1. Introduction to Home Finance

At Reazo, we understand homeownership is a big commitment and home financing can be confusing. Through Reazo’s in-depth research, we aim to help home buyers better understand and be less fearful of what it takes to finance a home. We arm you with as much knowledge as possible to ensure you’re making the most educated decision when financing your first home (or second). Ultimately, we aim to make you a real estate expert.

Only you know when you’re ready to buy your first home. Forget that your friends are buying houses, interest rates are the lowest they’ve been in years, you’ve rented forever and feel like you’re throwing away your money each month on rent, or your parents think it’s a good time for you to purchase a home. There is a lot to consider as a potential first-time home buyer and the more prepared you are, the higher the likelihood of making the best decision when you are ready to buy a home.

Educate yourself with the information below and you’ll walk away with a firm understanding of the financial side of home purchasing. Learn about loan options, grants, equity, homeowners insurance and more. Buying a home is the biggest investment you may ever make and probably the biggest up until this point in your life. Let’s take a look at everything you need to know about the financial side of home buying so you can purchase your first home.

2. Can I Afford to Buy a Home?

From Renting to Buying

If you’ve been renting and are contemplating homeownership, it’s important to take a look at the pros and cons of renting vs. buying (even if you aren’t a renter, this information may prove helpful). Consider the following as you begin your quest to become a first-time home buyer:

• Cost of renting vs. buying
• Size of your savings account
• Building equity
• Repairs

First, consider the cost of renting vs. owning a home. If you’re already renting for $1000/month and you pay approximately $200/year in renter’s insurance plus utilities, your average fixed monthly payment might be around $1350. After looking at homes online, you may have come to the realization that you could be making a monthly mortgage payment for a similar amount and you would own a house.

There are additional expenses associated with buying a house which must be taken into consideration. Some of these expenses include the down payment, homeowners insurance, private mortgage insurance (PMI), closing costs, moving expenses, and more. In addition, you’ll be paying for property taxes, possibly HOA fees, water, sewer, gas, garbage, higher utilities than you’re currently paying due to more square footage, the need to buy furniture and paint, etc. In a nutshell, the amount you see online for a mortgage payment is only a portion of what you’ll actually be paying once you buy a home.

Savings Account

Consider how much you have in savings, as you look toward homeownership. Do you have enough saved for a 20% down payment? Let’s say you’re pre-approved to buy a $375,000 home. A 20% down payment, which lenders prefer, would cost you $75,000 at closing. If you don’t have enough saved, and can only pay a small down payment (minimum is usually 3% down), you will end up paying for private mortgage insurance (PMI) on most conventional mortgage loans. In addition, 2-5% of the purchase price will go toward closing costs, but the seller may offer to pay for all or a portion of cost.

$375,000 Cost of Home + Additional Fees:

+ $11,250 Down payment (3%)     

+ $3,637.50 Annual PMI     

+ $7,275 Closing costs

Equity

When you buy a home you build equity, which is not the case when you rent. Equity is the amount of your home that you actually own as a result of mortgage payments and appreciation (fair market value of your home minus the loan balance). As a renter, you are not going to build equity from the deposit and the first/last payment you had to put down when you signed the rental agreement, let alone your monthly rent payments. You can kiss that money goodbye.

Making a large down payment will instantly build equity in your home. Aim for at least 20% down. As you pay your monthly mortgage payments, you continue to build equity. If you can make extra mortgage payments, you’re not only going to build equity quicker, you’re going to save on the interest that would have been charged on those payment down the line.

If you have a 30-year mortgage, refinancing to a 15-year mortgage can help you build equity too. Not only will you pay off your home in half the amount of time (paying more per month), you will save on the interest that would have been charged on those extra months and years of payments.

As you build equity, you will be able to tap into it to renovate your home or even use the money for other financial objectives. The renovation will help build more equity in your home as it will increase the value, in most cases. Ask your real estate agent which renovations will bring the highest return.

If the market denotes a higher home value, this also provides an opportunity to build equity in your home. For example, say your home was worth $300,000 when you purchased it and years later it appraises for $350,000. If you had paid down your mortgage to $280,000, you would have $70,000 in equity ($350,000 minus $280,000).

Repairs

Consider what happens when you have an issue in your home or apartment, something that requires a repair. As a renter, if you have a problem with a leaky sink or mice, for example, you call the landlord and he/she takes care of the issue and covers the cost. When you own a home, you are in charge of fixing the sink and getting rid of the mice -- you are your own landlord. As a homeowner, you cover the cost of repairs or the expense of hiring someone to make the repairs. This is a component of homeownership worth considering if you plan on buying a home.

After looking at the cost of renting vs. buying, the size of your savings account, and building equity in a home, there are other reasons you might want to buy a home:

• Home values are on the upswing (you’ll quickly build equity in your home)
• Home prices are low (buy low and sell high in the future)
• Home costs are predictable vs. rent increasing over time
• You want to live in the same place for more than a couple of years
• Option to rent out part of your home, or your entire home
• Interest and property taxes are tax deductible
• Pride in ownership
• Privacy

As you can see, there are incredible benefits to owning a home like building equity, and drawbacks like more expenses and becoming your own landlord. Let’s move on and take a look at which loan options are available to compliment your financial position.

3. Mortgage

The majority of buyers will not have enough savings to pay all cash for their home -- that’s where mortgage loans come into play.  What is a mortgage? A mortgage is a loan used to buy a home, and the home is then used as collateral. The loan is an agreement with your lender to borrow cash for the purchase of a home, and then you make monthly payments until the loan is paid in full.

To get a better understanding of mortgages, let’s look back at their evolution.  Mortgages have been around since the 1930’s and were mainly utilized by insurance companies.  These companies hoped to gain ownership of properties if owners failed to make payments. In 1934, the mortgages that we’re familiar with today came about, mainly due to the Federal Housing Administration (FHA).  In an effort to pull our country out of the Great Depression, the FHA initiated a new type of mortgage for those people who were unable to obtain mortgages under existing programs. Less than half of households owned homes at that time and the government wanted to change that. Before the FHA made changes, loan terms were limited to 50% of market value, and loans had to be repaid in 3-5 years with a balloon payment at the end.

The FHA started offering mortgages with lower down payment requirements and programs with a 80%+ loan-to-value (LTV) ratios (LTV is a lending risk assessment ratio used by financial institutes and lenders to approve a mortgage).  The length of the loan terms was changed from 5-7 years to 15-years, eventually offering 30-year loans that we’re familiar with today. Suddenly more people could afford to own a home. The FHA also set quality standards for home construction and established the amortization of loans. People could now pay incremental amounts of the loan’s principal amount with each interest payment.  The amount of the loan was gradually reduced over the loan term until it was fully paid off.

Today there are many mortgage and financing options available because the government wants you to buy a home to keep the economy moving.  Home buying also combats transiency, strengthens communities, helps people invest in their future and generally contributes to a higher quality of life.  Before we dive into the various mortgage options available today, let’s look at the importance of getting pre-approved for a loan.

Getting Pre-Approved / Pre-Qualified for a Mortgage

Now that you have a better idea of what a mortgage is, let’s look at what it takes to get pre-approved or pre-qualified for a mortgage loan and why it’s important.  

To get pre-approved or pre-qualified for a mortgage loan, you’ll need to visit a lender.  You might start out by asking friends who their lender was and if they would recommend them.  From there, you could talk to your bank, competing banks, and credit unions. If you already use a mortgage broker, talk to him/her about lender recommendations.  If you choose an online lender, know that you may be required to meet with the lender in person to complete the pre-approval process or pre-qualification process.  

Depending on the lender, you may be charged a fee to get pre-approved or pre-qualified.  Some lenders will charge an application fee, others will waive it to entice borrowers to use their services.  Before submitting your application, ask your lender about fees. If you are charged a fee, some lenders will roll it  into your closing costs.

The process of getting pre-qualified for a mortgage loan is less extensive than getting pre-approved.  Pre-qualification is a general, overall review of your financial standing (ex. income, debt, possibly your credit history) and can be determined with a lender over the phone. The pre-qualification states that you are most likely qualified for a loan and indicates the amount the bank might be willing to lend you.  A pre-qualification letter gives you an estimate of how much you can borrow and is a good starting point as you begin to look at homes.

Getting pre-approved gives you a price range so you know what you can afford.  This will save you from wasting time looking at house you could never afford to buy.  When you start the pre-approval process, your lender will look closely at documents such as pay stubs, bank accounts, tax returns, W-2’s, assets, credit information, monthly expenses, divorce decree (if applicable), and self-employment documentation, among others. The lender will look at your income (debt-to-income ratio; explained in more detail later in this article), credit score and overall financial standing to determine what type of loan you qualify for, the maximum loan amount, and the interest rate. Remember to bring a valid form of identification (driver’s license or passport).   

When you get pre-approved for a mortgage, your lender is confident you have the means to make a down payment and you have the income to support monthly mortgage payments.  Despite the pre-approval letter, the house you desire will have to be appraised. The amount of the appraisal must be more than or equal to the purchase price. If the purchase price is higher than what you’ve been pre-approved for, you will not be able to purchase the home.

If you want to be pro-active, you can start by taking a look at your credit reports and credit score before seeking a pre-approval letter.  This will give you some insight on the types of loans and interest rates you might qualify for. If you find any problems with your credit report, now is the time to take care of them.

It will take 2-4 weeks to get a pre-approval letter, in most cases, and it will be valid for 60-90 days (varies by type of loan).  There will also be a charge associated with it in most cases. You will be approved for a specific loan amount but you do not have to buy a home at that price. The loan amount is simply the maximum amount you’re pre-approved for, but it’s wise to purchase a home below that amount so you have money for other expenses.  

Even when you get pre-approved, it is not a guarantee.  Your real estate agent will want to know what a lender thinks you can afford so he/she will favor a pre-approval letter over a pre-qualification letter.  Regardless, your agent and sellers will take you more seriously if you’ve been pre-approved for a loan due to your creditworthiness.

Once you’ve made an offer on a house, your lender will go through the final approval process.  This will take much longer than the pre-approval process. Ask your lender for more information about this final approval to avoid any surprises.  An underwriter will determine if you meet the lender’s guidelines and receive final approval. Once you’ve been approved for a mortgage loan, you will receive a letter that you can share with your real estate agent.

Note: your loan approval can be revoked if you make a large purchase, like buying a new car, before  closing. It’s wise to avoid making any large out-of-the-ordinary purchases, especially on your credit card, and avoid signing up for any new accounts while waiting for the final approval.

