The Home Buyer’s Financial Guide, the 9 must know issues

The financial issues associated with buying a home are the reasons why most people succeed or fail. As a former mortgage broker I’ve helped many clients deal with the home buying financial issues properly. They are now home owners. I also saw people struggle with the money issues of buying a home. They were not financially prepared to buy a house. The frustration issue many times was that they did not understand the financial issues to buy a home. So, I was driven to create this Home Buyer’s Financial Guide.

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Key points

• Don’t guess what is needed for a mortgage use the pre-qualification and pre-approval process to know what is needed
• Know what paperwork is needed for a success mortgage application to go through underwriting
• Understand the cost associated with a mortgage
• Understand the funds needed to buy real estate
• Realize problems, challenges and documentation issues are part of the mortgage process

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1. Mortgage Pre-qualification

Mortgage pre-qualification is the first step in home ownership. Pre-qualification will find out if you can get a mortgage. Applying for a mortgage pre-qualification is basically, you just give a lender your name, phone number, and some basic information and the lender will give you a general idea of how much you can borrow. Also you will find out if you have the ability to get a loan.

Mortgage pre-qualification will give you the ball park range of home loan you can receive. This helps renters who want to be home buyer find their price range to search for a house. This information can save the first time home buyer days and even weeks. Because if they were looking at the wrong price point of houses, one on which they could not get a loan, then they wasted time in which they could have been house hunting for the right home.

Another benefit is the approximate monthly payment. The advantages of knowing this information can help in many ways. It is definitely nice to know for monthly budgeting purposes. It also can help determine what range of payment would fit into your life style. Lenders use the monthly payment on a property to determine a borrower’s qualifications. The payment includes principal, interest, property taxes, and insurance—commonly referred to as PITI. This income ratio is based just on the housing cost.

The next benefit of pre-qualification may not sound good but it could really help. The mortgage pre-qualification process could tell if you qualify for a mortgage. If the answer is no, you now have time to fix it. Sometimes credit reports show wrong information that can easily be fixed. Other times, there is a major problem that can take months to work out.

Finding this out early is extremely beneficial to you. Time is your friend if it is early in the house searching process. Time will kill a deal if it is near the end of a deal. Mortgage pre-qualification is fast, almost painless and helpful to you. Even if you are a year away from wanting to move into a new home, start the process now and reap the benefits.

This is an example of the information a mortgage pre-qualification will give

If a home buyer thought they could get a $200,000 home loan, but they can really qualify for a $230,000 mortgage, that could mean a whole new Sacramento neighborhood.  Or if the first time home buyer hoped for a $230,000 loan but could only get $200,000, they could have put offers on a house they could not afford to get. It is very important to know how much a lender is willing to loan before looking at a home.

The pre-qualification letter

The pre-qualification letter which generally only estimates what you may be able to borrow is given by a lender to help the home buyer show they have given the basic information to a lender. It is not a commitment of a lender to make the loan.

2. Mortgage Pre-approval

Mortgage pre-approval can give you an advantage over other home buyers who haven’t been pre-approved. Most home sellers give much more weight to an offer when the buyer is pre-approved not just pre-qualified. Loan pre-approval can make the difference of having an offer accepted or just over looked.

What is the clear difference between pre-approval and pre-qualification?

A mortgage pre-approval denotes that a lender has taken a detailed examination into the borrower’s credit information and has issued a preliminary credit review, pending documentation and the property information. Because a pre-approval includes a credit check, it’s more powerful than a pre-qualification letter.  The mortgage pre-approval letter is based on data provided by the borrower.

 
Home loan Pre-approval gives confidence to the home owner to begin home shopping because a lender is giving more of a commitment to lend the money. Obtaining a mortgage pre-approval commitment makes it easier to shop naturally because you know what loan amount the lender has approved.

“Focus on them to reach the goal—Home Ownership”.

