RE/MAX Lake LivingstonFinancingNothing happens until someone pays for it. This is true for real estate as well as just about anything else. Unless you are planning to pay cash for the property, you will need financing. There are hundreds of programs. There are conventional loans, FHA loans, VA loans, ARM’s, buy-downs, balloons, fixed rate mortgages, assumptions, wraps, contract for sale, wrap around mortgages, "B" & "C" loans and on and on. I will discuss the four major types of loans that are available in the market place since they will make up more than 90% of the market. This is likely the type of loan that you will be using. You may note that first time home buyers who make less than a certain amount are eligible for low down payment loans. The primary lenders in America are savings & loans, mortgage companies, commercial banks, mutual saving banks, credit unions, and life insurance companies. Many of these lenders sell the mortgages that you create into the secondary mortgage market. This source of money is available only to lenders who sell loans in packages of $ 1,000,000.00. The primary sources of secondary mortgagee money are Federal National Mortgage Association, Federal Home Loan Corporation, and Government National Mortgage Association. FNMA is the largest supplier of home mortgage funds. It is a wholly owned governmental corporation to provide funds for VA and FHA loans. FHLMC was created for conventional loans, chartered by Congress in 1970 to bring more conventional mortgage money into the housing industry. This is where the saving and loans and mortgage companies get a large amount of their money. GNMA is a government corporation with HUD to support the purchase of VA and FHA loans. This corporation guarantees loans and buys FHA and VA loans. VA LoansThis is only for veteran buyers. The advantages are that they do not require a down payment at all. Also, the seller can pay all of the closing costs and pre-paids if they are willing. The veteran can buy a home for as little as zero down. The qualifying formula is liberal and the VA works hard to obtain the loan for the "Vet". The interest rates are the same as conventional or FHA. The mortgage insurance premium is the lowest of any loan. The VA loan is usually the least expensive. Some of the disadvantages of the VA loan is that it takes a long time to finalize. This has been corrected to some extent in the past several years. It used to take up to 6 weeks to process a loan. Now it takes about 4 weeks. The buyer’s also feel that the appraisals required too many repairs and made it difficult to sell properties that needed a little repair or did not meet VA specifications. This too has been improved. The veteran must obtain a certificate of eligibility in order to process a VA loan. This only takes a short time, but he has to go to the Veterans Administration to obtain an eligibility certificate. The maximum amount of eligibility for the vet is $ 184,000.00. In order to qualify the veteran must have served 90 days during wartime or 180 days during peace or a reservists completing 6 years satisfactory duty. The veteran must have at least two years of employment history. He can have a bankruptcy as long as it was at least 2 years ago and there was a reasonable reason. The qualification ratio is no more than 41% of the veteran’s gross income (That is what he makes before deductions) for all debt including the house payments. Add the car payment, credit card debt per month, and any loans plus the house payment and that figure must be less than 41% of the veterans gross pay. Example: The house price of $ 100,000.00, interest rate of 7.5%, taxes of $ 2,800 per year and $ 1,000/year insurance. The veteran makes $3,200 per month with car payment of $250 and other debt of $ 175. Does he qualify for the loan? Principal and Interest payment: $
699.21 Total monthly house payment: $
1,015.87 Total: $ 1,440.87 Take 1,440.87/$ 3,200 = 45.03% Too high, the veteran cannot qualify for the loan. Could he qualify if his income was $ 4,000 per month? $1,440.87 / $ 4,000 = 36.02% Yes, he qualifies, provided he has sufficient residual income. This is a formula from a table. If the veteran has many dependents, the VA wants to make sure that there is sufficient residual income as well as meeting the ratio of income to debt. They will require a certain residual for each dependent. If a veteran has many kids, you better check with the lender. What total cash will be required to close? Down payment: $ 0 * Pre-paids and Closing costs will be discussed later in the HUD 1 Closing statement. Note that on the VA loan, the Closing costs and prepaids can be paid by the seller if he is willing. On most loan programs, the buyer must pay a certain down payment, closing cost and prepaid. No so with the VA loan. So, the VET could buy the house for no cash down. The VA has fixed rate, adjustable rate, graduated payment, and others. The main one used is the fixed rate mortgage. Federal Housing Administration Loans (FHA)The FHA loan is the highest ratio loan other than the VA loan. It allows the buyer to finance as much as 98% of the sale price of the home. It does require the buyer to pay for his own pre-paids and closing costs in most cases. There are options, but the most common is for the buyer to do what is called an acquisition loan. This loan allows the buyer to finance a portion of the closing costs. Example: Buyer has gross income of $ 3,500.00 per month. He is buying $ 100,000 house at 7.5% interest rate, $ 1,000/year insurance and $ 2,800.00 per year taxes. He has car payment of $250.00 and other debt of $ 175.00. Will he qualify? This is figured exactly like the VA contract, but you have to check on another ratio. The 41% of gross income for all debt is called the back ratio. The other type of ratio that is required by FHA is called the Front ratio: Example: Principal and Interest: $
