In this episode of The REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi kick of the Summer School series with a deep dive into the residential home-buying and closing process, explaining the steps and the key players involved – from mortgage pre-approval to contract negotiation to title, settlement and the closing. 

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Listen to the REconomy Podcast™ Episode 92:

“Nearly half of all consumers who take out a mortgage do not shop around prior to filling out a mortgage application. But it's important to shop for mortgages because the offers from lenders can vary substantively. We call that variance in Econ. And it's important to get the most competitive mortgage rate over the life of that mortgage, which is a long time, so it can cost a lot of money if you don't get the best one. In fact, interest rates can vary by more than half a percent for a conventional mortgage for borrowers with good credit rating and a 20% down payment.” – Mark Fleming, chief economist at First American

Transcript:

Odeta Kushi - Hello and welcome to episode 92 of The REconomy Podcast, where we discuss economic issues that impact real estate, housing and affordability. I'm Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark. Today we are going back to school, back to school.

Mark Fleming - Hi Odeta. And I see we are starting off strong with a Billy Madison reference. I love it. I am very excited for today's episode because it is the first of our Summer School series.

Odeta Kushi - That's right. Welcome to the first episode of The REconomy Summer School series, where we discuss real estate fundamentals both residential and commercial. So if you've ever wanted to take an intro to real estate course, you are in luck. 

Mark Fleming - Except, we'll do it in 10-to-15 minute episodes. You can listen at your podcasting convenience. There will be '80s references, of course, and all instead of hours-long lectures in a stuffy classroom. Bueller, Bueller. Get it?

Odeta Kushi - And we're starting off the series with the very, very basics. We're diving deep into the residential purchase and closing process. We'll cover every step and the key players involved in the process. As a recent home buyer myself, I'm happy to be on the other side of this process. Though, I must say my home-buying experience, once I found the home and my offer was accepted, was relatively painless.

Mark Fleming - But, Odeta, how many bidding wars did you actually have to lose in order to get there?

Odeta Kushi - I plead the fifth on that one. Let's not even go there. Alright, so let's start from the very beginning. You're thinking about buying a house and the first step is usually getting pre-approved for a mortgage.

Mark Fleming - That's right. To get pre-approved, you'll need to talk with a mortgage lender, obviously. They'll review your financial information, everything from your income, how much debt you have, your credit quality to determine how much home you can afford to buy. Very important. And they'll also quote your mortgage rate. But, on that point, it's very important to shop around for your rate. According to a study by the CFPB in 2015, nearly half of all consumers who take out a mortgage do not shop around prior to filling out a mortgage application. But it's important to shop for mortgages because the offers from lenders can vary substantively. We call that variance in Econ. And it's important to get the most competitive mortgage rate over the life of that mortgage, which is a long time. So it can cost a lot of money if you don't get the best one. In fact, interest rates can vary by more than half a percent for a conventional mortgage for borrowers with good credit rating and a 20% down payment. That can be big money on a house that is as expensive as they are today.

Odeta Kushi - So basically, failure to shop around is money lost. Now, it's important to note that you usually lock in your mortgage rate during the underwriting process after your offer on the home has been accepted. Rate lock periods vary, but the period typically depends on how long it is expected to take to close the loan. So, 30-to-60 days. All right, so you've got your pre-approval letter in hand, which not only tells you as the buyer how much you can afford, but also shows the sellers that you're a serious buyer. In a seller's market in particular, that's really important. When bidding wars ensue, removing as much uncertainty about the transaction falling through is critically important to the seller's final decision. If it's not clear that the buyer can finance the price being offered. Is it really an offer at all?

Mark Fleming - That's a great point that you have mentioned something -- a seller's market. Would you care to define some terms?

Odeta Kushi - All right, I see I've taken on the role of Econ-splainer, and I can't quite tell if this is a promotion or a demotion.

Mark Fleming - Oh, no, no. Promotion, of course.

Odeta Kushi - Of course. Yes. All right. Well, a buyer's market is one in which market dynamics favor buyers over sellers. For example, if there are more homes for sale in a market than there are buyers, the more negotiable properties become and the more negotiating power a buyer has. So in a buyer's market, it may be possible for the buyer to ask for seller concessions, or ask the seller to make repairs or offer a price that is below the seller's asking price. Now a seller's market is one in which sellers have the upper hand, usually because there are more home shoppers than there are homes available for sale. So, with those definitions, Mark, do you think we are currently in a buyer's or seller's market right now?

