Step Three: Secure Mortgage Financing
Does coming up short for a down payment scare you? What about the whole purchase price? Are you scared that your credit history will be an issue and you may be approved for zero loans? Have no fear, you are not the first and certainly will not be the last to feel this way. With the traditional mortgage industry expanding, there are even more opportunities to find a loan program suitable for you.
How to Finance a Home: The Breakdown
Applying for a mortgage loan involves the buyer seeking to borrow money to pay the seller what’s left, after you take the difference of the down payment and the purchase price. When the mortgagee (lender) lends the money, the mortgager (buyer) is required to sign a promissory note for the amount borrowed and to execute a mortgage to secure the debt.
The Process of Applying for a Mortgage:
- Choose the right loan officer or mortgage specialist by asking for referrals from your agent, relatives, and friends. Then conduct a few interviews. You want to find the right person to work with who is trustworthy and competent, just like your agent. After all, he or she will be feeding you financial advice during this process. A plus is that you are not under contract, so you are free to switch if, at any point along the process, you are having doubts. The process of finalizing a loan has many tedious steps that must be fulfilled in an accurate and timely manner.
Word of Advice: Do not be afraid to SHOP AROUND for the right officer. It is a common misconception that it is best to shop around for mortgage rates. Instead, focus on shopping around for the right loan officer. Rates depend on the loan program you choose, and the best officer will find the best program for you.
Right Officer = Right Loan Program = Right Lender(s)
Choosing an irresponsible loan officer or lender can RUIN A PURCHASE and your dream home could be lost. A good officer is upfront about all of his or her lender’s fees and rates. A good lender will give you a “good faith estimate” to see what you qualify to afford before anything else.
- Make a loan application and get approved.
Preapproval: A Crucial Aspect of The Home Buying Process
The application should take no more than an hour. You must submit a complete application to your loan officer, detailing your personal finances, such as your gross income, assets, monthly debts, Social Security number, work history, credit report/credit score (for which you may have to pay a monetary fee), etc.
Next, the lender examines your application. An underwriter will check all of the financial information that you provided for accuracy and decide on what sum of money the institution is willing to lend you.
Choosing the right lender: The Difference Between a Mortgage Banker and Broker
A mortgage banker can originate loans and do underwriting. This includes banks, credit unions, in-house approval, and a good local market understanding. They are more hands-on in creating their own loan agreements. The downside to this option is that many mortgage bankers have exclusive loan programs and offer less rate flexibility. The money they loan you comes from their affiliated banks.
A mortgage broker offers more loan program options, but they don’t usually originate loans and do underwriting. They shop your loan to many lenders. Unfortunately, their options may include longer approval processes, and have less qualification flexibility because they do not set their own loan criteria.
Mortgage Worthiness: Credit And Debt History/Credit Score
Approval comes down to what you earn, what you owe, funds available for down payment, and the level of financial responsibility.
Word of Advice: Do not settle for PREQUALIFICATION to begin your hunt!
DIFFERENCE BETWEEN PREAPPROVAL AND PREQUALIFICATION: Prequalification is a best-guess estimate, NOT a guarantee. Preapproval is a firm commitment by your lender for a certain loan amount in writing. It is the trick to making the earnest, most appealing offer to your target seller.
- Determine what you want to pay and select a loan option.
Your HOME MORTGAGE can be your BEST FINANCIAL ASSET if chosen wisely.
Types of Mortgage Loans:
I. Fixed Rate Mortgage Types: a choice between 10-year, 15-year, 20-year, 30-year, 40-year, and even 50-year fixed rate mortgages, which can be paid off gradually
II. FHA Mortgage: insured by the government through mortgage insurance that is funded into the loan
This commonly interests first-time homeowners because of a minimal required down payment and FICO credit scores don’t matter.
III. VA Loans: a type of government loan available to veterans who served in the U.S. Armed Services and, on occasion, the spouses of deceased veterans. Requirements depend on the years of service, and if they received honorable or dishonorable discharge. Borrowers of this loan do NOT need a down payment. The loan is funded by a conventional lender, but guaranteed by the department of lender affairs.
IV. Interest-Only Mortgage Types: Borrowers pay only the interest on the loan in low, monthly payments for a fixed period. After the initial period, the balance of the loan is due, which could mean a much higher payment, paying a lump sum, or refinancing. This does NOT mean the borrower pays only interest on the loan. These loans are typically held by individuals planning on holding on to a property for a short time period.
Downfall: Low monthly payments = Large payments due over time, equity accumulation delayed, etc.
V. Option ARM Mortgage Types: adjustable mortgages with periodic fluctuating interest rates. Buyers can choose from many payment options and index rates.
