Financing Your New Home
As it is with all great journeys, the first step you take will be the most important. The first step on your way to buying a Cape Cod house is the money. Figuring out how much you can spend first involves reviewing your monthly budget to estimate what you can afford to pay for a home. Make sure you have enough money budgeted each month to make the PITI (principal, interest, taxes and insurance) payments on your mortgage loan and set money aside for home maintenance. Plan ahead to be sure you can cover your monthly payments for several years. Also, you need to figure out how much you can swing in terms of a down payment. In addition to a down payment, you need cash for the home inspection and closing costs. If you are thinking of purchasing a fixer upper, you should figure out how much cash you have to invest in repairs or whether you can find a loan program that will allow you to include repair / renovation costs.
Next, make sure your financial house is in order by pulling your credit report. Lenders look at factors called the four Cs of credit: credit history, capital, capacity, and collateral.
Credit History = your credit score. Your credit score is based on your track record of paying your bills in a timely manner. A higher credit score may help you get a lower interest rate on your mortgage. Read through the report thoroughly and make sure all the information is correct and updated. Ideally, for at least one year prior to purchasing a home, you should make sure that you pay all your bills on time You can order your credit report and credit score from each of the three major credit reporting agencies: Experian; Equifax; and TransUnion. For more information on credit scoring, visit www.myfico.com.
Capital = your down payment. There are loan programs that not only require no money down, but also underwrite closing costs. It is important to note, however, that you will still need cash to put down with your initial offer (commonly called a binder) and a deposit with the signing of a purchase and sales agreement. (These funds get rolled into your down payment if you are using a traditional mortgage or refunded if you are using a no down payment program.)
Capacity = your debt-to-income ratio. This is a comparison of your gross (pre-tax) income to housing and non-housing expenses. Non-housing expenses include such long-term debts as car or student loan payments, alimony, or child support. In general, monthly mortgage payments should be no more than 29% of gross income, while the mortgage payment, combined with non-housing expenses, should total no more than 41% of income.
Collateral = value and condition of the house. Your lender orders an appraisal AFTER your have an accepted offer at a specified price. If the lender's appraisal comes back at a lower value than the negotiated sales price, your financing may be in trouble. This is why you need a buyer's agent who knows how to do a good market analysis before you put in an offer. (This is where Margaret's experience in the world of banks comes in really handy!)
In home buying, one of the most important math skills you will need is using percentages. In home buying, the interest rate you pay on a loan is given as a percentage. The amount of money you put down when you buy a house is described by a percentage. Lenders will decide how much you can afford to spend on a house by looking at what percentage of your total income will go to housing costs.
Your next step is to select a lender. Lenders can be banks, savings and loans, credit unions, mortgage companies, government agencies, or private individuals. Ask about the company itself and the experience of the actual loan officer you are interviewing. Ask about the types of loan products they offer and their rates and terms. In addition, ask people you trust if they know of any experienced, reliable lenders, and interview several. Cape House Real Estate can recommended some lenders (we like to go local). Mortgages have many features: some have fixed interest rates and some have adjustable rates; some have payment adjustments; on some you pay only the interest on the loan for a while and then you pay down the principal (the loan amount); some charge you a penalty for paying the loan off early; and some have a large payment due at the end of the loan (a balloon payment). Consider all mortgage features, the APR (annual percentage rate), and the settlement costs. Ask your lender to calculate how much your monthly payments could be a year from now, and 5 or 10 years from now. Mortgage calculators like the one below can help you compare payments and the equity you could build with different loan products. On any given day, lenders may offer different interest rates and fees to different consumers for the same loan, even when those consumers have the same loan qualifications. Lenders also consider the profit they receive if you agree to the terms of a loan with higher fees, higher points, or a higher interest rate. Shopping around is your best way to avoid more expensive loans. Shopping takes time and energy, but not shopping around can cost you thousands of dollars. To find the best loan, you have to do the shopping.
For more information on mortgage shopping, see Looking for the Best Mortgage -- Shop, Compare, Negotiate.
Have the lender issue a pre-qualification or pre-approval letter for your financing. Pre-qualification refers to when a lender calculates how much mortgage you likely can afford based on unverified information and no specific property. Pre-approval is a guarantee based on verified information that the lender will loan you a fixed amount of money, as long as an identified property appraises at or above the amount for which you are qualified and you buy within a certain time period. Getting either a pre-qualification or a pre-approval from a lender will clear up any mystery about what you can afford. You may qualify for more – or less – than you think! You will feel more empowered to buy if you have the certainty and security of a lender behind you. Typically, a buyer will first get pre-qualified prior to starting their search. Once the buyer has identified a specific property, they will go back to the lender and have them run the numbers with the specific property. Having this pre-approval letter submitted with the offer strengthens your negotiating position because the seller doesn’t have to worry that the deal will fall through because the buyer can’t get financing.
The final step is to apply formally for the mortgage loan. The formal application process usually occurs AFTER you have an accepted offer on a specific property. (A pre-approval letter (discussed above) can be issued after your submit this application but typically only upon your request. The real document is the loan commitment letter described further on.) After the loan officer takes your application, your request for credit is processed and underwritten. Underwriting refers to the work the lender does to decide if you are a good credit risk based on verified information you submit as well as an appraisal of the property. The person doing the underwriting is usually not the loan officer, which is why it is important that the loan officer is knowledgeable and experienced with different loan products. (We can recommend good loan officers!) Once the lender has reviewed your application, they will issue a commitment letter outlining the terms of the financing and any items that are outstanding (e.g., up to date income statements or title 5 certification for the property). This commitment letter is usually issued no later than a week prior to the closing and ideally about two weeks before. Once all the outstanding items have been submitted, the lender will issue a clear to close. It usually takes about 5 business days from the clear to close to the actual closing. And then you are the proud owners of your Cape Cod house!