Mark Fleming - Well, I bet given our regular listeners have heard us talk a lot about this in past episodes that they could easily answer that one. But since this is summer school, I'm going to be the two-handed economist here and say, whoa, it depends. Nationally, supply remains restricted, but has been rising and demand has struggled in the face of the higher for longer mortgage rate environment that we've talked about. Prices continue to reach new heights, but the pace of growth is decelerating, according to our First American data and analytics House Price Index. Months' supply is still below what's considered a balanced market of six months. And so, that all tells us it's more of a seller's market, at least nationally. But with more supply on the market and some pullback in demand, buyers should not be facing as much competition, so a slowly easing seller's market.

Odeta Kushi - All right, I'll take that. But, of course, real estate is local. In some markets, homes are sitting on the market for much longer, as buyers are hesitant to bite, while other markets are moving quickly. Variation exists even within markets, so it may be a buyer's market for some of our listeners. All right, so what is next in the home-buying process?

Mark Fleming - Well, speaking of real estate being local, the next move is usually to find a local real estate agent who knows the market you're interested in. And they can help you find listings that match your home-owning preferences. The agent will set up appointments for you to tour homes and ultimately help you navigate the negotiation process. When you find a home that you would like to make an offer on.

Odeta Kushi - Or the many homes you end up making offers on.

Mark Fleming - This is a case of, if at first you don't succeed, try again and again. And since we're now discussing your home-buying experience, again.

Odeta Kushi - Again, but I digress. Alright, so you've made the offer in a competitive market with multiple offers on that home. So maybe in that offer you choose to include an escalation clause. 

Mark Fleming - Yes, this is a smart move in a seller's market. Care to explain. 

Odeta Kushi - Yes, more Econ-splaining for me. So, this is when you structure your offer to say you will pay a certain amount over the next highest bid up to a maximum amount. So it allows you to win the bidding war without paying too much more than the next highest bidder and also assures you don't end up offering more than you're willing to pay.

Mark Fleming - That's right. Without getting into all the game theory here -- that's another class -- winning the war, paying no more than you have to, or importantly can afford to, that's sort of the cap of the maximum. You may not win the bidding war, but this is the safest way to fight it. Now, let's say your offer was accepted. You sign and you deliver your earnest money. That's a good faith deposit to show that you're a serious buyer. And don't worry, that gets applied to your downpayment when the transaction closes. 

Odeta Kushi - Well, congratulations to this hypothetical person we've created. Now, it's time for your lenders to start their detailed underwriting process. They'll verify all of your financial information. And they'll be asking for a lot of documents, such as bank statements, tax returns, pay stubs to ensure that you can afford the loan, the lender will also want to make sure of the property's value. That's where an appraiser comes in. The lender will order an appraisal to determine the fair market value of the property to ensure that the property is worth the amount that they're lending you. 

Mark Fleming - Very simply, a licensed appraiser visits the home, assesses its condition features, looks for comparable homes that have sold recently in the area, and uses that to determine the value and then submit a report to a lender. Remember, this is a thinly traded, heterogeneous good in this market for housing, and so appraisers help us get that price or value discovery.

Odeta Kushi - Yeah, I mean, where else do we have that? Maybe in the art world? Or in jewelry? That's where you see appraisers, right? 

Mark Fleming - That's very true. Are you saying you live in an artwork, Odeta?

Odeta Kushi - I don't know. I wish. It's not quite a piece of art these days. But, alright, so now the next step in the process is maybe you want to consider getting a home inspection to ensure that the home is in good shape. The inspector can point out structural problems or any needed repairs. The home inspection can also be a pretty good negotiating tool. Because if big issues are found, you may be able to ask the seller to make repairs. Or, if it's really big, you can pull out of the transaction altogether.

Mark Fleming - That's a very important point, Odeta. Because after a buyer's offer is accepted by a seller, the house is called 'under contract.' And I know that buyers, particularly first-time buyers, often feel a lot of pressure to finish the transaction, regardless of what is discovered. But, if you discover something big, you can in fact withdrawal from the transaction. This might mean you lose that earnest money deposit, but it might be the case that the earnest money deposit is less than the cost of that big issue that you would then inherit if you went through with buying the home. 

Odeta Kushi - That's a really great point. Thanks for mentioning that. Now, at this point. You may also be shopping around for property insurance, comparing quotes from different companies and making sure you're getting the coverage you're looking for. This is typically something the lender will require you to have, because, after all, the house you are insuring is the collateral for the lenders mortgage.

Mark Fleming - And, speaking of insurance, it's important to note that private mortgage insurance, or PMI as it's called, is required for conventional loans when the down payment is less than 20%. So often first-time home buyers get PMI. Typically, the PMI is added to your monthly mortgage payment. And the exact amount will be based on how much your down payment was, your credit score, the overall size of the loan that you're getting. You can cancel the PMI once your loan balance reaches 80% of the home's value, which can happen quickly with house prices appreciating and, of course, it's automatically cancelled when your actual principal balance reaches the 78% mark of the original value of your home. In other words, you pay it down to that point.

