I would like to share with you today a guest post of mine on Angry Retail Banker (ARB) from last month. The topic we decided on was reviewing the steps needed to get a real estate mortgage, from the perspective of those people that have never gone through the process before.
ARB is an excellent writer and a frequent commenter on our blog. He wrote a guest post on our site last year and I am returning the favor. Dear readers, ARB does not hold back on how he feels with the challenges with his work and ignorant customers. Be prepared for some serious rants at his website! He is writing the things many of us wish we could or would say.
My quest post on ARB’s blog on the subject of mortgages
Today’s topic is getting a new mortgage to purchase a home. This discussion begins with a few basic assumptions:
- This will be your personal home
- You will live in the residence
- It is a single-family property (not a multi-unit building)
- There is no renting of any portion of the home (roommates are a “grey area” subject and OK for the sake of this review)
- We won’t be discussing Home Equity Line of Credit (HELOC) today
These assumptions have a direct impact on financing rules, so you want to be careful how you approach the purchase of a property and the related mortgage. If ARB invites me back, we can get into financing rental properties and multi-family dwellings in another article.
OK dear Angry Retail Banker readers—let’s jump in with both feet.
Where can I get a mortgage?
A person can find many sources for securing a mortgage (loan) for the purchase of a home. These include mortgage brokers, traditional banks, credit unions, and even individuals, to name just a few. Sometimes banks are a great place to borrow money, or maybe—just like ordering checks—they are not very efficient.
For the sake of clarity, let’s call the sources “lenders.” Guess what? You are now becoming a borrower.
Neither a borrower nor a lender be. –William Shakespeare
By the way, the irony here is that I have done everything in my power to get rid of our personal and rental property mortgages. (I somehow feel like a sponsor today talking to new AA members.)
Last year, I wrote about how great it feels to become mortgage free. We have had so many mortgages in the past that I had lost count. However, today’s count is: ZERO!
Do I make enough money? How much cash do I need to put down?
The traditional lender wants the borrower to put at least 20% down of a home’s appraised price toward the purchase. This is referred to as “loan to value” or LTV for short. This gives the lenders a secure position from a risk perspectivewith your 20% “skin in the game” stake of your new home. Between the government and the lending actuaries, they know that defaults for the 20% down crowd are uncommon.
There are additional lending programs that allow as little as a 2.5% downpayment. Our veterans can apply using a Veterans Administration (VA) loan as part of their benefits for serving for our country. There are other options for non-veterans using Federal Housing Administration (FHA). The rules of qualifying for VA and FHA loans are quite specific. If you think you may qualify, I would highly recommend you do some research. It will end up saving you downpayment money and potentially allow for a less expense interest rate.
Borrower warning: There is a nasty thing called Private Mortgage Insurance (PMI) that will be required if you have less than the 20% LTV downpayment with your purchase. The lenders use a formula determining the “insurance premium” portion to cover the risk up to the 20% LTV amount. The less you put down and the more you borrow, the more PMI will cost. It will stay with you until your equity in your home is more than 20% AND you do a bunch of haggling with the lender to get it removed. It may require another appraisal. Most people won’t go through the hassle of getting it removed, and in many cases will sell their home when it’s time to move on to something else. This is an expensive insurance premium and it can add hundreds to your mortgage payment, none of it building additional equity in your house.
A good rule of thumb is the mortgage payment should be less than 40% of your gross income. If you and your spouse are both on the mortgage, your mortgage payment should not go over 40% of your household income.
We can talk about paperwork later, but it warrants discussion here. You will need to prove to the bank that you have money and the ability to continue working with your steady job or other stable income sources. If you rely on commission as a large percentage of income, be prepared to prove a history of receiving commission pay. For anyone applying, the lender at a bare minimum will ask you for your last two years of tax returns, a recent paystub from your employer, and proof of your source of funds for your downpayment.
The lender will want to follow the paper trail of how your downpayment was saved. If they see a magical deposit appear out of nowhere in your account statement, they WILL ask you to prove where that came from. The bottom line is that they want to ensure you did not receive that money as a loan. It is OK to receive a gift, but lenders will ask for a letter from the person proving the gift was not a loan.
Warning: If your downpayment is actually a loan and you declare to your lender that it is a gift, both you and the person claiming it was a gift are committing fraud! This is something that should be avoided!
Your credit score has a direct correlation to your interest rate and payment
A FICO score of 720 or better gets you the best rate. If your FICO score is over 720, you can put your credit swagger on when talking with your lender. It is a great idea to know your score by signing up for a free FICO score offer prior to beginning the mortgage process.
