Whether you are a first time buyer or this will be your third home purchase, below is a great deal of helpful information that will keep you informed during the home buying process.
Finding a Good Agent
The long and winding road that leads to the door of your new home can be confusing and exhausting. It helps to know you are not alone and that you have, at your disposal, your Agent’s professional expertise. I will help you to do the following:
- Educate you through the entire process
- Listen to your needs to understand your real estate objectives
- Help you understand all of the paperwork
- Handle any problems that arise during the transaction
- Properly prepare forms, contracts and disclosures, which are required by law, and make sure that they are legally correct
- Provide comparable sales data to assure that you are paying the proper price for your home
- Help you find the right home in the right neighborhood
- Screen homes before your inspection to make sure the property meets your needs
- Guide you regarding the repairs that should be made
- Show you homes in an effective and professional manner
- Guide you in your selection of escrow/closing and title people
- Oversee the closing process
- See that the completion of the transaction is smooth, including obtaining keys and taking possession of the property
- Help you spot sellers who are attempting to take advantage of you
- Help you understand the use and limitations of good faith deposits
- Advise you as to when you should seek the advice of an attorney
- Make sure the appraisal process is handled properly
- Help you to understand the complete loan, escrow/closing and title process
- Advise you as to any inspections such as septic, well or soil, which might be applicable to the specific property in which you are interested
- Guide you as to how the escrow/closing instructions should be prepared
- Properly handle the walk-through process with you prior to the final closing
- See that any repairs or requirements are met prior to the closing
- Advise you as to what course of action should be taken if the seller refuses to close the transaction
- Negotiate and deal effectively on your behalf with the seller, other agents, escrow/closing, title people and attorneys
- See that each and every facet of the buying process is effectively and professionally handled in your best interest
For most of us, buying a home is the biggest single investment we’re likely to make – and we’re only likely to do it maybe once or twice in a lifetime. The process is, by nature, filled with checks and balances – and many complex details. Traditionally, agents were legally obligated to protect the interests of the home seller. Today preferences are changing. One of these changes is that more homebuyers are choosing to have their own real estate agent, known as a buyer’s agent, to legally represent them.
A buyer’s agent represents you, the buyer, not the seller, and has full fiduciary duties, including loyalty to you. By definition, the buyer’s agent has your best interests in mind throughout the transaction. The percentage of homebuyers with buyer representation has grown significantly in the past decade. According to a recent National Association of Realtors® survey, nearly half (46%) of home buyers used the services of a buyer’s agent last year, and four out of every five buyer’s agent agreements were in writing.
The benefits of buyer representation is the dedication of a buyer’s agent to the home buyer. The buyer’s agent and homebuyer establish a mutual agreement, known as a buyer agency agreement, that will entitle the homebuyer to, but is not limited by:
- Loyalty The real estate agent must act in the best interest of the buyer.
- Disclosure All material facts such as relationships between agent and other parties, existence of other offers, status of earnest money, seller’s financial condition, property’s true worth, commission split with other brokers, and legal effect of important contract provisions.
- Confidentiality Any discussions, facts, or information that should not be revealed to others but does not include responsibility of fairness and honesty in dealings with all parties.
- Accounting in dealings Reporting of where any money placed in the hands of the broker is kept.
- Reasonable Skill and Care Arriving at a reasonable purchase price and advising the buyer of such, affirmatively discovering material facts and disclosing them to the buyer, investigating the material facts related to the sale. With a buyer agency, the interests of the homebuyer will be represented in the purchase of the home. This scenario is different from a typical transaction where the buyer is not technically represented.
Finding A Property
Are you ready to get started?! Once you’ve determined that you are ready to purchase a home, there are few things as exciting as searching for just the right property to call your own.
Remember, shopping for a home is a process that, whenever possible, should not be rushed. Make sure that you perform adequate research on the area, neighborhoods and the homes available on the market before you buy. You should do your best to look carefully and, whenever possible, try not to let your emotions make your final decision.
I will help to provide you with additional information on areas that are attractive to you, as well as schedule times for you to preview any properties that may be of interest.
An open house can be an opportunity for you to get information about homes and the housing market. Open houses are a common real estate practice because they give an agent the opportunity to market the home and to meet prospective buyers.
Here are some questions you may want to ask:
- Are you the listing agent for this house? Busy agents sometimes arrange for a colleague or assistant to conduct the open house. Don’t assume the person showing the home is knowledgeable about the house or has met the sellers.
- How long has the home been on the market? Well-priced homes in good condition generally sell in a short period of time. Unless the local market is weak, you will want to know why a particular home is not selling. Are there hidden defects? Is it overpriced? Are the sellers requiring something that may seem unreasonable as a condition of the sale?
- Have the sellers received any offers? If the sellers rejected offers that were too low or had contingencies or conditions, you should find out before you experience the same.
- Is any furniture or fixturing being sold with the house? If you’re thinking of buying the home, there is no better time to ask whether the seller would be interested in including the patio furniture or the dining room chandelier.
- Are there any special costs attached to the property? Is there a homeowner’s association that has dues or fees? Are there particular tax assessments? Are there any natural hazard issues to be aware of? Are there any hidden costs of owning the home?
- How does this house compare to others on this street? The local agent may be able to speak about recent sales in the neighborhood as well as some interior ideas seen in other homes.
When searching for a home, it’s easy to get overwhelmed with information and to forget the details of each particular home you’ve viewed – that’s why I’ve created this list to help you keep track of all the information you need to help you in this important decision.
When you view a home, keep in mind this checklist:
- Is there enough room for both the present and the future?
- Are there enough bedrooms and bathrooms?
- Is the house structurally sound?
- Do the mechanical systems and appliances work?
- Is the yard big enough?
- Do you like the floor plan?
- Will my furniture fit in the space? Is there enough storage space? (Bring a tape measure to better answer these questions.)
- Does anything need to repaired or replaced? Will the seller repair or replace the items?
- Imagine the house in good weather and bad, and in each season. Will you be happy with it year ’round?
- Take your time and think carefully about each house you see. Ask your agent to point out the pros and cons of each home from a professional standpoint.
- There isn’t a set number of houses you should see before you decide. Just be sure to communicate often with your agent about everything you’re looking for. It will help focus the search.
- Take detailed notes, take pictures, and make a video – anything to help you remember as much as you can. (Be sure to first secure the permission of the owner before photographing or taking video, though.)
- If the owner or the owner’s agent is present during your viewing of the home, don’t say too much about your likes or dislikes.
- Which items require ongoing maintenance (paint, roof, heating and air conditioning systems, appliances, carpet)?
- What about the neighborhood and the quality of life it affords?
- Does the home’s style, features and amenities conform to the neighborhood?
- Are there any potential problems with the home’s electrical or mechanical systems?
- Does the home appear to have any structural problems?
- Does the home appear to have any drainage or foundation problems?
New Home or Older Home?
There are pros and cons to each. While older homes can offer interesting architectural details like higher ceilings, for example, a home with higher ceilings can produce more expensive heating costs. New homes, on the other hand, are likely to be better insulated and more energy efficient. They offer the promise — but certainly not a guarantee — of fewer structural and mechanical problems. On the other hand, if you need to buy new draperies and landscaping at the outset, costs quickly can add up.
Don’t forget that the area surrounding new housing developments may not be finished – and when the empty field across the street becomes home to office buildings, the neighborhood could change dramatically. Green spaces and parks may not materialize as promised. Thorough research can help.
Your lender may tell you that you can afford to buy the house you adore, but are you comfortable with the monthly payments you will be obligated to make? Is the down payment within your means? Will you have enough cash to pay transaction costs and moving expenses? If the house needs major repairs, remodeling or redecorating can you save the necessary funds within a reasonable time period?
Size and Configuration
What size house do you need? What is the right combination of bedrooms, bathrooms and other living areas? How much storage is needed? Is a formal space for entertaining important or will more time be spent in the kitchen and family room?
Do you have a priority for a single level home versus a two story? Is central heating or air-conditioning a priority? What directions do the bedrooms and key living areas of the house face? Is there cross-ventilation? If you entertain, is there a bathroom easily accessible for your guests?
What house style suits you best? Modern or traditional? Mediterranean or cottage? Will your current furnishings determine the style of the house you choose? Are there pieces of furniture you own that require space consideration?
Some buyers become enamored with pricey home amenities that seem attractive and desirable at the time, but later prove to be more headache and less pleasure than anticipated. Do you really want a swimming pool? Are you planning on having children? That may mean you will need to enclose the pool or find alternative safety elements. How much landscaping or yard maintenance expenses are you willing to incur?
On average, people move to a new home every seven years. If you wanted to sell your home, how easy would it be to find a willing buyer? If you are interested in a very customized home, it is important to manage your resale expectations and gauge them against the future market conditions.
Preparing To Buy a Home
Before you step foot into the first home you look at, it’s a good idea to thoughtfully determine your wants and needs, and the difference between the two! By analyzing your needs you will be able to get a clear picture of exactly what you want your new home to look like and how it should function for you. Once you’re in the thick of viewing homes, it’s all too easy to fall in love with someone’s decorating or a home’s outstanding architecture – and to completely overlook that there aren’t enough bedrooms or bathrooms to fit your needs.
First, you should write down why you’re looking for a home. For example, are you currently renting and would like to have a home where you can begin building equity? Maybe you have outgrown your existing home or changed jobs which required you to move to a new city. These factors will all have an impact on how you approach your home search.
It is important to identify what you envision your home to look like and what features it should have. Writing this down helps to avoid ambiguity later in the home search process. You should make at least two lists: one should describe everything you would ideally like and the other should list the features of the home that are an absolute must. It is most likely that you will blend the two lists into one as you progress through the homebuying process. This is a natural and evolutionary process that becomes clearer as you determine what you want and what is available.
Approaching the task of buying a home can be overwhelming. It is a complex event during which there is so much to learn and to consider. How much can I afford? Where will the down payment come from? How much will I need and where can I find the best loan? How do I begin the look for a home, what should I expect from my real estate agent and what type of home is right for me?
These questions are just the beginning. Buying a home is one of the largest financial transactions in one’s lifetime, yet most people know very little about it. When embarking on the path to home ownership here are two very important points to remember:
- You can and should understand everything that is happening in the homebuying process.
- You will need to learn some new terms, apply some new concepts and take the time to learn about purchasing a home.
- Always remember that you are the most important person throughout the entire real estate process. It is easy to think that many others may have more expertise or clout, but the truth is that you, the buyer, are the one person in this transaction that makes it all happen. If you decide not to buy, the entire process comes to a complete stop.
- If you plan from the beginning to approach the homebuying process intelligently and with confidence, you are much more likely to buy the home you’ve always wanted, and have the confidence that the best decisions were made.
1. Make a decision to rent or buy.
2. Figure out how much you can afford.
3. Find the right real estate agent.
4. Get pre-approved.
5. Decide what kind of home you want.
6. Find the right neighborhood.
7. Begin the home search.
8. Preview the homes.
9. Make an offer.
10. Apply for a mortgage.
11. Have the inspections conducted.
12. Close the transaction.
13. Move into your new home.
There’s nothing quite like a home that you can truly call your own. A place where you can have the gleaming hardwood floors you’ve always dreamed of, a space to cultivate your own vine-lined patio, a way to provide a good neighborhood for your kids to grow up in, and a freedom from the whims of your landlord. These are the images that immediately come to mind, for many of us.
