If you’re reached the decision to buy a home, you have got to determine what price you can afford and how much money the bank will allow you to borrow. Once you’ve gone through the calculations for buying or renting, you probably know what you can afford in terms of a monthly house payment.
This may be a good place to start, but as we discussed earlier, there are a lot more costs that you will be responsible for once you own a home. All must be factored into your decision. The biggest outlay will be your down payment, which is normally 20% of the home’s purchase price.
At this point you still have no idea how much the bank would be willing to lend you. Therefore, during the second phase of the home buying process, you need to get pre-approved for a loan.
Getting a Pre-Approval Letter From the Bank
What does a Pre-Approval Letter state?
The pre-approval latter from the bank states in writing that the buyer (you) qualifies to borrow a certain amount of money towards the purchase of a home. This is on the condition that all the information you’ve shown the bank is verified as fact.
This letter accomplishes two important things:
Informs you of how expensive a house you may be able to buy
Lets the sellers know that you are serious about buying
This letter will not do any of the following:
Tell you how expensive a home you should buy
Inform you of what rate of interest they will offer you
Guarantee that they will give you the loan
What will it take to get a Pre-Approval Letter?
The best way to get a pre-approval letter is to reach out to no more than three reputable lenders. At this time you do not need to choose which one you’ll end up working with. All lenders use similar formulas when pre-approving people for home loans. Therefore, how much you can afford to pay for a home will be pretty much the same no matter which lender you choose. If you question what one lender tells you, try another but do not go to more than three because it could have a negative impact on your credit rating.
For your pre-approval to be as accurate as possible, show the bank the following documents:
Your W2 tax statement showing the earnings from your job
Tax returns from the last 2 years
Pay stubs for the last 2-3 months
Bank statements for the last 2-3 months (checking and savings accounts plus any brokerage accounts, etc.)
If self-employed, the last 2 years tax returns for your business
Your lender will take these documents, plus information from your credit report in making their determination. Your credit history and score count are given a great deal of weight in the pre-approval process. It would be a good idea to check your credit report in advance so that there are no surprises. This gives you a chance to clear up any mistakes or negative transactions. Because identity theft has become so widespread, people often do not find out about this until they view their credit report.
In real estate financing, there are two main types of mortgages:
Fixed rate mortgages maintain the same interest rate throughout the duration of the loan
Adjustable rate mortgages (ARM) starts out with a fixed interest rate for a certain time period, then can go up or down depending on what the market rate is.
The difference between the two has major long-term consequences. Fixed rate mortgages usually have a higher interest rate, but are perfectly appropriate for buyers who intend to remain in their home long term. With an ARM, you are gambling that your rate will stay the same or hopefully go down.
Fixed Rate Mortgage
When you have a fixed rate home mortgage, you can count on your interest rate staying the same throughout the span of your loan, which would typically be 30 years. If you reliably make your monthly payments, your house will be totally paid for in 30 years. You can also arrange for other terms, like a 15-year mortgage, which is the second most common timeframe. Some lenders offer 40- or even 50-year mortgages.
Advantages of a Fixed Rate Loan:
Amount of monthly payment is consistent
Payments won’t rise if interest rates go up
If rates go down, you can choose to refinance
Your interest rate is locked in so you don’t have to worry
Who is a fixed rate mortgage most appropriate for?
The way rates are now, practically everyone would benefit from having a fixed rate mortgage. If you were planning on staying in your home for at least 15 or possibly 30 years, this type of loan would serve you well. In the short-term, you may pay a little more, but if rates go up significantly, you would be in an excellent position.
Adjustable Rate Mortgage (ARM)
When you have an ARM, you will have a fixed rate of interest for a specified period of time. Once that’s over, your rate will fluctuate according to the market. If you sign on for a five-year ARM, your rate remains fixed for five years. Once that’s passed, your rates are free to go up or down according to the long-term rates at the time. Interest rates are typically lower to start with than for fixed rate mortgages, although this may not always be the case. Going back to 2008, that’s when ARM rates were higher than fixed rates.
Advantages of an Adjustable Rate Loan:
Interest rates are lower initially on an ARM when compared to a fixed rate loan
Your initial payments are lower
May help you qualify to borrow more money
Who is an ARM most appropriate for?
Many buyers were in the business of “flipping houses” in the early 2000s. ARMs worked well for them since they had no intention of hanging onto these homes for very long. Although I do not recommend buying to people who do not intend to stay in the house for at least seven years, if you fall into this category but still want to buy, an ARM might work well for you.