Dan Parisi

The home owner can target the neighborhood they want to live in. They can pick and choose which houses to visit without wasting time. The pre-approval letter will save the home buyer time, money and give them an edge when they find the house of their dreams to make the offer.

 Also applying to get mortgage pre-approval has the advantage of finding out about any problems with loan approval. This gives the borrower time to address issues early in the home buying process. Working with a professional mortgage broker can help solve issues with the loan approval.

Make sure lender is able to give a pre-approval letter

A pre-approval is more powerful than a pre-qualification letter. The pre-approval letter is different than the pre-qualification letter because the lender or their agent examines some of the documents and checks the credit report. Make sure the lender is ready to issue a pre-approval letter when needed. A pre-approval letter involves verification of the information. The lender will ask for documentation to confirm employment, the source of your down payment and other aspects of the borrower’s financial circumstances.

Don’t let the mortgage personnel short circuit the process and just write the letter without checking. The danger is that there may be issues in the credit report or with the documentation on the loan process that needs to be fixed.

A pre-approved makes for a strong offer on a home.

Sellers often prefer to negotiate with pre-approved buyers because the sellers recognize such buyers are financially qualified to acquire the financing they need to close the transaction. A pre-approval letter is an especially helpful position in close, multiple offer situations. When you find that just right home with the quality of life we enjoy in Sacramento you want to win the offer war. A strong pre-approval letter will help your offer get accepted.

Pre-approval letter involves verification

The key point in a pre-approval letter involves verification of the information. Start the verification and submission of records and paper work to the lender as fast as possible. The benefit is uncovering any financial problems or issues. Early time is useful in solving any issues. But last minute problems can end the whole real estate deal.

Find loan amount early

One of the big issues that come up in the pre-approval letter is the amount of the loan lenders are willing to make. Sometimes it is for 10’s of thousands of dollars less than the borrower would like and think they could handle.

These may mean looking in new areas or for a much different house. The current reality of the lending environment many times dictates what home could be financed. Finding out early in the search will save time and money. It could mean that in a hot real estate market missing out on a good house because of searching in the wrong price range.

Ignorance is not bliss. Reality may be different than desired. The number one time saver is searching for the correct price range house early in the process. Getting the pre-approval letter is one of the best tools to achieve this goal.

Loan To Value or LTV

Loan to value (LTV) is one of the key issues a lender needs to resolve before they make the loan. If the mortgage has a high loan to value it may not meet the guidelines of the mortgage. The loan to value ratio must meet the requirements of the lender for a particular loan.

Mortgage lenders are very careful in assessing risk factors for each mortgage applicant. The lender is essentially agreeing to become a partner to each homebuyer, and in turn the lending institution is completing their due diligence in verifying the risk factor. The LTV is a major risk factor that they evaluate. The important aspect of the loan to value is that it is appropriate for the loan which is being applied. The qualification guidelines for certain mortgage programs have become much stricter.

What is loan to value ratio? The loan to value or LTV ratio of a property is the percentage of the property’s value that is mortgaged. The LTV ratio is relationship between the amount of the mortgage loan and the appraised value of the property expressed as a percentage. The value of the property is the key.

The two key aspects are that the LTV is a ratio and that it is the appraised value that sets the value. The ratio is set by the formula: Loan Value Ratio = the mortgage amount divided by the Appraised value of the property.

An example of the LTV ratio is:
$400,000 mortgage on the property.
$500,000 appraised value of a home.
$400,000 / $500,000 = .80 or 80% Loan to Value Ratio

The appraised value sets the value for the loan not the purchase price. This is a source major misunderstanding for many home buyers. The appraised value is an opinion of a trained property evaluator. They can and do make many mistakes in setting the value of property. But the lender will go by the appraised value when setting the LTV not the purchase price.

A lending risk assessment is done before approving a mortgage. Typically, assessments with high LTV ratios are generally seen as higher risk. The mortgage can be accepted but the loan will generally cost the borrower more to borrow. And in many cases they will need to purchase mortgage insurance to make the loan.