Yet some of the biggest advantages of owning a home are less romantic and more practical – in fact, there are financial advantages to owning a home:
- Tax Deductibility You can deduct the cost of your mortgage loan interest from your state and federal income taxes. Since interest generally will account for most of your payment during the first half of your mortgage, the savings can be significant. Some of your costs at the time of closing (including prepaid mortgage interest) can be taken as deductions on that year’s income tax return, and points paid up front at the time of closing represent additional mortgage interest and may be taken as a deduction.
- Tax Deductibility of Property Taxes You can deduct all of the property taxes you pay.
Appreciation Potential Real estate is considered a good long-term investment because it usually appreciates in value. The effects of borrowing potential can increase as the value of the home appreciates.
- Capital Gains Exclusion When it’s time to sell your home the amount of capital gains you have to pay is reduced. A homeowner can exclude up to $500,000 per couple if married and filing jointly, or $250,000 if single or filing separately for homes that have been the taxpayer’s principal residence for the previous two years.
- Capital Gain Treatment Congress allows preferential tax treatment on gains from capital assets held for more than one year. This would be important for a homeowner who has gains in excess of the allowable exclusion.
Principal Accumulation Mortgages are designed to pay the interest for the time that the money has been used, as well as to retire the principal debt over a period of time. This payment plan means that part of the payment each month is for principal accumulation.
- Personal Enjoyment Pride of ownership is a valid reason for wanting to own a home. You can personalize your home while enjoying the financial benefits.
For the best evaluation of your financial situation, consult your financial advisor. He/she will be the most qualified to discuss the financial consequences of a home purchase decision, as well as help you to establish a plan that will achieve your home ownership goals.
The good news is that there are lots of folks out there who are very interested in lending you as much as 95% of the purchase price of your home, at very favorable interest rates. Furthermore, they are willing to spread out the payments over a long period of time so that you can afford the house you want. Home loans typically are offered in amounts of 80%, 90% and 95% of the price you are paying for the house. You are expected to pay the remaining amount in cash from your own funds.
The smaller the down payment, the greater the requirements are on a buyer’s financial condition. The reason a lender is willing to lend up to 95% of the value of the house is that history has shown real estate to be such an excellent investment. Lenders expect that the home will be worth more in the future than it is today – so their investment in your home is considered very safe.
That’s also why the interest rate you can obtain on a home loan is one of the best around. Consider that America’s largest and strongest corporations borrow at what is called the “prime rate,” and that today you can borrow a home loan – fixed at the same rate for many years – at substantially less than the prime rate. Lenders have found that home loans tend to be excellent investments, and you benefit every month when you make your loan payment.
What if I don’t have enough for the down payment?
Today’s homebuyers have more loan options. A homebuyer may have excellent credit and the ability to make the monthly mortgage payment, but not have the cash for the down payment. For this situation a nontraditional loan program such as an 80-10-10 may be the best loan. Homebuyers should not despair and assume that a home is out of reach. There are many loan options available for many different financial situations.
There is a rule of thumb that says that if you have the capacity to repay the mortgage, you can afford a single-family house that costs up to two and one-half times your annual gross income. (Annual gross income is the amount you make before taxes are deducted.) Like other rules of thumb, this is a general idea of how large a mortgage you can afford. But, because it is so simple, it doesn’t take into account all the information that will help you feel comfortable with your mortgage payments.
If you are buying a house with someone else (spouse, parent, adult child, partner/companion, brother or sister or other relative), you should consider your co-purchaser’s earnings and existing debts as well. Remember, if you apply for a loan with somebody else, you and your coborrower are both legally responsible for repayment of the mortgage.
Your buying power depends on how much you have available for the down payment and how much a financial institution will agree to lend you.
Your down payment
If you are a first-time home buyer, the price you can afford to pay for a house may well be limited by your ability to come up with the required down payment and closing costs. If you haven’t accumulated much savings, you may want to set aside funds for a down payment on a regular basis from your paycheck. Monies in your checking and savings accounts, mutual funds, stocks and bonds, the cash value of your life insurance policy, and gifts from parents or other relatives may all be suitable sources for a down payment.
Private Mortgage Insurance
Depending on the lender and loan type, you may be able to get a mortgage with as little as 3 percent or 5 percent down. However, putting less than 20 percent down often means you will be required to purchase private mortgage insurance. Private Mortgage Insurance (PMI) helps protect the lending institution in case you fail to make payments on your mortgage.
It is possible to get financing with 0-10% down and not pay PMI (Private Mortgage Insurance). This is why 80-10-10 financing was created. It is called 80-10-10 because a lender provides a traditional 80% first mortgage, a 10% second mortgage, and makes a cash down payment equal to 10% of the home’s purchase price. The same principle applies if the borrower can only afford to make a 5% down payment: 80-15-5 financing is also available.
Your closing costs
In addition to the down payment, you will also need to consider closing costs. The closing is the final step during which ownership of the house is transferred to you. The purpose of the closing is to make sure the property is ready and able to be transferred from the seller to you.
Closing costs generally range from 3 percent to 6 percent of the amount of the mortgage. So, if you were to buy a $100,000 house with a 5 percent ($5,000) down payment, you could expect to pay between $2,850 and $5,700 on your $95,000 mortgage. Sometimes, you can negotiate with the seller of a property to pay some of your closing costs, which will reduce the amount of money you will need to bring to closing.
How much a financial institution will lend you
Apart from having available funds for a down payment and closing costs, the other major factor limiting how expensive a house you can buy will be how much you can borrow.
When you apply for a mortgage, the lender will consider both your earnings and your existing debts in determining the size of your loan. Lenders generally use the following two qualifying guidelines to determine what size mortgage you are eligible for:
The amount of money you owe for mortgage payments, property taxes, insurance, and condominium or co-op fee, if applicable, should total no more than 28 percent of your monthly gross (before-tax) income. This is called the Housing Expense Ratio. The amount of money you owe for the above items plus other long-term debts should total no more than 36 percent of your monthly gross income. This is called the total Debt-to-Income Ratio.
Basically, lenders are saying that a household should spend no more than about one-fourth of its income (up to 28 percent) on housing and no more than about one-third of its income (up to 36 percent) on total indebtedness (housing plus other debts). Lenders feel that if they follow these guidelines, homeowners will be able to pay off their mortgages fairly comfortably.
These lender ratios are flexible guidelines. If you have a consistent record of paying rent that is very close in amount to your proposed monthly mortgage payments or if you make a large down payment, you may be able to use somewhat higher ratios. Some lenders offer special loans for low- and moderate-income home buyers that allow them to use as much as 33 percent of their gross monthly income for housing expenses and 38 percent for total debt.
Don’t Despair, There is a Loan For You
When you go to apply for a mortgage, the lender will use all the relevant data — your income, your existing debts, the purchase price of the house, your down payment, the interest rate on the loan, and the cost of property taxes and insurance — and calculate whether you qualify to borrow the amount of money you need to buy the house.
As you think about applying for a home loan, you need to consider your personal finances. How much you earn versus how much you owe will likely determine how much a lender will allow you to borrow.
First, determine your gross monthly income. This will include any regular and recurring income that you can document. It is the average income of a 2 year time period. Unfortunately, if you can’t document the income or it doesn’t show up on your tax return, then you can’t use it to qualify for a loan. However, you can use unearned sources of income such as alimony or lottery payoffs. And if you own income-producing assets such as real estate or stocks, the income from those can be estimated and used in this calculation. If you have questions about your specific situation, any good loan officer can review your documents.
Next, calculate your monthly debt load. This includes all monthly debt obligations like credit cards, installment loans, car loans, personal debts or any other ongoing monthly obligation like alimony or child support. If it is revolving debt like a credit card, use the minimum monthly payment for this calculation. If it is installment debt, use the current monthly payment to calculate your debt load. And you don’t have to consider a debt at all if it is scheduled to be paid off in less than ten months. Add all this up and it is a figure we’ll call your monthly debt service.
In a nutshell, most lenders don’t want you to take out a loan that will overload your ability to repay everybody you owe. Although every lender has slightly different formulas, here is a rough idea of how they look at the numbers. Typically, your monthly proposed housing expense, including monthly payments for taxes and insurance, should not exceed about 28% of your gross monthly income. If you don’t know what your tax and insurance expense will be, you can estimate that about 15% of your payment will go toward this expense. The remainder can be used for principal and interest repayment.
In addition, your proposed monthly housing expense and your total monthly debt service combined cannot exceed about 36% of your gross monthly income. If it does, your application may exceed the lender’s underwriting guidelines and your loan may not be approved.
There are a number of factors within your control that affect your monthly payment. For example, you might choose to apply for an adjustable rate loan that has a lower initial payment than a fixed rate program. Likewise, a larger down payment has the effect of lowering your projected monthly payment.
A lender takes into account many factors that reflect the financial condition of a homebuyer. With a variety of loan programs, buying a home is possible.
What Is A Credit Score?
When lenders evaluate a loan application, a process called underwriting, they try to evaluate your ability and willingness to repay the loan. They judge the borrower’s ability to repay by reviewing the income and stability of past earnings. This practice helps the lender to determine if the borrower can afford the loan payments. The review of past credit history is used to judge the willingness of the borrower to repay the loan.
Lenders want their evaluation to be as accurate, objective and consistent as possible. To help achieve this goal, home mortgage lenders use credit scores to assist in the underwriting process. Credit scores are numerical values that rank individuals according to their credit history at a given point in time. A credit score is based on past payment history, the amount of available credit, and other factors. According to Fannie Mae and Freddie Mac, two large investors in mortgage loans, credit scores have proven to be very good predictors of whether a borrower will repay his or her loan.
Credit scores are just one of many factors considered in the underwriting process. The lender will review the many components that make up the financial situation of a borrower. Even when a credit score is low, there are other factors that could overcome the negative credit issues and satisfy other underwriting criteria.
What is a FICO Score?
“FICO” scores are a type of credit score developed by Fair Isaac & Company. FICO scores use credit bureau information to obtain a score which indicates how likely someone is to pay their loan payments on time. FICO scores range from approximately 350 to 900. The higher the score, the lower the probability of default on the loan.
How Can Credit Scores Affect the Price of the Loan?
Just as credit scores are one factor in determining loan qualification, they may also be a factor in determining the price of the loan. The price of a loan means the interest rate and the points charged by the lender. The price charged for a loan will be higher or lower depending on various factors.
Credit scores are used in determining the price of a loan because they are believed to be good predictors of a borrower’s ability and willingness to repay the loan. Therefore, applicants with lower credit scores may pay higher prices for their loans because of the higher risk of default and loss on the loan. Many home loans are sold to investors, and investors will pay a more favorable price for loans they feel have a low risk of default.
There are many other factors relating to an individual borrower’s situation that may also affect the price of a loan, often even more than credit scores. These include the type of property securing the loan, the amount of the borrower’s equity in the property, the value of the property compared to property value in the area, the lender’s cost to make the loan and the type of loan selected. For example, a loan secured by a single family residence may have a lower price than a loan secured by a condominium because condominiums may be more difficult to sell than single family residences. Similarly, the price of a loan for which the borrower has made a 20% down payment may be less than a loan for which the borrower has made a 5% down payment because the first borrower has more equity in the property and, thus, a greater incentive to make the payments of the loan.
