Financing options range from simple 30-year fixed rate mortgages to complex interest rate buydowns.
The easiest way to learn about the financing process is to break it into three general categories:
Don’t wait until you’ve found your dream home to start shopping for a mortgage. In the time it takes to find a lender you like, the property can be sold to somebody else. That’s why it’s a good idea to start researching lenders even before you’ve found a home to buy.
There are five primary categories of lenders that offer residential financing.
- Commercial banks specialize in consumer and construction lending but many of them also offer a variety of residential mortgage products with competitive rates.
- Savings and Loan Associations currently originate about 16 percent of all home mortgages. Although these institutions had their share of problems in the late 1980′s and early 90′s, improvements in management and lending practices have greatly improved their stability and allowed them to continue providing residential mortgages.
- Mortgage bankers are either independent firms or subsidiaries of commercial banks. They focus exclusively on providing mortgages and do not accept deposits (as a bank would). They typically originate mortgages and then sell the loans to other financial institutions.
- Mortgage brokers are different from mortgage bankers in that they do not actually make loans. Rather, they generally are correspondents for a variety of lenders and process loans that are actually originated by these mortgage lenders. Brokers generally have different lines of products and are useful in locating financing for homebuyers with unique or less than “A” quality credit.
- Credit Unions are private banking organizations that often have very good mortgage rates for members. Membership is based on criteria such as residency in a certain city or state, employment, membership in an association or club, etc. There are over 12,000 credit unions nationwide with a membership of 70 million people.
As you research potential lenders, you’ll need to know something about the different types of mortgages so that you can determine which loan will work best for you. The four most common types of mortgages are outlined below.
- Fixed Rate Mortgages: These loans are the most common choice for first-time buyers and generally come with a repayment term of 15 or 30 years. They are fully amortizing with a fixed interest rate for the entire term. “Fully amortized” means that both the principal and interest on the loan will be paid off at the end of a fixed period of time. Fixed-rate mortgages are predictable and easy to understand because payments stay the same during the entire term of the loan.
- Adjustable Rate Mortgages (ARMs):These loans generally come with a repayment term of 15 or 30 years and have an interest rate that is adjusted periodically to reflect the value of money (interest rates). The interest rate for an ARM generally adjusts every 6 months, based on money market conditions, which causes the monthly mortgage payment to increase or decrease. Market conditions (and therefore interest rate adjustments) are based on a number of common market indicators or indexes. The most widely used index is the one-year Treasury Bill Index.Now you may be wondering, why would I want a mortgage that’s so unpredictable? The answer is simple. An adjustable rate mortgage provides a lower interest rate initially in return for taking the chance that the rate could be adjusted periodically with the market. In other words, your mortgage payment could be substantially less than the payment you would be making if you had a fixed rate loan. And as long as interest rates remain low, your loan payment will too.Another advantage to the ARMs lower interest rate is that it can enable a homebuyer to qualify for a loan even if he or she would have been ineligible for a fixed rate loan. However, adjustable rate mortgages do come with significant drawbacks. Future interest rate hikes may result in significantly higher mortgage payments. Although there are caps on payment increases, ARMs are best suited for those who expect an increase in income in future years and/or do not expect to live in the home for more than 5-7 years. Young families who are just starting their careers are often good candidates for ARM loans.
- Graduated Payment Mortgages (GPMs):These mortgages also have varied interest rates and are made over 15 to 30-year terms. However, they differ from ARMs because the interest rates for GPMs are established and predictable. It may help for you to think of the payments on a GPM loan as rungs on a ladder. As the interest rate increases, your mortgage payment will move up one rung on the ladder and increase according to the interest rate. A typical loan may have rates that are graduated over a 3 to 5 year period. The lender essentially raises the rate in later years to allow for lower rates in earlier years.The benefits of a GPM loan are similar to that of an ARM. The GPM allows for lower interest rates in earlier years and may be beneficial for families who expect future increases in income.
- Convertible Mortgages: These mortgages typically have a single, established rate for 3, 5, or 7 years, after which they are converted to market rates for the remainder of the 15 to 30 year mortgage. Lower interest rates during the early years of the loan are the primary benefit. However, the unpredictability of interest rates over time could result in a higher monthly payment at conversion.
In the past, lenders expected buyers to make a down payment of at least 20 percent of the purchase price of the home. Today it’s possible to purchase a home with a smaller down payment, thanks to Private Mortgage Insurance (PMI). By agreeing to insure against certain losses which lenders experience when a borrower defaults on a mortgage, private mortgage insurance companies assist lenders in making loans that would otherwise be deemed too risky. Here’s how it works.
