It’s important to understand financial terms so you can secure the best deal possible. At BLACK ENTERPRISE, we believe homeownership is the key to building wealth in America. Over the next three months, we will present a comprehensive guide to help you take this vital step toward improving your financial future.
Terri Sly had enough of paying rent. “I felt like I was throwing away money each month,” says Sly. “I wanted my own home.” Last January, after a four-month search, Sly moved in to her own place — a newly built, four-bedroom house in suburban Atlanta. “There was a lot of paperwork involved,” says the 29-year-old flight attendant. “But when I made my first mortgage payment, I felt that it was worth the effort.”
Sly had two advantages when she started searching for a home loan. First, she knew she wanted to buy a house in a subdivision where a friend already owned a home. Second, she knew a real estate agent with a solid reputation. “The agent recommended a local loan officer with Wells Fargo,” Sly says, “and my loan officer walked me through the entire process.”
To help you make it through the process of securing financing for your home, loan officers and mortgage brokers suggest that you take the following steps:
1. Learn the Language
Buying a home is one of the biggest purchases a person will make. It’s important to understand financial terms so you can secure the best deal possible. “Many lenders, real estate firms, and nonprofit groups offer free homebuying seminars, which can help you get started,” says Stephanie Simon, vice president of programs and products at Wells Fargo Home Mortgage Emerging Markets Division in Silver Spring, Maryland. “When you’re trying to finance a home, you’ll run into terminology you won’t find elsewhere. These seminars can help you understand what people are talking about.”
2. Don’t Let Cost Deter You
“One common misconception is that you need lots of money to buy a house,” says Simon. “There are ways to buy a house with very little money. In fact, one recent trend has been an increase in low, down-payment mortgages. People want to hold on to their cash to use for other things.”
Nevertheless, you can’t expect to get a free ticket for a new house. “You should have at least 10% of the cost of the house saved up to cover a down payment, closing costs, and other expenses,” says Lisa Wilds, a Pittsburgh-based residential loan officer for National City Corp.
3. Check Your Credit
When you apply for a home loan, lenders will scrutinize your credit history. Wilds suggests paying down your financial obligations such as credit card debt and car loans. And Simon advises reviewing your credit report. “You need to know what’s there before a lender does,” she says.
You can get your credit report from Equifax (800-685-1111), Experian (888-397-3742), or TransUnion (800-888-4213). “If there are any errors, you will need to work with all three [agencies] to clear them up.”
As you check your credit, you can find out your “credit score,” a standardized measure used by many lenders to assess potential borrowers (900 is considered an ideal score). “Credit scores over 620 have a good chance for a conventional mortgage,” says Debbra Carrigan, residential mortgage sales manager for Bank of America in Oakland, California. “If you’re below that score, and especially if you’re below 600, you may have to use more creative financing and pay a higher interest rate.”
Even if you have had credit problems, don’t give up on looking for a mortgage. When Ronald Jacobs, 41, and his wife, Bonita, 35, of Oakland, California, filed for bankruptcy in 1998, they were told by lenders to keep a clean credit record for two years before applying for a mortgage. “We kept our record clean, kept current on all bills, and went through a first-time homebuyer’s program sponsored by a local community group,” says Ronald. Working with Carrigan, the couple found a 30-year, fixed-rate mortgage in 2000 and have since refinanced at a lower interest rate.
4. How Much Can Your Afford?
In real estate lingo, you need to be “pre-qualified” to buy a house for a given amount. No real estate agent will bother showing you $300,000 homes if your finances won’t stretch beyond $50,000.
“[Being pre-qualified] just gives you an idea of how much of a mortgage you can expect, based on your income,” says Keith Gumbinger, vice president of the Butler, New Jersey-based HSH Associates, a financial publishing company that compiles mortgage industry data. “As a rule of thumb, you can get a mortgage of 2.5 to 2.75 times your income.” Thus, if you make $60,000 a year, you might be pre-qualified for a mortgage of $150,000–$165,000. You can calculate how much home you can afford at blackenterprise.com (blackenterprise.com).