Getting pre-approved is beneficial and can help you get into a home faster than without pre-approval.  Other reasons to get pre-approved for a mortgage include the following:

• You’ll know exactly what you can afford and what you cannot
• Saves time: you aren’t wasting time looking at houses you can’t afford
• Avoid the disappointment of finding a home outside of the price range you’re qualified for
• Your real estate agent will ask for, and prefers, a pre-approval letter
• Gives you an advantage over buyers who haven’t sought pre-approval
• Makes you aware of issues that exist with your credit and gives you time to correct them

4. Benefits of Being a First-Time Home Buyer

There are advantages to being a first-time home buyer that aren’t available to return buyers.  For instance, you will have access to special loan programs that can get you into a home quickly and affordably.  Some benefits include low down payments, subsidized interest, and fewer lender fees. Imagine only paying a 3% down payment, compared to the lender recommended 20%.  Regarding interest, there are 3rd parties available who can pay for loan interest, saving you a significant amount over the life of your mortgage loan. With options like these, mortgage loans are more affordable and enable you to pay off the loan much faster.  (More information provided below.)

Qualifying As a First-Time Home Buyer

If you don’t think you qualify as a first-time home buyer because you’ve owned a house in the past, there are some important facts you should know about.  In some cases, a first-time home buyer is defined by whether or not you owned a home in the last 3 years.  In other words, you could become eligible as a first-time home owner despite the fact that you’ve owned a home in the past.  Other factors that can qualify you as a first-time home buyer include the following:

• If you are a single parent, who only owned a house with your ex when you were married
• If you are a displaced homemaker who only owned with a spouse
• If you owned a principal residence that was not permanently attached to a permanent foundation in accordance with applicable rules
• If you own a property that did not comply with state, local or model building codes and that cannot be complied with for less than the cost of building a permanent structure

Talk to your real estate agent or lender to see if you qualify as a first-time home buyer despite the fact that you owned a home in the past.

5. Getting Your Finances In Order

In order to figure out what you can afford, start by getting your finances in order.  As mentioned earlier, look at how much you have in savings and how much can you contribute to a down payment.  It’s best to start saving for a down payment early, long before you decide on the house you wish to buy. Lenders typically recommend putting 20% down which will lower your monthly payment amount and you won’t have to buy private mortgage insurance (PMI:  insurance intended to protect the lender in the event of foreclosure if you fall behind on payments.).

As a first-time buyer may only need to put 3% down on a home, depending on the loan.  If you’re qualified to purchase a $200,000 home, you would pay a $6,000 down payment at 3%.  At 20%, you would pay $40,000 down. As you can see, not only will you save a significant amount of money with a lower down payment, you will get into a home quicker.  Let’s look at other financial components essential to the home buying process.

FICO/Credit Score

When you look at your credit rating or FICO score, you’re not only looking at the number but how accurate the information is.  If you suspect any errors, report them to the Consumer Financial Protection Bureau (CFPB). Errors on your credit report could make you appear risky to lenders, and in turn, make it difficult to get a loan, better lending terms and interest rates.  Common errors might include a clerical error when someone entered your information incorrectly from a hand-written application. In some cases, a loan or credit card payment may have been applied to the wrong account inadvertently. Contact your credit bureau (Experian, Equifax, or TransUnion) and the organization who made the error.  Filing a dispute online will probably be the most efficient way of getting the issue corrected. You may want to ask to be copied on any correspondence as they work to resolve the issue so you have a record of the rectification. Once they have corrected the inaccuracy (30-90 days), you will want to look at your credit report to verify that the information has indeed been updated.  Your credit bureau will most likely provide a free credit report once the dispute has been recorded. Now that you know your credit score is accurate, let’s look at how it rates.

Your credit card debt and other outstanding debt greatly affects your credit score and whether or not a lender will provide a loan.  Credit scores generally range from 300-850. 700-749 is considered an excellent score while 300-649 is considered poor.  The higher the score, the least amount of risk in the eyes of your lender. If you have a low credit score, your lender will probably encourage you to work to increase it before loaning you money.  

Another important point when it comes to getting your credit score from the internet… it may not be accurate and you should only consider it a starting point.  The only credit score that really matters is the credit score you receive from your lender. Once you receive your lender-generated credit score, you will know exactly what type of loan you qualify for.  Also, if you need a better credit score to qualify for the loan you’re seeking, you can get assistance to improve your score.

Credit Utilization Rate

Since the amount owed on all of your credit cards effects 30% of your credit score, aim to pay down balances to 30% or less, as recommended by FICO.  Be aware of your credit utilization rate (aka: credit utilization ratio). This rate is the amount of revolving credit you’re using divided by the revolving credit available to you (lenders will look at this when analyzing your credit score).  For example, if you have 2 credit cards with $10,000 combined credit available to you, one with a balance of $100, the other with a balance of $8,000, your credit utilization rate is 81% ($8,100 / $10,000). Lowering the balance will lower the percentage, making it more favorable for you to qualify for a loan.  

Per-Card Utilization Rate

Per-card utilization rates are also considered by lenders and reflect how well you’re managing your finances.  This is similar to the way the credit utilization rate is calculated but it compares the balance of an individual credit card to the available credit on that card.  In the $10,000 credit limit example above, a $100 balance vs. a $8,000 balance results in a 1% and 8% per-card utilization rate, respectively. Again, keeping your credit utilization rate below 30% is commonly recommended by FICO.

Boost Your Credit Score

When trying to get approved for a mortgage, it’s important to have a good credit score.  If you’re score is less than desirable, you can work to improve it and qualify for a more favorable loan and lower down payment.  Improving your score translates to paying off your mortgage faster by saving money on finance charges and interest rates.

Lending institutes want to make sure you’re trustworthy and high credit scores earn their trust.  When you have a high score, lenders view you as someone who can handle your finances and meet financial obligations.  They’re more likely to lend you more money towards the purchase of a home and give you a better interest rate. For example, having a score 100 points higher than what you have now could earn you a 1% lower interest rate.  Might not sound like much until you realize it could save you more than $12,000 over the life of a $300,000 loan.

To boost your credit score, the following options are important to consider or try one of these options:

• Call your credit card company to have a recent late payment fee forgiven
• Aim to pay down credit card balances to 30% or less
• Work to pay off maxed-out credit cards
• Charge something small to rarely used or inactive credit cards then pay off card
• Consolidate credit card debt

When you forget to make a credit card payment and are faced with a late fee, pay the past-due balance right away. By paying the outstanding balance quickly, you minimize long-term financial damage. It’s much less likely the late payment will show up on your credit report or jeopardize your credit score if you pay shortly after it’s been posted as past due.  Keep in mind, a tardy payment doesn’t result in merely a late fee; your credit card company can raise the interest rate on your credit card too.

Waiting more than 30 days to pay the credit card balance and other fees will result in a black mark on your credit report for 7 years.  Just one late payment will drop your credit score a considerable amount and ruin otherwise excellent credit.

At 180 days past due, your credit card balance can be turned over to collections.  Do everything you can to prevent this from happening because you’ll end up with a black mark on your credit score for 7 years, even if you pay off the amount due to the collections agency.  In addition to paying the card balance, you will have to pay fees to the collections agency.

Let’s back up and look at how you can get the late fee waived.  If it’s unusual for you to miss a payment and accrue a late fee, you’ll have a good chance of the credit card working in your favor.  Give them a call and explain your circumstances (be honest). Every credit card company is different, but most will waive the late fee as long as it’s rare for you to have a late payment. Some companies will allow you to wait the late fee up to 2x per year (every 6 months).  Other companies may require you to sign up for automatic payments before they’ll waive the late fee. Talk to your creditor to see what options exist so you can maintain a good credit score.

Paying down your credit card balance is also favorable in improving your credit score.  The general rule is to pay the balance down to less than 30%. Paying off a maxed-out card is going to have a greater impact on your credit score than if you’re paying off a card with balance of $3,000 with a $5,000 limit.  This is because credit bureaus are looking at your credit-to-debt ratio. Slowly pay off a maxed-out card will gradually increase your score. If you want to see the fastest improvement in your credit score, it’s best to pay off the card in its entirety vs. paying it off in small amounts over a long period of time.

Also, as you’re paying down credit cards, consider asking your credit card company to lower your interest rate.  If you’re consistently making payments and significantly lowering the balance, creditors are more likely to consider your request.  This will save you a lot of money as you pay down the remaining balance.

Consolidating your credit card debt with a personal loan will not only help you effectively manage your debt, it can improve your credit score. In other words, all of your debt would be rolled into one loan. Getting a personal loan with a fixed rate, that’s lower than that of your credit cards, will save money over the long haul and help you pay off the debt faster.  Less debt leads to a lower credit utilization score which leads to a higher credit score. Through consolidation you only have one monthly payment, making it easier to pay on time which, in turn, will boost your credit score.

If you decide to consolidate your credit card debt, the creditor will pull your credit report (a “hard pull”) to qualify you for a loan.  This adds an inquiry to your credit report which will drop you credit score slightly and briefly. Fortunately, the debt consolidation will reduce your utilization which ultimately increases your credit score.  If you want to avoid a drop in your credit score, it’s best to get prequalified for a loan. Getting prequalified results in a “soft pull” of your credit report which does not result in an inquiry on your credit report.  Another benefit of getting pre-qualified before consolidating your debt is the option to shop around for the best rates.

You might even consider hiring a credit repair company to help remove black marks on your credit score.  These companies can remove late payments, liens, repossessions and more from your credit record making it easier for you to qualify for a home loan and favorable interest rate. They will even communicate with your credit card company(ies) on your behalf.  Many of these companies charge a fee but may also offer a free consultation and possibly a money-back guarantee. Consider this, the amount you’ll pay for their services may be insignificant compared to the amount you’ve been paying in late fees and high interest rates.

Consider using a credit analyzer tool to help determine the quickest way to pay off credit card debt based on the amount of money you have.  A credit analyzer can help you understand which factors are impacting your credit score, ways you can improve your credit score, and how to save money so you can buy a home.  This can be a great tool for estimating monthly house payments and saving for a down payment. You’ll also learn how to avoid common credit mistakes. This tool is free in some cases and a variety of options are available online.

If you have a rarely-used credit card, you can use it in favor of a better credit score.  Making small purchases then paying off the card right away will improve your credit score.  Credit reporting agencies take into account the length of time you’ve had a credit card too, so check to see how long you’ve owned this card.  The longer you’ve owned the card, the more it helps your credit score (as long as there isn’t a balance). If you’ve had it in your possession for years, merely holding onto it without making a purchase can benefit your credit score.  

