Congratulations,
homeownership can be the most rewarding financial decision you will ever make.
Not only will your home provide you with a sense of identity; it will provide
security of your investment, offer tax advantages, and after time, can be
a valuable source of equity from which you can borrow from.
These are just a few of the
reasons that make obtaining a home a rewarding and worthwhile experience.
These same reasons also make the purchase of a home one of the largest, most
important, financial decisions people will ever make. However, if you are
not informed of the options that are available, and are not aware of all the
details involved in the mortgage buying process; the purchase of a home could
very well be the most uncertain, frustrating purchase of your life.
A fundamental knowledge of
the process of obtaining a mortgage loan is necessary in order for you to
make an informed home purchase. Being an informed buyer also makes lenders
and real estate agents less frustrated. If all parties of a real estate transaction
are informed, the chances of "unexpected developments," that can dissolve
a transaction are greatly reduced.
Beginning with this issue,
we are starting a comprehensive six part series on the complete mortgage process.
This series will provide a step-by-step mortgage guide that will be useful
to you, the borrower, as well as any person involved in the mortgage process
(lenders, real estate agents, etc). The six steps are as follows:
Qualifying
In this step we will help the buyer figure out the amount that the buyer is
qualified to borrow, and determine any options available to the buyer to increase
borrowing power. Alternative lending programs, such as those backed by the Federal
Housing Administration (FHA), the Veterans Administration (VA), and The Federal
National Mortgage Association (Fannie Mae) will be briefly explained to
show the qualifying options available to the borrower.
Loan Types
This step will help the buyer determine what type of loan is best-suited for
his or her financial and personal situation. The buyer will learn about the
Graduated Equity Mortgage (GEM), the Graduated Payment Mortgage (GPM), fixed
rate, adjustable rate, balloons, Jumbos, conforming, 2-steps and Buydowns. (Mortgage
Terms)
Finding and Securing the
Right Property
The buyer will learn how to select the real estate agent that will best serve
his or her needs. We will point out the differences between an agent that works
for the buyer and an agent that works for the seller. We will give pointers
on how to find the right property, and negotiate the contract once the property
is found. Other important topics that will be discussed are the role of the
real estate attorney and home inspection.
Costs
We will inform potential buyers of all the costs involved in completing a purchase.
Points, application fees, documentation preparation fees, prepaid expenses and
closing costs will all be discussed in this section. We will point out the difference
s between, and the reasons for needing homeowners/hazard insurance, mortgage
insurance, and title insurance.
Loan Processing and Approval
We will take the buyer from the loan application to the final approval of the
loan. The role of the loan officer/originator, loan processor, and the underwriter
will also be discussed. We will explain how to do the whole process in enough
time to b eat the closing date.
Closing
A buyer that does not come to the closing fully prepared may run into unpleasant
surprises that could not only delay the closing of the deal, but could very
well dissolve it altogether. We will make sure the buyer is prepared for the
most crucial pa rt of the entire Mortgage Buying process. We will tell the buyer
what happens at the closing, who needs to be there, and what documents to bring
(and expect).
Part I - Qualifying
In order to help illustrate
the six steps of the process we will use a hypothetical potential buyer -
Mortimer Gage. We will refer to him as Mort.
Our buyer, Mort, is in a
dilemma. Mort and his wife have just found the house of their dreams. The
house cost $125,000 and is just the right size, close to his job, in an affluent
community and has a fenced-in back yard. This probably doesn't sound like
a dilemma to you. As a matter of fact, it wasn't a dilemma for Mort until
he received a letter from the bank. Although Mort had always paid his bills
on time and achieved a good credit status, he was distressed to find out that
his income was insufficient for the loan amount requested. To make matters
worse, the owner of the house is in a hurry to sell; and with potential buyers
visiting the house on a daily basis, Mort is frantically searching for a lender
that will accommodate his situation.
Poor Mortimer made a mistake
that is frequently made among home buyers. Mort looked for and found a house
that he thought he could afford, but couldn't. Mort should have gone to a
financial institution first to determine what size mortgage he could afford.
