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MORTGAGES

Qualifying

The mortgage industry uses basic guidelines to determine your ability to qualify for a home loan. Credit history, Capability, and Collateral are the three C’s that are the foundation of approving all loans. Investors, or the lenders that are lending you the money, are examining your history of borrowing money via your Credit report and FICO scores. They verify through tax returns and current paycheck stubs that your income and employment are consistent and stable, and therefore you are Capable of re-paying the loan. They require an appraisal on the property that you are purchasing to verify that the Collateral for the loan is worth the risk. Another guideline used to determine your ability to re-pay the loan is your debt to income ratio. Traditional guidelines allow 32/38 percent ratios. The top ratio, or 32%, is determined by dividing your proposed mortgage payment including principal, interest, taxes, and insurance (PITI) by your gross monthly income. The bottom ratio, or 38%, is determined by dividing your proposed mortgage payment (PITI) plus your total other monthly liabilities by your gross monthly income. If your debt to income ratio exceeds the 32/38 percent ratio, other compensating factors such as cash reserves or overall financial stability will be considered by the underwriters for final loan approval. You may also consider a lower interest rate, rather than a 30 year fixed, an adjustable rate mortgage may help you qualify, or increase the down payment that you are bringing to the closing table.

Loan Types

When considering which type of loan program to use to finance a home purchase, a number of personal factors need to be considered and planned. Think about your current financial picture, how do you expect your finances to change, how long do you intend to own this property? How much of a down payment are you considering? What is your risk tolerance with the financial market? What have property values done lately and where are they headed? What are closing costs? If you don’t take the time to consider these factors, you could be spending a lot more money than necessary when financing a home. You need to understand the relationship between interest rates and points. The purpose of paying points (a point is 1% of the loan amount) is to lower the interest rate on the loan. A lower interest rate means lower monthly payments. Over time, the savings from these lower monthly payments will pay for the extra points paid for at closing. In most cases, it will take several years for the points on a loan to pay for itself. If you were to sell the home or refinance within that time, you would be better off paying the higher interest rate. Only you can decide which loan program is best for your financial future. The following are your traditional loan types:

Conventional Loans – these loans must meet Fannie Mae or Freddie Mac guidelines, as the majority of these mortgages are purchased by these institutions for investment purposes. They are not insured by the FHA or guaranteed by the VA. Private Mortgage Insurance (PMI) is required by the lender when your down payment is less than 20% and your LTV (loan-to-value) is greater than 80%. Conforming loan limits are $359,650 for single family residences.

Jumbo Loans – these mortgage loans exceed the conforming loan amounts set by Fannie Mae and Freddie Mac. Since these two agencies will not purchase these loans, they usually carry a higher interest rate to enhance their value and marketability to investors.

Fixed Rate Mortgages – with this type of mortgage your monthly payments for principal and interest never change. Fixed rate mortgages are available in 30, 25, 20, 15, and even 10 year terms. There are also “bi-weekly” mortgages, which shorten the life of the loan by calling for half the monthly payment every two weeks, (since there are 52 weeks in a year, you pay 26 half payments, or 13 months worth every year). A 30 year fixed rate is amortized over a period 360 months, whereas a 15 year fixed rate is amortized over a period of 180 months.

  1. Guaranteed rate for the term of the loan
  2. Protection from rising interest rates
  3. Ideal for borrower’s that plan on retaining the property for more than 10 years
  4. Generally have higher payments than alternative mortgages

Traditional Adjustable Rate Mortgages (ARM’s) – these loans generally begin with an interest rate 1% - 3% below a comparable fixed rate mortgage. However, after the fixed period of time, generally 1, 3, 5, or 7 years, the interest rate will be adjusted based on a pre-selected economic index and margin. The most common indexes are the one year Treasury Bill and the LIBOR (London Inter-Bank Offering Rate). The new interest rate is determined by adding this index to the pre-selected margin. Caps are a valuable feature of the ARM’s. Caps determine the maximum or minimum interest rate that your payment will adjust to on the first adjustment period, each periodic adjustment, and the maximum lifetime adjustment.