Let’s say you want to buy a home but you can only afford a down payment of 3 percent of the purchase price. You find a lender that offers a loan program which allows a 97% loan-to-value ratio. You apply for the loan and are approved with the condition that you must obtain private mortgage insurance coverage.
With the help of the lender, your loan information is sent to the PMI company and coverage is granted. The cost of PMI coverage is usually added to your monthly mortgage payment to cover future premiums.
At closing, you will pay the first year’s PMI premium with your other closing costs. Coverage is usually required until your loan-to-value ratio is reduced to 80%. At that time, you can request that the lender drop the PMI. But be aware that it is your responsibility to keep track of your loan-to-value ratio and make the request for PMI coverage to be discontinued. The lender will not do this for you and it’s doubtful that the insurance company will either!
FHA and VA loans are commonly referred to as government loans-a term that is a bit misleading. These loans are not actually made by the government, but are insured by government agencies. Mortgage insurance is available through two programs of the federal government:
- The Federal Housing Administration (FHA) Mortgage Insurance Program, operated by the U.S. Department of Housing and Urban Development (HUD); and,
- The Veterans Administration’s (VA) Loan Guarantee Program.
With FHA insurance, you can purchase a home with a very low down payment (from 3 to 5 percent of the FHA appraisal value or the purchase price, whichever is lower). Although there are no income restrictions, most of the FHA-insured financing is provided to lower income, first-time homebuyers. FHA mortgages have a maximum loan limit that varies depending on the average cost of housing in your area. To find out what the maximum loan limit is, call your local FHA office or talk to a mortgage lender that offers government-insured loans.
Veterans get an especially good deal through the VA Loan Guarantee Program. Qualified veterans can buy a house with no down payment! Moreover, the qualification guidelines for VA loans are less strict than for either FHA or conventional loans. If you are a qualified veteran, this can be an attractive mortgage program, to say the least!
A number of states sponsor programs to help first-time homebuyers qualify for mortgages. In some areas, local housing agencies also offer attractive loan terms to eligible homebuyers that meet special income guidelines. For information on the availability of these programs in the Orange County area, check with the following agencies:
- Anaheim Housing Authority – (714) 765-4320
- Orange County Housing Authority – (714) 480-2700
- Habitat for Humanity – (714) 434-6200
- HUD (Santa Ana Office) – (888) 827-5605
- Garden Grove Housing Authority – (714) 765-4340
- Santa Ana Housing Authority – (714) 667-2200
- California Housing Finance Agency – (310) 342-1250
After you’ve selected the lender and the loan program that’s right for you, it’s time to apply for the loan.
- Start by requesting a loan application package from the lender and making an appointment for a loan interview. During the initial phone call, be sure to ask the lender for a list of the documentation you will need to bring to the interview.
- Complete the loan application package as completely as possible prior to the loan interview.
- During the loan interview, the loan officer will go over your application with you to make sure that all the needed information has been provided. You will also be asked to provide documentation for the information given on your application. This documentation typically includes:
- The purchase contract for the house.
- Account numbers and addresses for all bank, IRA, and other investment accounts. You should also bring the last two months bank statements for the account(s) from which you will draw your down payment.
- If you are not self-employed, you will need to provide copies of your most recent paycheck stubs and W-2 forms for the last two years. If you are self-employed or work on commissions, you’ll need to provide tax returns for the past two years as well as a year-to-date profit and loss statement to substantiate your income.
- Names and addresses of all your creditors and the approximate balances you owe. This includes credit cards, car loans, home loans, student loans, and any other credit obligations you may have.
- Proof of mortgage or rental payment history in the form of cancelled checks or money order receipts.
Pay attention to what your loan professional tells you! Quite often they will ask for detailed information that is needed to complete the loan package and present the best picture of you. Although at times this can be an uncomfortable process, your cooperation will improve your chances of obtaining the loan.
Your loan officer will then take the information provided in your application and pre-qualify you for the loan you are applying for. Chances are your real estate agent will have already done a pre-qualification prior to putting an offer in on the house. However, the loan officer will repeat the process to make sure nothing has been missed.
Based on your passing this preliminary qualification, the loan officer will give your file to a loan processor for a more in-depth analysis and verification of the information contained in your application. In order to complete the loan processing, the loan officer will ask you to sign an authorization form or forms that will allow the lender to obtain direct verification of your employment, bank account balances and history, as well as credit payment history.