You would be surprised how many lenders are willing to assist you in the hopes
of getting your business.
Luckily for Mort, he came
across such a lender. The lender informed Mort that the financial industry
uses basic guidelines to determine your maximum mortgage value. One such guideline
is the 28/36 percent ratio to compare your gross income before t axes to your
expenses. The first number of the ratio (28) is the maximum percent of Mortimer's
and his wife's gross income that should go for housing expenses. These expenses
are referred to as PITI payments - Principal, Interest, Taxes, Insurance.
The second number (36) is
the maximum percent of Mortimer and his wife's gross income that should be
allocated to all of their credit expenses (including housing expenses, and
any installment debt (i.e credit cards, auto loans).
Mortimer and his wife's income
total $41,000. According to the 28/36 ratio:
28% = .28 x 41,000 = $11,480/yr
11,480 12 = $956.67/mo.
$956.67 per month can be used for PITI payments.
Now, let's assume taxes are $1,500 and insurance is $300 per year.
11,480 - (1500 + 300) = $9,680/yr
$9,680/12 = $806.67/mo.
$806.67 a month can be allocated to the mortgage payment (for principal and
interest).
Assuming that the current
interest rate is 8% for a 30 year fixed rate mortgage -
Given Mortimer's $806.67/mo.
mortgage limit, he could afford a $109,936 mortgage (The principal and interest
payments on a $109,936 mortgage for 30 years at 8% are $806.67 per month).
The problem is that the mortgage
on Mortimer's dream house is more than $109,936 ($112,500 to be exact). The
monthly payments on a $112,500 mortgage for 30 years at 8% would be $825.49.
What options are available to Mortimer that will allow him to borrow more
with his present income?
1) Obtain a lower interest
rate on the mortgage. For example: For a 7.5% 30 year fixed mortgage, Mort
could afford a $112,500 mortgage (at $786.62 per month).
2) Increase the down payment.
Currently, Mortimer is putting 10% down ($12,500) on a $125,000 home. This
leaves him with $112,500 to finance. If Mort were to put $15,100 down, it
would leave him with $109,900 to finance (which he qualifies for on an 8%
loan).
3) Check into FHA programs
(that are insured by the Federal Housing Administration) that use a more favorable
ratio of 29/41 percent. If Mort qualifies for an FHA loan, he could afford
a maximum monthly mortgage payment of $840.83.
4) Check into Community Homebuyer
programs (loans that are funded by the state government and sponsored by the
Federal National Mortgage Association) that offer more lenient guidelines
of 33/38 percent. If Mort qualifies for a Community Homebuyer Pro gram, he
could afford a maximum monthly mortgage payment of $977.50.
5) Consider other mortgage
programs that would allow Mort to qualify at an initially lower payment, such
as Graduated Payment or Equity Programs, three year and five year adjustable
rate programs, or five (5/25) and seven (7/23) year balloon programs .
These offer either a lower
initial interest rate or lower initial payments, and are easier to qualify
for than 30 year conventional loans. However, Mortimer, as well as all other
buyers must be aware that there are disadvantages to these alternate l oan
programs. Although the initial rate on adjustable rate and balloon programs
are lower than fixed rate programs, at a later date,the interest rates on
these loan programs could very well increase above the rate of a conventional
15 or 30 year loa n. Graduated Payment programs can actually add to your outstanding
loan balance (negative amortization).
6) Try to find a lending
institution that makes portfolio loans or in house loans. Since these institutions
are using their own funds to back the loan, and only have to conform to their
underwriting requirements, they may have more flexible guidelines for borrowers.
The final decision to see
if Mortimer's income-to-debt ratio is acceptable is up to the underwriting
department of the financial institution. The underwriters will check to see
if his income is stable and increasing on a steady basis, and if his do wn
payment is substantial. Be sure to read our next issue, when Mortimer learns
about the different loan programs available, and determines which program
best fits his needs.
Go
to Part 2: Choosing a Loan Type