  1. Ideal for borrower’s looking for a lower initial interest rate
  2. Lower initial interest rate can increase purchasing power
  3. Borrower’s long term plans with the property are to sell or refinance within the fixed period of the ARM
  4. A rapid rise in interest rates can drastically increase payments once the initial fixed period has passed, however, if rates go down, your mortgage payments will drop also

Piggyback or Split Loans – can avoid paying mortgage insurance when the down payment or equity in your home is less than 20% of the value. The total mortgage payment is generally lower than one loan with mortgage insurance. This is available with most fixed rate and adjustable rate loans.

  1. 80/20 – 100% financing, 80% 1st mortgage / 20% 2nd mortgage
  2. 80/15/5 – 95% financing, 80% 1st / 15% 2nd / 5% down payment
  3. 80/10/10 – 90% financing, 80% 1st / 10% 2nd / 10% down

Interest Only Mortgages – payments on the mortgage cover the interest only of the loan for a period of time, usually 10 years. Once the interest only period is over, the loan is then recast to a principal and interest payment over the remaining term of the loan. The interest only monthly payment is calculated each month based on the current balance. If you make voluntary prepayments of principal during the interest only period, the subsequent monthly payment will be based on the lower principal balance.

  1. Ideal for borrower’s looking for the lowest minimum monthly payment
  2. The entire payment is tax-deductible because it is all interest
  3. Generally recommended for high-income move up borrowers, or if you are temporarily cash strapped
  4. Suggested for borrower’s that can invest the difference of a full principal and interest payment to possibly acquire assets greater than the principal balance
  5. Does not build equity unless the home appreciates

Home Equity Line of Credit – this is an interest only loan that uses the equity in your home as a line of credit. The interest rate is determined by the PRIME index plus a predetermined margin. The interest rate is not fixed. The line of credit remains open for a period of time, usually 15 years. If you pay down the principal balance, you can then re-draw funds without having to qualify for a new loan. Lines of credit are generally available as a 2nd mortgage or subordinate lien to the property.

Balloon Loans – this type of mortgage has a short term, typically 5 or 7 years, but the monthly payment is amortized over 30 years. At the end of the term of the loan, it is then due in full. Balloon loans are common as a 2nd mortgage, a 30 due in 15 is amortized over 30 years, but is due in full in 15.

Limited Documentation Loans – this type of financing is available to buyers with higher credit scores who have difficulty documenting their income, work non-traditional jobs or whose incomes are inconsistent or cyclical. Qualification and pricing varies by documentation type.

  1. Stated Income/Verified Assets – income is stated on the application but no documentation is required such as paycheck stubs or tax returns. Employment must be verified. Assets must be verified.
  2. Stated Income/Stated Assets – income and assets are stated on the application but neither is verified. Employment must be verified.
  3. No Income/No Assets (NINA) – employment verbally verified, but income and assets are neither stated nor verified.
  4. No Doc – Income, assets and employment are not stated or verified

Subprime Loans –are available to those with less than perfect credit, or are having difficulties qualifying for conventional loans. These loans are usually available in a 2/28 (fixed for 2 yrs., then adjustable for the remaining term) or 3/27, (fixed for 3 yrs., then adjustable). These loans carry a higher interest rate and margin than conventional loans and usually have a prepayment penalty.

  1. Interest rates are higher, some offer 30 year fixed but mostly 2/28 or 3/27
  2. No PMI requirements
  3. Adjustment period is usually 6 months after the initial fixed period
  4. 2 or 3 year prepayment penalty is standard
  5. Interest Only option available
  6. No reserve requirements
  7. Allows for higher debt-to-income ratios

FHA Mortgages – these loans are insured by the Federal Housing Administration, a division of the Department of Housing and Urban Development (HUD). FHA sets underwriting standards for approving applicants, and in many cases, are more lenient than conventional underwriting guidelines. This leniency makes it easier for borrowers to qualify for a mortgage loan with lower down payment requirements and a higher monthly debt allowance. FHA limits the type of loan programs it insures, but it will insure the more popular 30 year fixed, 15 year fixed, and the 1 and 3 year adjustable loan programs. However, borrowers are limited to the amount that they can borrow determined by the county in which the property is located.

