Explaining the Loan Process
First: Get Pre-Approved
Buying a home is a wonderful investment, but it should be approached with the right strategy. BEFORE finding a home, and falling madly in love with a neighborhood, people should first talk to a mortgage loan officer to get pre-approved. Pre-approved is superior to pre-qualified. Pre-aproval is a in depth process….if you call and get pre-qualified in 2 minutes….it is really useless. Just filling out the application will take more than 2 minutes.
It’s Best for the Buyer
Getting pre-approved gives the buyer a chance to find out how much home they can afford. A competent loan officer will tell the buyer not only the principal and interest payments per month, but also the estimated taxes, insurance and mortgage insurance monthly amounts. This gives the borrower a true number to work with in order to decide their comfort zone when looking at potential properties.
It’s Best for the Realtor
Once the buyer is pre-approved they can contact a real estate agent and start looking for a home. Agents have the ability to search for a home based on a number of criteria. Some of the items can be number of bedrooms, number of baths, square footage, location and total price. Incorporating the maximum price along with the other criteria can eliminate homes outside of the buyer’s criteria.
Many people think that getting pre-approved for a mortgage loan is just as simple as a car loan. However, nothing could be further from the truth. A mortgage is a very detailed loan that requires a number of documents and the correct procedures in order to complete the entire process. It all starts with the loan application.
The first step in getting a home, and possibly the most important step, is the application.
The application is a lengthy form completed by the loan officer on behalf of the borrower. This form actually covers the potential homeowner’s entire financial situation in amazing detail.
For starters, people are asked for their name, social security number, date of birth, current address and current place of employment. If the application is for the purchase of a home an address of the new home will be requested. However, it is not crucial if a new home has not been picked out yet. The loan officer can continue with the application with an assumed address and change it later if necessary.
It is important to note that all borrowers need to show at least two year’s history for their residence and employment.
Next, the borrower will be asked about their assets. The term assets is a very broad term and can include a whole host of items such as
- any available money in checking accounts
- most recent savings account balances
- stock and bond investments
- land ownership
- any rental properties
- retirement accounts such as 401-k or IRA accounts
- income from ownership in businesses
Finally, the application will provide an estimate of the amount financed, the estimated closing costs, prepaid items and any money that the borrower will need to pay at the closing.
It cannot be stressed enough that the borrower needs to provide as much accurate detail about their income, assets and employment history. Making sure this information is up to date and correct will make the approval and underwriting process much easier.
Processing the Application
Processing is a broad term that covers a lot of ground. Once the loan officer has completed the loan application with the borrower and determined a price range for the home purchase, the borrower (or borrowers) have work to do. It is at this time that the borrowers will gather all the necessary documentation to qualify for the loan. People who receive a paycheck and a W-2 will likely need the following list of items:
- Pay stubs covering the past 60 days
- Bank statements (checking and savings) covering the past 60 days
- Past two year’s W-2 forms from all jobs
- Most recent statement from retirement and/or investment accounts.
The list of items for self-employed individuals is slightly different. They will need these items:
- the last 2 years’ tax returns for their business
- the last 2 years’ personal tax returns
- cash flow statement for the current year
- Personal bank statements (checking and savings) covering the past 60 days
- Most recent statement from retirement and/or investment accounts.
All this is done without a home picked out. Once you put an offer on a home the lender can get a detailed cost breakdown….property taxes, home owners insurance, HOA expenses for this home and other expenses can be detailed.
The loan officer will have the borrower sign several documents such as the full loan application, the Good Faith estimate, the Truth in Lending and a few more forms. The processor will go over these documents, along with the financial documents mentioned above and make sure everything is in order. Once everything is signed and collected the processor will order the appraisal and the title insurance binder.
The appraisal is used to compare the home under contract with three or more other similar homes that have sold within the last 6 months. All comparable homes will usually be similar in design, square footage, general features and most importantly the location. The appraisal is used to determine the actual value of the home that the borrower wishes to buy.