Having a 720 or better score will make qualifying for your mortgage much easier. If your downpayment is 20% or more, your FICO score is above 720, your income falls in the 40% maximum mortgage payment, and the home appraises for the value you need, BAM! Just like that, you will get mortgage financing.
A great website for checking current mortgage rates is Bankrate.com. Some bank or credit union websites also provide those rates as well as handy mortgage calculators that will help you determine your mortgage payment.
Folks with less than stellar credit will pay higher interest rates. I can’t stress enough how important it is to build a good credit history now. It will save you thousands in interest costs and make qualifying so much easier. There are three credit-reporting agencies (Experian, Equifax, Trans Union) that you need to contact directly to clear up erroneous information about your credit history. It is worth the effort.
Fees, fees, and more fees with your mortgage
There are fees for everything. I will probably miss a few, but here are the ones that immediately come to mind:
- The Origination Fee. This is an overall fee that is charged by your lender as part of their profit in creating this loan. Often you will see this referred to as “Points.” One point is equal to 1% of the total amount of your loan. These origination fees can anywhere from zero to two points or more. Points can also have an effect on the interest rate. I recommend you “do the math” to see what the points and interest rate combinations will cost you. A 1% origination on a $200K loan will cost you $2,000! Does it get you a better interest rate?
- An appraisal fee. A cost you must pay the lender to send its contracted appraiser to determine the value of the home. The cost is typically around $400 to $500. The appraiser, through market and construction analysis, estimates the home’s value. The bank will use this value to ensure your downpayment is within the 20% LTV requirement. If it is not, the seller may need to lower his or her price, or you must contribute more downpayment, or a combination of both options.
- Loan documentation fee. There are fees for handling all this paperwork in the lender’s office and they are charged to you. The total for this cost is around $100.
- Express mail fees. For anything that requires overnight delivery, plan on paying for that at the close of escrow (the final signing and acknowledge of the sale). Plan on $50 to $100.
- Wire transfer fees. This is the cost of the lender sending funds to the title company to close escrow on the house purchase. Plan on $20 to $30.
- ETC. I know I am forgetting several more items that will cost you another $100.
Did I mention there would be some fees? It is helpful to have a bunch of these $100 bills ready!
Outside of the mortgage fees are the additional closing costs for recording the home sale with your county assessor’s office. Don’t forget the purchase of Title Insurance and numerous other processing fees. Those costs will run $500 or more.
How long does a mortgage take to complete with the lender?
I believe the new industry average is around 30 days to get financing from a lender. The recent sale of our home took our buyers exactly 32 days to fund. It is possible to accomplish this more quickly, but it is also highly likely you can hit some snags that slow the entire process down. Be sure to respond to information requests and questions from the lender as quickly as possible.
Is there a lot of paperwork with a mortgage?
Yes. Next subject please!
Prepare yourself for signing a pile of documents one or two inches high for your mortgage loan agreement. You will be giving away the naming rights to your next born child and agreeing to pay back your lender no matter what (nuclear blasts, war, job loss, stock market crashes, death). They might also request a sample of your blood and ask why you didn’t get an A on your 8th grade science exam.
I exaggerated a bit.
You will be signing many documents. I would recommend you have your lender email the documents to you so you have a chance to understand what they are and why they are required. Don’t let the title company try to rush you through at the close of escrow, asking you to simply sign without knowing what you are signing.
Nearly all of these documents are boilerplate forms used in nearly every closing. The important thing is to look at addendums and other items listed that are not part of the standard forms. Those are the items that are unique to your loan agreement and to which you should pay special attention.
You have completed your mortgage process and moved into your home
You have purchased your new home and have a brand new mortgage. Congratulations and welcome to years of debt! You move in and then find out you need repairs, remodeling, or decorating to give the house your own special touches. Essentially everything will cost you money.
Now is a great time to read personal finance blogs like this one and those listed in ARB’s blogroll. If budgeting your money has been a non-starter in the past, you might want to rethink that habit now. I would recommend you find this movie and watch it before spending with reckless abandon.
In about six weeks, you will receive a mortgage coupon book and a strong recommendation from your lender to autopay your mortgage each month—that is, if they didn’t require autopay from the outset. My preference has been to go with autopay so the burden is on the lender if they have not deducted and received the payment by the due date. I trust that you created a budget and watched “The Money Pit” so that the credit card bills are not hitting at the same time as your first mortgage payment.
I hope that this article was useful to those people starting the process of their first mortgage. It does get easier each time you go through the mortgage documents and qualifying requirements. Your next mortgage is as easy as getting food from your favorite drive-through restaurant.
Just kidding, the lenders keep changing the rules to keep the masses confused!
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