  1. Ideal for 1st time homebuyers or borrowers that have not had an ownership interest in a property for the last three years
  2. Private Mortgage Insurance (PMI) is required for loan-to-values over 80%
  3. Limitations on lender’s settlement charges
  4. Full documentation only

VA Mortgages – guaranteed by the Department of Veterans Affairs (DVA). One of the biggest advantages of using a VA loan is that the borrower can finance the purchase of a property with no money down. However, VA loans are restricted to individuals qualified by military service.

  1. No down payment required
  2. No mortgage insurance required
  3. Up Front VA Funding Fee
  4. Limitations on lender’s settlement charges

Finding and Securing the Right Property

Once you know how much house you can afford, you are now ready to find the property that not only fits your practical needs, but emotional needs as well. When searching for a house, it is recommended that you consult a professional Real Estate Broker. Colorado state law requires that Broker’s must disclose to you, in writing, under which agency they will be representing you.
  1. A Seller’s agent works solely on behalf of the seller and owes duties to the seller, which includes the utmost good faith, loyalty and fidelity. The agent will negotiate on behalf of and act as an advocate for the seller. The agent must disclose to potential buyers all adverse material facts about the property actually known by the Broker.
  2. A Buyer’s agent works solely on behalf of the buyer and owes duties to the buyer, which includes the utmost good faith, loyalty and fidelity. The agent will negotiate on behalf of and act as an advocate for the buyer. The agent must disclose to potential sellers all adverse material facts concerning the buyer’s financial ability to perform to the terms of the transaction and whether the buyer intends to occupy the property.
  3. A Transaction Broker assists the buyer or seller or both throughout a real estate transaction with communication, advice, negotiation, contracting and closing without being an agent or advocate for any of the parties. A transaction broker must use reasonable skill and care in the performance of any oral or written agreement, and must make the same disclosures as agents about adverse material facts concerning a property or buyer’s financial ability to perform under the terms of a transaction and whether the buyer intends to occupy the property. This disclosure should take place prior to viewing any homes. If the property is listed at a realistic price (according to what similar homes have sold for in the area) an initial offer price of 90- 95% of the list price is normal. The seller will then respond to your offer by either accepting it, rejecting it, or in most cases making a counter offer. You then have the option of accepting the counter offer, rejecting it, or making another counter offer. Although there is no limit to the number of counter offers that can be made, the second round of negotiating is usually the last. Everything regarding the property can have a perceived dollar value, and is therefore negotiable. This includes the purchase price, the personal property included in the home, the financing concessions, the closing date and the possession date. Another advantage of using a real estate Broker is that they are not personally involved in the purchase. Brokers are able to objectively point out good points and bad points on each property.

Loan Processing & Approval

The loan application is the most important form a borrower will fill out regarding home financing. Since most underwriters never meet the borrower, the application will be the only means by which an applicant can be judged creditworthy. For this reason, it is important to fill out the application completely and correctly. Once you complete the written loan application, your information and the property to be purchased are put under close examination to determine if, based on the guidelines of the particular loan program, both qualify. Law requires that lenders provide certain notices to the buyer. The Good Faith Estimate and the Truth in Lending Disclosure must be provided to you within 3 business days of completing the Loan Application. Other disclosures that are required at the time of the loan application are The Equal Credit Opportunity Act, Privacy Policy Disclosure, Servicing Disclosure, Fair Credit Reporting Act, Right to Receive Appraisal, and a Good Faith Estimate of Provider Relationships. At this point, all supporting documentation must be provided to your lender. This includes paycheck stubs, W-2’s, tax returns, bank statements, and evidence such as canceled checks for your mortgage or rental payments. Documentation will vary depending on the loan program and the unique and compensating factors of your file. You may decide whether to float or lock the interest rate on the loan. When you lock your rate, you are securing that interest rate and any discount points as of the marketplace of that day. Locks are available for varying lengths of time, from as brief as 10 days to as long as 120 days, with small increments in the interest rate from the shortest to the longest period. If you decide to float the loan, you run the risk of interest rates rising or the possibility of them falling. Unforeseen events, economic earthquakes elsewhere in the world while Americans are sleeping, can and have caused us to awake to a completely different financial landscape in the morning. It is your choice to play the market. Once this documentation is compiled, the file goes to the processing department, and everything is checked for accuracy. The processor orders the required verifications (employment, bank deposits, and rental payments) and checks for loan guideline compliance. In order to verify facts on the property being purchased, the loan processor orders the appraisal and the title commitment. Investors approve home loans on the basis of the appraised value of the property or the purchase price, whichever is lower. In the event of borrower default, the home is the collateral for the loan. The lender does not want to grant a loan that is larger than the value of the collateral. For example, if the amount owed on a home mortgage is $100,000 and the property is only worth $80,000, the buyer has little to lose by defaulting on the mortgage, but the lender has $20,000 to lose. This is the reason why lenders require Private Mortgage Insurance (PMI) for conventional loans with a down payment of less than 20%. The appraisal determines the fair market value and condition of the property compared to like properties that have recently sold. The title commitment is issued stating the conditions under which title insurance will be insured. This process begins with the title company providing a search and examination of the public records to determine and disclose the current facts relating to the ownership of a piece of real estate, such as: 1) who currently owns the property, 2) any liens or encumbrances against the property or its owner, 3) easements and/or restrictions, and 4) other recorded interests. The investor requires assurance that its lien position is superior to all others. A second mortgage would be in second lien position.