The title insurance binder is protection for the buyer and the lender that the deed of record is correct before the home is sold. It also ensures that the new deed reflecting the new owners will be properly recorded after the sale.
Once the appraisal is complete and the title insurance binder is accurate all of the previously mentioned documents are combined and sent to the underwriting department.
Different Types of Mortgages
It is assumed in this country that any reasonably intelligent adult understands the basic points of a mortgage before purchasing a home. That could not be further from the truth. For this reason, we want to explain the basics of the common types of mortgages.
Conventional – This is one of the most common types of mortgage loans available. It usually requires excellent credit scores (typically 700 and above) and a down payment of at least 3-5% of the purchase price. The conventional mortgage will usually offer the absolute best interest rate and payment compared to other programs.
FHA Loans – Authorized by the Federal Housing Authority (FHA) these loans are common for people buying their first home. The loan only requires a down payment of 3.5%* and the credit score requirements are less stringent compared to a conventional loan. FHA will allow the seller to pay up to 6% of the purchase price in closing costs to aid the buyer.
An added bonus is that the down payment can be a gift from a relative or friend. Another type of FHA loan, called FHA 203k loans, are also available if the house you are looking at needs rehab work done. The 203k loan allows borrowers to get the money needed for necessary repairs plus the price of the home and finance it all with one loan.
VA Loans – The Veterans Administration sanctions lending to veterans of the military. The VA loan does not require any down payment and also has lenient credit qualifications. In order to qualify for a VA mortgage loan a person will need to meet service criteria. The criteria vary based on active duty during war, reserve duty or duty served in the United States.
USDA Rural Housing – A division of the United States Department of Agriculture (USDA) provides home lending for properties in rural areas. No down payment is required if the appraised value of the home is high enough. For properties with a sufficiently high enough value, the closing costs can be added to the loan balance as well. The loan does have restrictions on income levels for the borrowers. Your loan office can compare your income to the USDA rules for your area and determine if you are eligible.
These are the primary types of loans available to the first time home buyer. Although the rates will vary from one loan to the next they are usually extremely close to each other. In order to decide which loan is best for your situation, you should consult with your loan officer.
The Mortgage Payment
Understanding a mortgage payment is very important for a home buyer. Most loans payments, such as for a car, are fairly simple to understand because it usually involves just two parts, the principal payment and the interest payment. However, that is not the case with the majority of mortgage loans.
Below is an example of what makes up a typical mortgage payment. We’ll assume there are escrows in place and mortgage insurance is required. This is called PITI (principal, interest, taxes and insurance)
For this example, we will assume that your down payment is less than 20% of the home’s asking price. For conventional loans loans, any time a buyer pays less than 20% as a down payment; the borrower will be charged with mortgage insurance. This is an insurance protection to help the lender against any losses. The amount of the monthly mortgage insurance will depend on the type of loan, the borrower’s credit, the loan to value ratio, and the outstanding loan balance. The mortgage insurance is calculated as a percentage of the outstanding loan balance.
Homeowner’s Insurance One common practice for home buyers is the use of an escrow account. This account is a holding place for the homeowner’s yearly homeowner’s insurance premium as well as the property taxes. This is a great way to not be caught short when your homeowners insurance premium is due.
When a loan officer calculates the monthly mortgage payment they will usually add an amount to cover 1/12th of the annual homeowner’s insurance policy.
Each time a mortgage payment is made some money is deposited into the escrow account. When the insurance premium comes due, money is removed from this account and directed to the insurance agent.
Similar to the homeowner’s insurance, taxes are also accrued in the escrow account. When a person first buys the home, the taxes are pro-rated. The seller of the home pays the taxes for the part of the year in which they owned the home. This allows the new buyer to pay taxes only covering the time they actually owned the property.
Just like the homeowner’s insurance, 1/12th of the annual property tax amount is added to the monthly mortgage payment. When the monthly payments are made part of the payment is put in the escrow account to cover the annual property tax bill.
Principal and Interest
This is similar to other loans. The interest amount is determined based on the stated interest rate for the mortgage, the term of the loan and the borrowed amount. Each month the amount of interest being paid goes down as the amount of principal goes up, reducing the outstanding balance a little more every month.