It’s worth noting that closing a credit card can negatively affect your credit score by changing your credit utilization ratio.  Credit reporting agencies look at the amount of credit you have available through your credit card(s) and the more you have available to you, and the less you use it, the more favorable it is for your credit score.  In other words, having a lower balance-to-credit-limit ratio, is rewarded when you have an unused credit card.

Here’s something else to consider if you want to close a credit card.  If you don’t pay off the balance before requesting the cancellation of your credit card, the credit card agency might bump up your interest rate to the maximum allowable by law just to penalize you.  Pay the balance down to zero, contact your credit card company to confirm the balance is zero, then request the cancellation. Ask to get the cancellation in writing, via email or snail mail. By the way, if you have numerous credit cards, don’t close them all at once.  Doing so will change your credit utilization ratio and negatively affect your credit score.

If you don’t have a credit card, now is the time to get one.  You need credit accounts reported to your credit report in order to improve your credit score.  No credit is bad credit. Open a credit card, use it once in awhile (low-priced purchases) and pay it off monthly.  Cards with high limits play in your favor when it comes to your credit score.

Compare Mortgage Rates

Once you’ve determined your credit score will be good enough to get pre-qualified for a loan, take time to research the best mortgage rates.  You can start by going online to find mortgage rate calculators that will provide a variety of rates from various lenders. These rates will be based off of your target home price, the amount of your down payment, the loan type, and your credit score but may include other factors.  Keep in mind, most of the online results will be for the top banks only yet many more options exist.

Take your time while shopping online for mortgage rates.  Look at customer reviews, ratings, and comments. All of this can save you from a bad experience and wasted time.  Be aware of bank and mortgage apps that quickly approve you. These apps may also limit you to few loans options. You might find a better rate by shopping locally or online.  When you find a good rate and bank online, know that you may be required to sit down face-to-face with a mortgage broker.

You may find a better mortgage rate by visiting your local bank or credit union.  If you’re unsure what type of a loan you qualify for, start by visiting the bank you’re currently using for your checking/savings account.  Don’t feel obligated to use them as your lender, unless they have the best mortgage rates.

Mortgage rates can vary week by week.  It’s important to find an interest rate that is low to save yourself mounting interest as you pay off your mortgage.  The larger the loan, the more you’ll notice the amount of interest growing over the life of the loan. For example, imagine having a 30-year mortgage loan at 5.9% interest.  On a $300,000 mortgage, you would be paying somewhere around $17,700 the first year in interest. The same 30-year mortgage at 3.25% would drop the interest to around $9,750 the first year.  As you can see, a low rate can save you thousands of dollars a year.

When you find a good mortgage rate, talk to your lender about locking it in place (known as a rate lock) and the rules associated with it.  With a rate lock, you may get locked into a specific type of loan and/or may not have an option to take advantage of a lower rate should the option become available.  A rate lock is a great way to protect yourself against market fluctuations. If rates go up while you’re locked in, your rate will not be affected while you wait to close on your loan.  Locking in your rate will save you from spending additional money on interest each year (could save you $100’s or $1000’s annually). You will typically take advantage of a rate lock after you’ve signed a purchase agreement.

Depending on the lender, your rate will likely be locked in for 30-45 days, although it varies by lender.  This rate lock is typically free of charges but, if it needs to be extended, fees may be charged. Make sure the rate lock period is long enough to cover the entire home buying process.  If it takes you 60 days to close on a home but your rate is only locked in for 45 days, you’ll likely be faced with additional fees to extend the lock or you may lose the low rate all together.  These fees may or may not be refundable. Talk to your real estate agent about the predicted amount of time it will take to close on your new home then, if you think you’ll need more time than the length of your rate lock, talk to your lender.  

If you decide against a rate lock, you may choose to float your rate.  When current rates are high, but there’s a chance rates will drop, floating your rate may be a good choice.  The opposite is true if rates are climbing, which may lead to paying much higher than necessary rates. You can exercise your right to a lower rate only once and then your rate gets locked down.  Also, there is a charge for a float down due to the additional cost to the lender. Terms of the float down are set by each lender so they will vary.  For example, one lender may charge 1 point for a float down, while another lender may charge 1.6 points.

Whether you choose to lock in a rate or go with a float rate, get it in writing.  When my husband and I were buying a home together, we talked to our lender and thought we had locked in a low interest rate.  We put in an offer on a house, contacted the lender to let her know we were signing a purchase agreement, and discussed our low rate.  Our lender denied having agreed to the low rate. Unfortunately, we did not get it in writing. After much discussion, we were able to convince her to give us a low rate, close to what we originally agreed on, after threatening to go with another lender.  Save yourself the hassle of possibly losing a low rate by getting the lender to put it in writing.

You will be charged origination points and discount points when you take out a mortgage loan.  Origination points, or origination fees, are charged by your lender to compensate the loan officer (ex. lender’s cost to process the loan).  Lenders typically charge 1 origination point (1 point = 1 percentage of the loan) and these fees can usually be negotiated. The number of points vary per lender.  For example, if you need a $150,000 mortgage loan, 1 point would cost you $1,500. Points will be listed on the Loan Estimate that you receive from your lender.

Mortgage points, or discount points, are charges paid directly to the lender in exchange for a lower interest rate.  You will be paying for these points at closing. In essence, you pay some interest up front in exchange for a lower interest rate throughout the term of your loan.  Less interest means you’re paying lower monthly mortgage payments. If you don’t plan on staying in the house for more than a few years or you plan on refinancing in a few years, paying for points isn’t a good idea.  The real benefit of discount points is seen over the long haul.

Mortgage Application

A mortgage application is a document you use to apply to borrow money to purchase real estate.  The document will include information about the home you wish to purchase along with information about your financial background.  A lender will use this information to determine how much they will lend you, for how long and at what interest rate.

As part of the application process, your lender will look at your finances, including your housing expenses (mortgage, home insurance, taxes, condo fees, PMI if required, etc.).  Housing expenses should be less than 35% of your pre-taxed income. The amount of your down payment is also an important part of this process. At this point, your lender will run a credit check give you an idea of how much they’re willing to  loan you. Now that you know the approximate amount you can spend on a home, it’s time to start looking at houses.

Did you know your mortgage application can be rejected?  A recent study by the Federal Reserve reflected 1 in 8 applications were denied.  Your mortgage application could be denied for a variety of reasons, including lying on your form or one of the following:

• High debt-to-income ratio
• You recently applied for a new credit card
• You rarely use an existing credit card
• You recently switched jobs
• You have unpaid medical bills or missed payments
• You have been self-employed for less than 2 years
• You are not earning enough
• You don’t match the lender’s profile
• Your down payment cannot be verified

If you find yourself on the receiving end of a rejected mortgage application, talk to your lender to get a better understanding of why it was declined.  For example, you may learn that you have bad credit, defaulted on a loan, or missed numerous credit card payments. Your lender can provide solutions for dealing with issues like this and working to improve your credit score.

If there are errors in your credit report, talk to the credit bureau (ex. EquiFax, TransUnion, Experian).  They will investigate, correct it within 30 days, and notify you.

Once you’ve identified and fixed any problems, you will have a greater chance of being approved for a mortgage in the future.

There are other ways to quickly improve your credit score and get approved.  The following options might play in your favor:

• Large down payment
• Collateral
• Get a cosigner (who has good credit)
• Try to get approved by a different lender

As was previously mentioned, a large down payment will save you from having to pay PMI, you’ll have lower monthly payments and will save you $1000’s on interest.  Even if your credit isn’t perfect, lenders may be willing to loan more money if you can provide a large down payment.

When you use collateral as a down payment you’re essentially paying for the down payment with assets which can be liquidated for cash, equivalent to the 20% down payment.  Collateral might include stocks, bonds, gold, land or others. Once you’ve signed a contract to purchase a home, get your asset appraised (might be unnecessary with stocks and bonds).  You will then submit the appraisal to your lender. When you agree to use this asset as collateral, and sign off with the lender, you also agree to give up the asset if you default on your loan.

Factors such as income, credit, and financial history can prevent you from obtaining a mortgage and that’s where a cosigner might be your best option.  A cosigner uses his good credit history to backup your credit history and help you secure a home loan. The cosigner becomes as legally responsible for the loan as you.  In other words, if you were to default on the loan, the cosigner would be legally responsible for the debt.

When you apply for a mortgage and are denied, consider going with a different lender.   Another lender may be willing to approve a mortgage based off of your financial history.  Although, your best move would be to make some changes to your financial situation before scheduling an appointment.  For example, look at your credit report closely in case a creditor made a clerical error. Report the error to your creditor and and get proof that the payment was made before approaching a new lender for a loan.  If you decide to go to another lender after being denied a loan, keep in mind that every loan application shows up on your credit history which can be a red flag for some lenders.

6. Lender Criteria

Lenders will focus on two criteria to determine how much you can afford and how much of a credit risk you are -- the housing expense ratio (aka: front-end ratio or mortgage-to-income ratio) and the total debt-to-income ratio (aka: back-end ratio).  The front-end ratio looks at how much you make each month in proportion to how much the mortgage will cost each month. In addition to the cost of the mortgage, it includes the cost of private mortgage insurance, homeowners insurance and property taxes.  These costs are commonly referred to as PITI: Principal, Interest, Tax & Insurance. Lenders don’t want to see your monthly mortgage payment exceed 28% of your gross monthly income (31% or less for FHA loans). To calculate your front-end ratio, simply multiply your annual income by 0.28, then divide the amount by 12 to determine your maximum monthly mortgage payment.

Example:  If your gross income is $44,000 per year

$44,000 x 0.28 = $12,320

$12,320 / 12 = $1,026.67

Based off of this equation, you would be able to afford a $1,026.67 maximum monthly mortgage payment.

If you have a higher than recommended front-end ratio, for example, 38% for a $1,045 monthly mortgage payment based off of earnings of $33,000/year, you would need to have other factors in place to be considered for a mortgage.  A substantial down payment, sizable savings, and good credit scores can help those who have high front-end ratios.

The back-end ratio analyzes the percentage of gross income that must go towards debt payments like your mortgage, credit cards, car loans, student loans, medical expenses, and alimony, among others.   This ratio helps lenders evaluate a borrower’s credit risk. Lenders prefer to see less that 36% of your monthly income going towards total debts, although if you have good credit, lenders may be a bit more flexible.  The back-end ratio is determined using your income before taxes so you must take into consideration other expenses such as food, health insurance, gas, etc. In other words, you’ll want to budget beyond what the calculations consider “affordable”.