From here, the complete loan file will be given to the underwriters. The underwriters determine whether this loan and all supporting documents meet the criteria and guidelines of the investor. The underwriter considers your ability to re-pay the loan, if you have the cash required to bring to closing, the property's condition and value and the buyer's overall credit worthiness. After consideration of all of this information, the underwriter will decide whether to approve, conditionally approve, or deny your loan. Conditionally approved would occur if the underwriter feels that there is additional information needed to meet the investor's criteria, such as a missing W-2 Form, a doctor's letter regarding an illness, an attorney commenting on a lawsuit, or an accountant explaining unusual financial statements. Once you receive final loan approval, the file will be given to the closing department to prepare the closing documents, and final figures will be sent to the title company to prepare the final HUD Settlement Statement. Responding promptly to the lender and exercising prompt communication between all parties involved is the best way to get through this process as quickly as possible.

Closing the Transaction

After you have received final loan approval, congratulations are in order. You are only one step away from being a homeowner. The sixth step of the mortgage buying process is the actual closing of the real estate transaction between the buyer and the seller. This is the most crucial step of the mortgage process because legal documents are signed and substantial amounts of money exchange hands. It is to the buyer's advantage to become educated on the required closing costs and documents to be brought to the closing prior to the closing date to prevent any delays in finalizing the transaction. The settlement agent prepares the final HUD Settlement Statement and presents the closing documents to the parties involved in the transaction. According to The Real Estate Settlement Procedures Act (RESPA), the person conducting the closing or settlement for the lender must provide a settlement statement to the buyer and the seller of residential property 24 hours prior to closing.

The settlement statement consists of all figures pertaining to the transaction that both the seller and the buyer are responsible for. The most common settlement charges are:

  1. Broker's commission: Any other sales charges incurred by the broker are also listed.
  2. Lender's charges: what the mortgage lender charges to originate the loan, the loan discount points, the appraisal fee, credit report, tax service fee, processing and underwriting fees, doc prep fees, flood certification inspection fee, and any other charges, all of which must be itemized.
  3. Items required by lender to be paid in advance: pre-paid interest on the loan, the mortgage insurance premium, and premiums for hazard insurance.
  4. Reserves deposited with lender: certain payments into reserve accounts may be required on a monthly basis for such items as hazard insurance, mortgage insurance, real estate taxes, and assessments.
  5. Title charges: the settlement or closing fee, title examination fees, endorsement coverage’s and title insurance for the lender. The one time fee for title policy (including the search and examination) averages $430 for a $100,000 home. Buyer's charges are approximately $285.
  6. Other charges: Government recording and transfer fees, survey costs, a pest inspection, or miscellaneous charges.
The buyer is responsible for the gross amount due, including the purchase price and the settlement charges. The buyer will be credited the deposit of earnest money, the principal amount of the new loan, and any credits from the seller. The difference is the amount of certified funds to be paid at closing. The closing of a real estate transaction can be a painless process if both the buyer and the seller come prepared. Play it smart and ask the advice of professionals when in doubt.