Lenders will evaluate your loan-to-value ratio while they are underwriting your loan. In general, borrowers with lower LTV ratios will qualify for lower mortgage rates than borrowers with higher LTV ratios. Mortgages with a lower LTV ratio are considered less risky to lenders because they have more equity in their homes. The more equity means the borrower is less likely to default on their mortgage. But if they do default the property will have less loan value at foreclosure and the lender has a better chance of not losing money.

Financial institutions utilize LTV ratios before approving a mortgage application. Understanding what the LTV ratio is will aid in knowing if the loan will be approved or if expensive mortgage insurance will be needed. Working with a mortgage professional can help with the details of the LTV and how it fits in with the loan product and lender. LTV is a big part of the decision if a lender will make the loan or not. Knowledge is power.

3. Debt-to-Income Ratio (DTI)

The debt-to-income ratio (DTI) is a very important factor in qualifying for a mortgage.

What is a debt-to-income ratio?

The debt-to-income ratio compares the applicant’s total fixed monthly expenses, like monthly housing expense and other monthly debt obligations to their gross income.

Some examples of monthly housing expenses are monthly housing costs or the housing ratio and other payments like home equity loan payments, car payments, monthly credit card minimum payments, personal loans, student loan payments, monthly alimony or child support payments and any other standing monthly payments.

The housing debt-to-income ratio

The rule is the maximum housing debt to income ratio (DTI) is 43%.

Knowing the housing debt-to-income ratio rule of 43% DTI can be the basis to find out how much house a person can afford to buy, based on his income and other expenses. This may entail certain income tests involving analysis of income and use of these qualification ratios. The qualifying ratios are the housing ratio, or front-end ratio, and the debt ratio, or back-end ratio. An applicant must be required to satisfy the DTI ratio to qualify for a Qualified Mortgage loan.

If a borrower has over 43% DTI there may be mortgage loans in the market place but it will be harder to qualify and a higher cost loan. This may be in the form of higher interest rate, fee or both. But the amount may not be very much more. Sometimes just a quarter percent interest more and maybe only one more point of loan fees. The market changes every day. Check with a mortgage professional before making any decision.

The back-end ratio 

The front-end or housing debt-to-income ratio measures how much of the borrower’s income is allocated toward mortgage expenses, including PITI. The back-end ratio measures how much of a person’s income is allocated to all other monthly debts. This ratio is the sum of all other debt obligations divided by the sum of the person’s income.

The back-end ratio or I like to think of it as the total debt to income ratio compares what portion of your income is needed to cover all of your monthly debts. The total debts include housing expenses in addition to loans, credit cards, car loans, boat loans and other monthly credit obligations.

Lenders like to see a back-end ratio that does not exceed 36%. However, some mortgage lenders make exceptions for ratios of up to 50% for borrowers with good credit. Some lenders consider only the back end ratio when approving mortgages, while others use it in conjunction with the front-end ratio.

A quick warning; lenders, mortgage brokers, banks, and websites talk about the “DTI” and a percentage 43%, 50% or 55%. But they do not specify which DTI they are talking about. Is it the front-end ratio or the back-end ratio?  Make sure you get clear what DTI numbers they are talking about.

4. Mortgage Down Payment

The down payment presents the biggest obstacle to home ownership for most buyers, especially first-time buyers. Mortgage down payment can be as little as zero to over 20 percent. There are benefits and liabilities for each down payment strategy.

FHA loans require just 3.5 percent in cash for a down payment. Loans insured by the Federal Housing Administration (FHA) offer first-time home buyers the advantage of a down payment as low as 3.5 percent. But rising premiums for the required mortgage insurance (MIP) have made these loans very expensive. 

Mortgage down payment requirements and options

VA loans require no down payment and has no monthly mortgage insurance. Veterans using the VA Home Loan Guarantee in Sacramento benefit must pay a funding fee. 