Back-end ratio = (total monthly debt expense / gross monthly income ) x 100

You can use an online debt-to-income ratio calculator to determine your score.

You’re considered a high-risk borrower if a high percentage of your paycheck goes to debt payments every month. For example, if you earn $1,200/month but pay $600 in monthly debt expenses, you would have a ratio of 50%. This exceeds the recommended minimum of 36%, but some lenders will make exceptions if you have good credit.  

To lower your back-end ratio, avoid taking on more debt, avoid making big purchases on your credit card(s), and pay off as much debt as possible before applying for a mortgage.  Your primary focus should be paying down or paying off high-interest credit card debt.

Remember, lenders are looking at both the front-end and back-end ratios when determining whether or not you qualify for a mortgage.  The combination of both may prove to be in your favor even if one of your scores isn’t ideel.

7. Ways to Finance a Home

All-cash offers:  Pros & Cons  

Many of us will need to obtain financing in order to be able to purchase a home, but there are others who will be able to pay all-cash.  If you have the means to pay all-cash for a home, be aware of the pros and cons. Some of the pros include the following:

• Very attractive for sellers
• May get a lower purchase price
• Avoid the hassle of getting a mortgage
• No mortgage payments
• No mortgage origination fees
• No mortgage interest payments
• No lender fees
• Faster closing
• Available equity

When you pay all-cash for a home, you get to bypass all of the pains that come with getting a mortgage then paying mortgage payments, interest, and origination fees.  

Sellers may accept your offer over a higher-priced offer that requires a loan.  Say you offer $325,000 all-cash on a home listed at $330,000. Even though you’re offering less than asking, your offer will likely be accepted over a full-asking offer with financing.  Sellers know that an all-cash offer if more likely to close than an offer with loan financing. Plus, closing is faster.

When you buy with all-cash, you will be able to take advantage of immediate equity in your home.  Equity is determined by the amount of money you put down when you purchase your home. When a buyer gets a mortgage loan and puts down a 20% down payment, they have 20% equity in their home.  All-cash provides full equity in your home which can be used for renovations or to finance other expenses.

What about the cons associated with a full-cash offer?  Because you’re paying out such a large amount up front, you may experience loss of liquidity.  Make sure you have a considerable amount of money saved to cover emergencies because it’s difficult to access cash tied up in real estate.  If you get into a financial bind, you may have to tap into equity or sell your home.

• Loss of liquidity
• Available funds for large, unexpected repairs
• Additional expenses:  taxes, title insurance, appraisal fee, inspection fee, HOA fees
• Negate homestead exemption

Despite having paid all-cash, you’ll still have expenses like closing costs, real estate transfer taxes, fee for title insurance, appraisal fee, and the home inspection fee. Additional expenses might include having to pay monthly homeowners association (HOA) fees, used to fund property improvements and maintenance.  These fees, which cost start around $200-$500/month, are usually associated with the purchase of a condo and some single-family communities. Although there are cons to consider when making a full-cash offer, paying cash will give you full ownership and many advantages.

Although the thought of paying all-cash for a home and not having a mortgage payment sounds like a good option, having a mortgage can come with the advantage of making money.  When you have a mortgage payment that’s locked in, you may actually make money during inflationary periods. As inflation rises so does the value of your home. During an inflationary period, you earn more equity and your home-to-loan value increases -- all favorable perks of having a mortgage instead of paying all-cash for your home.

Homestead exemption may be negated without a mortgage, if you find yourself in serious debt in the future.  If you paid all-cash for your home and filed a claim for homestead exemption, intended to protect your home's value from property taxes and creditors after the death of a spouse, creditors could force the sale of your home to satisfy their claims.  

Mortgage Loan Options

Earlier we talked about getting approved for a mortgage loan.  Now let’s take a look at the variety of mortgage loans that are available.

Conventional Loans

As the most popular type of loan today, conventional loans are not government-backed, guaranteed or insured by the government making them risky from a lenders’ standpoint.  These loans are offered by private mortgage lenders and have conforming loan limits associated with them (ex. In 2019, $484,350 in most states; $726,525 in higher cost areas like Hawaii and Alaska).  

The requirements for conventional loans are tougher making it more difficult to qualify for, in comparison to government loans (ex. strict income guidelines).  They offer lower competitive rates and the down payment can be as low as 3% but can vary. Borrowers with excellent credit, and therefore a low risk of defaulting on the loan, are best suited for this type of loan.  Borrowers may be required to complete an online course.

One of the most popular benefits of a conventional loan is no upfront mortgage insurance fee even if you put down less than 20%. However, there is a monthly mortgage insurance fee for those paying less than 20% down.  You do not have to buy PMI if you put down 20%+.

A large majority of conventional loans are “conforming” mortgages because they conform to Fannie Mae and Freddie Mac guidelines.  These two government-sponsored enterprises (GSEs) provide money for the U.S. housing market, buy mortgages and sell them to investors.  This makes mortgages more widespread. 

Let’s look at non-conforming loans, for those borrowers who don’t qualify for a conforming loan.

Non-conforming mortgage loans, which are also conventional loans, do not meet GSE guidelines.  These loans are often called “jumbo” mortgages because they have larger loan limits than conforming loans.  When borrowers don’t qualify for conforming mortgages, because the amount they need to borrow is higher than the conforming limit for the area, they might qualify for a non-conforming loan.  

These loans are best for high-risk borrowers, those who have poor credit, a large amount of debt, recent bankruptcy, or for homes with a high loan-to-value ratio.  Getting a loan that exceeds conventional loan limits, is more difficult to qualify for because the loan amount is high. Also, they may include fees or insurance requirements. Since they’re riskier, some lenders shy away from them. There are even super jumbo loans for loans on houses priced over $1 million.

“Portfolio” loans are non-conforming, flexible mortgages held by mortgage lenders on their books, hence “portfolio” in the name. Instead of working with a lender who services your loan from another location, you can maintain your relationship with the original lender. In other words, these loans aren’t sold to another lender, instead, the lender keeps the loan on his/her books and earns consistent interest on the loan.  These loans are for people with bad credit, bankruptcies, foreclosures, tax liens or student loan debt, who wouldn’t qualify for a conventional mortgage. These loans may have features that other mortgages don’t because lenders can set their own guidelines and they don’t sell them to investors.

Subprime mortgages compliment buyers with low, less-than-favorable credit scores. The term subprime refers to a borrower’s credit score, usually below 600. These loans typically have high interest rates (often ARMs) and fees. These are geared toward buyers who have problems consistently making payments and are generally at higher risk of defaulting on their loans.  Without these types of loans, people wouldn't be able to qualify for conventional mortgages. Borrowers are encouraged to work to improve their credit score so they can eventually qualify for a conventional loan, offering better interest rates and lower fees.  Subprime mortgages can also fall under the following names:

• Near-prime
• Subpar
• Non-prime
• Second-chance lending

Conventional 97 loans are offered by Fannie Mae and are only given to first-time home buyers.  There are loan limits associated with the loan which are typically set by your county.  A fixed-rate mortgage is required and terms can be up to 30 years. There is no income limit and the loan doesn’t require the borrower to have perfect credit either.  These loans only require a 3% down payment, leaving the buyer with a mortgage balance of 97% loan-to-value. The borrower’s FICO score typically needs to be 680+ and is dependent on the borrower’s financial profile. The borrower needs to have at least a 43% DTI (debt-to-income) ratio to ensure they don’t get in over their head after getting a mortgage.  

• No income limit
• Do not have to have perfect credit
• 3% down payment
• 680+ FICO score
• 43%+ DTI

HomeReady mortgage loans are conventional loans offered by Fannie Mae.  These loans aim to help low-to-moderate income borrowers, whether they’re first-time or repeat homebuyers.  Credit scores need to be 620+, with higher scores typically result in better pricing. These loans are free from representations and warranties and are simple and quick to obtain if you qualify.  A unique feature of this loan is that the borrower can cancel their mortgage insurance once equity grows to 20%.

These loans are flexible in allowing contributions from family and friends and there is no minimum personal contribution, which sets them apart from other types of loans.  In other words, you can accept a larger down payment or closing costs in the form of a gift or grant.

Another unique feature of HomeReady loans is the income from others in your house can help you to obtain approval.  In other words, rental or boarder income can help you get approved for this type of loan.

• Lower down payment
• Lower credit score requirements
• Lower mortgage insurance
• Family/friends can co-sign on your loan
• Accepts larger down payment and closing gifts
• Cancel mortgage insurance at 80% LTV

Government Loans

FHA loans are guaranteed by the FHA, have down payments as low as 3.5%, offer competitive rates, and are geared towards making homes more affordable for low- to middle-income families.  These loans are favored because they have the lowest credit score requirements of any type of mortgage. Mortgage insurance premiums (MIP) are charged for this type of a loan. FHA mortgage limits vary state by state and are broken down by low-cost areas and high-cost areas (Alaska, Hawaii, Guam and the Virgin Islands).

• FICO score 580+, but a lower score may be accepted with a higher down payment  
• Debt ratios should be 31% or less on the front end, 43% on the back end
• Borrowers may qualify for down payment assistance or grants

When a borrower has FHA mortgage insurance, they pay an upfront premium of 1.75% of the loan and they also pay annual premiums.  With the upfront premium, the FHA gets paid by the lender at closing, then the lender adds the premium to the loan balance. Borrowers will pay mortgage interest on the premium until the loan is paid off.  In addition, borrowers will pay annual premiums based on the length of the loan, the size of the down payment, and the size of the mortgage.

Once the buyer has paid debt down to 78% of the home’s value, with a 15-year FHA loan, the FHA will cancel your mortgage insurance.  With a 30-year FHA loan, you’ll still need to pay debt down to 78% but will also have to make mortgage payments for at least 5 years before being able to cancel.  FHA loans do not require an appraisal so if you pay your loan down to 78% you can cancel your insurance, even if the value of the home has declined (unlike PMI).

(Later in this article, we look at FHA loans called 203K rehab loans.  These loans are geared toward properties in need of rehabilitation.)

VA loans are mortgages guaranteed by the U.S. Department of Veterans Affairs, designed for active military and veterans, and issued by private lenders.  There are many benefits to VA loans including no down payment, low rates, 100% financing, and they don’t require mortgage insurance. These loans usually close in 40-50 days.  You’ll need to find a lender that specializes in VA loans.