The underwriter reviews the entire loan file. Everything from the income documentation, the asset documents, the appraisal and the title binder are all reviewed. Based on the type of loan that the borrower is seeking, the underwriter will compare the facts contained in the application and other documents against the guidelines and rules for that specific loan, plus any additional mortgage overlays.
The decision to approve the loan is guided by three principles
Credit – the borrower’s past credit history is a good indicator of whether or not the borrower has the intention of repaying the loan. Reviewing various types of loans, their duration and how the borrower handled each type of debt will show the underwriter if the borrower wishes to repay the loan.
Capacity – This is a mathematical computation to show that the borrower has enough income to pay for the loan. The underwriter will look at regular wages, overtime wages if the person has worked on the job for more than two years as well as commissions. All of this factors into determining the borrower’s capacity to pay any existing debt on top of a new mortgage.
Collateral– This is where the appraisal and title insurance come in. The underwriter will go through the appraisal to see that the home is being compared to very similar properties. The pictures of the homes are inspected to determine the pride of ownership of the previous owner and see if there are any problems. The title binder is studied to make sure there are no “unknown” liens preventing the borrower from taking over ownership of the property.
Because each type of mortgage has varying rules the underwriter will compare the borrower’s information to the right guidelines for the loan. Consider the process of underwriting a loan in comparison to high school standardized tests. Standard tests are administered across the country to multiple grades. If a student scores at a certain reading level, then the person is awarded a particular grade level on their test. In other words, if the student’s knowledge meets a particular minimum level, they are deemed to be at or above their grade level. A mortgage underwriter does a similar function comparing a person’s credit, income and work history to the loan guidelines.
Once the underwriter has determined that all rules are being followed according to the lender’s policies the loan will be signed off and sent to the closing department.
Once the underwriting department has approved the loan and sent the file to closing a few more items are necessary. In the case that the homeowner is using an escrow service, an insurance policy and a property tax statement will be needed. The insurance policy is to replace the value of the home in case of fire, weather event or any other liability that may arise. The property tax statement provides the current year’s tax information so that the property taxes can be paid now and yearly going forward. An escrow service takes care of making the yearly insurance payment as well as the property taxes. The homeowner simply pays those amounts along with the monthly mortgage payment.
At the closing there will be the title company’s representative present to make sure of a few things. First and foremost is to properly identify the sellers and the buyers. This is usually done by getting a picture ID from each party. Secondly, many, if not all, of the documents must be notarized at the time of signing. Finally, the representative is there to explain all of the documents that will be signed by the borrowers and sellers. The outline of the amount being borrowed, the interest rate for the loan, the number of months for the loan and the monthly payment, including escrow, are all laid out in black and white for everyone to see.
There will be many forms to sign. Each form will be explained and you have the right to read over them and ask any questions. The representative or your loan officer will be able to answer any questions you may have.
Once all items are signed you will get a copy of everything to keep for your records. And then you will get something very precious: your set of keys!
Summing Up The First Time Home Buyer Loan Process
As you can see, there are quite a few details covered in the whole process of buying a home. However, if you are able to get your finances organized, promptly respond to requests from your loan officer, and have realistic expectations then you should experience a rather smooth process for buying a home.
Home Buyer Guide: Getting a Loan
“Success is more a function of consistent common sense than it is of genius.”
So you want to make an offer on a house. You need to show the seller you can afford to buy the house. A Pre approval from a lender is necessary. Why a Pre approval?
Pre approval or Pre qualificatiom?
There are 2 different approval processes, pre qualification and pre approval. I always recommend a pre approval.
A pre qualification is a less complete process it looks at your existing debt, income and credit. A pre approval looks at the same things but all information is verified. You supply all paperwork supporting your loan application– pay stubs, tax return sand account statements (to verify the source of the down payment, funds to close and reserves). This has to be done regardless so do it upfront!