As indicated earlier, your credit report and history are key to obtaining your home loan. We encourage you to view your credit report yourself, prior to the lender’s viewing of it, by contacting one or all three of the major credit reporting companies: Equifax, Experian, and TransUnion. All you have to do is call and request it. Once you receive it, check the “high credit limit,” “total loan,” and “past due” columns. It is a good idea to get copies from all three companies to assure there are no mistakes since any of the three could be providing a report to your lender. Fees, ranging from $5-$20, are usually charged to issue credit reports.
Credit reporting companies:
Experian (800) 682-7954 www.experian.com
Equifax (800) 685-1111 www.equifax.com
TransUnion (800) 888-4213 www.transunion.com
You can also get a copy of your credit history at the following online location:
What if I find a mistake in my credit history?
You can correct simple mistakes by writing to the reporting company, pointing out the error, and providing proof of the mistake. You can also request to have your own comments added to explain problems. For example, if you made a payment late due to illness, explain that for the record. Lenders usually understand about legitimate problems.
What about my overall (or FICO) score? What does it mean?
Prior to the late 1990s, credit scoring had little to do with mortgage lending. When reviewing your credit worthiness, an underwriter would make a subjective decision based on past payment history. Then things changed.
Lenders studied the relationship between credit scores and mortgage delinquencies and found a definite relationship. Almost half of those borrowers with FICO scores below 550 became ninety days delinquent at least once during their mortgage. On the other hand, only two out of every 10,000 borrowers with FICO scores above eight hundred became delinquent.
When can I stretch the percentages?
Depending on your area’s housing market, lenders sometimes will allow you to stretch their allowable debt ratios. One of the best ways to encourage your lender to do so is to increase your down payment, as indicated in the following chart:
Underwriters sometimes also will stretch the ratios for other “compensating factors,” including:
- Strong cash reserves after close of escrow
- A new payment that’s only slightly higher than current rent or mortgage payment
- A history of increasing earning capabilities
- A history of an ability to save money
- A large cash down payment
Though you may be willing to spend a certain amount, the real determination of how much house you can afford is driven by how much a lender calculates you can afford. So before you begin to search for the perfect house, it is very important to begin the homebuying process by getting preapproved. Getting preapproved for a home mortgage loan will provide you with a preliminary statement on the size of loan for which you can qualify. Knowing this, you can then focus your home search.
In general, lenders allow your total monthly housing costs to go as high as but not more than 30 percent of your gross monthly income. The second requirement is that not more than 36 percent of your gross monthly income can be tied up in the total monthly house payment and payments on long-term debt.
Lenders use slightly different formulas for determining the “total monthly house payment.” These costs generally include the mortgage principal and interest payment, property taxes as a monthly sum, and hazard insurance as a monthly sum. These four items are referred to as PITI (principal, interest, taxes and insurance). Other costs may be included in this calculation if your down payment is less than 20 percent or if you are responsible for homeowner’s association dues. The calculations may vary from lender to lender, but will provide you with a gauge.
The Preapproval Letter
Your friends and family may know you to be reliable, dependable and someone who pays bills on time, but all others in a real estate transaction will require you to prove it. That’s where preapproval comes in. A preapproval letter is more reliable than a pre-qualification letter. In the preapproval process, a lender will examine your finances and will make a preliminary statement on the size of the loan for which you’ll qualify.
Preapproval is an involved process. The lender will take all pertinent information regarding your finances and perform an extensive check on your current financial status. This procedure will ultimately give you the exact loan amount that you will be eligible for (depending on what type of loan you decide to select.) Being preapproved lets the seller know that you have gone through an extensive financial evaluation and there should be no unexpected obstacles to buying the home. It makes your offer much more powerful.
Preapproval gives you a very good indication of:
- How much down payment you’ll need
- Your closing costs
- Your monthly payment (including PITI: principal, interest, taxes and insurance)
- The type of loan for which you qualify and which best suits your needs; and,
- Special programs for which you may be qualified, including those for veterans, first-time buyers, teachers, etc.
To become preapproved you will need to provide a lender with the following:
- Your employment and income history (including recent pay stubs)
- Your monthly debts
- The amount and source of cash available for the down payment and closing costs
Preapproval letters are not binding on the lender, they are subject to an appraisal of the home you want to purchase and are time sensitive. If your financial situation changes, interest rates rise or a pre-determined date passes, the lender will review your situation and recalculate your maximum mortgage amount accordingly. You can research lenders yourself and ask them to preapprove you.
Making an Offer
A written proposal is the foundation of a real estate transaction. Therefore, you need to enter into a written contract, which starts with your purchase offer. This proposal not only specifies price, but all the term and conditions of the purchase. There are a variety of standard forms used by agents and bound by both the law and local practice. After the offer is written and signed, it will be presented to the seller by your agent in the presence of the seller’s agent, or by the seller’s agent alone.
The purchase offer you submit, if accepted as it is written, will become a binding sales contract (known as a purchase agreement). It is important that it contain all the items that will serve as a “blueprint for the final sale.” The purchase offer includes such items as:
- Address and legal description of the property
- Sale price
- Terms: for example, all cash or subject to the buyer obtaining a mortgage for a given amount
- Seller’s promise to provide clear title (ownership)
- Target date for closing
- Amount of earnest money deposit accompanying the offer, and whether it will come in the form of a check or cash. Also included may be the disposition of the deposit should the buyer back out of the deal at a later date.
- Method by which real estate taxes, rents, fuel, water bills and utilities are to be adjusted (prorated) between buyer and seller
- Provisions about who will pay for title insurance, survey, termite inspections and other details
- Type of deed to be given
- Other requirements such as disclosure of specific environmental hazards, seismic hazards or other locally-specific clauses
- A provision that the buyer may make a final walk-through inspection of the property just before closing
- Any contingencies
The Purchase Agreement
Your agent will use a standard form of Purchase Agreement, developed by the Association of Realtors ® , a local Association of Realtors ® , or a private publishing company, depending on the custom in the area. You can make changes – but the seller must agree to each of the changes you make.In the United States, oral contracts are not enforceable – real estate contracts must be in writing. Even if you give me, your agent, permission to bargain on your behalf, I must have a Purchase Agreement signed by all buyers before I can present your offer.
When you read the Purchase Agreement, try to imagine yourself as an independent party who has no knowledge of the transaction other than what’s included in the contract. Is the meaning of each clause clear? For example, to avoid miscommunication list all personal property you expect to be included in the transaction. Also, it’s a good idea to stipulate the exact date and time of possession – if you’re not specific, you and your moving van could arrive and find that the seller still inside the home!
Specify in the contract that the seller is obligated to repair any damage (along with the conditions causing such damage) noted in the pest control report and the reports of other inspections.
Self-explanatory, but still the most important term. Earnest money
Along with your Purchase Agreement, you will submit earnest money to demonstrate your seriousness about the home. “Earnest Money” is generally between 1% and 5% of the purchase price. If your offer is accepted, the earnest money becomes part of your down payment or closing costs. If the offer is rejected, your money is returned to you. If you back out of a deal against the terms of the contract, you may have to forfeit the entire amount.
“Title” refers to the legal ownership. The seller should provide title, free and clear of claims by others not acceptable to you, the buyer. Title insurance will assure that the home is free of “unacceptable liens” or “encumbrances.” It’s negotiable who will pay for the title insurance policy.
A clause which specifies that the obtaining of a mortgage loan on the property on terms and conditions acceptable to you is a condition of the sale, and provides for the refund of your deposit if you fail to get the mortgage loan.
This clause provides for a pest control inspection and report by a licensed pest control operator. Sometimes sellers will provide this report prior to the purchase agreement. If not, it provides for a method of allocating whether seller, buyer or both will pay for the repairs disclosed by the report. Your lender may require a certificate from a qualified inspector stating that the property is free from termites, pests and dry rot.
I strongly recommend an inspection and written report by a home inspector who is a licensed general contractor to determine the condition of plumbing, heating, cooling and electrical systems, the structure of the home, the grading, roof, siding, windows and doors. Most buyers prefer to pay for inspections (generally between $300 – $500) so that it’s clear that the inspector is working for them, not the seller. I also strongly recommend that you request any such additional inspections as may be recommended by your home inspector, such as a separate roof inspection, foundation or soils inspection, pool inspection, etc. These additional inspections may reveal conditions or defects beyond the ability of a general home inspector to ascertain.
Other Disclosure and Inspection Terms
See the section on “What you need to know” for a detailed discussion of these disclosure and inspection items.
You can specify, in your Purchase Agreement, that certain conditions must be met before the sale goes through. Contingencies are crucial, so be sure to speak up and tell me what’s important to you, so that all of your concerns are reflected in the offer. They may include:
- Your ability to obtain specific financing from a lending institution. This contingency will ensure that if you can’t find the loan, you will not be bound by the contract.
- That the home inspector you hire provides a satisfactory report within 10 days (for example) after the seller accepts your offer. With the proper contingency, if the report does not satisfy you, the contract becomes void.
- The sale of your existing home.
- Obviously, in a slower home sale market, sellers are more willing to accept contingencies than they are during more active circumstances. Too many contingencies in a strong real estate market may prevent your offer from being accepted. Make sure your contingencies are clear.Earnest Money
- This is a deposit that you give when making an offer on a house. A seller is understandably suspicious of a written offer that is not accompanied by a cash deposit to show “good faith.” The real estate agent usually holds the deposit, the amount of which varies from community to community. This amount will become part of the down payment.
In most instances, the buyer will select the escrow company which is also the title company providing the title insurance policy after close of escrow. In some counties where the custom is for the seller to pay for the title insurance policy, the seller will select the escrow and title company.
You can negotiate which closing costs you will pay and which will be paid by the seller. However, be aware that longstanding custom regarding the handling of the allocation of these costs makes many of them hard to negotiate on terms different from local custom. If a seller was obligated to pay a certain closing cost when he or she bought the property, they will expect you, the buyer, to pay the same cost on your purchase. See the section on “Who Pays What?” which details these cost allocations in the area we serve.
Withdrawing an offer
In most cases the buyer may withdraw an offer right up until the moment the offer is accepted. Consult us as to the best and safest way to withdraw your offer.
You will have a binding contract if the seller, upon receiving the written offer, signs an acceptance just as it stands, unconditionally. The offer becomes a firm contract as soon as the signed offer is delivered to you or me, your agent. If the offer is rejected, then the offer is no longer valid. If the seller likes everything except the sale price, or the proposed closing date, or the terms of your offer, you may receive a written counteroffer, with the changes the seller prefers. You are then free to accept or reject the counteroffer, or even to make your own counteroffer.
Each time either party makes any change in the terms, the other side is free to accept or reject it, or counter again. The document becomes a binding contract only when one party finally signs an unconditional acceptance of the other side’s proposal and that final, unchanged document is delivered to the other party or their agent.
How the seller may counteroffer
The buyer and seller can negotiate and agree about any of the terms, conditions, costs and who pays for them. Some terms and conditions that are negotiable include:
- Termite inspection fee and costs to repair any damage
- Closing costs
- Points to the buyer’s lender
- Buyer’s broker
- Repairs required by the lender
- Repairs of conditions or defects disclosed by the seller, uncovered by inspectors, or required by governmental agencies
- Date for the close of escrow
- Date and time for possession by buyer
- A holding over, or rent back, by seller after close of escrow.