The loan application process is designed to assess the risks the lender will be taking in loaning you the funds you need to purchase a home. This risk includes your ability to repay the loan as well as the value of the property you want to buy (since this will serve as collateral for you loan). To assess the value of the property, a professional appraisal will be ordered to ensure that the value is at least the same as the purchase price. If the value comes in at less than the purchase price, the lender may drop the amount of your loan to preserve the desired loan-to-value ratio. In most cases, the loan applicant (that’s you!) is charged for the cost of the appraisal.
Once the information in your loan application has been verified and the property has been appraised, the loan processor will submit your file for underwriting.
Underwriting involves the evaluation of all the documents that make up your loan file to determine if the loan should be approved or denied. In general, your application and documentation will be assessed according to the “four Cs” of credit-capacity, credit, character, and collateral.
- Capacity – Do you have the capacity to repay the debt? Lenders will look at your income and expenses to answer this question. Do you have the funds you need to make the down payment, pay for closing costs, and have any cushion left over after the loan closes? The lender will verify the funds you have in checking, savings, CD’s, stocks, and other investments to make this determination.
- Credit History – Will you repay the debt? Lenders use your credit history (as reported on your credit report and/or verified by the loan processor) to determine how you’ve handled credit in the past, how much credit you are currently carrying, and whether or not you are living within your means. They also look for signs of stability: how long you’ve lived at your present address, how often you move around, and how long you’ve worked at your present job.
- Character – Is it important to you to live up to your obligations? This is one of the hardest items to judge and yet one of the most important aspects of a credit decision. Some people will take great care to be truthful in their business dealings and follow through on the obligations. To a lender, these are signs of good character. On the other hand, some people fail to follow through on obligations, or practice unscrupulous business dealings-these factors will count against them when they apply for credit. Because no amount of analysis or legal documentation can protect a lender from the excessive costs and risk of loss which come from dealing with such a person.
- Collateral – Is the property you are buying of sufficient value to back-up the loan? Your lender will want to make sure that it is just in case you ever default and the lender is stuck holding the bag.
If all goes well, your loan will be approved and you’re ready for the next step in the home-buying process-closing the loan.
If your loan is approved, the lender will notify you, usually by sending an approval letter. This is your formal notice that you have qualified for the loan. The letter should state the following key information:
- The loan amount. This is generally the amount you requested in your loan application. Check this amount carefully to make sure it equals the purchase price less the down payment.
- The loan term. Once again this should be the period requested in your loan application.
- The interest rate.
- The loan origination fee (points).
Additional closing costs will generally not be listed in this letter. You will be given a set amount of time to accept the loan offer and to close the loan. Go over the letter and be certain that you understand and will be able to comply with any conditions set by the lender. If there are any areas you are not sure about, contact the lender and discuss them.
If your loan is rejected, lenders are required to explain in writing their decision to deny credit. If you are still determined to buy a home, you should talk to the lender to find out what steps you can take to correct any problems or to improve your ability to get a mortgage in the future. Don’t be embarrassed to talk to your loan officer. You may be able to provide additional information or documentation that will cause your request to be reconsidered.
If your loan is approved, the final days and weeks prior to closing can be a stressful period-for both you and the seller. The good news is-you’re almost there! But before you start celebrating, here are a few points to keep in mind.
- The signed sales contract and the signed loan approval letter obligate both you and the seller to complete the transaction. If you fail to do so, not only will you forfeit your deposit, you may also find yourself embroiled in a lawsuit.
- To prevent any mishaps, try to keep your financial situation the same as when you applied for your home loan. In other words, DO NOT make any large purchases-such as new furniture, window coverings, or appliances-anything that will put you in debt or obligate you for monthly payments. Even a small change could put your loan qualification in jeopardy and spoil the deal.
- Try not to worry about the seller backing out of the deal. He or she is legally obligated to complete the transaction as well. Failing to do so could be cause for legal action.
A target closing date is usually set in your purchase contract but as we all know, things can change. Here’s what you need to do to make sure closing takes place in a timely manner.
- Review your approval letter and purchase agreement. Make sure that closing takes place before the lender’s commitment and your purchase contract expires.
- Once your loan is approved, you will probably be given the option to lock-in your interest rate prior to closing. It’s up to you to close escrow prior to the expiration date of your lock-in.
Buying a home is an involved process with lots of paperwork, conditions, and legalities to be attended to. To make sure all these details have been covered, the “closing” or “settlement” meeting must take place before you receive the keys to your new home. Depending on which part of the country you live in, your closing may be handled by your mortgage company, lending institution, real estate broker, title insurance agency, or escrow company. In California, an escrow company most often handles it so let’s take a closer look at this process.