Loan Pre approval
Few people can buy a home for cash. According to the National Association of REALTORS® (NAR), nearly nine out of 10 buyers finance their purchase, which means that virtually all buyers — especially first-time purchasers — required a loan.
The real issue with real estate financing is not getting a loan (virtually anyone willing to pay lofty interest rates can find a mortgage). Instead, the idea is to get the loan that’s right for you — the mortgage with the lowest cost and best terms.
I routinely suggest that clients start the mortgage process well before bidding on a home. By meeting with lenders — either online or face to face — and looking at loan options, you will find which programs best meet your needs and how much you can afford.
I also recommend pre approvals for another reason: Purchase forms often require buyers to apply for financing within a given time period, in many cases, seven to 10 days. By meeting with loan officers in advance and identifying mortgage programs, it won’t be necessary to quickly find a lender, check credit, and rush into a financing decision that may not be the best option.
What is it?
“Pre-approval” means you have met with a loan officer, your credit files have been reviewed and the loan officer believes you can readily qualify for a given loan amount with one or more specific mortgage programs. Based on this information, the lender will provide a pre approval letter, which shows your borrowing power. You can visit as many lenders as you like and get several pre-approvals, but keep in mind that each one carries with it a new credit check, which will show up on future credit reports.
Although not a final loan commitment, the pre approval letter can be shown to listing brokers when bidding on a home. It demonstrates your financial strength and shows that you have the ability to go through with a purchase. This information is important to owners since they do not want to accept an offer that is likely to fail because financing cannot be obtained.
How do you get pre-approval?
Real estate financing is available from numerous sources. I will suggest one or more lenders with a history of offering competitive programs and delivering promised rates and terms.
The loan officer will carefully review your financial situation, including your credit report and other information. The lender will then suggest programs which most-closely meet your needs. For instance, a first-time buyer may qualify for state-backed mortgage programs with little money down and low interest rates, while a repeat purchaser (someone who has bought a home before) with more equity (money invested in the home) might want to get a 15-year loan and the lower overall interest costs it represents. Typically, first-time buyers opt for the traditional 30-year loan, with either a floating interest rate or a fixed rate of interest over the life of the loan.
Home Buyers Guide: Qualifying for a Loan
“If you don’t build your dream, someone else will hire you to help them build theirs.”
Qualifying for a Loan
The guidelines are just guidelines and they are flexible. If you make a small down payment, the guidelines are more rigid. If you have marginal credit, the guidelines are more rigid. If you make a larger down payment or have sterling credit, the guidelines are less rigid. The guidelines also vary according to loan program. FHA guidelines have one qualifying ratio. VA guidelines have a different qualifying ratio. A lender can guide you through the maze of requirements and options that may work for you.
There are 3 major factors in qualifying for a home loan. Employment history, debt to income ratio, FICO score.
In order to qualify for a loan, the applicant or applicants should have a steady employment history, having been with the same employer for at least two years. If this is not the case, the applicants will not likely qualify. For those who do not have two years worth of employment history, it may be possible to make an exception, but this will be up to the underwriter.
In order to qualify for a mortgage, lenders examine your debt-to-income ratio of AA/BB (the required ratio can vary depending on the down payment and the type of loan you’re getting). For example if a ratio of 28/36 was required, what would that really mean in english? This means that no more than 28 percent of your total monthly income (from all sources and before taxes) can go toward housing, and no more than 36 percent of your monthly income can go toward your total monthly debt (this includes your mortgage payment). The debt they look at includes any longer-term loans like car loans, student loans, credit cards or any other debts that will take a while to pay off.
Here’s an example of how the debt-to-income ratio works: Suppose you earn $35,000 per year ($2916.66/mo) and are looking at a house that would require a mortgage of $800 per month. According to the 28 percent limit for your housing, you could afford a payment of $816 per month($800/$2916.66), so the $800 per month this house will cost is fine (27 percent of your gross income). Suppose, however, you also have a $200 monthly car payment and a $115 monthly student loan payment. You have to add those to the $800 mortgage to find out your total debt. These total $1,115, which is roughly 38 percent of your gross income. That makes your housing-to-debt ratio 27/38. Lenders typically use the lesser of the two numbers, in this case the 28 percent $816 limit, but you may have to come up with a bigger down payment or negotiate with the lender.
