Insider's Guide to Saving Money &
Eliminating Risks When Buying Your First Home!
Chapter 5 - Financing Options
Financing your first home can be the most frustrating part of the home buying process. This is the time when you figure out how to pay for the home. Most people have to take out a mortgage loan in order to afford the price. Which mortgage loans are right for you? How much of a down payment will be necessary? What is escrow?
You will have many questions about financing your first home. By knowing the facts, paying attention to interest rates, and looking into all of your mortgage options, you will be able to choose repayment terms that will fit your current income and allow you to safely make those monthly payments.
Types Of Home Loans
Deciding which home loan is the right one for you will depend on what you qualify for and what your lender is willing to give you. There are a few types of mortgage loans, including:
- Fixed rate mortgage loans
- Adjustable rate mortgage loans
- Balloon mortgages, and
- Jumbo loans
You should be familiar with these loans so that you will be able to make an informed decision when it comes to financing your new home.
Fixed Rate Mortgage Loans
For first time home buyers who are on a strict budget, choosing a fixed rate mortgage may be the loan for you. Your monthly payment will never change for the life of the loan because you will lock into the interest rate given at the time the loan was processed. You can take out loans that range from ten to thirty years.
There are many advantages to taking out mortgage loans that have fixed rates. You will be able to create a monthly budget for yourself, you will never be surprised by the amount you will have to pay each month, and you will be able to lock into a low interest rate.
The disadvantages may not mean much to you now, but as your family or your income grows, you may want to refinance and pay less each month so that you will be able to afford renovations, vacations, and other luxuries.
Since your mortgage is fixed, if interest rates drop, you will be trapped paying a higher rate. While you can refinance your mortgage, you will have to wait a certain amount of time, and even then there may be complications.
For those who have limited income, who have lower credit scores, or those who want the security of paying the same amount each month, then a fixed rate mortgage is the loan for you.
Adjustable Rate Mortgage Loans
If you expect to make more money in the next few years, and want to buy a bigger home, you may be interested in an adjustable rate mortgage. The major difference between an adjustable rate mortgage and a fixed rate mortgage is that the interest rate will vary year to year in an adjustable rate mortgage.
While the interest will be capped, you will still be paying more for each year that you own the home unless interest rates drop over an extended period of time. Most adjustable rate mortgages cannot be raised more than 2 interest points per year, and up to 7 points for the life of the loan.
These loans are good for those who want a larger home and who expect to increase their earning each year to afford the increase. If you are in a position to take out an adjustable rate mortgage, you will be able to lock into a fixed rate that may be lower than your original rate.
This is the main advantage of these loans. Most lenders will only give you two years to lock into a rate or the loan will remain adjustable for the life of the loan.
Balloons Mortgages
If you are only planning on living in your first home for a few years (usually five to seven), you should look into a balloon mortgage. These mortgages require that you pay them off in five to seven years. They have a lower interest rate that is fixed.
If after the term of the mortgage has passed and you want to remain in the home, you will have to refinance and choose a fixed rate or adjustable mortgage to pay off the existing mortgage, as balloon mortgages cannot be renewed.
Only consider this mortgage if you are planning on moving after a certain amount of time or if you think you can pay the mortgage off in that amount of time.
Jumbo Loans
Most first time home buyers will not need to take out a jumbo loan unless they are buying a very large home. These loans are valued over $275,000 and are used to purchase land and a home. More collateral will be needed in order to qualify for one of these loans. The interest rates are comparable to fixed and adjustable rate mortgages, and have the same payment terms.
Now that you know about the types of mortgages that are available, you should be thinking about which lender to use. With so many lenders out there, it may be difficult to sort through all of them and find the right one. Doing a little homework will help you get the lowest interest rate possible.
Where To Find A Lender
These days there are many places to find a mortgage lender, such as:
- Newspaper advertisements
- Television advertisements
- Family or friends
- Your Current lender
- Your Current bank, or
- Online
- YOUR TRUSTED REALTOR!
As you can see, finding a lender should not be too difficult. You may have to contact several lenders before you find a lender that will give you a loan that meets your needs. When you apply for a home mortgage loan, the lender will check the following:
- Your credit score
- Your credit history
- Your current income
- Income of co-signer
- References (professional and personal)
- Current interest rates based on the amount you are asking for
- Status of other loans you may have
- Number of years you have been eligible to work, and
- Number of years you have had credit
There are many factors that will go into your approval or denial of a home loan. You will have to be patient. You should contact a few lenders to see which ones will give you the best deal. Once the offers have been received, you will have to make some important decisions.