VI. Balloon Mortgage: usually a fixed-rate loan with relatively low payments for a fixed period. After the initial period, the entire balance of the loan is due immediately, which makes this a risky loan for some borrowers.
VII. Reverse Mortgage: allows senior to convert equity in their homes to cash. The loan does not have to be paid back with interest as long as you reside in the house. One must check that this loan is federally insured because it is commonly subjected to aggressive lending practices and false advertising.
- Submit to the lender an accepted purchase offer contract. This should be decided based on three factors: how much money you want to spend on a down payment, your interest rate, and the term/length of your loan.
Word of Advice: Remember that you don’t have to put a great deal of money down. Many individuals simply don’t have a lot to lie out. Think outside of the box; don’t be conventional. Try considering what assets you or your family has that you could sell to raise some money. Unclutter your basement or garage of old antiques and make money for a new home. It’s a WIN-WIN!
This contract decides what you NEED to borrow. First, you are given a rough estimate of the loan offered, as well as the fees and down payment you will need to cover.
Down Payments: The more you put down, the less you have to borrow monthly payments with less interest over time.
If you put 20% down (which means you have an “80% loan to value ratio”), you do not need PMI (Private Mortgage Insurance), which lenders in the U.S. require buyers who borrow a high percentage to purchase. It is an additional, non-tax deductible monthly payment made by the buyer that protects the lender. For those who have PMI, once he or she reaches the 20% mark—meaning the total of your principal payments and down payments leave the loan balance below a certain LTV (Loan to Value)—it can be cancelled if the owner initiates it.
As your home increases in value, through appreciation, the principal amount you borrowed becomes a smaller percentage of the home’s actual worth.
Refinancing is the process in which a new lender calculates a new loan amount against the new appraised value of your home. If the Loan-To-Value is at or below the 80%, no PMI is necessary.
Now to avoid Mortgage Loan Insurance from the very beginning, there is a process called Piggybacking (taking out a second loan). This covers the difference between the cash you have and what you need in order to hit the necessary 20%. The second loan—a home loan, rather than an insurance payment—will require you to pay a higher rate, but for a shorter time period. Therefore, the second loan is tax-deductible.
Word of Advice: Paying the 20% down is a good financial decision. Avoid having a PMI if you can.
Lay a solid financial foundation by taxing tax-deductions on your interest payments (which helps build equity faster); making investments in your home, such as repairs or improvements that add value; and accelerating your principal payments above simply the monthly mortgage one.
Interest rates impact how much house you can afford! Naturally, everyone wants the lowest rate possible because it will reduce the amount you pay every month or allow you to buy a more expensive property for the same payments.
Word of Advice: There is NO RIGHT TIME or RIGHT INTEREST RATE! If you wait until the market goes down, there is a chance you will get priced out. Remember: refinancing is always an option to achieve a more desirable rate.
Your interest rate is determined based on three things: the interest rate of the time based on the current real estate market, your credit history, and the kind of mortgage you select—fixed or adjustable.
You have the MOST control over the mortgage you choose. A fixed-rate mortgage provides stability because payments will not change over time. Thus, you can lock in a good rate. An adjustable rate mortgage (variable rate or ARM) is fixed for a period of time and then will rise and fall in set intervals with changes in the market and several financial indexes, making it the riskier of the choices. As ARM rises, a lifetime payment cap exists to stop the rate from growing each month which, although it sounds like a good thing, may only increase your debt with extra interest.
Term: A mortgage loan’s term decides how much interest you pay over the length of the loan and how quickly you build equity by paying down the loan. Short Terms, such as a 15-year mortgage, build equity quickly and are suitable for those who can afford a higher monthly payment, thus reducing the amount of interest paid over time. Shorter periods will also naturally have lower rates.
However, if you are worried about committing to the higher monthly payments, you can choose the 30-year mortgage and incorporate voluntary prepayment when you can, helping to speed up the decrease of the principal amount and providing more financial flexibility (Check the agreement for prepayment penalties!).
Long term loans, such as for a 40-year mortgage, increase the length of time you have to pay back your loan, so each monthly payment will be lower, meaning you can qualify for a more expensive home.
Monthly Payments: PITI
Amortization: the lender calculates all you will pay during the life of your loan, plus what you are borrowing, and divides the result by the amount of payments to be made.
As equity increases and the primary loan amount decreases during this process, payments are made toward the Principal, Interest, property Taxes for local governments, and homeowner Insurance.