• Military, veterans and some spouses qualify
• $0 down payment
• Pay funding fee
• No PMI

VA loans also include funding fees.  Funding fees are one-time fees used to offset VA loans that go into default, helping to reduce taxpayer costs, and allow the VA to continue to offer home loan programs to military homebuyers. This fee can be paid upfront or the borrower can have the fee calculated into their monthly mortgage payment. In some cases, borrowers with service-related disabilities can be considered exempt from paying funding fees.  Others who may be exempt include the following:

• Those receiving disability compensation as a result of service-related medical issues
• Those on active duty who provide a certificate or military orders which show the Purple Heart award
• Those who are entitled to receive compensation for a service-connected disability, if they receive retirement pay in lieu of compensation or active duty pay
• Those rated as eligible based on a pre-discharge exam or review
• Surviving spouses of one who died in service, from a service-related cause, or totally disabled and receiving Dependency and Indemnity Compensation (DIC)

Reservists and National Guard members can expect to pay slightly less than other military members.  Simply go online to use the free VA funding fee calculator to see what you might pay for a funding fee.

USDA loans, also known as rural development guaranteed housing loans or rural development loans, are designed for those with low to modest incomes wanting to buy rural/suburban properties (over 97% of the U.S. is eligible, although city homes are excluded). These loans require no down payment, 100% of the home’s purchase price can be financed, and mortgage rates are discounted.

• No down payment
• Low mortgage rates
• Fixed interest rate
• 15- or 30-year loan
• Low mortgage insurance fees
• No prepayment penalties
• FICO:  640 minimum

Borrowers must personally occupy the home as their primary residence, be a U.S. citizen / U.S. non-citizen / qualified alien, must not have been suspended or debarred from participating in federal programs, and must be willing to meet credit obligations in a timely manner (640+ credit score).  Borrower’s DTI should be less than 41% of their income, although a good credit score could forgive a higher DTI. This type of loan can be used for an existing or new construction home. Talk to your real estate agent or lender or go online to see if you’re qualified.

Although USDA loans require mortgage insurance, the rates are low.  When purchasing a home expect to pay a 1% upfront fee at closing, based on the size of the loan (ex. $100,000 loan requires a $1,000 upfront mortgage insurance premium).  This mortgage insurance amount is added to your loan balance so you don’t have to hand over cash at closing. There is also a small 0.35% annual fee, based on the principle balance, for all loans. Following the example above, this would amount to a monthly fee of $29.17 added to your mortgage payment to cover mortgage insurance. (NOTE: closing costs can vary by state and lender.)

• 1% of the home loan upfront
• 0.35% annual fee on the loan amount

Even though USDA loans are for those with modest incomes, people with higher incomes can qualify using the 115% rule.  For example, if the income limit is $60,000 for a family of 4, this family could be approved for $69,000 under the 115% rule.  

You can visit the U.S. Department of Agriculture online to see if your area, or an area near you, is USDA-eligible. The site also lists lenders of the Rural Housing Program.

Piggyback Loan

It’s unusual to see piggyback loans today but they were popular during the mid-2000s, during the mortgage boom. A government-backed piggyback loan is a second mortgage loan made at the same time of the main mortgage which enables borrowers to avoid paying for private mortgage insurance.  If a borrower only has enough for a small down payment (ex. 10%), they can get a piggyback loan to boost the borrowed amount to 90% of the price of the mortgage, hence avoiding PMI.  This second mortgage will typically reflect higher interest rates which are often adjustable. Although it’s rare to hear of this type of loan today, there’s always a chance that it could make a comeback.

Interest-Only Loan

Another type of loan that’s unusual in today’s home buying landscape is an interest-only loan in which the buyer only pays interest on the mortgage.  Most of these loans have a 30-year term. This type of loan appeals to buyers who want a bigger home than they can currently afford or they’re planning on selling within a few years.  Some of the advantages of this type of loan include the following:

• Interest-only payments for up to 10 years (varies)
• Low monthly payments
• Monthly payments can be deducted from taxes
• Option for buyers who plan on selling within a few years

Most of these buyers using this type of loan are banking on earning more in the future so they can afford larger payments at the end of the fixed term, usually between 5-7 years.  Once the term ends, borrowers begin paying off the principal of the loan, pay a lump sum, or refinance their home. Some borrowers will be shocked to learn how much of a payment increase occurs at the end of the fixed term.  

Some of the disadvantages associated with interest-only loans include the following:

• Rising mortgage rates (if adjustable rate mortgage)
• Huge spike in monthly payment at end of interest-only period
• Borrowers spend the extra money they saved instead of investing it and being prepared for the end of the fixed term
• Borrowers income might not grow enough to enable them to afford larger payments when the time comes

Fixed-Rate and Adjustable-Rate Mortgages (ARM)

Loan programs typically offer the option of a fixed-rate or adjustable-rate (ARM) mortgage (also known as variable-rate).  With a fixed-rate mortgage, your interest rate will remain the same for the life of your loan. With an ARM, your interest rate will start out low, lower than the interest rate for fixed-rate mortgages, but it can be changed periodically.

Examples of fixed-rate mortgages:

30-Year Fixed Rate:  This is the most common term that homeowners choose.  This rate will provide the lowest monthly payment and your rate will never change.

15-Year Fixed Rate:  This rate will reflect higher monthly payments but more of the payment goes towards the principal balance.  Your rate will be lower than a 30-year loan. One major benefit of a 15-year mortgage is paying off the loan in half the time, saving a lot in interest.

ARMs, also known as variable-rate mortgages, may start out with a low interest rate but then increase once you’re past the adjustment period.  For example, you may be charged 3.25% interest your first year then pay 5% interest during the next adjustment period. This increase may increase the amount of your monthly payment and extend the life of your loan.  

When you’re only planning on living in your home for a few years, an ARM might be a good option because you won’t be affected by interest rate changes for a very long period of time.  On the other hand, if you plan on staying in your home for a long period of time, there’s a chance you could end up paying more than you borrowed, despite making all of your payments on time.   

The initial rate on an ARM could last anywhere from 1 month to 5+ years, depending on the ARM product your choose.   The term of an ARM is often time reflected in the name. For example, if you were to get a loan with an interest rate that changes every 3 years, you would have what’s known as a 3-year ARM.  

Examples of ARMs:

5/1 ARM:  The interest rate on a 5/1 ARM is fixed for the first 5 years of the loan and is generally low during that time.  After 5 years, the rate will increase annually. These loans are typically for buyers who plan on staying in their home for less than 5 years or those who intend to pay off the loan in 5 years or less.  

Interest-Only (I-O) ARMs:  As the name implies, you only pay interest for a specific number of years with an interest-only (I-O) ARM payment plan.  This will keep your monthly payments small for a period of time. The interest-only period on an I-O ARM can vary depending on your loan.  Following the interest-only period, you will start paying back the principal along with the interest. The longer the I-O period, the higher your monthly payments will be after the end of the I-O period.  This results in an increased monthly payment, even if interest rates stay the same. It’s important to know that some I-O loans can have adjustable interest rates during the I-O period.

With ARM’s, you’re assuming more risk over the long haul because interest rates will undergo scheduled changes throughout the life of your loan.  Your monthly payments could go up or down and a lower interest rate might not result in a lower monthly payment. The rate is adjusted on the basis of an index which reflects the cost to the lender of borrowing on the credit markets.  Be aware that different lenders may have the same initial interest rate, but different rate caps.

Fortunately, ARMs come with caps which limit the amount rates can change.  Caps types are either annual or life-of-the-loan and save you money by capping the amount of interest that you’ll be charged over the life of your loan. With the annual cap, interest rate changes within any given year are restricted. The life-of-the-loan cap limits the maximum and minimum interest rate for the life of the mortgage.

Examples of ARM caps:

• Initial adjustment cap
• Subsequent adjustment cap
• Lifetime adjustment cap
• Periodic rate cap

The initial adjustment cap controls the maximum amount the interest rate on an ARM can jump when it is adjusted for the first time, after the period of fixed rate expires.  This cap is typically 2% or 5%. At the first rate change, the new rate may not exceed two (or five) percentage points above the initial rate during the fixed rate period.

The subsequent adjustment cap is associated with interest rate increases in the adjustment periods that follow.  A 2% cap is typically.

The lifetime adjustment cap controls how much, over the life of the loan, the interest rate may increase in total.  5% is most common. In other words, the rate would never be more than 5 percentage points above the initial rate.

A periodic rate cap on an ARM limits the change in your interest rate during the adjustment interval and is designed to safeguard the consumer (the adjustment period is the period of time between rate changes).  For example, if you’re current rate is 6% and the periodic rate cap is 1%, your new rate must fall between 5-7%, regardless of index changes. If interest rates dropped or remained steady, you could save more than if you had a fixed-rate.  

ARM components:

1. An index
2. A margin
3. An interest rate cap structure
4. An initial interest rate period

After the initial interest rate expires, adding a margin to the index will calculate a new interest rate.  This margin will be disclosed by your lender when applying for a loan and can vary from lender to lender (shop around for the lowest margin).  The index moves up or down, resulting in the adjustment of your interest rate. According to the FHA/HUD website, the following are acceptable index options on FHA insured ARM loans:

1. Constant Maturity Treasury (CMT)
2. 1-year London Interbank Offered Rate (LIBOR)

Your lender will provide written information on different types of ARMs, including the following:

• Loan terms and conditions
• Index and margin
• Rates and how they’re calculated
• How often rates changes
• Caps/limits on rate changes
• Other features

Talk to your lender to find out what the annual percentage rate (APR) is because if it’s a bit higher than your initial rate, you will likely pay a significantly higher amount payment as the loan adjusts, even if the general interest rates remain unchanged.

Before considering an ARM, think about other debts that may crop up (ex. tuition) that will affect your ability to pay a higher mortgage.  An unexpected large expense could affect your ability to pay a higher mortgage if interest rates go up significantly.

If you aren’t planning on living in your new home for very long, you will likely be unaffected by rising interest rates and an ARM might make sense.  For example, if your interest rate stayed the same for 2 years and then you decided to move, you would likely paid less interest than your friends who chose a fixed-rate mortgage.

Owner Financing

This is an interesting twist on getting financing for the purchase of a home.  With owner financing, part or all of the money required to buy a property is put up by the current homeowner.  In other words, the buyer is borrowing money from the seller to buy the seller’s home. Oftentimes, when lenders refuse to finance a seller’s property, owner financing becomes a useful option.  

