an enjoyable process.
Let’s take a closer look at some of the parts of the process by following Sally’s experience (remember her?) and looking at where they start to break down. We asked the question — how might we make things better?
Searching for a home
Most people look forward to this part, Sally included. She spent years saving with her parents and then negotiated a gift from them, always daydreaming about the home she wants to have. Unfortunately, like most of us, Sally only thinks about the exciting parts beforehand. What streets does she find lovely? How will she design her dream kitchen? Should she try to get an extra bedroom to rent it out?
There are two major pieces that play into her search — what she can afford, and finding the right agent.
Affordability. Now that Sally has at least a little capital up front, she’ll have to work with a lender to get a sense of how much house she can buy when her down payment is combined with a mortgage.
This can be done in two ways: a mortgage prequalification or preapproval. A prequalification is much faster — it can be done over the phone — but a preapproval is binding and attractive to sellers. Sally, like most millennials, lives in a seller’s market, meaning she’ll need to get a preapproval.
How can she get preapproval? Imagine gathering every financial document you’ve gotten in the past few years. W2s, tax forms, interest statements for your student loans, credit reports, bank statements, pay stubs. Woe betide you if you’ve tossed that stuff or lost it. You’ll need all or most of it for a lender to give you an binding picture of how much they’re willing to lend.
Once Sally knows how much house she can afford, she can actually start looking. Depending on the market she’s in, this can either be an exciting, invigorating excursion into the imagination of the life she’s embarking upon, or a hellish, stressful, and exhausting process of falling in love and losing out, sometimes several times over. For most people, it’s a combination of both.
It’s arduous, and we’re left wondering: how might we find more flexible, open, and accessible ways of buying into real estate?
Finding an agent. While there’s been plenty of movement to change the process, buying and selling real estate still works primarily through agents. Agents have access to the MLS, a limited access database where nearly all homes for sale are listed. So Sally will need to find someone to work with — probably through referrals from friends and families. She’ll certainly look on sites like Zillow and Redfin, but like many millennials, her agent will play a significant role. The agent will hopefully get to know Sally and her needs to show her specific homes. Sally will probably need to sign a contract, committing not to work with other agents, so her gateway to the real estate market will flow almost entirely through her single agent.
Sally’s agent will be paid on commission when she buys — usually around 6% of the purchase price, split between the buyer’s and seller’s agents. In theory, this means she wants to find Sally her perfect home, as much as Sally does. In practice, this means that since Sally is already pretty much sure to buy (she’s saved the money, gotten a preapproval and signed with an agent), the agent is incentivized to show Sally the most expensive homes she could qualify for and realistically buy. Seems like the incentives are a little misaligned.
Sally will spend several weeks getting a sense of how the market works in her area. Are there offer deadlines? Do homes typically sit on the market, or have many offers? What drives value? How much above or below asking price do homes tend to go for? What types of contingencies exist on offers?
She’s doing something important here. Working with the agent, seeing houses and exploring is helping her to build her market intuition around pricing and value, and the sooner she starts, the better. She probably has never done this seriously before — she’s much more familiar with rent prices in her area from her own and friends’ experiences. Understanding the purchase market is going to be both necessary and important in the homebuying process.
On first glance, the role of the agent seems outdated, but for many, they’re critical. They provided guidance and support into a transaction many homebuyers have little experience with. We wonder a lot about how this role will evolve in the coming years, as more and more of the search process shifts online and much of the market intuition is driven by data. We puzzle over questions like, how might we redefine the real estate agent’s role in a way that better prioritizes the buyer’s evolving needs?
Found a perfect fit?
Once Sally finds a great house, you’d think the process would be simple. She has the money, and she loves the place, so it should be as easy as two or three clicks, right?
Not quite. She’ll have to do a few things here — namely, figuring out how much to offer the seller, what types of contingencies to put in, and working with her agent to submit the offer.
Price of the house. We talked about how houses are illiquid. Because of that, understanding their true value is actually pretty hard. The house Sally loves might have been sold recently or three decades ago. Regardless, the current market dictates the price. Where Sally lives, the market’s been growing hotter and hotter and the houses are growing in value. Her real estate agent gives her some guidance here on how much to offer, suggesting she offer a little above where she’s comfortable so she has a better chance of getting the property.
How is Sally figuring out how to make a fair offer? She’s frantically researching all the comparable properties she can, looking at their asking prices, sale prices, and trying to see if there are patterns in contingencies in the offers, the dates of sale, the time on the market, and ultimately, she really isn’t sure. Did she offer enough? Too much?
Now, we’re contemplating questions like, how might we help people feel more confident in what a home is worth? How might we increase price transparency for both buyers and sellers?