The homebuying process is one of discovery. Throughout, you will receive crucial information on the condition of the property – from its physical attributes to the condition of its title. Piece by piece, you will learn what you need to know to make an informed purchase. Following is an explanation of the most significant parts of the puzzle.
Transfer Disclosure Statement
The seller of your property is required by law to furnish you with a “Real Estate Transfer Disclosure Statement,” (TDS), in which the seller will make known to you important disclosures about that property, including any known existing conditions, any hazards or nuisances. For example, if the property drains improperly or if there are cracks in the chimney and the seller knows about it, he or she is required to let you know via the TDS.
In the TDS, the seller’s agent and the buyer’s agent are also obligated to inspect the property and to provide results regarding any known existing conditions, any hazards or nuisances. If the TDS is delivered to you after execution of the offer to purchase, you have three days if the form is delivered to you in person or five days if it is delivered to you by mail, to use it to terminate the contract if you are not satisfied with its contents.
Home Inspection Report
Just as important as the TDS is the home inspection report. While the TDS documents the property’s condition, to the knowledge of the seller, a home inspection will provide you with the additional insight of a construction expert.
As a result, I advise anyone buying a home to first have it inspected by a professional home inspector who is:
- a licensed general contractor
- a member of a recognized home inspection trade group
- has professional liability insurance
Your home inspector will provide you with a written report, which will advise you of the physical condition of the property as determined from the inspection of accessible areas. Generally, the cost is approximately $300-$500.
The report also will identify areas that could not be inspected and may recommend additional inspections by other experts in areas including roofs, foundations, soils, drainage or pools. Less usual, but also recommended from time to time, are inspections for health-related risks such as radon gas, asbestos or problems with water or waste disposal systems. While additional inspections will cost more money, they definitely are worth it if they uncover an expensive defect in the property.
A general inspector will focus on the structure, construction, and mechanical systems of the house, and will make you aware only of repairs that are needed. Generally, an inspector checks (and gives estimated prices for repairs on): the electrical system, plumbing and waste disposal, the water heater, insulation and ventilation, heating and cooling systems, water source and quality, the foundation, doors, windows, ceilings, walls, floors, and roof.
The inspector does not evaluate whether or not you’re getting good value for your money.
Usually, there will be an inspection clause in the contract. Sometimes, the seller will provide a report of a home inspection aid for by the seller. If conditions or defects are disclosed in the report you can:
- Negotiate for the seller to fix the problems prior to close of escrow,
- Receive a credit from the seller for an amount to make the repairs; or
- Cancel the contract if your and the seller cannot agree on the repairs or their costs.
It’s not required that you attend the inspection, but it’s a good idea and I strongly recommend that you do, since generally you will learn a great deal about your property. The inspection also provides a great opportunity to hear an objective opinion on the home you would like to purchase and it is a good time to ask general, maintenance questions of an expert.
Pest Control Inspection Report
While you are in escrow, you should have the property inspected by a licensed pest control professional. While termites or other pest infestations are not common, pest control operators also are trained to look for dry rot, usually caused where wood comes into continuous contact with water. Dry rot can be serious and should be fixed immediately. If any condition is discovered in a pest control report, it needs to be corrected and the property re-inspected by a certified pest control inspector, before you close the sale of the home. Pest control reports generally cost around $200-$300.
Smoke Detector and Water Heater
During the escrow process, sellers are required to provide for you evidence that they have equipped the home with smoke detectors, and that water heaters are braced, anchored, or strapped to resist falling in an earthquake.
How Much Should I Offer?
Generally, I will help you with this. However, there are several things to consider as you develop your purchase offer:
- Is the asking price in line with prices of similar homes in the area? I will conduct research, called a “Competitive Market Analysis” or CMA, on comparable properties, to help you come up with an educated opinion on the worth of the property.
- Is the home in good condition – or will you have to spend a substantial amount of time and money making it the way you want it?
- How long has the home been on the market? If it’s been for sale for a while, the seller may be more eager to accept a lower offer.
- How much mortgage will be required? Make sure you really can afford an offer that you plan to make.
- How much do you really want the home? The closer you are to the asking price, the more likely your offer will be accepted.
Common points of negotiation
The buyer and seller may negotiate many of the associated costs of the transaction. Some common items are: price, financing, closing costs, repairs that need to be made, appliances and fixtures, landscaping, painting and occupancy time frame.
Offers are occasionally rejected outright, but it is common for a seller to counter an offer with terms acceptable to them. But don’t let this stop you. Now you begin negotiating. I will help you.
There are many options to explore:
- Maybe you offer more money, but ask the seller to cover some or all of your closing costs or to make repairs that wouldn’t normally be expected.
- Or, you provide the seller with more time to move in exchange for a price break, if you know extra time is what they need.
- Just remember – don’t get so caught up in negotiations that you lose sight of what you want and what you can afford!
Closing The Deal
It is customary and prudent for a buyer and seller to have a third, disinterested party to assist them in carrying out the terms of their agreement. In California, this procedure is known as an escrow. When opening an escrow, the buyer and seller establish terms and conditions for the transfer of ownership of property. Your escrow is created shortly after you execute the contract to purchase your home. The escrow becomes the depository for all monies, instructions and documents. The Escrow Officer has the responsibility of seeing that all terms of the escrow are carried out.
NOTE: In some states, the process of completing the purchase of a home is known as the “Settlement” process. Often the seller and buyer will come together at the Settlement table where documents are signed and exchanged. There may be a settlement attorney who facilitates this process. In California, the term “Escrow” is used to describe the process of completing the sale of property.
The escrow holds all monies, instructions and documents for the purchase of your home, including your down payment funds and your lender’s funds and documents for the new loan. The escrow officer takes instructions based on the terms of your purchase agreement and your lender’s requirements. The escrow officer can hold inspection reports and bills for work performed as required by your purchase agreement. Other elements of the escrow include hazard insurance, title insurance and the grant deed from the seller to you. Escrow cannot be completed until the instructions (requirements) have been satisfied, and all parties have signed escrow documents.
The escrow holder’s duties include:
- Serve as the neutral agent and the liaison between all parties involved.
- Prepare the escrow instructions.
- Request a Preliminary Title Search to determine the status of title to the property.
- Comply with the lender’s requirements as specified on its instructions to escrow.
- Receive and handle purchase funds from the buyer.
- Prepare or secure the deed and documents related to the escrow.
- Prorate taxes, interest, insurance and rents.
- Secure releases of all contingencies or other conditions imposed on the escrow.
- Record the deed and any other documents.
- Request title insurance policy.
- Close the escrow pursuant to instructions supplied by the seller, buyer and lender, if any.
- Disburse funds as authorized by the instructions, including charges for title insurance, recording fees, real estate commissions and loan payoffs.
- Prepare final statements for all parties involved that account for the disposition of all funds held in the escrow account.
How do I open an escrow?
Your real estate agent will open the escrow for you. As soon as you execute your purchase agreement, your deposit is given to the title company for deposit into the escrow account. How will you know where your money has gone? Written evidence of your deposit generally is included in your copy of your purchase contract. Your funds will then be deposited in your separate escrow or trust account and processed through your local bank.
Escrow instructions define all the conditions that must occur before the transaction can be finalized. Your escrow instructions specify, in a debit and credit format, the disposition of your purchase funds. They also provide for title protection for your home.
What information will I have to provide?
You may be asked to complete a statement of identity. Because many people have the same name, the statement of identity is used to identify the specific person in the transaction through such information as date of birth, social security number, etc. This information is kept confidential.
How long is the escrow?
The length of an escrow is determined by the terms of the purchase agreement and can range from a few days to several months. On average, it takes 30 to 45 days.
While there’s no such thing as a typical homesale – each has a character and a flow of its own – there are certain aspects you can expect. While local real estate practices may vary, here are the basic activities that occur during the transaction, from receiving an offer to closing escrow.
Your role during the escrow process should be an active one. Don’t wait for the seller to volunteer information – stay on top of it yourself and take reasonable care, along with me, your agent, to protect yourself.
For example, when you review the Transfer and Disclosure Statement, TDS, keep an eye out for questions answered “unknown” or left unanswered. Ask about them until you are satisfied with the answers.
Let’s talk about your specific concerns or plans for the property. Concerned about the open parcel behind the house? Ask about it!
You may also wish to investigate the following non-physical conditions, including:
- Governmental zoning, requirements and limitations
- Governmental permits, inspections or certificates
- Limitations, restrictions and requirements affecting use of the property
- Rent and occupancy control
- Proximity and adequacy of law enforcement, crime statistics, proximity of registered sex offenders (see section on Megan’s Law) and other criminals
- Proximity to fire, police and other services
- Proximity to commercial, industry or agricultural activities
- Existing and proposed transportation, construction and development, which may affect noise, view or traffic, airport noise, or odor
- Wild and domestic animals, other nuisances, hazards or circumstances
For Further Protection – Home Warranties: Home warranties have become a more popular option on homes for sale. For protection you may wish to have a home warranty that either you or the seller pays for. (It’s negotiable.) Warranties range in price from $300 – $600 and, for a fixed rate, generally cover limited aspects including plumbing, electrical, pest control and a host of other related areas. If you have a problem, generally you’ll pay $35-$50 to have a professional come out inspect and fix problems that are covered. Warranty agents typically are on hand 24 hours a day, 7 days a week to take your calls in emergencies.
Buyer Disclosures 101
During the escrow process, you will be informed of specialized conditions that affect the home you wish to purchase. They may include the following:
Sellers of properties built prior to 1978 have the following obligations to you:
- Give you a HUD pamphlet entitled “Protect Your Family From Lead in Your Home”
- Disclose all known lead-based paint and related hazards and provide you with any available reports
- Include a standardized warning as an attachment to the contract
- Complete and sign statements verifying that requirements have been met
- Retain the signed acknowledgement for 3 years
- In addition, sellers must give you a 10-day opportunity to test for lead
California law requires sellers to disclose to you, via a “Natural Hazard Disclosure Statement” or NHD, if properties are located in one of six predetermined “natural hazard” zones. (If the property is not within one of these zones, sellers, of course, have no such obligation.)
The six zones are:
- A flood hazard zone as designated by the Federal Emergency Management Agency (FEMA)
- An area of potential flooding after a dam failure (also known as an inundation area)
- A very high fire hazard zone
- A wildland fire area, also known as a state fire responsibility area
- An earthquake fault zone
- A seismic hazard zone
If an NHD is delivered to you after you signed the Purchase Agreement, you will have three days to rescind the agreement. However, if you receive the NHD before you signed the Purchase Agreement then you cannot use the NHD to rescind.
Especially (but not exclusively) if you are buying a home in a newer area, you may be locating into a Mello-Roos tax district, and the seller must provide to you a “Notice of Special Tax” to let you know. If this notice is delivered to you in person, you have three days to rescind your offer. If it’s delivered via U.S. mail, you have five days to decide.
Basically, a “Mello-Roos Community Facilities District” is formed by a local government, district, or agency to finance public services and facilities including police and fire departments, ambulance and paramedic services, parks, schools, libraries, museums and cultural facilities.
If you’re buying a condominium, townhouse or other planned development (for purposes of this discussion, we will call them all “condominiums”), there are things you need to know about common areas (such as greenbelts and recreational rooms) and the homeowner’s association.