Owner financing may include a bank loan in combination with money borrowed from the seller.  Some buyers will pay a down payment, although it isn’t required. A promissory note is created to cover the terms of the agreement between the buyer and seller.  Terms include the interest rate, monthly payment and schedule, among others. These terms might be subject to local laws and regulations. If the entire purchase amount is being financed by the seller, they will keep the title until the buyer pays off the loan.

Owner financing benefits the seller in many ways.  For starters, they can sell their home quickly. The seller can decide on the price of their home and sell it for more if they wish.  Sellers will receive a steady stream of income as the buyer works to make payments. A seller will typically pocket more money because they aren’t paying fees associated with a lender agreement.  A seller who is facing capital gains tax would also benefit from owner financing.

If sellers are dealing with a crowded market, owner financing provides an opportunity to be more competitive.  An economic downturn can also be advantageous to the seller because, during that time, it’s difficult for buyers to get conventional financing and have enough money for a 20% down payment.

Buyers benefit from this type of financing as well. Owner financing includes little or no buyer qualifications, a variety of loan repayment options (ex. fixed-rate), lower closing costs (no origination points, processing fees, administrative fees, etc.), and faster possession.  If a buyer can only get a small mortgage, the seller can lend the buyer the rest. If the seller requests a down payment, the buyer may only have to pay a small amount compared to what’s charged by lenders.

For sellers, there are downsides to owner financing including the buyer defaulting on the loan.  If the seller still has a mortgage, he/she might face foreclosure. The seller needs to be organized in order to keep track of monthly payments and any late payments.  Because of this, some home sellers hire a third party to collect the payments (additional fees will be paid for this type of service). Sellers must also take extra time to investigate the creditworthiness of the potential buyer.  If the seller decides to hire a real estate attorney, they will have to pay fees.

Buyers face downsides too, including the possibility of paying a much higher interest rate than they would have if they had financed with a lender.  For example, the seller might choose to charge a high interest rate if the buyer has a low credit rating. The seller might charge a large balloon payment at the end of the loan period which may cause financial hardship for the buyer.  The buyer cannot sell or refinance the property until all payments have been made and the title has been transferred in their name.

As you can see, there are benefits and drawbacks to owner financing no matter if you are the buyer or seller.  In either case, it’s best for both parties to hire real estate attorneys to make sure the financial agreement covers everything.

Programs for Specific Occupations or Profiles

• Law Enforcement Officers
• EMT’s
• Nurses
• Firefighters
• Teachers
• Veterans
• Low-to-Moderate Income

Certain occupations come with perks when it comes to home purchases.  Law enforcement officers, for example, receive a 50% discount off of the appraised value of properties that have been foreclosed on by HUD (Department of Housing and Urban Development).  If they purchase with a mortgage approved by the FHA, the down payment requirement is only $100. Teachers, firefighters and EMT’s can qualify for this program as well (some restrictions apply).  In addition, assistance programs exist to provide grants or loans to cover down payments and closing fees.

• Good Neighbor Next Door
• Officer Next Door
• Teacher Next Door
• Keystone Challenge Fund
• State Housing Initiative Program
• Among others

Certain groups and populations (Ex. Native American) may be eligible for other discount programs sponsored by state and local governments or other organizations.  Visit the HUD website to discover various programs offered in your state.

Low-to-moderate income households can take advantage of one or more of the following benefits:

• Below-market interest rates and payments
• Low down payment stipulations
• Grants and loans for down payments
• Mortgage insurance discounts

Some low-to-moderate income programs, like Freddie Mac’s Home Possible Advantage loan and Fannie Mae’s HomeReady program, offer low down payment options.  The mortgage insurance associated with these loans is discounted too. If you’re buying a home outside of the city limits, you may qualify for a USDA mortgage (Rural Housing).  A USDA mortgage requires no money down and includes 100% financing.

Veterans can take advantage of VA home loans, backed by the U.S. Department of Veteran Affairs.  There is no minimum credit score, no down payment, you can finance 100% of the purchase price, there is no mortgage insurance, and sellers can pay up to 4% of the purchase price in closing costs so you may end up paying nothing out-of-pocket at closing.

As you can see, there are many discounts available for specific occupations and profiles.  Let’s take a look at other programs, loans, and financing options to help you buy a home.

8. Down Payments

Although down payments have been mentioned throughout this article, this section will provide more details.  A typical down payment is 5-20% depending on the loan. If you qualify for a FHA loan, for example, you will only have to pay 3.5% down.  Overall, having a substantial down payment can save you from having to pay PMI on top of your monthly mortgage payment and from paying extra interest over the life of the loan.

Some believe that if you cannot afford at least 3% down, you might not be ready to own a home and accept the financial responsibility of home ownership.  Dave Ramsey, financial guru, is a true believer in saving until you can afford 15-20% down on a 15-year fixed mortgage, where your payment is no more than a quarter of your take home pay.  This advice is worth considering. Paying somewhere between 0.5%-5% of the original amount of your mortgage loan per year in mortgage insurance may prove too costly for some. On the other hand, if home buyers can afford to pay this percentage on top of the amount of their monthly mortgage, it’s worth it just to get into a home.

As mentioned earlier, the amount of your down payment helps your lender determine the loan-to-value (LTV) ratio of the property (how much you’ll owe after the down payment), and determines whether or not they’re going to extend credit to you.  When you make a higher down payment, your lender will typically offer a better interest rate on the loan. Which translate to saving a lot of money over the life of the loan. Use a mortgage calculator to see how a large down payment can save you on interest over the life of your loan.

Some mortgages do not require a down payment. VA loans and USDA loans are good examples and they come with low rates. Talk to your lender to see if you qualify for these types of loans.

Funding a Down Payment

Various forms of down payment assistance exist including loans, grants, and tax credits.  Some options will require repayment of funds, others will not.

Loans, for example, to help with a down payment may run in parallel with your main mortgage, offer deferred payments, or may be forgiven after a set number of years (under certain circumstances).  There are a variety of second mortgage loans including the following:

• Soft second mortgage
• Deferred payment second mortgage
• Forgivable second mortgage

When loans run in parallel with the mortgage, as a second mortgage, the homebuyer may have varying payment options.  Some may have deferred payments, others will pay for a portion or all of their down payment, others may be required to gradually pay back all funds as they’re paying off their first mortgage, or others may have to make monthly payments.

Soft second mortgage programs provide down payment assistance to get the homebuyer into the house quickly but require the borrower to repay the down payment.  Some loans don’t include interest while others do, and some may amortize. The down payment term on repayable loans can range, on average, from 5- to 30-years with varying repayment terms.  In some cases, repayment begins immediately. In other cases, repayment begins after a predetermined number of months or years. A partial balloon payment may be due at the end of the loan period.

Second mortgages, with deferred payments (aka:  deferred or silent second programs) delay repayment of the down payment assistance until the borrower moves out, sells, refinances, or rents the home.  If the home buyer plans on living in the house for many years, he/she will benefit from appreciation of the home’s value. When it comes time to sell, refinance, rent the home or move out, the homeowner may be faced with a 1099 tax form.  Talk to your lender about this being a possibility so you’re prepared to deal with it should you receive one.

Other loans, known as forgivable second mortgage programs (aka: soft second), forgive some or all of the original down payment assistance amount.  It’s similar to a grant but instead of providing a lump sum payment, funds are provided over a period of several years.  With this type of short-term mortgage, it’s typical for a percentage of the second mortgage to be forgiven each year, for a fixed number of years.  Much of the time these types of programs only last for 5 years. In that amount of time, the homeowner can build up equity which, in turn, helps them qualify for a standard mortgage when the forgivable second mortgage ends.  If the borrower doesn’t meet the program’s conditions, the loan must be repaid, possibly with interest.

Other Considerations for Down Payment Assistance

Besides the information listed above, you can visit down payment resource programs online to see if you meet the minimum program qualifications.  Some of the criteria you’ll be faced with are the following:

• Minimum credit scores
• Cash reserve requirements
• Income requirements and thresholds

Income thresholds are based on median income in the area.  Household size is a common basis for determining income limits (ex. limits are higher for large families in comparison to a single person).

The requirements for home eligibility include the type of home, price, and the home must be the buyer’s primary residence.  The type of homes that are eligible include single-family homes, townhomes and condos, although some multi-family properties may qualify as well.  The price of the home is limited to a percentage of the median home prices in the desired neighborhood (some homes qualify when above the median price).  

In some cases, the buyer will be required to take a homeownership education course (can be done online in most cases) in order to fully qualify for down payment assistance.

Secondary programs also exist to provide down payment assistance.  For example, the U.S. Department of Commerce offers down payment assistance programs.  The following are among some of the states offering down payment assistance programs and include the maximum amount they can contribute (varies yearly and per state):

• Orlando, Florida:  $42,000
• New Jersey:  $800
• Connecticut:  $14,000
• St. Louis County, Missouri:  $30,000
• Montana:  up to $40,000

Assistance from the U.S. Department of Commerce can save you hundreds to thousands of dollars.  Talk to your lender to see if this type of assistance is available in your area.

FHA down payment assistance programs

Nearly 87% of single-family homes potentially qualify for down payment assistance, if they’ve qualified for a FHA insured loan.  Average down payment assistance benefits range from $5,000- $20,000, although some states cap the amount of assistance they offer.  Additional assistance might be in the form of a loan, grant, or other options, and it’s possible to get coverage for both the down payment and closing costs (more information provided below).  

To provide more of an opportunity to get down payment assistance, the federal government has even designated targeted areas, as defined by each state, where there is a high percentage of low income families who can qualify for assistance. Don’t hesitate to talk to your agent or lender about federal, state, county and city government agency programs, non-profits, and even employer options, that offer home financing assistance.

Options for Funding a Down Payment:

Grants

Grants are a great option to consider if you need help covering the cost of a down payment.  Grants are gifted to the homebuyer by an eligible third party and do not need to be repaid.  Grants do not incur a lien on the home being purchased or an associated note or deed.

As an example, HUD’s Good Neighbor Next Door grant provides down payment assistance to law enforcement officers, firefighters and more.   Ask your mortgage lender or broker for more information on first-time homebuyer grants available in your county or state. (See the “Programs for Specific Occupations/Profiles” section for more information)

The National Homebuyers Fund (NHF) provides a grant for up to 5% of the value of your loan, but no more than $10,000, to help with the down payment, if you qualify.  This grant must be used with a VA, USDA, FHA, or Fannie Mae 30-year fixed, full amortization mortgage loan.

Cash Gifts

Cash gifts are another option when you can’t come up with the full down payment.  Cash could come from your family, church, a non-profit or an employer. Lenders will look closely at where your assets and money are coming from so you’ll need to be upfront about wanting to use a cash gift for a down payment.  