5. Decide On A Lender or Broker
When lining up financing, you can work directly with a lending institution or you can hire a mortgage broker who’ll choose from a number of lenders.
“I started out with a broker through a referral,” says Janine Greer, 35, an insurance adjuster in Oakland, California. “It soon became apparent that he didn’t know what he was doing; he was telling me that I’d have to sell my car to get rid of my car loan in order to get a mortgage. The bottom line was that he never found a lender. Fortunately, I connected with Debbra Carrigan at Bank of America, who put together the loan I needed.”
There are instances, however, when brokers can work in your favor. “If your credit history is not great, a broker may be helpful in shopping for the best possible deal,” says Holden Lewis, a reporter for Bankrate.com in North Palm Beach, Florida. “However, you need to do some research or get references in order to find a competent, trustworthy broker.”
Gumbinger says start locally. “If you already own a home, you might begin with your present lender. Otherwise, ask people you know for leads. Find out who has had a good experience.”
Grumbinger warns against finding your loan online. “The Internet can be a great resource for learning about mortgage rates and various types of loans,” he says. “However, the lenders you’ll find on the Internet are often data mining firms. If you enter your personal information, your name and e-mail address will be sold to any number of marketers for solicitations.”
6. Retain A Lawyer
Most experts suggest having a good lawyer at your closing. In fact, you should have an experienced real estate attorney examine all paperwork before you make any commitments or sign any contracts. “We recommend a lawyer unless you’re thoroughly familiar with not only the mortgage process but also the various filing requirements,” says Gumbinger. “These include having the title search done, arranging for the appraisal and inspections, and other tasks that require knowledge of town and state law. If there are problems, it might even invalidate the mortgage transaction. If you don’t use a lawyer, who can you call [for help]?”
7. Select the Right Mortgage
There are many types of loans potential homeowners can choose from other than the traditional 30-year, fixed-rate mortgage and the adjustable rate mortgage (ARM) that increases or decreases each year. Thirty- and 15-year, fixed-rate mortgages are the most common, says Wilds. “I generally suggest 30-year mortgages,” she says. “The monthly payment is lower so you can afford to carry a larger mortgage. Some people, however, prefer the 15-year mortgage, which might have an interest rate that’s about a quarter of a point lower.” Homeowners who are in for the long haul will save large amounts of interest if they pay off their mortgage in 15 years rather than 30 years.
If you’re going to stay in the house for five years or less, says Lewis of Bankrate.com, an ARM is probably the best choice because the initial interest rate will be lower than most fixed-rate loans. “Currently,” he says, “3-to-1 and 5-to-1 ARMs are popular because you lock in an attractive rate for three or five years. Then the rate may go higher, year by year, but that won’t make a difference if you plan to be in another house by then.”
8. Ask About Loan Programs
When she bought her new home, Sly says she got “a loan with a 5.5% rate locked in for the first five years.”
Sly’s loan officer helped her find a program that required only a token down payment — about $1,000 on a house selling for more than $120,000. Greer found a program for first-time homebuyers that enabled her to purchase a new home near downtown Oakland. “My total outlay was about $10,000,” she says. “That’s a lot easier to put together than $20,000.”
According to Greer, she borrowed $155,000 to buy her house, but because of the program, she may have to repay only $125,000. “If I stay in the house for 10 years, some of the debt will be forgiven, and more will be forgiven after 20 years,” she says.
The Jacobses
found a federally funded program that helped them with their down payment. “We wound up buying a newly built, $175,000, four-bedroom house in 2000 with $15,000 of our own money, $30,000 from this program, and a $130,000 mortgage,” says Ronald. Saving on the down payment has left the couple with more money to spend on their three children.First-time homebuyers such as Greer and the Jacobses are often eligible for special mortgage programs. “They might offer lower interest rates, a lower down payment, or reduced costs,” says Wilds.
Federal Housing Administration (FHA) loans are among the most popular now because they can be obtained with relatively low down payments. While conventional loans require 20% down, an FHA loan might require only 5% (for more on FHA loans go to www.fha.com).