You should feel free to contact your lender at any time during the home buying process with questions and concerns you may have. Other important information the lender will need before granting you a loan include:
- The home inspection report
- The termite inspection report, and
- The home appraisal
These reports are very important to a lender because they will tell the lender how much the home is actually worth and the types of damage that have lowered the overall value of the property.
Lenders expect homeowners to remain in the home for at least five years. This will allow them to make a profit on the money they have loaned you. It is not worth it to them if you have to sell the home shortly after buying it because there is too much damage and you can no longer live there.
Applying For A Home Loan
When applying for a home loan, you will have to bring the information listed above to the lenders office, or if applying online, supply copies that are faxed to the lender. You will be asked additional questions that will help lenders determine if you are able to pay the loan back on time. These questions include:
- Number of years renting a home or apartment
- Late payments on credit cards and other loans
- Active loans (such as student loans or car loans)
- Number of years at your current job
- Additional income
- Amount of the loan and number of years to pay it back
- Number of years living in an area
- Dependants that are living at your home
- Tax returns and bank statements
Applying for a loan can take a week or more. This is because background checks, credit checks, and references must be checked first before the loan will be processed.
In the meantime, you should be concentrating on gathering your paperwork, calling friends and family that you want to use as references, and sorting through your papers in case you cannot find everything the lender requests.
If you don't have your back tax returns, you can contact the IRS and request them by year. Many times, lenders will need to see returns from at least three years ago. Bank statements and bill statements from the past year should be enough to secure a loan.
If you are turned down for a home loan, you will be notified as to the reasons why. This can be devastating, but you should find other lenders and try to apply again. If you have poor credit, you may need to go through a lender that specializes in granting loans to those with poor credit. You may have to pay a higher interest rate, but at least you will be granted a loan.
Reasons for possible denial include:
- Poor credit or not enough credit
- Length of time at your job is too short
- Income level for the amount of loan requested
- Loan default
- Failure to pay rent or other bills, or
- Too much credit
Applying for a home loan can be stressful, but if you have good credit, steady employment, and enough income, you should have little trouble qualifying for a loan.
What Not To Do When Applying For A Home Loan
There are a few things you should not do after applying for a home loan:
- Buy a new car
- Begin a new job
- Buy new furniture and other large items using your credit cards
- Apply for a credit card, or
- Default on student loans or other loans
All of these actions will cause your credit score to change which will give lenders an inaccurate view of your spending habits and your overall credit score. If you take a job that pays less than you noted on your home loan application, your lender may not agree to grant you the loan.
If possible, do not begin a new job until you have moved into your home. Try not to spend money on credit cards. Buy furniture and other items using cash, or wait until you have signed the final contract and are a homeowner.
Increase Your Chances For Approval
There are a few ways to increase your chances for loan approval that will also help you determine what you will be able to afford each month:
Many experts agree that applying for a loan before you find a home and being pre-approved will help you create a budget, buy a home that is in your price range, and help lenders make their decisions faster.
- Ask for only the amount you will need
One way to increase your chances for a home loan is to not ask for more than you will qualify for. This means you will have to look at your income level, the amount of debt you have, and the expected monthly mortgage payment. You should also factor in cost of living expenses, because your lender will. Apply for the amount you will need and nothing more.
If you are thinking about buying a home in the next few years, you should prepare by paying off those credit cards and only using them for emergencies. Do not cancel your existing cards since this may actually lower your credit score. By showing you have a zero balance on your credit cards, you will be showing lenders that you know how to use credit wisely and you have been paying your cards off on time.
This includes your electric bill, rent, student loans, and other bills that you may have to pay each month. By creating a track record that can be traced, you will be showing lenders that you are a responsible person who deserves to have a home loan.
How Home Appraisals Can Affect Your Home Loan
Unfortunately, a home appraisal can affect the status of your loan. If the home appraisal comes under the selling price of the home, most lenders will not grant the loan. This can be heartbreaking, but there are a few solutions that may work depending on the rules of the lender. The following options are available:
The Homeowner Reduces The Selling Price
Depending on the appraised value in comparison to the asking price, some homeowners will be willing to lower the price of the home if they need to sell quickly.
You should not count on this happening since many homeowners want to receive the price they are asking for. You may have no choice but to find another home.
A Higher Down Payment
Some lenders will grant you the loan if you agree to pay a larger down payment on the home and assume the financial risk. This is only an option if you can afford to pay a larger down payment. Do not risk your financial security in these cases; it is just not worth it.
Dispute The Appraisal
You can send a letter to your lender disputing the appraisal or have another appraiser determine the value of the home. You will have to pay for this second appraisal, which may or may not yield the same results. There is no guarantee that your lender will accept the second appraisal.