The California Homebuyer’s down payment Assistance Program (CHDAP) can help with the down payment. It is complicated. It takes time. And any real estate offer with a CHDAP down payment is at a disadvantage to other offers. But with the right real estate agent, they can build the case for the offer and get it accepted by the seller.

Save for a down payment

Time is a friend when starting early to save for a down payment. Overcoming the down payment issue is one of the major steps a want-to-be home owner must surmount. Qualifying for a mortgage and the down payment are the two biggest obstacles to achieving the dream of home ownership.

5. Improve and fix credit problems

Learn if there are any issues with the mortgage application. Take action to fix the problems during the time you are looking to buy a house.

Work with a mortgage professional to improve and fix credit problems. They will help with specific actions to take to improve and fix credit problems. Some general ways to work on the problem are to first find out if there are problems.

Check your credit report.

Get copies of your credit report–then make sure the information is correct. Make sure to check all 3 national credit reporting companies. There may be a problem one has that is fixable, if it is known.

Go to www.annualcreditreport.com. This is the only authorized online source for a free credit report. Under federal law, you can get a free report from each of the three national credit reporting companies every twelve months. Request your credit reports from Equifax, Experian or TransUnion.

You can also call 877-322-8228 or complete the Annual Credit Report Request Form and mail it to Annual Credit Report Request Service, P.O. Box 105281, Atlanta, GA 30348-5281.

Understanding how credit works

One of the most important things a person can do to improve their credit score is pay bills by the due date. Delinquent payments and collections can have a major negative impact on a credit score.

Pay off debt rather than moving it around. Also, don’t close unused cards as a short-term strategy to improve your credit score. Owing the same amount but having fewer open accounts may lower your credit score.

Understanding how credit score is determined can help with improving and fixing credit problems.

Credit score is usually based on the answers to these questions:

Do you pay your bills on time? The answer to this question is very important. If you have paid bills late, have had an account referred to a collection agency, or have ever declared bankruptcy, this history will show up in your credit report.

What is your outstanding debt? Many scoring models compare the amount of debt you have and your credit limits. If the amount you owe is close to your credit limit, it is likely to have a negative effect on your score.

How to improve you credit score

It takes time to improve credit scores. Find out early in the home buying process to give the necessary time to improve and fix any credit issues. The negative information on a credit report, such as late payments, a public record item (e.g., bankruptcy) or too many inquiries take time to repair.

Actually, the credit score is not rebuilt. The credit history is rebuilt, which then is reflected by the credit score. The length of time to rebuild a credit history after a negative change depends on the reasons behind the change. Most negative changes in credit scores are due to the addition of a negative element to a credit report, such as a delinquency or collection account. These new elements will continue to affect a credit scores until they reach a certain age.

• Delinquencies remain on your credit report for seven years.
• Most public record items remain on your credit report for seven years, although some bankruptcies may remain for 10 years and unpaid tax liens remain for 10 years.
• Inquiries remain on your report for two years.

Pay bills on time and wait. Time is the ally in improving a credit scores. There is no quick fix for bad credit scores. Don’t make any bad financial decisions when trying to buy a home. Bad information travels fast to the reporting agencies. Ignorance is not a good thing when dealing with credit. Use the tools to find the credit history and score. It is the path to home ownership for most people.

Borrowing the funds to buy a home

Without a mortgage it is impossible for most people to buy a home. Learn to improve and fix credit problems to keep the dream of home ownership alive.

If you have not started the mortgage process, now is a great time. Fill out the secure mortgage application as soon as possible.  Find the best mortgage broker to get the best real estate loan with the lowest fees and interest rates. This is the best way to secure a mortgage. If your credit is great and you have standard income, shopping online could be a good option.

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The 4 stages of a mortgage loan

1. Mortgage Pre-qualification
2. Mortgage Pre-approval
3. Mortgage Approval
4. Funding the Mortgage funds

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6. The Earnest Money Deposit (EMD) and Down Payment Ready

Confirm EMD and Down Payment Money

The earnest money deposit (EMD) is a significant part of the home buying process. The EMD demonstrates to the seller the buyer’s commitment. There are biding strategies that use the earnest money deposit to enhance the offer. The same price offer could be given with a dramatic EMD giving the decisive edge to one offer over another. Have the money positioned to fund the real estate transaction.