You will be required to make monthly payments, known as regular assessments, to maintain common areas, as well as special assessments to replace a roof or repair the plumbing, as determined by the homeowner’s association (HOA.)
Condominiums also may have regulations regarding architectural requirements, limitations on pets, and age restrictions (i.e., senior housing). These must be formally disclosed to you during escrow. You may receive this information via the following documents, to the extent that they exist and are available:
- Declaration of Restrictions: Commonly known as “CC&Rs”, or Conditions, Covenants and Restrictions
- Articles of Incorporation or Articles of Association Bylaws
- All current financial information and related statements, including operating budget, estimated revenue and expenses, HOA reserves, estimated remaining
- life of major components (including roofs, plumbing etc.), and regular and special assessments
- A statement describing the HOA’s policies and practices in enforcing lien rights or other legal remedies for default in payment of its assessments
- A summary of the HOA’s property, general liability, and earthquake and flood insurance policies
- On existing HOA’s, a statement describing any restrictions on the basis of age, such as authorized senior citizen housing
Many smaller HOAs will not have all of these documents, but must provide what they do have. We recommend that you review these documents thoroughly, because they will affect you firsthand.
If a registered sex offender lives in the neighborhood in which you want to locate, you have the right to investigate – this is made possible due to a 1996 statute known as “Megan’s Law.” (Note that the seller does not have an obligation to provide this information to you.)
To investigate, you may:
Log on to: http://caag.state.ca.us/megan/index.htm
Call (900) 448-3000 to access the California Sex Offender Information Database. (There may be a charge to check names by telephone.)
Call your local police department to locate a CD-ROM records viewing station.
- Step 1. The Application
The key to the loan process going smoothly is the initial application interview. At this time the loan officer obtains all pertinent information and documentation so unnecessary problems and delays may be avoided. This is the best time to discuss loan programs best suited to meet the homebuyer’s needs.
- Step 2. Automated Underwriting
After the application is completed, the loan officer inputs the application into the automatic underwriting system. This is an automated financial evaluation program that analyzes the data from the loan application of the borrower, such as income, credit history, debts, property details, debt-to-income rations, etc. This process evaluates the borrower’s financial picture and makes a credit decision. In conjunction with this review, the loan officer requests a credit report run on the borrower(s).
- Step 3. Requesting Documentation
The next step after receiving the initial lending decision is that the loan officer will request certain documents such as bank statements, W2’s (2 years), verification of funds, landlord details and any other supporting documentation that has been requested.
- Step 4. The Homebuyer Goes into Contract on a Property
- Step 5. Loan Submission
Once all of the necessary documentation has been acquired, the loan officer puts the loan package together and submits it to the underwriter for final approval. The final loan package includes the contract on the property, the property appraisal, preliminary title reports and any conditions that were identified in the automated underwriting process. The loan officer submits the final loan package to the underwriter for formal loan approval.
- Step 6. Loan Approval
The underwriter reviews the contract, property appraisal and preliminary title reports and validates the conditions from the automated underwriting process. File disposition is achieved. Assuming all criteria are met, the loan is approved and/or other conditions may be requested as terms of funding.
- Step 7. Rate Lock
The loan officer will discuss the loan programs available to the homebuyer(s) in conjunction with discussing the final loan approval and conditions. Based on the outcome of the property purchase and final loan approval process, the buyer may wish to or need to review other loan programs. A final loan program decision is reached and the request for rate lock is made.
- Step 8. Documents Are Drawn
After the loan approval, the loan documents (including the note and deed of trust) are completed and sent to the title company. The escrow officer calls the borrowers to come in when the papers are ready for final signature. At this time, the borrowers are told how much money they will need to bring in to close the loan.
- Step 9. Funding
Once all the parties have signed the loan documents, they are returned to the lender, who reviews the package. If all of the forms have been properly executed, the funds are then transferred. At closing, the borrower must present a cashier’s check or arrange for a wire transfer of funds directly to the title company for the required closing costs and payments. No personal checks are accepted. Also, funding conditions must be submitted and satisfactorily met at this time.
- Step 10. Recordation
When the title company receives the funding check from the lender, the title company makes the lender’s security for the loan a matter of public record. This is done by recording both the note and deed of trust at the County Recorder’s office. Escrow is now officially closed.
Below are some of the costs you may incur. Some are one-time fees, while others recur over the life of the loan. When you first apply for your loan, you will receive a Good Faith Estimate of Settlement Charges and a booklet explaining these costs, to minimize surprises. Generally, you can expect closing costs to equal from 3 to 6 percent of your mortgage loan amount.Appraisal Fee
This is a one-time fee for an “appraisal,” a statement of property value required on most loans. An independent fee appraiser makes the appraisal. Unique and more expensive homes usually have a higher appraisal fee.
Credit Report Fee
This one-time fee covers the cost of your credit report, which is processed by an independent credit-reporting agency.
Document Preparation Fee
There may be a separate, one-time fee that covers preparation of the final loan papers, including the note and the deed of trust.
Loan Origination Fee
Often referred to as “points,” one point is equal to one percent of the mortgage loan. As a rule, if you are willing to pay more in points, you will get a lower interest rate. Anything in addition to one point is referred to as “discount points.”
Miscellaneous Title Charges
The Title Company will charge fees for a policy of title insurance and escrow services, which may include charges for document preparation, notary fees, recording fees and a settlement of closing fee. These are all one-time charges. Local custom by county will dictate whether buyer or seller pays all or a portion of these fees.
Private Mortgage Insurance (PMI) Premium:
Depending on the amount of your down payment (generally less than 20%), you may be required to pay a fee for private mortgage insurance, which protects the lender against loss due to foreclosure. You may also be required to place funds into a special reserve account (called an impound account) for PMI, which will be held by the lender.
Depending on the day of the month your loan closes, this charge may vary from a full month of interest to just a few days of interest. If your loan closes near the end of the month, you will have to pay only a few days of interest.
Taxes and Hazard Insurance
Based on the month you close, property taxes will be prorated between you and the seller. You may also be required to pay a full year’s hazard insurance (or homeowner’s insurance) premium in advance. In addition, you may also be required to place funds into a special reserve account (impound account) for taxes and insurance, which is held by the lender. You absolutely must have this to obtain a mortgage.
The “dwelling coverage” portion of your hazard insurance covers costs to completely rebuild your home, while the “liability coverage” protects you against accidents that occur on your property. “Personal Property Coverage” pays to replace your possessions and generally totals 50 to 75 percent of the dwelling coverage amount. Flood and earthquake insurance policies also are available and are recommended if you are in high-risk areas.
Title Insurance Fees
There are two title polices – a buyer’s policy, which protects the new homeowner, and a lender’s title policy that protects the lender against loss due to a defect in the title. These are both one-time fees.
Closing Costs: The Good Faith Estimate
The Good Faith Estimate
The Good Faith Estimate of loan closing costs are made pursuant to the requirements of the Real Estate Settlement Procedures Act (RESPA). These are estimated settlement costs which the buyer will be responsible for in conjunction with the settlement of the mortgage loan. There are two general categories of closing costs, non-recurring and recurring. Non-recurring closing costs are items that are paid once, while recurring costs are items paid repeatedly over the life of the loan.
This is a detailed summary of costs you may have to pay when you buy or refinance your home. They are listed in the order in which they should appear on a Good Faith Estimate you obtain from your mortgage lender. Elements of the Good Faith Estimate are: (Costs will apply differently to each homebuyer and are not particular in total to all homebuyers)
Non-Recurring Closing Costs Associated with the Lender:
- Loan Origination Fee
- Loan Discount Fee
- Appraisal Fee
- Credit Report Fee
- Lender’s Inspection Fee
- Mortgage Broker Fee
- Tax Service Fee
- Flood Certification Fee
- Flood MonitoringOther Lender Fees
- Document Preparation Fee
- Underwriting Fee
- Administration Fee
- Appraisal Review Fee
- Warehousing Fee
Items Required to be Paid in Advance
- Prepaid Interest
- Homeowner’s Insurance
- VA Funding Fee
- Up Front Mortgage Insurance Premium (UFMIP)
Reserves Deposited with the Lender:
- Homeowners Insurance Impounds
- Property Tax
- Mortgage Insurance ImpoundsNon-Recurring Closing Costs not associated with the Lender:
- Closing/Escrow Fee
- Title Insurance
- Notary Fees
- Recording Fees
- Pest Inspection
- Home Inspection
- Home Warranty
- Homeowner’s Association Transfer Fee
Refinancing Associated Costs
- Reconveyance Fee
- Demand Fee
- Sub-Escrow Fee
- Loan Tie-In Fee
NON-RECURRING CLOSING COSTS ASSOCIATED WITH THE LENDER:
Loan Origination Fee: The loan origination fee is often referred to as “points”. One point is equal to one percent of the mortgage loan. As a rule, if a borrower is willing to pay more in points, then the borrower will get a lower interest rate.Loan Discount Fee: On a government loan, the loan origination fee is normally listed as one point or one percent of the loan. Any points in addition to the loan origination fee are called “discount points”. On a conventional loan, discount points are usually lumped in with the loan origination fee.
Appraisal Fee: Since the property serves as collateral for the mortgage, lenders want to be reasonably certain of the value and they require an appraisal. The appraisal is used to determine if the price you are paying for the home is justified by recent sales of comparable properties. The appraisal fee varies, depending on the value of the home and the difficulty involved in justifying value. Unique and more expensive homes usually have a higher appraisal fee. Appraisal fees on VA loans are higher than on conventional loans.
Credit Report Fee: As part of the underwriting review, the mortgage lender will want to review the borrower’s credit history. The cost varies depending upon the type of report requested.
Lender’s Inspection Fee: This is generally associated with new construction and is associated with what is called a 442 inspection. Since the property is not finished when the initial appraisal is completed, the 442 inspection verifies that construction is complete with carpeting and flooring installed.
Mortgage Broker Fee: About seventy percent of loans are originated through mortgage brokers and sometimes the points associated with the loan are listed here instead of under Loan Origination Fee. They may also add in any broker processing fees in this area. The purpose is to clearly indicate how much is being charged by the wholesale lender and how much is charged by the broker. Wholesale lenders offer lower costs/rates to mortgage brokers than you can obtain directly, so you are not paying “extra” by going through a mortgage broker.
Tax Service Fee: During the life of the loan the borrower makes monthly property tax payments, either on one’s own or through an impound account with the lender. Since property tax liens can sometimes take precedence over a first mortgage, it is in the lender’s interest to pay an independent service to monitor property tax payments.
Flood Certification Fee: The lender must determine whether or not the property is located in a federally designated flood zone. This fee is usually charged by an independent service to make that determination.
Flood Monitoring: From time to time flood zones are re-mapped. Some lenders charge this fee to maintain monitoring on whether this re-mapping affects the property.
Document Preparation Fee: Before computers made it fairly easy for lenders to draw their own loan documents, they used to hire specialized document preparation firms for this function. This was the fee charged by those companies. Now lenders draw their own documents and a fee is charged on almost all loans.Underwriting Fee: A fee is charged for the cost of underwriting the loan.
Administration Fee: If an Administration fee is charged, then generally there will not be a fee for underwriting.
Appraisal Review Fee: Even though a borrower will probably not see this fee on a Good Faith Estimate, it is charged occasionally. Some lenders review appraisals as a quality control procedure and charge for the activity.