697.15 Total monthly payment: $
1,054.81 $1,479.81/$ 4,000 = 37% Yes, he will qualify on the back ratio. $1,054.81/$ 4,000 = 26.4% Yes. he will qualify on the front ratio as well since the maximum amount of front ratio is 29%. On the FHA loan the buyer must qualify on total debt (Back ratio) as well as a certain percentage of gross income to just the house payment (Front ratio). How much cash will the buyer need? For the this example we will assume the loans will be more than $ 50,000.00. Loans less than $ 50,000.00 can get lower down payments. Price: $ 100,000.00 $102,000 x .95 = $ 96,900.00 Factor 500.00 Loan amount: $ 97,400.00 Total down payment 2,600.00 Method #2 $100,000.00 x .9775 = $ 97,750.00 Total down payment: 2,250.00 Take greater down payment of the two methods. Down payment: $
2,600.00 However, on this loan, the seller can pay the prepaids thus reducing the total cash to close by $ 1,867 in our example. In order to qualify for an FHA loan the buyer must have at least 2 years of stable employment history with good credit. If he has had a bankruptcy or foreclosure, it must be at least 2 years ago with a good reason. If this occurred during the past 2 years, the applicant would not be considered. However, the credit history must be nearly perfect since the bankruptcy or foreclosure and marginal loans that may have been approved for someone without a bankruptcy or foreclosure will not be approved. The lender also would want the buyer to have reestablished his or her credit. Bankruptcies or Foreclosures will not prevent a buyer from obtaining a loanAny monthly obligations would count against the buyer for purposes of debt ratio analysis if they are either reoccurring or will take longer than 12 months to pay off. If the obligation is less than 12 months, then it will not be considered a debt for the ratio analysis. The buyer must have sufficient cash for the down payment (he cannot borrow the down payment) , but can obtain a gift from a relative. The major reason the FHA loan is used is that it offers normally the lowest down payment in the market for a person who is a non veteran. (Note: Some Conventional programs are getting pretty competitive in regards to down payment) It also has an easier guideline on evaluating the individual for credit reasons. The disadvantage is that it is more costly to the buyer. There are two private mortgage insurance payments the buyer has to make. One is added to the loan amount, the other is added each month. One other advantage is that the FHA loan is assumable. The new buyer must be approved by the lender, but if a person has a low interest rate and many years later the rates go up, the loan could be assumed by another party and keep the low rate. You will note that the interest rate effects the payment far more than price changes. Conventional FinancingA conventional loan is a loan which is not insured or guaranteed by any agency of the state or federal government. In the past, it required down payments of 20% or so, to obtain a conventional loan. Now, with private mortgage insurance companies, the down payments are as low as 5% with even more aggressive programs for first time home buyers. The advantages for the conventional loan over the VA and FHA loan is that it has lesser loan limits, it requires less administration, less time, and the guidelines require far less repairs on the house than the VA or FHA loan. The disadvantages is that it takes more cash to obtain financing under most conventional loans, the underwriting is more difficult and the ratios for qualification are much more stringent. For example, the VA and FHA loans allow 41% of the total debt against gross income, conventional loans only allow 36%. This is major in getting people qualified. Just like the VA loan and FHA loan, there is mortgage insurance required. The VA mortgage insurance is very low. It is called a Funding Fee. The FHA mortgage insurance is called Mortgage Insurance Premium and the conventional is called Private Mortgage Insurance. The difference between the conventional loan and the federal backed loan (VA & FHA) is that the loan has to be underwritten by the lender first then go to the PMI company to be underwritten. The costs of the PMI is less then FHA and more than VA in most cases. If a person puts down at least 20% of the sale price in cash, there will be no PMI premium. The interest rates on the conventional compared to VA or FHA are the same. However, buyers pay a higher portion of closing costs than VA or FHA. That is taken into account by the seller in the negotiation process. Under the conventional loan, the buyer must have at least 2 years of stable employment history. Bankruptcy can be disregarded after 7 years. Any monthly payment with 10 months remaining will not be counted against him for debt ratio purposes unless the amount is over $ 100.00 per month, then it will be counted against him until it is paid off. No gifts for down payment are allowed for high ratio loans. The buyer must have at least 3% of his own funds and in some cases 5% of his own funds. Example: Same buyer as VA and FHA making $ 4,000.00 on a $ 100,000.00 house. The taxes are $ 2,800.00 per year and the insurance is $ 1,000.00 per year. Down Payment: $
5,000.00 Would our buyer qualify for a conventional loan? He qualified under the VA and FHA loans. Total monthly house payment: $