When lenders look at the size of the cash gift, they will verify when the gift was received (some companies look at a 60-day history of assets to qualify for a mortgage), and how the amount compares to your total monthly qualifying income.  For example, if you’re getting a conventional loan, a gift deposited in your bank account cannot exceed 50% of your total monthly qualifying income. Other types of loans will have varying rules and restrictions.

The gift must be accompanied by a gift letter which you’ll submit to your lender.  Quickly obtain a letter from the person who provided the gift to avoid the hassle of trying to get it once you sit down with your lender.  The letter should include the name of the donor, their address and phone number and their relationship to you. It also needs to include the amount of the donation, the date the money was transferred to you, a statement indicating it’s a donation and not a loan, the donor’s signature, and the address of the property you are purchasing. Other requirements may exist depending on your lender and the type of loan.  Check with your mortgage lender for the most up-to-date information about gift money.

401k or IRA

Another option, when you do not have enough money for a down payment, includes borrowing money from your 401k or IRA.  These aren’t necessarily favorable options. If you decide to borrow from your 401k, you may face penalties. To save yourself from having to pay a penalty due to early withdrawal, you can roll the down payment amount into an IRA.  You won’t be able to rollover a 401k if it’s with a current employer -- it would have to be from a former employer. If you don’t roll it into an IRA, you will face a penalty of 10% on the withdrawn amount and you’ll pay income tax on it too.

When taking out a loan from your 401k (held with current employer), the loan amount can be $50,000 or half of the value of the account, whichever is less.  Since this is a loan, you will be expected to pay it back so consider if you can afford to make these payments in addition to paying for a mortgage. These payments may affect your mortgage qualification because of the amount of the monthly payments.  If you’re paying a large amount monthly to cover the 401k loan, it may be difficult to pay your mortgage every month.

When paying back a 401k loan, if your plan allows for this, you will not have to pay taxes or penalties but you will be required to pay interest (usually 2 points above the prime rate).  Also, you may have a limited number of years to pay back the loan. If you leave your current employer, associated with the 401k, you may be forced to pay back the outstanding balance within a few months or be faced with a hardship withdrawal.  A hardship withdrawal comes with a hefty penalty from the IRS. There’s a lot to consider with a 401k loan and it’s best to talk to your lender before considering one.

Withdrawing money from your Roth IRA or traditional IRA are also options for a down payment (or even closing costs).  Before considering this option, remember that these accounts are designed to save money for retirement.  If you cannot afford a large down payment, you may want to consider waiting to buy a home or finding funds elsewhere so you have enough money for your retirement.  

With a traditional IRA, first-time home buyers can withdraw as much as $10,000 to cover part or all of the down payment.  $10,000 is the lifetime limit -- if you decide to buy another home in the future, you will not be able to withdraw from your traditional IRA to fund a down payment.  If you withdraw funds before 59 1/2, you will have to pay income tax on the withdrawal.

You can use Roth IRA earnings towards a down payment, up to $10,000, if the account has been open for at least 5 years (if less than 5 years, earnings are taxable).  The $10,000 lifetime limit also exists for this IRA.

Larger-Than-Required Down Payment

Benefits of a Larger-Than-Required Down Payment

Putting down more than the required down payment amount comes with many benefits.  First of all your mortgage balance will be smaller and so will your monthly payments.  A smaller loan balance creates a shield to preserve equity in your home even if market values decreases.  In turn, this could aid in the ability to refinance or sell your home in the future.

• Lower LTV ratio = lower mortgage rates (typically)
• No PMI
• Save on interest

You will also save on interest, over the life of your mortgage, because you will have fewer payments. Consider using a mortgage calculator to compare the amount of interest you would save if you put down 20%, for example, or a larger amount.

Disadvantages to a Larger-Than-Required Down Payment

Believe it or not, there are disadvantages to putting down a larger than required down payment.  While saving for a large down payment, you will be paying rent along the way (if renting). Housing prices could increase during that time resulting in a lower overall down payment when you find a home.

The money that you save to put toward a future down payment may take a bite out of money you could be saving towards other investments, including your retirement account.  For example, if you’re saving $300/month toward a down payment but aren’t contributing to your 401K, you could be setting yourself up for issues as you get closer to retirement. Consider how this will affect you in the long term and whether you should allocate some of the money you’re saving to other investments.

When it comes to saving for a down payment, take into consideration how long you plan to live in the house.  If you plan on living in your house for a few years, not decades, it may be worth it to make a small or average down payment.  The benefits of a larger than required down payment will be rewarded over the long haul, not during the first few years of owning a home.

As you can see, there are a lot of pros and cons when it comes to making a larger-than-required down payment. Take a look at your current financial position and see how it can benefit you in the short- and long-run. Talk to your real estate agent and lender to get their input on the size of your down payment and how it can help you as you prepare to purchase a home.

9. Extra Costs

Closing Costs

Closing costs have been mentioned throughout this article and are a good example of an unexpected expensive. Closing cost fees may include the appraisal fee, loan processing fees, title search and insurance, mortgage points, deed-recording fees, credit report charges, among others.  The buyer is typically responsible for paying these fees, but you can ask the seller to cover a portion or all of them as you negotiate the purchase agreement.

2-5% of the purchase price will go toward closing costs and, if the seller agrees to pay for them, you could save thousands of dollars.  For example, if you’re purchasing a $350,000 house, closing costs may run anywhere from $7,000 to $17,500.

Talk to your real estate agent about closing costs, which fees you will be responsible for and how much can be negotiated with the seller.

PMI (Private Mortgage Insurance)

PMI has been mentioned throughout this article and is worth exploring more, as there are a variety of private mortgage insurance options associated with conventional loans.  PMI is required by lenders when a buyer can only pay a portion of the required 20% down payment on a conventional loan. PMI basically protects the lender in the event of a foreclosure.  It does not protect the buyer, but it does allow the buyer to purchase a home with a reduced down payment. When a buyer wants to purchase a home but doesn’t want to spend years saving for a 20% down payment or simply doesn’t have the means to save that much money, PMI will allow them to get into a home faster. A variety of private mortgage insurance options exist including the following:

• Borrower-Paid PMI (BPMI), AKA: PMI
• Lender-Paid PMI (LPMI)
• Single Premium
• Split Premium

The most common type of PMI is borrower-paid monthly mortgage insurance (BPMI), better known as simply PMI.  PMI is attached to the monthly mortgage payment, increasing the amount due each month.  The borrower has the option to pay part of the PMI upfront, resulting in lower monthly payments (talk to your lender to see if this option is available).

PMI, or BPMI, is not permanent.  Once the balance of the mortgage has been paid down to 80% of the home’s value (20% equity), the buyer can ask the insurer to cancel PMI.  At 78% of the home’s value, the insurer is required to cancel the PMI. If you do not have a good payment history or have liens on the home (ex. a home equity loan), you may not be able to cancel PMI.  The following loan-to-value (LTV) ratio helps buyers calculate whether or not they’ve paid down their home’s value to a point where they can request PMI be cancelled:

Mortgage amount owed / appraised value

$292,000 / $365,000 = 80%

PMI can provide quite a return on your investment. All the while you’re paying your mortgage and PMI fees, you’re building equity in your home.  Even better, if the home appreciates, the return on your investment increases as well.

Lender-paid PMI (LPMI) is paid for by the lender to help the borrower avoid or reduce the monthly payment that’s associated with PMI and cannot be cancelled.  The lender raises your interest rate to cover the cost of the mortgage insurance and then makes money off of that interest. It’s important to point out that the lender uses adjusted interest rates, so LPMI works best with short-term loans.  In addition, if the borrower opted for a long-term loan (ex. 30-year), he/she would be paying interest throughout the life of the mortgage and would have to pay it off the mortgage completely to get rid of it.

With LPMI, the borrower can opt for a 1-time, lump sum payment at the beginning or pay a higher interest rate on your loan on a monthly basis.  If the latter of the two options is chosen, the borrower will pay a higher monthly mortgage payment each month for the life of your mortgage, unlike PMI payments which stop once the borrower reaches 80% of the original value of their home.  The amount paid each much will be lower than PMI payments. Because of the amount buyers can save monthly, they can oftentimes qualify for more home.

With single premium PMI (SPMI) or single-payment mortgage insurance, buyers pay an upfront, lump sum for the mortgage insurance premium which eliminates the monthly PMI payment.  SPMI is popular in competitive housing markets, especially where sellers want to see the buyers highest and best offers. It typically saves the buyer a significant amount of money over the life of the loan (monthly premiums can really add up when you have PMI). This is a good option if you plan on staying in the house for a long time vs. a couple of years.  Buyers with SPMI  also have a better chance of getting approved for a higher priced home.

Split premium PMI, which is uncommonly used, provides another opportunity to pay reduced monthly premiums and qualify for a bigger loan.  The cost is split into an upfront payment, paid at closing, and then paying monthly installments on the remaining balance.  With this type of PMI, the amount paid upfront can be covered by the seller, builder or lender, and is especially favorable in a seller’s market.  

Split premium PMI can be refundable or non-refundable.  A partial refund may be available depending on how long the insurance coverage was in place.  The non-refundable version could also result in a partial refund if it’s cancelled under the Homeowners Protection Act of 1998.

Borrowers need to keep in mind that financing split premium PMI into the loan amount may increase LTV which can result in higher mortgage rates.  With split premium PMI, the buyer may qualify to cancel their mortgage insurance sooner by making extra payments and paying down the mortgage balance.  

Considering mortgage insurance options listed above, it may seem more attractive to save 20% for a down payment.  Take into consideration the amount of time it will take to save that much money. If it takes years, some potential home buyers can find themselves in a quandary when the time comes to buy a home -- housing prices may have steadily climbed during the years they were saving for the down payment.  For example, homes in their price range, from 4 years ago, now costs an additional $25,000. After 4 years of saving for a down payment, they no longer have enough for 20% down and must continue to save. At this point it might be wise for them to put down the amount they’ve saved and pay PMI fees, as they won’t have to pay PMI for very long.  Also, consider that during those years spent saving for a down payment, they have missed out on the opportunity to build equity in a home too.

As you can see, there are pros and cons to saving for a 20% down payment and various options available for mortgage insurance.  Talk to your lender about providing side-by-side comparisons of different types of mortgage insurance and the resulting monthly payments (if any).  Look at how much you can afford in loan costs, the amount you want to pay monthly and the number of years you plan on living in the house. If you cannot afford the mortgage insurance and monthly mortgage payments, talk to your lender about improving your financial profile so you can move closer to your dream of becoming a first-time home buyer.

