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.