Another reason for getting an adjustable rate mortgage would be if you plan on refinancing soon. Maybe you are working on improving your credit and expect to be offered a much better rate fairly soon, you could consider an ARM now and refinance at a lower rate several years down the road.
Unconventional Types of Mortgages
Fixed rate and adjustable rate mortgages, the conventional mortgages discussed above, typically must conform to the guidelines set down by Freddie Mac and Fannie Mae. In most markets at the present time, the maximum securitized loan is no more than $417.000. In large cities like New York City, the maximum is $625,500.
This is why people who want to buy more expensive homes turn to jumbo loans. In order to qualify for a jumbo loan you would usually need to have better credit, make a higher down payment, and agree to a higher interest rate.
With a balloon mortgage, you’ll have a fixed rate of interest for some period of time. While you’re making these payments, the principal owing on your loan is not being fully amortized, which is similar to an adjustable rate mortgage. What makes a balloon mortgage different from an ARM is the full balance owing on the principal comes due in a balloon payment when that period of time ends.
Although your monthly payment is typically lower with a balloon mortgage, you are forced to either pay off the loan in full when its due or otherwise you can try to refinance. Before entering into an agreement for this type of loan, you need to have a clear picture of exactly how you plan on paying off the balance in full as a balloon payment when it comes due; otherwise, you might be pressured to refinance the loan at a time when interest rates are higher than you would like.
If you’ve served in the military, you likely qualify for a VA loan. What’s great about VA loans is that no down payment is required, plus the VA actually guarantees the loan. This means that your lender will not be on the hook. This loan is only offered to veterans and the borrower is not required to pay for mortgage insurance to secure the loan. The downside is that the interest rate you may be offered could be more than that on conventional loans or even FHA loans.
Federal Housing Administration (FHA) Loans
The government subsidizes FHA loans, allowing you to buy a home with no more than a 3.5% down payment. For first-time homebuyers, this is usually a great option if your credit is not as perfect as you would like. However, with an FHA loan you will have to buy mortgage insurance, which safeguards the lender. It can be costly, so factor this amount into your budget. If you can make at least a 5% down payment, or more, there may be better options for you by going with a conventional mortgage.
Now that you understand how the various types of loans play out, it’s time to get ready for the most mundane part of buying a home: the lending process. If you’re well prepared and organized it can go quite smoothly, if not it can be a nail-biting experience. It all depends on how quickly you can fill out the paperwork and gather the documentation and how your lender handles their end.
To make the process as painless as possible, heed the following information:
Be Careful in Selecting Your Lender
The right lender can make all the difference in the world. Most homebuyers only look at the interest rates being offered and choose the lender offering the lowest rate. But there is more to it than just that. Find out whether or not the lenders you’re considering intend to sell your loan to a third party or if they are planning on servicing your loan themselves.
Furthermore, it is crucial that you deal with someone who can appropriately manage your expectations. Once you get pre-approved for a loan, the process continues until just a couple of days before escrow closes. All this time, you have a legal contract to buy the house and are releasing all your contingencies in the timeframe you agreed to, but you are still have not received “final approval” on your loan. This can be frightening unless you have a lender walks you through the process ahead of time, while checking in with you along the way. This will help to relieve your anxieties.
Before choosing your lender, ask for referrals and check references. You can speak to your Realtor, family, friends and neighbors about this and go online as well. Make sure that you are dealing with a bank that has an excellent reputation. Find out if you can whether they go out of their way to be easy to work with, or not. You can read anonymous online comments, but since there is no identifying information they could be written by a cross-town competitor.
Pulling Together Your Down Payment
As discussed above, a down payment is the amount of cash you initially pay on your home, which reduces the amount you have to borrow for your mortgage. If you’re applying for a conventional mortgage, the lender will usually require 20% of the selling price or value of the home. The lender prefers that you have a substantial investment in your home from the start.
Where you can legitimately come up with the money for the down payment:
Another piece of property you’ve sold
Checking and savings accounts
Stocks and/or Bonds
What are banks looking for?
Banks are looking for proof that the money you’ve pulled together for your down payment is legitimately yours. They are going to want your bank statements for the last three months at least. They will scour them for any unusual transactions, like large deposits. This is because borrowers might have friends or family transfer money to them just to increase the balance for appearances sake.
If you do have large deposits, you will be asked to explain them so the bank is satisfied that the money is not coming from anywhere else. A lender could flag a transaction for as little as $1000, it all depends
on what they deem necessary. Just be prepared to explain everything in detail.