How much should the earnest money deposit be?

The EMD is 1 to 2 percent of the total purchase price. The EMD can also be used to make a more aggressive offer. The Sacramento real estate market is very competitive. Making an offer with a higher EMD can set your offer above the competition. Use the EMD with a cash offer and show how committed the buyer is to winning the bid on the specific property.

Is the EMD funds part of the down payment?

Assuming that all goes well and the offer is accepted by the seller, the earnest money will go toward the down payment and closing costs. In most cases, after your offer is accepted and you sign the purchase agreement, you give your earnest money deposit to the Title Company or Escrow Company.

What happens if the real estate deal does not close?

If the deal falls through, the purchase agreement covers how a refund is handled. Understanding how the purchase agreement handles the return of EMD will minimize failed expectations if the deal falls apart. The real estate professional and or the legal team helping the buyer should explain these issues up front.

The first time home buyer should plan on at least 2 percent EMD. Many times the expectation is only 3,000 dollars as an EMD. This can work for many offers. But the real estate market or property owner may demand a much higher EMD to accept the offer.

Where should the EMD and down payment funds be stored?

If the family is helping with down payment keep these issues in mind

If funds are coming from family, make sure they understand the time line. In many cases the funds have to be in your accounts 60 or more days before escrow closes. Understand the loan requirements before putting in an offer. The mortgage professional should make known all the issues with the down payments. Ask questions of the loan personnel about the down payment. Find out early if there is a misunderstanding with the family member giving the funds. Sometimes promises are made that they can’t keep.

Verify the funds are ready for both the EMD and full down payment. This will solve any problems before they can blow up a real estate deal on the property that may be a dream home.

7. Loan cost evaluation.

The two documents that outline and explain the costs of a mortgage are the Loan Estimate and Closing Disclosure. These documents have a ton of information. They are an attempt to show the cost of getting a mortgage with the lender. The true cost of a mortgage hits the borrower like a ton of rocks. All the fees, costs, requirements and other funds add up quickly to a significant amount of money. (These links are to the .gov site designed to explain these documents — Loan Estimate Explainer and Closing Disclosure Explainer)

The cost to get the mortgage

The cost of getting the mortgage has some standard fees, service costs and origination charges. The document fee, underwriting fee, credit report, flood certification, closing and escrow fees, title insurance, notary fees, recording process service fee, and recording fee are the basic numbers. But each local area can have more fees.

The prepaid surprise funds needed

There are a number of funds needed to be prepaid. These generally go into the mortgage impound account (many times this is called the escrow account. I think it creates miscommunication, so I call it the impound account). The prepaid funds are for the home owner’s insurance premium, mortgage insurance if needed on the loan, prepaid interest, property taxes and others more specific to the property.  These funds are needed to close. Be ready to add that to the funds needed to close.

Other fees and costs to get a mortgage

Each loan has specific requirements by the lender to be approved. Most need an appraisal. This cost is going up every year. A clear pet report may be needed. The California purchase contract creates some issues for the home purchaser. If the realtor fills out the contract in a way that creates many outlined inspections, the lender may mandate that all inspection issues are cleared.

Inspections that could cause a delay to the loan getting approved and funded

The government requirements and retrofit if checked can create additional costs of re-inspection if all the items are not correct in the house. The smoke alarm and carbon monoxide device installation and water heater bracing will be noted by the appraiser and the lender will get notified of the status.

I had a home close delayed because the buyer’s agent checked pool inspection. The pool inspector did not like the color of the water and charged a few hundred dollars and 2 weeks to get the water color corrected. Use the inspections allocation wisely. Knowledge is power when buying a home.