664.25 $1,029.91/$ 4,000 = 25.74% This is good on the front ratio since 28% is the guideline. House payment: $ 1,029.91 $1,454.91/4000 = 36.72 Does not qualify since it is over 36%. There is some judgment on the part of the underwriter, and they may qualify the person as long as they are close to 36% so they could be a little bit over and still qualify. Adjustable Rate Vs Fixed rate LoansFixed rate loans have one interest rate for the life of the loan. If the rate today is 7.5% and you take a fixed rate loan, that will be the rate and payment for the life of the loan. (Taxes and Insurance could go up, but the principal and interest will remain the same) The advantages are obvious. If rates go up, your payment will stay the same. The disadvantage is that if you took a fixed rate loan at a time where rates were high, you would have to pay the higher payment unless you refinanced. (Refinancing will cost in the range of $ 2,500 in most cases) I have seen cases where people were paying 12% rates when the market was at 7.5%. The reason was that they may have bad credit and cannot qualify to refinance, or the value of the house is less than the current value. The lender will want you to pay enough cash so that there is at least 5% or 10% equity. You may not have the cash so you make payment at the higher rate until the house has that equity. This could take a long time. The benefit of an adjustable rate loan (ARM) is that the rate is adjusted up and down as the market moves. The rate is usually adjusted annually based on some interest rate index. A normal ARM currently would be T-Bill rate plus 2.75% adjusted annually with no more than 2% above or below the beginning rate per year. It could have a floor of 6% and a ceiling of 12%. I see the benefit of the ARM in a relatively higher market. There is no real reason to take a chance on the rates if the fixed rate is low in the first place. The ARM’s normally do no go low enough in the lower rate market to offset the potential higher rate if it goes up. In any deal, is the upside potential equal to the downside potential. This must be considered in the interest rate game as well. ARM’s are normally better for the advanced more sophisticated buyer who can stand the higher payments in an up market and take advantage in a lower market. If a buyer is on a fairly specific budget, stay away. I have seen 17% interest rates in the late 70’s that put many homes into foreclosure. There are many variations of the adjustable rate mortgage. They can be structured many ways, with many different names, but the bottom line is do I float the rate or take the fixed rate. Period. Enclosed is a self-qualifying form. Use it for your own analysis. Price Vs Interest Rate FluctuationI have asked many potential buyers what is more important, the price of real estate or the interest rate charged. Most will say price. Most are incorrect. Their are exceptions such as comparing Houston prices to California prices. However, it would take some kind of major change in the Houston price structure to make up for a 2.5% change in interest rates. Let’s take a look. Forgetting the escrow payments for a minute, look at the monthly payment of a $ 100,000.00 fully financed at 7.5% for 30 years. $ 100,000.00 @ 7.5% = $ 699.21 per month. Raise the interest rate to 10% and see what the payment is. $ 100,000.00 @ 10% = $ 877.57 per month. The difference is $ 178.36 per month. The house would have to go up to $ 125,507.98 to cost $ 877.57 per month at the 7.5% rate. Mortgage Company InformationLock Vs FloatMany mortgage companies will let you lock a loan before you have the house. This is a nice advantage to you especially if the market is somewhat unstable. What this means is that you can get a guarantee for 30 days and go out and start looking for a house. You are guaranteed that rate no matter what happens to the market in the next 30 days. Once you have a house under contract, you then can get the better of the rate they gave you in the beginning or the rate when you bought your house. Once you have the house, then you have another choice. You can either agree to the better of the two interest rates and they will guarantee this rate for say 45 days while you process your loan or you can let the rates float. If you let them float, the rates can improve or worsen. You will then get the rate on the day of closing. I do not recommend you doing this. Junk FeesSome mortgage companies charge reasonable processing fees, others charge too much. You can ask the lender to give you a copy of their "Good Faith Estimate of Closing Costs". They are required to give this to you anyway, but if you ask before you make a commitment to them, you can see what they charge for underwriting, processing, and administration fees. I was at a closing where the buyer paid nearly $ 2,200.00 in fees. I felt terrible for him, but he chose the lender and I was the listing agent on that transaction. Your Realtor can give you advise on who to use who does not over charge. Underwriting FeeThis is the fee charged by the lender to look at the loan package and give the final approval. It actually is another profit center for the mortgage company. However, you will rarely see a loan without one. Processing FeeThis is the fee charged to process your loan. This cover the cost of taking the application, sending out for verifications of employment and money in the bank, ordering the credit report, ordering the survey, etc. Origination PointAny point is one percent of the loan amount. Most lenders charge 1.0% of the loan amount as a profit center. There a quite a few who do not charge the origination point, but they may have a slightly higher interest rate. Whether the buyer wants to pay for the point is determined by his cash and how long he wants to stay in the house after he buys it. Example: If the origination point is $ 1,000.00. If the buyer can get a 7.5% rate with one origination point and he can get a loan without the origination point for 7.75% he must decide