Convincing a seller to say yes. Like most millennials, Sally lives in a hot market, so she’ll need to do a few things to convince the seller that she’s serious and credible. Preapproval was a good start, but she’ll probably have to put something called earnest money into escrow.
Earnest money is often 1–3% of the purchase price — enough that if you lose it, it will hurt. You get it back if the seller declines your offer, but not if you back out. Think of earnest money like a deposit you give to your landlord while he’s reviewing your application.
Her earnest money is likely tens of thousands of dollars — enough that Sally will also think about putting some contingencies into her offer. Contingencies are basically conditions that the seller and the house need to meet in order for Sally to stay interested in it. Say Sally put an offer down, and learned afterward that the house was infested with termites. She’d want a way to back out of the offer since there’s new and important information.
Another common contingency is a financing contingency. Even if Sally is preapproved, her lender requires the house be appraised to determine its true value. If the bank lends Sally $400,000 for a home that’s only worth $50,000, they lose money if Sally stops paying her mortgage and they have to foreclose. In fact, many people who are “underwater” (meaning they owe more on their home than it’s worth) do stop paying their mortgages. If Sally can’t get the house appraised for at least as much as she’ll need to borrow, the bank won’t give her a loan and she’ll have to come up with the money herself.
Contingencies are good for buyers, but sellers often dislike them. From their perspective, selling a house and negotiating offers is time intensive, and they’d prefer to do it as few times as possible. So sellers will often reject offers with significant contingencies — sometimes, even if those offers are higher than other offers. Deciding what contingencies will protect Sally, without alienating the seller of the house she wants, is a tricky balancing act. She’ll have to do her best to navigate it..
Her agent will offer her some help in figuring out standard contingencies for her market and deciding how much to offer. However, the offer is ultimately Sally’s — and it’s exhausting to put it together. After some protracted paperwork, Sally’s agent will submit her offer to the seller’s agent — and they’ll both cross their fingers.
Getting the house
Let’s say you’re like Sally, and you manage to do all that: you come up with the cash, you submit yourself to the full body cavity search of financial documents to get your mortgage preapproval, submit to what feels like a full body cavity search of documents, you find a house you adore, you figure out how much and how to offer, you make the offer and, lucky you, the seller accepts! You’re done, right? Not exactly.
All those contingencies you set up? Yep, you’ll have to actually act on them. Typically, you’ll have a month or so to finalize the sale. You’ll need to schedule an inspection on the house, to make sure it’s structurally sound. Your bank will require you to complete an appraisal and finish the filing process for your mortgage. And there will be many more documents to fill out.
You’ll also have to engage the services of a title insurer, who figures out if the seller actually owns the property in question and has the right to transfer it. Title insurers look through historical ownership records, then offer you insurance in case a stranger ever shows up claiming ownership to your house. Unlike auto insurance, however, you won’t be filling information into calculators to get the best rate here. More likely, at this point, the process will have exhausted you enough that you’ll just go with whatever title insurer your real estate agent suggests. What’s another thousand on top of the hundreds of thousands you’re spending?
Your real estate agent or lawyer will likely guide you through this process, but you won’t have a clear sense of price transparency or even if you’re doing everything right. Lots of people we talked to described the whirlwind of that first month, and the daze they left the agent’s office in on the closing date. You’ve signed more papers than you’ve ever seen, but finally — it’s yours.
So many things have happened once you’ve made your offer, your head is probably spinning. We wonder: how might we take this huge overload of information and make it more bite sized? How might we let people play with the pieces of real estate process earlier, so it doesn’t feel quite so overwhelming?
Finally a homeowner
The keys are handed over, and you finally have your castle. On average, you’ll hold onto it for 13 years — so hopefully you made the right choice. A huge portion of your net worth is now locked up in your home, and it’s time to start making those mortgage payments and rebuilding your savings.
Many of you told us you’re thinking about buying a house and renting it out, to make it more affordable. Doing that can be even tougher. Your financing criteria are stricter since you’re buying an investment property. You need to look at all the same things but now you have something else to consider — how rentable is it? What types of renovations might be needed? Do you need to buy furniture or appliances, and if so, which ones? How much time will it take to manage, or how much will it cost to hire a property manager?
So that’s the monster. That’s the process of buying residential real estate today. There’s no way we really “get ready” for this purchase. Of course, we could buy a share of a REIT to try and learn a bit and prepare ourselves, but most of those are commercial, and many aren’t available to us unless we just happen to have a high minimum investment lying about. We can try airbnb-ing or subletting our rentals to earn a little more cash flow, save for a downpayment and get a sense of how much we could monetize this huge asset we’re thinking about buying. We can ask family and friends for ad hoc advice and support. But that’s about it.
The way we buy homes is tough and complicated and broken. It shouldn’t be. How might we take the “real estate monster” and make it a little smaller, a little friendlier, and a little better for people?