Private mortgage insurance (PMI) is typically required on mortgages where the down payment is less than 20% of the loan. PMI protects the lender, not the consumer, from default on the loan, and the cost is built into the mortgage payment. The cost of PMI varies and is based on the amount of coverage, the type of loan, and the amount of the down payment.
Once the buyer has paid off more than 20% of the original loan amount, he or she can have the PMI payments removed from the loan.
There are other innovative mortgages available as well. “There are renovation mortgages that are based on the future value of the home after you’ve made improvements with some of the money you’re borrowing,” says Simon. “There are also home asset management accounts, where you go through the process once to get a mortgage for buying the house, as well as a home equity line of credit you can tap as needed.” To find out more information on the types of mortgage loans available, check out the Mortgage Information Service (http://mortgage-x.com).
9. Get A Pre-approval Letter
“A pre-approval is more meaningful than a pre-qualification,” says Gumbinger. “Sellers may be more interested in dealing with you because you look like a serious buyer.”
To get pre-approved for a loan, you have to present some financial information to a lender. That lender will look at your income, your debts, your credit rating, etc., and pre-approve you for a certain loan. For example, you might be pre-approved for a 30-year, fixed-rate mortgage at 5% until a given expiration date, typically 30 to 90 days.
Pre-approval largely goes by the numbers. “Individual circumstance will vary,” says Lewis, “but a rule of thumb is that lenders will want to see total housing payments of no more than 28% of your pre-tax income.” With $60,000 in annual income, or $5,000 per month, for example, a lender might like to see total payments of no more than $1,400 a month.
“The catch,” says Lewis, “is that your total payments include principal, interest, taxes, and insurance, and you won’t know up front how much you’ll owe in taxes and insurance. Another rule of thumb is that your tax and insurance payments will be about the same as your principal and interest payments on a mortgage.”
10. The Paperwork–Perserver
“Pre-approvals are helpful,” says Gumbinger, “but they’re not as binding as you might think. You still need to submit documents that corroborate your financial information to get a loan. Thus, property must be appraised at a certain value, too.” For example, a lender won’t approve a $150,000 mortgage loan if its appraiser says the house you want to buy is worth $125,000.
After you find a house you like, and your bid has been approved, you’ll have to go back to the lender and turn your pre-approval into a solid commitment. You’ll have to “clarify and verify” all the financial information you submitted to get your pre-approval.
You also may have to clear any hurdles in your path. Your assets will be evaluated. Often, says Carrigan, “lenders look for employment history showing at least two years in the same line of work. In some cases, higher education can be used instead of employment history if you’re new to the work force.”
The general rule is that you’ll need to show three examples of how you’ve handled credit to build up a credit history. “If you don’t have enough of a credit history, you may be able to use regular monthly payments such as rent, phone, [and] cable TV,” says Gwen Thomas, consumer real estate multicultural executive for Bank of America in Charlotte, North Carolina.
Sly says she ran into a snag when construction of her home was delayed, pushing the closing back a month. “That meant more paperwork,” she says, “such as a new pay stub to show continued employment.”
And she faced even more paperwork at the closing. “There were many documents to sign, which became a little intimidating, but my loan officer and my real estate agent were there to help me get through,” she says. Support by competent professionals and knowledge of the financing process can be the keys to getting the home you want.
Avoiding Bad Homeowner Loans
What abuses do homebuyers need to avoid when they take out home loans? The Federal Trade Commission (FTC) warns about the following:
Equity stripping: This occurs when a loan is made based on the equity in a property rather than on a borrower’s ability to repay the loan. As a general rule, loans made to individuals who do not have the income to repay them are designed to fail. They frequently result in the lender acquiring the borrower’s home and any equity the borrower had in the home.
Packing: Here, the practice of adding credit insurance or other “extras” increases the lender’s profit on a loan. Lenders often stand to make significant profits from credit insurance and, therefore, have strong incentives to encourage consumers to buy it as part of a loan.
Flipping: A lender may encourage a borrower to repeatedly refinance a loan, often within a short time frame, charging high points and fees each time.
SOURCE: FEDERAL TRADE COMMISSION