Find Another Lender
This is a last resort move because it will postpone the closing for another month or so and there no guarantee that the lender will accept the appraisal.
Since home appraisals are required by most lenders, you should find out during the loan application process the policies that the lender has when dealing with appraisals. If your lender will not accept a lower selling price, you putting a larger down payment, or other solutions to a low appraisal, you should consider finding another lender just in case there are any problems down the road.
Home appraisals are based on the current value of homes in the neighborhood, homes that are comparable in size, the housing market, and the age of the home. While you can expect to hear different numbers from different appraisers, you will see that these numbers will usually not be too far off.
The only real benefit of a low home appraisal is that it will tell the homeowners to list the home for less money so that they will be able to sell it. In the meantime, you will have to find another home.
How Home Inspections Can Affect Your Home Loan
While a poor home inspection will usually not deter a lender from granting a home loan, you should be aware that some lenders will not grant a loan if there is termite damage or structural damage to the home due to water or age.
This will also lower the overall appraisal of the home, which could be another issue that lenders may have when deciding to approve a home loan.
If the home inspection is not favorable, ask your lender what will need to be done in order to rectify the problem. Many times removing the termites and correcting the water damage is all that will be needed. Many times homeowners will foot the bill for these types of repairs.
Additional Fees For Home Loans
You may notice that you will have to pay small fees throughout your home buying experience. It seems that every piece of paper you sign, file, or request will cost you some money. Here is a list of fees that you may be charged:
- Credit report fee
- Loan discount fee
- Lender’s inspection fee
- Appraisal fee
- Loan origination fee
- Mortgage insurance application fee
- Assumption fee
- Hazard insurance
- Title search, and
- Title insurance
These fees can add up, so you will want to be prepared and have a little extra in savings for when these fees come up. Some of these fees can be put off until the closing, but you should be planning for them in advance.
Escrow And Other Loans Terms
As you are going through the home loan process, you will run across a few terms that you will not understand. You should ask your lender to explain these terms so that you will fully understand the type of loan you are applying for, the lenders policies, and other information that will be important throughout the life of the loan. Here are some common terms you may encounter:
While this term can mean different things in different situations, you will see it often when closing on a home. If you place a down payment on a home, it will be in escrow until all the paperwork has been signed. The money is held by a neutral third party, such as another bank or escrow service, and will be distributed once the deal is over. You can ask your real estate agent about escrow services in your area.
Even though you have heard of a mortgage before, you probably thought of it as the home loan you will be paying once you move into your new home. Technically, a mortgage is a lien on your home created by your lender. If you cannot make payments on your home, the lender will have the right to sell the property in order to gain the money that they have lost.
This is a term that refers to homes whose owners could not make payments each month. Once a lender has decided to sell the home, it will be in foreclosure. You should find out ways to work with your lender in case you miss a mortgage payment at any time. Having this knowledge in advance will make financial emergencies easier to deal with.
A mortgage broker is a person who does not work for a bank, but rather works on commission to match homebuyers with many lenders that may not be in your area. If you have poor credit, you may want to secure a home loan through a mortgage broker because you will have a better chance than going through a bank that only has one lender to choose from – themselves.
This refers to the interest rate on your loan. If you choose an adjustable rate loan, for example, your points may be capped each year so that they cannot exceed a certain number.
A down payment is helpful in several ways. It will lower the amount of money you will need for a home loan, it will allow lenders to see that you are responsible for paying off a mortgage, and it will move the home buying process faster. Most first time homeowners will put down no more than 20% for a down payment.
You do not want to overextend yourself by putting a huge down payment on a home because you may not have enough money to pay your mortgage, afford new furniture, or make home repairs.
This is one way that lenders will sue to determine if you can afford your monthly mortgage payments on your current income. The lender will subtract all your reoccurring debt to determine how much is left for a mortgage payment.
This is why not buying a car or spending money on your credit cards is so important when buying a home. The less debt you have will mean more available money for your mortgage payment.
- Private Mortgage Insurance
If you cannot afford to put down more than 5% on a home, you may not be approved for a loan. But if you purchase private mortgage insurance, your lender may agree to give you the loan. This extra insurance will protect the lender in case you default on the loan by paying them at least 15% of the total loan value. This will cost you a little extra each month, but it may be worth it.
Before you apply for a home loan, you should obtain copies of your credit report so that you can check for errors; see how much money you owe on credit cards and loans, and to see what your credit score is. This is another way that lenders will determine if you will receive a loan.
There are three credit reports that you should obtain, because you will not know which one the lender will base their decisions on.
Next: Chapter 6 - Making An Offer!