Creative Financing Options:
I. Conventional Finance: Owner owes 0-$100,000+; may include a basic loan, down payment, possibly a private second loan, and one-to-two monthly payments
II. Owner Finance: Owner balance 0-$20,000; includes a loan from the owner, a down payment, possibly a private second loan, and one-to-two monthly payments
III. Assumable Finance: Owner balance $80,000; includes a balance assumed from the owner, a down payment, possibly a private second loan, and one-to-two monthly payments
IV. Wrap Finance: Owner balance $80,000; includes an original loan to be paid back, new loan from the owner, a down payment, and one monthly payment
If unable to take ownership just yet, try the Lease Option—lease the property until you save enough funds to purchase and buy it when the contract ends.
- Get an appraisal and title commitment.
A professional appraiser is hired by the lender to estimate the value of a property based on location, condition, and comparable sales of the immediate area. The hope is that the property appraises for at least what you offered to pay for it! The lender will decide your final loan amount, based on whichever is less—the appraisal value or the sale price.
The title company checks that the owners are the true and only owners with full property rights to sell ,and that the property has a clear title able to be transferred to new owners.
Clear title: no liens or unpaid claims for contracting work, electrical repair, etc. are being held against the property.
- You’re CLEAR TO CLOSE! The last step is for the lender to transfer funds to the seller, and once that transaction takes place, you OWN your first home!
Word of Advice: Rent is paid the first of the month. Mortgage, however, is paid at the end of the month. If you close before the end of the month, the lender will require payment for the days between closing and the end of the month. Pay that and you are free of worry, knowing your first payment is completed.
Word of Advice: Borrow what you NEED. Lenders decide what you may borrow, but you decide what you CAN afford. You do not have to borrow the entire sum of what you were approved for.
FEES: Commonly associated with U.S. home loans. Prepare yourself! Closing gets costly!
Word of Advice: Closing costs and lender’s fees can add 3-5% to your home’s purchase prices, so be sure to compare what lenders charge when taking the time to compare their programs. Do your research and speak up; lenders WILL negotiate with you!
Lender Fees: include charges for origination/points of prepaid interest, administration, application, brokerage, commitment, document preparation, and underwriting.
Possible Loan Strategy: Loans with more points—meaning more interest paid upfront—come with lower interest rates. This choice pays off only over a longer period of time, so before making your final decision, consider how long you may be in this home.
Third Party Fees: include charges for your credit report, home appraisal, extermination/inspection, recording, settlement, survey, tax and insurance payment, title search, title insurance, and courier services for all necessary documentation.
Word of Advice: You CAN ask the seller of a home to pay some/all closing costs.
Word of Advice: Consider that your financial profile will change as time passes when deciding how much you can afford. If you know you are going to start a family, scale back. If you know you are about to come into some extra money, you may want to expand your options. It’s all about making decisions you are most comfortable with that provide you with FINANCIAL SECURITY through accumulating equity and new worth.
STORY TIME: Nancy & Dave
Now the Fun Stuff; Financing Anyone?
Nancy and Dave had their eyes on this beautiful, fully-detached home for sale on a 50 x 100 lot, equipped with a deck and pool. With four bedrooms, three bathrooms, a new kitchen with upgraded stainless steel appliances, and a full basement with a three-quarter bathroom, this particular Staten Island home caught home of Nancy’s heartstrings. From the moment she stepped into the foyer, she had this feeling: “This is my home.” The $600,000 price tag, however, deterred husband Dave from supporting his wife’s infatuation with this particular listing.
Nancy was determined to own this property. The question was “HOW?” Similar to how one shops around for a good real estate agent, one must shop around for a good loan officer and mortgage rates. The main problem is that they do not have enough money in the bank for a good-sized down payment. Therefore, it is essential that they figure out the most suitable mortgage program for them. The more they pay upfront, the less they will have to pay in interest every month. In addition, there are different types of creative financing based on your financial flexibility. For Nancy and Dave, it was a matter of being strategic. With a military background, Dave was actually educated by his loan officer that he is eligible for a VA loan, meaning in repayment of his fifteen years of service in the army and his honorable discharge, he was eligible for a program that did not require ANY down payment. Although funded by a typical lender, this kind of assistance is guaranteed by lender affairs. Therefore, they can purchase this home without a down payment and focus on building up funds to make their monthly payments.
Unfortunately, after about a year, they started to have issues paying their monthly fees and considering they anticipated staying in this house for years to come, they refinanced their mortgage in hopes to achieve a lower interest rate. The basic rule of a lender is that after twelve months, they can look to improve their interest rates. If there is a will, there is a way. With some research under the now-extensive umbrella of financing options, a homebuyer can find the right payment method for him or her—it just takes time and research.