The mortgage broker versus bank lender

I was a mortgage broker and I have gotten mortgages from a bank. The Loan Estimate and Closing Disclosure paperwork details loan costs differently. The banks don’t have to show all the costs. The mortgage broker must show a cost but can show how it will be paid for by the loan.

Here is the point to know; the loan interest rate has a big impact on the cost of the loan. Lenders can make most of their money on the difference in the interest rate. The spread of your rate and the market rate is where the money is made. Therefore you can impact greatly how much money you have to pay upfront by the interest rate of your mortgage note.

8. Mortgage Application Problems

Mortgage loan issues

Problems with the mortgage application process within the current regulation climate are normative.  The first time home buyer should not feel singled out when problems occur in the mortgage application process. The system creates problems. It is up to the mortgage professional to work through the issues, find the best solution and satisfy the lender’s needs.

Who has the final approval on your mortgage?

Many home buyers think the person taking the application is the person who has a big say if they get the loan. Unfortunately, that is not the case. The lender has loan underwriters who actually ok the loan. They have rules and policies that the lending institution establishes to ok the loans. They also have to deal with government regulations in addition to pseudo government entities, rules and guidelines.

This creates the complexity that frustrates the borrower with the process. Getting a mortgage to buy a home is way more complex than it needs to be and the process makes it even more frustrating than it should be, but that is the current state of the mortgage industry.

The paperwork is the most important part of the mortgage process to the underwriters

Paperwork, documentation and validation of information are three key areas of the mortgage application. The mortgage loan originator explains what is needed to get the loan. Then the borrower provides that information, only to find out there is more needed.

What is the loan process?

The process goes generally like this. The borrower applies with a lender. They supply a list of the paperwork, documents and validations needed to the mortgage loan originator (MLO) or bank representative. They tell the borrower what to get. The borrower submits all that to the MLO, who should check to see if it is all there before submitting it to the lender for underwriting determination. 

If the MLO does not do the work of double and triple checking all the documents that is the first problem. The underwriter will find out if one of the documents requested is not done exactly right.

The underwriter and the loan package

But once the underwriter takes a look at a full and complete loan package, they may request more information and documents as part of a normal loan underwriting process. The borrower could view this as a problem, but it is really just part of the process.

The problem is when the underwriter comes back with a finding that the borrower needs more income to qualify for the loan. Or they may state more of a down payment is needed to meet current loan approval standards. Or the property could have some valuation issues like the real estate appraisal is lower than the debt to loan value will allow. These are problems that take some work to resolve.

Time is crucial at this part of the real estate transaction. There are time constraints in most real estate contracts on how long the loan process can take. There must be good communication between the mortgage professional and the real estate professional and the buyer and seller. If this breaks down, so can the deal. As a first time home buyer, the unfamiliar stress can create some hard ship.

Working with professionals is the key

Working with professionals is the key to the assurance of the issues being resolved in time to make the real estate transaction conclude successfully. Coffee Real Estate agents work closely with the mortgage personnel to deal with problems. Realtors that just assume the deal will flow smoothly are often caught off guard and a deal that could have closed, will not. It is best to be looking for problems and proactively solving them before they kill the deal.

9. The Loan Approval Notice

A loan approval or commitment is made by a mortgage lender to a homebuyer after the loan package has been reviewed by the underwriter. At this point the lender is willing to provide the funds to the buyer with a mortgage loan for a home purchase.

The commitment documents also describe all of the major terms and conditions of the loan agreement. Make sure the numbers are the same as you received in the other loan documents. They should include the loan amount, the interest rate, the life of the loan, and the fees and charges that have to be paid when the loan is concluded. Your mortgage escrow is paid with your monthly mortgage payment to cover property tax and insurance payments with the goal they are paid on time. 

The funding of the mortgage

The lender will set a date and time to wire the funds into the escrow account that is handing the real estate transaction. Once all the funds are in the escrow account the escrow agents will record the real estate transfer and the change of ownership is official. The house is now your new home.