Odeta Kushi - Now, moving along to another insurance that we know very well. Title insurance. The title insurance industry is the guardian of private property rights, and the title examination plays a vital role in this protection by researching the property's history. This can uncover things like liens, the seller's current mortgage or lien disputing payment for work by a contractor, if the seller has unpaid taxes or even court judgments for money owed. When one gets title insurance, the insurer will search, find and try to resolve with the seller anything they find. That's called curative. And they also insure lenders and borrowers from these problems and that the buyer will have clear ownership.

Mark Fleming - That's right. Good to know that nobody can claim later to be an owner, or if they do, the title insurer will hire attorneys on your behalf to defend your covered ownership rights as they say. Our team recently completed an analysis which found that in just one year almost 1.9 million court judgments or orders, a million financing statements, 900,000 local city, utility and other government-related liens, 600,000 state and federal tax liens were recorded for unpaid taxes, and over 200,000 HOA foreclosures, meaning you didn't pay your HOA dues, and 150,000 mechanic's liens were filed in the public record. So it happens out there. The curative work that is conducted by the title insurer helps the buyer, so they won't have to worry about those issues, quote, encumbering the property when they move in.

Odeta Kushi - Yeah, you definitely don't want to find out about these issues after you've bought the home. And then there are cases of fraud and forgery, such as when a fraudster impersonates an owner by forging a deed conveying property to an unsuspecting buyer.

Mark Fleming - Now that reminds me, I recently read an article about scammers who made fake documents to try and auction off Elvis's Graceland estate. Talk about the disappointment for that buyer finding out they aren't actually the owner of Graceland, because the so-called seller wasn't fraudulent and wasn't supposed to be the seller at all.

Odeta Kushi - Yeah, that's a little concerning. And that's certainly an example of an instance when it would be helpful to have a title insurance policy that will cover you for losses you incur due to fraud or forgery, either before or after you purchase a home. All right, all right. I think that's enough with us being title nerds. Moving on to the next step of the process, settlement or closing of the transaction. 

Mark Fleming - Yes, we're getting close to the end, the transaction settlement provider gathers and prepares all of this necessary documentation, the mortgage documents, invoices for all the other things that were paid, commission information, contractual contingencies, and everything to sort of make the closing package. These documents are prepared to be ready for signing at the transaction closing as they call it.

Odeta Kushi - And they keep everything organized. There are a lot of documents and moving pieces in this process. All right, now we're finally at closing day what to expect? 

Mark Fleming - Well, traditionally, that means going to the settlement providers office and signing all of that paperwork in person with...ready for it? Ready for it? A pen. You know, that instrument commonly used in the 1980s to sign documents? Do you know what I speak of, Odeta?

Odeta Kushi - Oh, gee, is that the structure of an '80s reference? And yes, I do know what a pen is. At least, I may have seen a picture of one on the internet of one.

Mark Fleming - Exactly. That rare thing found only in pictures on the internet. Listeners, my eyes are rolling right now. But, all kidding aside, these days there are actual virtual choices that don't require pens.

Odeta Kushi - Ah, yes, those I'm more familiar with. An eClosing, where signing is done electronically in the document, but with an in-person notary, or in some states the notaries are online and remote. However, it's accomplished, you get your keys. Congratulations, hypothetical homeowner. 

Mark Fleming - Congratulations, indeed. Now, there is one last step that quietly happens after the closing and is done by those same settlement providers. They ensure the mortgage lender receives their signed documents, the buyers deed and mortgage are officially recorded in the public record at the local deed registry, and all the money is dispersed to the appropriate parties. 

Odeta Kushi - And, voila, it's all done. That's it. And that also concludes the first lecture, I mean episode, of The REconomy Podcast Summer School series. Please join us for the next episode. And, as always, if you can't wait, you can follow us on X. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

Thank you for listening, and we hope you enjoyed this episode of The REconomy Podcast from First American. We're pleased to offer you even more economic content at firstam.com/economics. This episode is copyright 2024 by First American Financial Corporation. All rights reserved.

Opinions, estimates, forecasts and other views contained in this page are those of First American’s Chief Economist, do not necessarily represent the views of First American or its management, should not be construed as indicating First American’s business prospects or expected results, and are subject to change without notice. Although the First American Economics team attempts to provide reliable, useful information, it does not guarantee that the information is accurate, current or suitable for any particular purpose. Depending on the nature and location of the home being purchased, there may be additional inspections or types of insurance required. Any contingency rights must be specified in the real estate documents and agreed to with other parties in the transaction. Curative work analysis findings cited are estimated based on a sample review of public records. The information provided does not constitute legal advice.

This transcript has been edited for clarity.