Warehousing Fee: This is rarely charged, however, some lenders have a warehouse line of credit and add this as a charge to the borrower.
ITEMS REQUIRED TO BE PAID IN ADVANCE:
Prepaid Interest: Mortgage loans are usually due on the first of each month. Since loans can close on any day, a certain amount of interest must be paid at closing to get the interest paid up to the first of the month.Homeowner’s Insurance: This is the insurance paid to cover possible damages to the home and other items. Normally the first year’s insurance is paid at the close. When purchasing a condominium, the Homeowner’s Association Fees normally cover this insurance.
VA Funding Fee: On VA loans, the Veteran’s Administration charges a fee for guaranteeing the loan. Based upon the use of the borrower’s VA eligibility, the fee is either two or three percent of the loan balance. Instead of paying for this as an expense, commonly it is financed into the loan balance.
Up Front Mortgage Insurance Premium (UFMIP): This is charged on FHA purchases of single family residences or Planned Unit Developments and is 2.25% of the loan balance. Like the VA Funding Fee it is normally added to the balance of the loan.
Mortgage Insurance: Though rare, some first time homebuyer programs require the first year mortgage insurance premium to be paid in advance. Most mortgage insurance is simply paid monthly along with the mortgage payment. Mortgage insurance covers the lender and covers a portion of the losses in those cases where borrowers default on the loan.
RESERVES DEPOSITED WITH THE LENDER:
Homeowners Insurance Impounds: The lender will divide the annual premium by twelve to determine the estimated monthly payment to the impound account. Since the lender is allowed to keep two months of reserves in the account, the borrower will need to deposit two months’ premiums into the impound account in the beginning.Property Tax Impounds: This amount varies according to when the real estate transaction closes and when the taxes are due.
Mortgage Insurance Impounds: When required, lenders allow this premium to be paid monthly. However, a borrower may be required to put two months’ worth of mortgage insurance payments as an initial deposit into the impound account.
NON-RECURRING CLOSING COSTS NOT ASSOCIATED WITH THE LENDER:
Closing/Escrow Fee: The fees associated with the closing.Title Insurance: Title Insurance assures the homeowner that they have clear title to the property. The lender also requires it to insure that their new mortgage loan will be in first position.
Notary Fees: Most loan documents have multiple sets that must be notarized.
Recording Fees: Certain documents are recorded with the local County Recorder’s Office.
Pest Inspection: This is also referred to as Termite Inspection. This inspection tests for pest infestations and other items such as wood rot and water damage. If repairs are required, the amount to cover those repairs is usually covered by the seller, but it is a negotiable item. Usually the pest inspection fee is paid by the seller and is not normally reflected on the Good Faith Estimate.
Home Inspection: Since it is the homebuyer’s choice to obtain a home inspection, this cost may not be reflected on the Good Faith Estimate. However, it is highly recommended.
Home Warranty: This is an optional item. A Home Warranty usually covers such items as the major appliances, should they break down within a specific time. Often this is paid by the seller.
Homeowner’s Association Transfer Fee: When buying a condominium or a home with a Homeowner’s Association, the association often charges a fee to transfer all of their ownership documents to the buyer.
REFINANCING ASSOCIATED COSTS:
Interest: When closing the transaction on a refinance, there may be outstanding interest due on the old loan.Reconveyance Fee: This fee is charged by the existing lender when they “reconvey” their collateral interest in the property back to the borrower through recording of a Reconveyance.
Demand Fee: The existing lender may charge a fee for calculating payoff figures.
Sub-Escrow Fee: This fee is actually charged by the Title Company.
Loan Tie-In Fee: This fee is charged by the Escrow Company.
The Escrow Process
After all of the contingencies have been removed or satisfied, your loan has been finally approved and documents have been drawn, you are now ready to close the escrow. Here are some of the things that you should think about in advance of closing.
When do I sign escrow instructions and where do I do this?
Your escrow officer or myself will contact you to make an appointment for you to sign your escrow instructions and final loan papers. At this time, the escrow officer will also tell you the amount of money you will need (in addition to your loan funds). Your loan funds will be sent directly to the escrow by the lender. You may sign your escrow instructions and loan documents at a title company office, your real estate agent’s office or some other location agreed upon by all parties.
What should I look out for during the final walk-through?
Prior to your closing-day escrow appointment, if provided in your Purchase Agreement, you will have the chance to perform, with your agent, a walk-through. This will likely be the first opportunity to examine the house without furniture, giving you a clear view of everything. Check the walls and ceilings carefully, as well as the results of any work the seller has agreed to do in response to the inspection’s findings. Any problems discovered previously that you find uncorrected which the seller agreed to correct, should be brought up prior to closing.
In order for escrow to close, you must provide what is known as “Good Funds.” This means that escrow can close:
- On the same day as your deposit if the final down payment and closing funds are deposited by cash or electronic transfer (“wired funds”).
- On the next business day after the business day of the deposit, if the funds were deposited by cashier’s check, teller’s check or certified check.
- If the payment is made by personal or business check, when the deposit is made available for withdrawal by depositors. Depositing banks may hold these
- types of funds for up to three business days for most “local” items and up to seven business days for “non-local” items.
The Escrow Appointment
Once your loan is approved, you will be asked to go to the Title Company to sign the loan documents and escrow instructions that specify disposition of your loan funds. You will sign these documents in the presence of a notary public. When you’ve signed everything, your lender will make one final review of the documents and conditions for closing. Once completed, the lender will send the loan funds to escrow. Often, lenders require three business days before the loan is funded. Below is a list of items you will need in preparation for the appointment to sign escrow papers:
Identification — One of the following forms of identification must be presented at the signing of escrow in order for the signature to be notarized: a current driver’s license, passport, State of California Department of Motor Vehicles ID card.
Cashier’s Check — You need a cashier’s check or a certified check issued by a California (or your state) or your financial institution made payable to the title company. If using a personal check, the title company may delay the closing until the check has cleared.
Fire and Hazard Insurance — You must have fire and hazard insurance in place before the lender will send the money to fund the loan. Whenever you buy a home, you must have insurance. Provide your escrow officer with the insurance agent’s name and contact information so they can make sure that the policy complies with your lender’s requirements.
What’s the next step after I’ve completed my sign-off?
After you have signed all the necessary instructions and documents, the escrow officer will return them to the lender for a final review. Upon completion, the lender advises your escrow officer that the loan is ready to be funded.
What is an “escrow closing?”
Once all the conditions of the escrow have been satisfied, the escrow officer advises you of the date the escrow will close and takes cares of the technical and financial details. The culmination of the transaction, an escrow closing signifies legal transfer of title from the seller to you. Usually the Grant Deed and Deed of Trust are recorded within one working day of the escrow officer’s receipt of loan funds. This completes the transaction and signifies the “close of escrow.”
What do I get at closing?
Escrow will record the deed of trust, disburse the funds, provide both parties with a final financial accounting in the form of a settlement statement, and close the escrow.
- Settlement Statement
- HUD-1 Form (itemizes services provided and the fees charged; it is filled out by the closing agent and must be given to you at or before closing)
- Truth-in-Lending Statement
- Mortgage Note
- Mortgage or Deed of Trust
- Keys to your new home
What can I expect to happen on closing day?
You’ll be asked to present your paid homeowner’s insurance policy or a binder and receipt showing that the premium has been paid. The closing agent will then list the money you owe the seller (remainder of down payment, prepaid taxes, etc.) and then the money the seller owes you (unpaid taxes and prepaid rent, if applicable). The seller will provide proofs of any inspection, warranties, etc. Once you’re sure you understand all the documentation, you’ll sign the mortgage note, promising to repay the loan. The seller will give you the title to the house in the form of a signed deed.
You’ll pay the lender’s agent all closing costs and, in turn, the lender will provide you with a settlement statement of all the items for which you have paid. The deed and mortgage will then be recorded in the County Recorder’s office. At that point, you officially will be a homeowner.
In some cases, the escrow agent will be instructed to hold funds in escrow to pay off obligations, which may not be completed until after the close. For example, funds may be set aside to correct a structural problem, remodeling or termite repair work. Upon completion of the project, the escrow agent, having received proper documentation and releases will disburse the reserved funds.
When will I receive the deed?
The original deed to your home will be mailed directly to you at your new home by the County Recorder’s office. This usually takes several weeks and may take longer depending on regional activity.
After the close…
If the funds from the new loan are being used to pay off an existing loan (generally, if you are selling one property and buying another), the old lender is required by law to issue a full reconveyance (release) of its loan. As soon as the deed of reconveyance removing the previous deed of trust is received, it must be recorded and the original will be returned to you. This may take several weeks. However, this delay is normal, and is nothing to be concerned about.
Your lender may retain this loan in its own portfolio or may sell the loan to either a private or public agency, such as the Federal National Mortgage Association (Fannie Mae). In either case, you will receive specific instructions as to how to make your loan payments.
Finding a Home Loan
Unless you’re planning to make an all-cash purchase (in which case you’ll be a very popular buyer!), you’re going to have to secure a mortgage. Though the process can be complex and daunting, it helps to understand what to expect and to take the time up front to really sit down and know what you want and need from your lender. This section is devoted to helping you reach both those aims.
In exchange for your mortgage, you will pledge your home as security for repayment of your loan. The lender agrees to hold the title to your property until you have paid back your loan plus interest. A mortgage loan is composed of two major components: principal and interest.
Principal is the actual amount of money you borrow. If you borrow $150,000, your mortgage principal is $150,000.
Interest is what you pay for the use of the money you borrow. How much you pay depends on a number of factors, including the interest rate, the type of loan and other factors, which are outlined in this guide. Interest can be deducted from your taxes, making it one of the most attractive practical benefits of home ownership. Your tax advisor will be able to provide more details about the tax savings benefits.
Amortization refers to the way in which the balance of principal versus interest changes over time. During the first few years of your mortgage (typically for the first 2 to 3 years of a 30-year loan) most of your payments will be applied toward interest. During the final years of your loan, your payments will be applied almost exclusively to the remaining principal. This process is called amortization.
How should I choose a lender?
Carefully! Look for financial stability and a reputation for customer satisfaction. Select a company that gives helpful advice and that makes you feel comfortable. It is best to select a lender that has the authority to approve and process your loan locally, so you can more easily monitor the status of your application and ask questions. Plus, it helps when the lender knows about local home values and conditions. Do research — ask your agent, family and friends for recommendations.
What is the best way to compare loan terms between lenders?
Speak with companies by phone, in person, or search the Internet. In addition to your research, I can provide a variety of proven lender and mortgage options. While competitive rates are important, remember that most lenders get their money from the same sources and therefore essentially have the same rates. As a result, the decision often comes down to other factors.
The Interest Rate
Interest Rates are most important when you lock a loan. What is important is that you have a loan program that fits your particular financial situation and needs at the time you purchase your home. Remember that each 1/4 point (0.25%) may not have as much impact as you think.
There are four main sources from which you can obtain a home loan:
- Savings and loan associations
- Commercial banks
- Mortgage bankers
- Mortgage brokers
- Savings and loan associations (S & Ls)
Historically, Savings and Loan organizations have concentrated on home loans. However, with deregulation, the U.S. government has opened the door for S & Ls to provide checking accounts, savings accounts, personal and business loans, etc. Nevertheless, their primary lending focus still is on home loans.