what is best. Monthly payments @ 7.5% = $ 699.21 With origination point Monthly payments @ 7.75% = $ 716.41 Without origination point The difference is $ 17.20 per month or $ 206.42 per year. It will break even in approximately 5 years. If you plan to be in the house for a long time, go ahead and pay the point. If you are not sure, take the slightly higher rate. The key to this is how the lender prices the rates. Sometimes it is better one way other times the other way. The difference of interest rates with Vs without the origination vary. Discount PointsDiscount points are very similar to the origination point. This is merely a buy down on the loan. If the rate is 7.5% and you give, say, 2 points, the lender may drop the rate to 7.0%. The same evaluation must go on as the origination discussion. The above three items are the major lender expenses. They may have some small charges, such as messenger, but these are the major ones. Check into the HUD 1 Closing Statement discussion for a full disclosure of total estimated charges. Making the Choice of Mortgage CompanyThe best deal is the lowest quoted rate. No, No. No. That holds true for any service company. You do tend to get what you pay for. Sometimes a Mortgage company may take a position on the market and give you a low quote. If the market does not move to that level and they would take a loss giving you the lower rate, you may find that they will not approve your loan. Make sure that you work with a reputable company who will honor their locks. They should be large enough that they could not stand a poor reputation by not honoring a loan. A small broker will be more willing to quote low and walk your loan, than a larger reputable company. Again, make sure that you know up front what is going to be charged. The traditional mortgage company uses loan officers. They do a great job and can pretty well tell you if you can get the loan. You can go to a mortgage company who will quote you based on the market for that day for their own mortgage company. Or, you can go to a mortgage company (Broker) who represents itself to many lenders. They will find the mortgage company who best fits the needs of the customer at the best rate possible. The cost of processing with either company is about the same. There are advantages and disadvantages from each kind of company. The more traditional mortgage company tends to be harder on qualifications, but the process of obtaining the loan is a bit easier. Either way, you can find just the right loan if you try. The key is the person with whom you are working. If he or she is professional and tries to do the best for you, it will work out for you. There is a loan for everyone! The problem is that the person with poor credit could find themselves at very high rates with say, 25% down. However, the market is open and there are all kinds of programs out there.
Pre-approved or Pre-qualifiedWe have discussed the value of being pre-approved. This means that you have visited the loan officer and they have run the ratios on your income and debt and may have a end file credit report. This is good, but not absolute. Pre-qualified means that the loan officer has done everything that they need to approve the loan. They will have the full credit report, verifications of employment and deposit, all the tax returns, bank statements and whatever they need. It is absolute. This is best, but not required to begin shopping. The AppraisalThe lender will collect from you when you make the application money to pay for the credit report (Normally $ 50.00) and the appraisal. (Normally $ 300.00) The appraisal is paid by you to insure that you are not paying too much for the house. This is the mortgage companies way of not lending more on the house than it is worth. They will do the appraisal by comparing size and quality of homes in the same neighborhood. They will also report to the mortgage company on the appraisal any repairs that are required depending on the type of loan and guidelines set up by the mortgage company. Once the conditions such as repairs have been met and the house appraises at least for as much as the sale price, the mortgage company will draw the legal papers needed to close the transaction and turn these over to the title company. A house is appraised by finding usually 3 comparable sales that have closed within the past 6 month. The appraiser will then compare those sales against your house. They will make adjustments for size, quality, design, amenities, etc. and come up with an appraised value. This value must be a least as much as the sale price of the house. If it is not, the lender will require either the price to be reduced or the buyer to put down more cash. The ApplicationThis is where more fear comes from than any other part. This is where you say, "Am I really doing this?" It is reasonably easy and in fact, you don’t even have to meet anyone. You can merely fill out the universal loan application form (Form 1003 enclosed) used by all lenders in this area. They normally want two years tax returns, three months bank statements, a current paycheck stub and some odds and ends. The following are those items that are needed to finalize a credit application. They do not necessarily have to be available when the loan application is taken, but it is helpful: Check for the appraisal and credit application: Usually around $ 400.00 total. Your Gross income for the past 2 years with W-2’s and most recent 2 paycheck stubs. 2 years tax returns. Copy of the fully executed earnest money contract. If you own rental property, show copies of the leases. Copies of bank statements, 401K’s, money market certificates. etc. Copy of divorce decree if applicable.
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