You also have to think about what you can afford. The lender will tell you what you can afford based on the lower number in the debt-to-income ratio, but that’s not taking any of your regular expenses (like food) into account. What if you have an expensive hobby or have plans for something that will require a lot of money in five years? Your lender doesn’t know about that, so the $1,400 mortgage it says you qualify for today may not fit your actual budget in five years — particularly if you don’t see your income increasing too much over that period.
Range from from 300 to 850.
Borrowers with high FICO scores — the top tier ranges between 760 and 850 — can expect lenders to offer them lower interest rates and more loan choices. Scores of 620 or lower usually place a borrower in the “subprime” category, and they can expect to be quoted significantly higher interest rates and may be offered fewer varieties of loans. A FICO score of about 500-520 is generally the minimum that will qualify for a mortgage. You can work with your lender to improve these scores.
How Much Home Can You Afford?
“My definition of an expert in any field is a person who knows enough about what’s really going on to be scared.”
Step one– How much home can you afford?
My recommendation is to create a budget. The reality of life is that everyone has different expenses and different spending habits. When I diet I use a food diary to keep myself honest. The same is true of a budget.
Buy a 3x5 notebook to carry around with you. Write down everything you spend money on for a month. Everything! This will give you the data to create your budget. Yes write down that latte.
The only true way to know how much you can afford is to look at how much you spend. Once you have an idea what you spend now turn that information into a budget. This will help you set your priorities and save for a down payment…..or that vacation in Rome.
There are lots of forms online that will help you to detail your spending. A suggestion is– Dave Ramsey. These help you to see what you can afford and see how you may be able to save.
With a budget you can see what kind of a mortgage payment you can really afford. Now you can gather your down payment.
5 Steps to Save for a Down Payment
One of the greatest hurdles to home buying is coming up with the down payment. Here are a few softer practical strategies to help you clear the hurdle and come up with the cash you need.
1. Plan for progress – Your Dream Budget Saving isn’t all dollars and cents, it’s a little emotional. That’s why we recommend finding a
few visuals to remind you why you’re saving. They could be photos or a list of features of your dream home. Whatever your focal point, store it close to your budget, wallet, or in the place you pay bills to remind you of what you’re working for.
2. Slow your Spending – The 10-day Rule The biggest enemy of spending is the impulse buy. For purchases over $25 exercise self discipline
and give yourself 10-days to decide if this purchase is for a real need or a want?
3. Avoid the Convenience From coffee on the go to lavish meals out, consumers pay quite a bit for convenience. Avoid your local convenience stores and become friends with your kitchen to help your bottom line.
4. Track Expenses – Face Your Truth We scoured the net and all the experts agree, the only thing more powerful than creating a budget is tracking it. Schedule time with yourself each week to face the truth about your spending and find new ways to save.
5. Eliminate the Excess Spending Locate the excess in your budget and slash it. Trade the gym for home workouts, movie nights out for rentals at home, and keep an eye out at the end of each month for services.
Serious Sources for a Down Payment
One of the best ways to save money is to hide it from yourself. Payroll deductions or allocating a piece of your direct deposit to a special savings account can be a great way to trick yourself into saving.
You know it’s coming, why not use it toward your down payment? If you’re really serious about home ownership, talk to an accountant about tax planning to make sure there is a little green at the end of the year to help you with your down payment.
Borrow from the 401k:
It’s not losing your retirement, it’s more so using a piece of one investment to make another. First-time homebuyers can one-time
borrow up to $10,000 from their Individual Retirement Accounts (IRAs) without paying the early withdrawal fees. Be sure to talk to your 401k or IRA administrator to find out how it will impact your retirement. (I am not sure I like this idea!)
Yes, I said it; more work. If you’re serious about reaching your down payment goal, consider spending a few hours working part time. 10 hours/ week at $10/hour all year will get you $5200 closer to your goal.