The largest and most diverse of all finance institutions, commercial banks offer a wide variety of services including savings accounts, investments, charge cards, as well as commercial, personal, residential and business loans, among others.
Mortgage bankers typically use their own money to fund mortgages; however, they ultimately sell the loans to another entity such as a bank, a savings and loan, pension or retirement funds, private investors or government agencies such as FNMA (“Fannie Mae”) or GNMA (“Ginnie Mae”), which purchase residential mortgages. When mortgage bankers sell a block of mortgages, they often will continue to service the loan and will be responsible for the collection of your payments. The mortgage banker is paid a small percentage of the interest (usually 1/4 % to 1/2 %) for this servicing agreement.
Unlike mortgage bankers, mortgage brokers do not loan their own money. Mortgage brokers will arrange financing for a borrower from a lender, which could be a bank, savings and loan, a private individual or a credit union or pension fund. As the liaison between borrowers and lenders, they are paid a commission or a fee, which is paid by the borrower, the seller or even the lender.
While there seem to be hundreds of different mortgages available, they all fall into a few basic categories. Some may fit your needs well, while other programs may be unwise or unattainable. It’s important to realize that the best product depends on where you are in your life. The best choice is the loan program that best fits your needs at the time you purchase a home.
In recent years, lenders have developed a greater variety of loan programs, mainly because they have found that homebuyers have a variety of different needs. First Time buyers, families “moving up” into larger homes as they need more space, or moving into smaller homes after children have gone on to start their own families; all have different needs. There are so many different individual loan programs available that to compare them all would be impossible. The following provides brief descriptions of the most common categories of mortgage loans.
Fixed Rate Mortgages
Fixed-rate mortgages are the most popular type of mortgage. With this mortgage, the interest rate will remain the same for the entire term of the loan. Typically, the longer the term of the mortgage, the more interest is paid over the life of the loan.
Adjustable rate mortgages all have certain similar features. They have an adjustment period, an index, a margin, and a rate cap. The adjustment period is simply how often the rate changes. Some change monthly, some change every six months, and some only adjust once a year. An Adjustable-rate mortgage (ARM) is a mortgage in which the interest changes periodically according to corresponding fluctuations in an index. All ARMs are tied to indexes. Indexes are simply an easily monitored interest rate that moves up and down over time. Adjustable rate mortgages vary and are tied to different indexes.
This is a “traditional” mortgage, not directly insured by the Federal Government. Most conventional loans under $300,700 are administered through Fannie Mae or Freddie Mac (private corporations but regulated by the government). Loans greater than this amount are called “jumbo loans” and are funded by the private investment market.
These loans are insured by (but not funded by) the Federal Housing Administration (FHA) a division of the U.S. Department of Housing and Urban Development (HUD), and designed for, in general, low- to middle-income borrowers and many first time buyers. There are, however, limits to the maximum loan amount which will vary from county to county. FHA loans have somewhat more relaxed qualifying standards and ratios than conventional loans and have the availability of both 15 and 30 year fixed as well as 1 year adjustable mortgages.
For those qualified by military service, the Veteran’s Administration (VA) insures (but does not fund) 15 and 30 year fixed as well as 1 year adjustable mortgages with lower down payment requirements and somewhat more lenient qualifying ratios.
No/Low Down Payment Mortgages
Sometimes having enough funds for the down payment and closing costs as required by a basic fixed-rate mortgage is not achievable. There is an array of no and low down payment mortgages. These types of loans are designed for homebuyers’ varying needs and take into account the many other factors that qualify the financial condition of the borrower. Some loans are designed for buyers with good credit histories, some offer more flexible qualifying requirements and may be helpful for limited incomes, and others balance a low down payment with a higher interest rate.
Some adjustable rate mortgages allow the interest rate to fluctuate independently of a required minimum payment. If a borrower makes the minimum payment it may not cover all of the interest that would normally be due at the current interest rate. In essence, the borrower is deferring the interest payment, which is why this plan is called “deferred interest.” The deferred interest is added to the balance of the loan and the loan balance grows larger instead of smaller, which is called negative amortization.
Mortgage hybrids are a cross between a fixed rate and an adjustable-rate mortgage. They generally have fixed rates for the first three, five, seven or ten years and then they convert to adjustable-rate mortgages (ARMs) for the remainder of the loan term. With hybrid loans the fixed rate is established up front. Once the fixed-rate portion of the loan ends, the mortgage then behaves like an ARM with rate changes and monthly payments moving up and down each year as interest levels change. The attractiveness of these types of loans is that a borrower can sometimes find a 5/1 ARM rate at up to a full percentage point below a comparable fixed rate loan, and for several years the homeowner can benefit from a lower rate. Generally, the shorter the fixed-rate period, the better the up-front discount, the longer the fixed-rate period, the smaller the discount when compared to 30-year financing.
Loan Terms: 15, 20 or 30 Years
As the term of the loan (period over which the loan is paid) decreases, so does the amount of total interest paid. It is a good exercise to make a comparison between a 15 year term monthly payment and a 30 year term monthly payment. The monthly payment difference is often smaller than anticipated. The savings over the term of the loan, however, can be substantial. For example, comparing a 15 year term to a 30 year term, $100,000 mortgage at an 8.5% fixed rate yields the following:
- If you cannot qualify for a shorter term loan, try to add at least the amount of 1 additional payment per year—this will take nearly 10 years off a 30 year loan.
- Points or No Points
- A large component of your mortgage decision has to do with one of the first charges associated with the loan. This is the “points” attached to the mortgage.
- A point is equal to 1% of the loan amount, and is paid to the lender or the mortgage broker at closing. Each loan product and buyer situation is different.
- You will need to understand your options and make the best decision based on your situation.
Thirty-year fixed rate loans are what most people think of when they hear the word “mortgage.” Fixed rate loans are also referred to as “fully-amortized” loans. One of the aspects that buyers like about fixed rate loans is that the payments stay the same for the life of the loan. Generally, these loans are offered in a 15- or 30-year duration.
A 30-year loan will provide larger tax deductions, as you will be paying more interest than principal during the first 23 years of the loan. A 15-year loan, on the other hand, is paid off twice as quickly and usually has a lower interest rate. You build more equity because your payments pay more principal. As mentioned earlier, you (or the seller) also can “buy down” your loan by paying more tax-deductible points up front, to lower your fixed interest rate.
Balloon Loan A fixed loan that is amortized over a 30-year period but becomes due and payable at the end of a shorter term (i.e., 5, 6, 7 or 10 years). Some of these loans have an option to be extended with a new rate or rolled into another type of loan. Usually, the rates of these loans are lower than those for a regular 30-year fixed rate loan, but they are not recommended if you plan to stay in the home for a longer period of time.
Graduated Payment Mortgage (GPM) A fixed-rate loan that has payments starting lower than the payments on a standard fixed rate loan, which increase by a predetermined amount each year for a specific number of years, usually five years.
Adjustable Rate Mortgages (ARMs) are attractive to many homebuyers for one reason: lower payments in the first years of the loan. Typically, an ARM will have a low introductory rate, sometimes called a “teaser” rate. This rate is usually much lower than the fixed rates available at that time.
Adjustable rate mortgages (ARMs) have payments that increase or decrease on a regular schedule, and are linked to specific economic indexes or margins. These indexes measure borrowing and lending costs throughout the United States and are independent of the lender and can be independently verified at any time. (Many ARMs are indexed to Treasury bills or securities, Certificates of Deposit and other rates.)
When comparing ARMs that have different indexes, look at how the index has performed recently. Some indexes are published in newspapers, making them easy to track. Lenders are required to provide you with information on how to track the index and a 15-year history of the index, but keep in mind that past performance is not necessarily indicative of future performance.
An ARM will have a low Initial Interest Rate, sometimes called “teaser” rate. The loan will begin to adjust at a certain interval, usually every six months or annually. When the loan adjusts, the lender will use three things to determine the new interest rate: the index, the margin and the cap(s).
The index is a benchmark by which changes in the market interest rates are gauged. Common indexes include the 1 Year T-bill, the 11th District Cost of Funds, Prime, LIBOR, or even Certificate of Deposit (CD) rates.
In order to determine the new rate on the adjustment date, the index is added to the margin. The easiest way to understand the margin is to put the word “profit” in front of it. It is the amount of excess of the index that the lender is going to charge in interest; it is essentially the lender’s profit margin.
To insure that your payments do not change dramatically in any given six-month or one-year period, adjustable rate mortgages provide protection in the form of interest rate caps. There are two kinds of interest rate caps: periodic (annual, semi-annual, etc.) and lifetime. For example, a loan may have a semi-annual rate cap of 1%, or an annual rate cap of 2%. The loan will also have a lifetime rate cap, frequently 6% over the initial rate. The caps insure that even if interest rates rise rapidly, the monthly mortgage payment will not be as dramatically affected.
Is an ARM for You?
Would you like a loan with an interest rate below a 30-year fixed rate mortgage and pay zero points? A loan for which you do not have to document your income, savings history or source of down payment? These benefits can all be possible with an Adjustable Rate Mortgage. There are numerous advantages to ARM loans.
Some common advantages are:
- The ability for borrowers to qualify when they might not do so with a fixed rate mortgage;
- The possibility of obtaining a larger loan and a more expensive home;
- The chance that the rates may go down without refinancing; and,
- Often, there are less costs to obtain the loan.
However, with an ARM, there is the likelihood that your rate and payment will increase during the life of the loan. Adjustable Rate Mortgages all have an adjustment period, an index, a margin and a rate cap. The “adjustment period” simply indicates how often the rate changes. Some rates change monthly, some change every six month, and some only adjust once a year. Indexes are monitored interest rates over time. ARMS have different indexes. The margin does not change during the life of the loan.
How do I choose the best loan program for me? Your personal situation will determine the best kind of loan for you.
- Do you expect your finances to change over the next few years?
- Are you planning to live in this home for a long period of time?
- Are you comfortable with the idea of a changing mortgage payment amount?
- Do you wish to be free of mortgage debt as your children approach college age or as you prepare for retirement?
Your lender can help you use your answers to questions such as these to decide which loan best fits your needs. The remainder of this article will outline for you why these questions – and the answers you provide to them – are a crucial part of your loan search.
How large of a down payment do I need?
There are mortgages now available that only require a down payment of 5% or less. But, generally speaking, the larger the down payment, the less you have to borrow, and the more equity you’ll have. Mortgages with less than a 20% down payment generally require a private mortgage insurance policy (PMI), which can be expensive.
Nevertheless, PMI is a fact of life for many homeowners. Even if you begin your mortgage with PMI, with time and appreciation, you often can reach 20 percent equity – at which time you can have the PMI removed. Often, removing PMI is just a matter of asking the lender, paying for an appraisal, paying a fee to the lender (approximately $300 – $500) and providing the necessary paperwork.
What does the interest rate really mean to me?
A lower interest rate allows you to borrow more money than a high rate with the same monthly payment. Interest rates fluctuate from day-to-day, so ask lenders if they offer a rate “lock-in,” which guarantees a specific interest rate for a certain period of time.
Remember that a lender must disclose to you the Annual Percentage Rate (APR), which shows the cost of a mortgage in terms of an annual interest rate. Because it includes the cost of points, mortgage insurance and other fees, the APR generally will be higher. It will provide you with a good estimate of the actual cost of the loan.
What happens if interest rates drop after I finalize my fixed-rate loan?
If rates drop more than two percentage points or so and you plan to be in your home for the next 18 months, you may want to consider refinancing. However, since refinancing may require you to pay many of the same fees paid at the original closing, plus origination and application fees, you should make this decision carefully.
What are discount points?
Discount points (or just plain “points,” as they are frequently called) allow you to lower your interest rate by paying prepaid interest up front. Each point equals 1% of the loan amount, and generally, each point paid on a 30-year mortgage will reduce the interest rate by 1/8 (or.125) of a percentage point. Sometimes lenders will provide you with the opportunity for a “buy down” – which literally offers you a chance to buy down the cost of the loan by paying more points up front.
When you shop for a loan, ask lenders for an interest rate with no points. Then, ask them how much the rate decreases with each point paid. Discount points are smart if you plan to stay in a home for some time since they can lower your monthly loan payment. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay some of them.
What’s considered a reasonable loan fee?
In most cases, loan fees should not exceed 5 percent of the loan amount, unless you are paying for a lower interest rate. However, there may be exceptions. I can help you evaluate loan fees and to understand exactly how much the entire loan will cost. It’s important to know all your loan costs up front.
Once you have selected the type of loan you prefer and qualify for, the lender will ask you to complete a loan application, which will require a great deal of personal and financial information, including the following:
1) Your residence history
• Your previous addresses for the past two years
• The length of time you’ve lived at each address
• If you currently rent, your landlord’s name and addresses (for past 12 months)
2) Your employment history
• The names and addresses of all your employers for the past two years
• The dates you worked at each place of employment
• If there have been any gaps in your employment, explain why
3) All outstanding loans and credit cards
• The creditor’s name(s) and address(es)
• Your account number(s)
• The current total balance you owe and the months left to pay
• The amount of the monthly payment
4) Savings, checking or investment accounts
• The names and addresses for each financial institution
• Your account numbers
• The current balance or value
5) Real estate you currently own
• The property address(es)
• The estimated market value
• The outstanding loan balance
• The amount of your monthly payment (including taxes, insurance, homeowner’s association dues)
• The amount of your rental income (if applicable)
6) Personal property you own
• The net cash value of your life insurance
• The make, year and value of your automobile(s)
• The value of your furniture, jewelry and other personal property
7) Tax records
• Some lenders may require copies of your tax records from the previous two years
Being prepared with the necessary documentation will expedite the mortgage loan process. Here’s a checklist, so you don’t forget what you’ll need to efficiently move the loan process along:Real Estate Contracts
____ Purchase Agreement (for the purchase of your new home).
____ Sales contract (if you are selling a home).
____ Past 24 months of residence with complete addresses.
____ Length of time you lived at each address.
____ Name of landlord and his/her address (if currently renting).
____ All original pay stubs for past 30 day period.
____ Employers for the past two years with complete addresses.
____ Dates of employment for each job.
____ W2s for most recent two years.
____ Most recent tax returns (with all schedules) for past two years.
____ If there have been any gaps in employment, prepared explanations.
____ Copies of most recent monthly statements for all loans and credit card balances.
____ Copies of most recent three months’ bank statements for all accounts, stock brokerages, mutual funds, IRAs, Pensions, etc.
____ If you are self employed or received a 1099, your most recent tax returns for the past two years with all schedules and a year-to-date profit and loss statement and balance sheet.
____ If you own 25% or more of a corporation, the most recent corporate tax returns for the past two years with all the schedules and a year-to-date profit and loss statement and a balance sheet.
Current Real Estate
____ Property addresses.
____ Estimated market values of property.
____ Amount of monthly payment and outstanding loan balances (bring copy of most recent loan statement).
____ If you own rental property, your most recent tax returns for the past two years with all schedules and a current agreement.
____ Net cash value of your life insurance.
____ Year, make and value of all vehicles.
____ Value of your furniture and personal property.
Bring your federal tax forms for the past two years, along with a profit and loss statement.Separated or divorced
Bring a copy of your divorce decree and separation agreement, plus documentation of any alimony or child support payments you are required to make. If you are receiving alimony or child support and want it to be considered as income, you’ll need proof of this income such as the court clerk’s history of payments or cancelled checks for the past 12 months.
Including pension, disability, Social Security or any other form of public assistance with your income. Bring a copy of an award certificate or a check from the issuing agency.
If you have had a bankruptcy, a foreclosure or judgments against you over the past seven years, bring information on the proceedings. Information on bankruptcies should include a copy of the bankruptcy discharge and schedule of both debts and assets. Judgments against you should include an attorney’s letter that discusses the outcome of the proceedings.
Applying for a Department of Veterans Affairs (VA) loan
Bring your DD214 form (discharge) papers or your certificate of eligibility.
When your loan is submitted for underwriting, it goes directly into the hands of an underwriter whose job is to determine your “creditworthiness” or your ability to repay the loan. An underwriter takes into consideration the following aspects when deciding whether or not to approve your loan:
Your work history
A stable history of employment in the same line of work is considered ideal. Job-hopping is not. However, if you have switched jobs within the same line of work for advancement in your field, it should not be a problem.
In looking at your ability to repay the loan, your job stability and gross income (in relation to your expenses) are critical. Most income must be verified as having been received for at least two years to be used for qualifying purposes.
Your credit history
Via your credit report, the underwriter looks at your past payment history. A consistent pattern of late payments, collections, etc., obviously is not looked upon favorably – and you will be asked to explain about your bad credit conditions. Bankruptcies generally must be discharged for at least two years, the reason explained, and you generally must reestablish credit to be considered.
The underwriter wants to see your net worth, determined as: the money you have available for a down payment, closing costs, cash reserves (money left over after closing of escrow to cover 2-3 months mortgage payments) and other liquid assets. The underwriter also will want to see the “source of funds” – where the money for the down payment and closing costs is coming from. Don’t move money around (pay off bills, receive a gift, etc.) without first consulting your loan officer about the best way to do it, since it may affect the underwriter’s view of your loan.
The underwriter will be concerned with the amount of debt you have because it affects your qualification and ability to repay the loan. Excessive use of credit may not be looked upon favorably.
Because the property is the lender’s collateral for the loan, the value, marketability and condition of the property are extremely important. The underwriter looks at the appraisal for this information, and generally verifies that the appraisal and the purchase price are in the same ballpark.
Your monthly mortgage payment is made up of several components. This housing expense is commonly referred to as “PITI” or principal, interest, taxes and insurance. PMI (see below) and homeowner’s association dues may also make up a portion of your total payment.
The original balance of money loaned, excluding interest. Also, the remaining balance of a loan, excluding interest. Interest is calculated based on the principal.
The charge, in dollars, for the use (loan) of the money.
The county assessor determines the property tax based on the value of your home. There are two tax installments due each year. The first installment is due November 1st and is delinquent after December 10th. The second installment is due February 1st and is delinquent after April 10th.
Taxes may be impounded, depending on the amount of your down payment. (A down payment of less than 20% usually requires an impound account).
An impound account, set up by the lender, is a trust account to which a portion of the monthly payment is credited so that funds will be available for the payment of taxes and insurance when they’re due. This way, the lender actually pays your tax bill for you. (Supplemental taxes usually are still the responsibility of the homeowner.)
An insurance policy pays for the loss of a home from certain hazards, including fire. You obtain homeowner’s insurance from your own insurance agent. The standard policy pays replacement costs, minus depreciation based on actual cash value. Talk to your insurance agent about the different types of insurance available. Hazard insurance expense may also be impounded in the trust account with taxes.
Private Mortgage Insurance (PMI)
Depending on the amount of your down payment, you may be required to have PMI. A down payment of less than 20% usually requires PMI. Because loans with small down payments involve substantially more risk for the lender, they need protection in case the loan goes into foreclosure. Mortgage insurance helps cover the lender’s loss in the event of a foreclosure. Because of this insurance, lenders are able to offer loans with lower down payments.
PMI premiums are collected monthly as a part of your mortgage payment. The cost of PMI varies with the amount of your down payment. Can you pay off your loan ahead of schedule? Yes. By sending in extra money each month or making an extra payment at the end of the year, you can accelerate the process of paying off the loan. When you send extra money, be sure to indicate that the excess payment is to be applied to the principal. Most lenders allow loan prepayment, though you may have to pay a prepayment penalty to do so. Ask your lender for details.
Your Rights As A Consumer
In addition to the right to view your credit report and know your FICO score, you also are protected by RESPA, the Real Estate Settlement Procedures Act passed by Congress. RESPA requires your lender to provide you with a “Good Faith Estimate of Settlement Costs” early in the loan process. Be aware, however, that the amounts contained are only estimates. Keep your Good Faith Estimate so you can compare it with the final settlement costs, and ask the lender questions about any changes.
Through a Servicing Disclosure Statement, which will be given to you by your lender, RESPA also requires your lender to tell you if it expects someone else to be servicing your loan. Your lender will have three days from the time you apply for the loan to let you know about this.
RESPA regulations also require all parties involved in your transaction to disclose affiliated business arrangements. If anyone involved in your transaction (your lender, agent or title officer, for example), refers you to another service provider (including lenders, title officers, inspectors, etc.), the “Servicing Disclosure Statement” indicates that you generally are not required to use these providers, and are free to shop for other affiliates.
HUD-1 Settlement Statement
The U.S. Department of Housing and Urban Development also provides protection via the HUD-1 Settlement Statement. One business day before closing, you have the right to inspect this statement, which itemizes the services provided to you and the accompanying fees charged. Be sure to call the settlement agent if you wish to inspect this form. The form generally must be delivered or mailed to you at or before the settlement.
Escrow Account Operation and Disclosures
Your lender may require you to establish an escrow or impound account to insure that your taxes and insurance premiums are paid on time. You probably will have to pay an initial amount at the settlement to start the account and an additional amount with each month’s regular payment. Your payments may include a “cushion” or extra amount to ensure that the lender has enough money to make the payments when due. RESPA limits the amount of the cushion to a maximum of 2 months of escrow payments.
At closing or within the next 45 days, the person servicing your loan must give you an initial escrow account statement. That form will show all of the payments which will be expected to be deposited into the escrow account, and all of the disbursements that are expected to be made from the escrow account during the year ahead. Your lender or servicer will review the escrow account annually and send you a disclosure each year, which shows the prior year’s activity and any adjustments necessary in the escrow payments that you will make in the forthcoming year.
For more information on RESPA
Visit the web page at http://www.realtor.org or call (800) 217-6970 for a local counseling referral.
There are several Federal laws, which provide you with protection during the processing of your loan. T he Equal Credit Opportunity Act (ECOA), the Fair Housing Act and the Fair Credit Reporting Act (FCRA) prohibit discrimination.
ECOA prohibits lenders from discriminating against you on the basis of race, color, religion, national origin, sex, marital status, age, if any or all of your income comes from any public assistance program or if you have exercised any right under any Federal consumer credit protection law.
The Fair Housing Act also prohibits discrimination in real estate transactions on the basis of race, color, religion, sex, handicap, familial status or national origin. Frequently, there are differences in the amounts of settlement costs charged to you – they may be based on your credit worthiness or they may be unlawfully discriminatory. It is important that you examine your settlement documents closely, especially lines 808-811 on the HUD-1 settlement statement. If you feel you have been discriminated against by a lender or anyone else in the homebuying process, you may file a private legal action or complain to a state, local or Federal administrative agency.