Quick Fix Credit Repair
Try this google search–quick fix credit repair (599,000 results) or fast credit repair ( 17,000,000 results)…you get the idea. People want to fix their credit and they want to do it fast, now, today. That’s why you are here…right? You messed it up fast so you can fix it fast….just like my diet. Sadly no you can’t lose 50 pounds today or fix you credit today. But you can fix your credit and you can start today.
Simple measures to improve credit scores exist …And when these simple measures are performed methodically and consistently, (with time) they’ll reap you positive results. And it really is not that hard to do.
Be Aware Of What Your Credit Score Is
- Check your Credit Report right away … and then check it regularly in the future. Free websites such as Credit Karma, allow consumers to continually monitor their credit scores.
- Check for accuracy – (Personal info, Social Security Numbers, Date of Birth, Full EXACT Name, Address)
- Check for rating
- Check to make sure ALL your credit accounts are being reported
- Check to see if late/missed payments are showing? If so, what is the true status of these accounts?
Understand What Is Used To Determine Your Credit Score
- Payment History – 35%
- New Accounts/Credit Requests – 10%
- Length of Credit History – 15%
- Total Debt Percentage – 30%
- Credit Mix – 10%
The highest credit score that can be obtained is an 850. Consumers with credit scores under 600 are often considered risky borrowers while borrowers with credit scores of 720 or greater are considered very solid borrowers. Lets make you solid!!
Get Current On Any Delinquent Accounts
Pay your bills! Pay them on time, as they are due, each and every time
Catching up on late payments can increase a credit score relatively quickly once a credit report reflects the payment. Accounts with missing payments can destroy a your credit score so it’s important to stay current on all accounts!
Dispute Any Errors On Your Credit Report
If there are incorrect accounts on your credit report, it’s extremely important they’re removed. Contact the creditor and get it fixed. Do not ignore it!
Pay Off or Lower Balances On Accounts With Small Balances
This changes the income to debt ratios. Your income to debt ratio is a factor that can have a large impact on mortgage pre-approvals.
Pay Off or Lower Balances On Accounts With High Interest Rates
Paying off or lowering the balances on these high interest accounts can potentially mean extra money each month to use towards a down payment on a home.
Pay Bills On Time
Why do I even have to say this….ALL your bills should be paid on time. This will improve your credit report. Pay fines, parking tickets, etc. Even seemingly small unpaid debts can be sent to a collection agency and end up wreaking havoc on your credit/Credit Scores
Work On Your Credit Utilization Percentages
30% or lower of available credit is recommended – 10% is even better. Generally speaking, consumers with credit utilization percentages of 10% or less are consider to have excellent ratios.
Don’t Close Old Accounts
There is a temptation to pay off and close accounts. DON’T! By closing old accounts, you could be potentially hurting your credit history length. You are also reducing the available credit you have. That can hurt your debt percentage (available credit/used credit).
Don’t Keep Opening New Accounts
One of the reasons opening new accounts can hurt a credit score is because when a new account is opened, generally, a credit inquiry is pulled. Too many credit inquiries can negatively impact a credit score.
For Those With No Credit Yet
If you are young and have no credit….or believe in cash only…Having no-or-little credit history reporting to the Credit Bureaus reaps low Credit Scores or No scores at all. So you need to build your credit.
A secured credit line is one which a borrower uses an asset as collateral to secure the account.
- Mortgage lenders will often suggest secured credit cards to borrowers who don’t have enough established credit lines. Once a buyer obtains a secured credit card, lenders will suggest making small purchases each month and paying off the balance each month.
- Open up a credit card (known as revolving debt) with a modest borrowing limit. Major retailers and gasoline companies are two (2) good examples of this type of debt.Use the newly-established credit card by charging purchases within your budget constraints. Pay the balance on time and in full each month (I recommend that first-time credit users open only one or two credit lines, to begin with. Take small steps. Learn to handle your credit wisely. Crawl before you walk. )