Mortgage Insurance Premiums (MIP)

Like PMI, mortgage insurance premiums (MIP) help protect lenders when borrowers purchase homes with less than a 20% down payment but applies to FHA government-backed loans, not conventional loans.  Since FHA loans have very low down payment requirements (3.5%), the default risk is higher and the terms aren’t as flexible, hence MIP.

MIP includes an upfront premium (UFMIP) and an annual premium.  UFMIP must be paid at closing and is 1.75% of your base loan amount.  If it isn’t paid entirely in cash, it can be added to the total amount of the loan.  Your lender sends the fee to the FHA and is required to pay it within 10 days of the closing.  If late, the lender, not the borrower, must pay a late fee before the FHA will approve the insurance.

As an example of upfront premiums, if $200,000 is borrowed, the total loan amount would be $203,500 ($200,000 x 0.0175 = $3,500 + $200,000).  

Other than the UFMIP, FHA borrowers will pay annual MIP fees.  FHA annual mortgage insurance premiums (FHA MIP) are calculated annually but paid monthly as part of the borrower’s mortgage payment.  These fees are determined by the loan amount, loan term and LTV. Those with lower LTV values or with <15-year mortgage terms may qualify for lower annual premiums.  The annual premium is 0.85% for most FHA loans. Even if mortgage premiums change, existing borrowers will be locked into their original rate.

FHA borrowers can expect to pay mortgage insurance premiums for a long time.  With <15-year mortgage term and > 90% LTV, the mortgage premium will have to be paid for the full term of the loan.  With the same mortgage term and < 90% LTV, the borrower would pay premiums for 11 years. Longer term loans have similar premium payment terms.

Borrowers making a 10% or greater down payment on a home priced under $625,500 can expect to save a significant amount whether choosing a 15- or 30-year mortgage.  In addition, the borrower will be able to cancel MIP after 11 years. The same borrower purchasing a home priced over $625,500, can expect to pay more overall but, again, will save a significant amount when paying at least 10% down.

Depending on when you get your FHA loan, MIP can be removed after 11 years if you put >10% down when you got the loan. Otherwise, removing MIP can only be done through a full refinancing, as opposed to PMI which can be removed once a specific threshold is met.  With refinancing, you must have paid down your LTV to 80% or less to be eligible.

For the most up-to-date MIP rates and information, visit the US Department of Housing and Urban Development.

Property Taxes

When buying a home, additional expenses like property taxes are inevitable.  The way property taxes are paid/collected can vary by state/county but in most cases, property taxes are collected 2x per year.  Check with your real estate agent or lender to find out how much you’ll pay for property taxes and how often.

In many cases, your lender will set up an escrow account along with your mortgage.  In addition to your monthly mortgage payment, you will make escrow payments to pay for your property taxes.  Escrow accounts are required by lenders when borrowers put down less than 20%. Some borrowers who pay at least 20% down, will not have an escrow account but, instead, discipline themselves to save enough for property tax payments.  Others will opt to get an escrow account, regardless of putting down 20%+, to help them stay on top of property taxes and other expenses, like homeowners insurance.

The annual property tax payment is divided by 12 and is paid monthly along with the mortgage payment.  In most cases, a buyer prepays a couple of months’ worth of taxes into the escrow account at the close of escrow (when finalizing the sale).

Your lender has access to the escrow account and is responsible for submitting the property tax payments directly to the appropriate payee.  This way, the buyer doesn’t have to deal with a sudden, large property tax payment 2x year.

Each year your mortgage lender will review your escrow account to ensure you have enough in there to cover property taxes (and homeowners insurance payments).  Since taxes can fluctuate, lenders will adjust the escrow account annually to compensate. There may be times you end up with a refund or have to pay extra for a deficiency.  

Homeowners Insurance

Another expense you’ll be faced with is homeowners insurance.  Homeowners insurance is required by most lenders when you finance your home.  There are exceptions, especially if you didn’t need a loan to purchase the home… but it would still be wise to have it.

Homeowners insurance is used to protect your home in case of unforeseen disasters like fire damage, natural disasters, explosions, damage caused by aircraft, etc.  Since your lender is basically part owner of your home while you’ve got a mortgage, he/she wants to make sure your home stays in good shape. Your homeowners policy will cover most repairs to keep the value of your home from dropping.

Imagine if your home was destroyed in a natural disaster, like a hurricane.  Most of us would not be able to afford to rebuild. That’s where homeowners insurance comes into play.  It will most likely cover a lot of the expenses associated with rebuilding. If you’ve made home improvements, like adding an attached garage or remodeling your kitchen, you’ll want to ask your insurer if you need to make changes to your policy to match the increased value of your home.

Your important valuables can be protected with homeowners insurance too.  If you own high-end electronics, for example, your insurance could repair or replace it in the event of a burglary.

You can even get help from your insurance if someone’s injured on your property and decides to sue you. Homeowners insurance can assist with legal fees and possibly coverage for the injury.

Talk to your insurance provider to learn more about the amount and type of protection your homeowners insurance offers -- the protection may be subject to limitations and stipulations.  For example, if your belongings were damaged due to a house fire, you might only receive 50-70% of the value from your insurer. Don’t assume you’ll be covered in case of a disaster only to be faced with a situation where you are underinsured and struggle to recover due to lack of coverage.  Check your policy every few years to ensure it meets your needs.

10. Lender Credit

When you finally find the house of your dreams and learn of the incidental costs, you may begin to wonder how you’re going to pay for everything.  In addition to the down payment and moving costs, you’ll be faced with closing costs like appraisal fees, title, loan processing fees, legal fees, inspection costs, etc.  To help pay for these expenses, you may be able to take advantage of lender credit.

Lender credit is provided by your mortgage lender to help offset mortgage-related closing costs.  When the lender offers the money in credit, say $2,000, that credit is then applied to the borrower’s mortgage.  As a result of accepting the lender credit, the borrower will be faced with a higher interest rate. Even if they qualify for a low interest rate, the lender will increase the rate to cover loan origination fees, commission, and the borrower’s closing costs.  Although the interest rate may be very low, say an additional 0.5%, it will add up quickly over the life of your loan. For example, if the borrower has a 30-year mortgage, they will accumulate enough interest to have covered the initial closing costs and more.  Those borrowers with shorter mortgage periods or those planning to move out of the home within a few years, will find lender credit most advantageous.

For some borrowers, paying the small, additional amount each month on their mortgage is worth it compared to having to come up with thousands of dollars in cash at closing.  It’s also beneficial if the borrower plans on refinancing.

Borrower-paid compensation may be an option for some.  Instead of paying the lender, the borrower pays the loan originator’s commission.  The advantages of borrower-paid compensation is the borrower can negotiate the loan originators fee for service and secure the lowest possible interest rate.  The disadvantage is the borrower usually pays out-of-pocket for the loan originator’s commission. On the flip side, the borrower can use seller contributions to cover the commission then use lender credit for the other closing costs.  Talk to your lender to determine whether or not this is a viable option for you (not all lenders offer borrow paid loans). APR is higher on borrower-paid vs. lender-paid compensation.

Lender-paid compensation is repayment to the broker for the borrower interest rate credit.  This will not be disclosed on your loan estimate but will be included in your closing disclosure.

It’s important to look closely at the loan estimate whenever you’re considering lender credit.  Borrower-paid compensation will be disclosed on the loan estimate but lender-paid compensation will not.

11. Closing Cost Credit From Seller

Buyers can ask sellers to pay for any and all of their closing costs as part of their contract.  This can result in saving the buyer thousands of dollars on most every major loan type. Closing costs vary by lender and from loan to loan so it’s always best to get more than one quote to help you save money.

Common terminology used when closing costs are covered by the seller:

• Seller Concessions
• Interested Party Contributions (IPC)
• Seller Assist
• Seller Credits

Oftentimes, sellers offer closing cost assistance as an incentive to buyers to increase the chances of the home selling. The seller may cover part of the closing costs or the entire amount.  The money can only be used for closing costs vs. compensation for new appliances or to cover the buyer’s down payment, for example. Once a purchase price is agreed upon, the buyer and seller agree to raise the sales price of the home to cover the buyer’s closing costs.

There are limitations to a seller paying for closing costs.  For instance, seller concessions may not exceed the total cost of the buyer's closing costs.  In addition, when the price of the home is adjusted in the contract to compensate for the seller paying closing cost fees, that adjusted sales price must be supported by the home loan valuation.  If the home’s appraised value is below the adjusted sales price, the buyer’s request for seller concessions will be rejected.

Seller concessions face legal limits based on the type and size of the loan.  For example, conventional loans have limits associated with LTV values. A LTV ratio above 90%, the seller can be asked to pay 3% of the purchase price. A LTV ratio between 75-90%, the seller can pay as much as 6%. Less than 75% LTV ratio and the seller can contribute up to 9%. Talk to your real estate agent or lender about the type of loan you have and your seller concession options.

12. Discount Points

Discount points, known as points or origination fees, are used by lenders to lower the buyer’s interest rate in exchange for the buyer paying an upfront fee (the opposite of lender credits).  The points are calculated based off of the loan amount, and each point is equivalent to 1% of the loan amount. The buyer will pay for these points at closing and the points will increase closing costs.

The lowering of a borrower’s interest rate is relative to the interest rate he/she could get with a zero-point loan at the same lender.  If the loan has one point it should have a lower interest rate than a loan with zero points, if both loans are the same kind and offered by the same lender.  For example, both loans would have the same fixed-rate, loan term, loan type, down payment, etc. The precise amount that your interest rate is reduced depends on the lender, type of loan and market conditions.  Different pricing structures are used by different lenders -- another good reason to shop around for your mortgage. Ask your lender how discount points will impact your interest rate.

When a buyer takes advantage of points, they may spend a bit more upfront, but will reduce their monthly payments. Take time to calculate how long it will take to pay off the amount you’re putting down in points and you may find it’s worth it in the long haul.  Say you pay $2000 in points. If this saves you $20 on your monthly loan payment, it would take you approximately 8 years to pay it off. For buyers who intend to stay in their home for many years, this proves beneficial. If the buyer gets a low rate, and can afford to pay a decent amount in points, he/she will not only save on monthly payments but may not need to refinance in the future (avoiding additional fees).

Negative points exist too.  Some people use negative points to decrease the amount they pay in closing costs. Although this helps with closing costs, the buyer will pay more in interest. With one negative point, your lender could increase your interest rate slightly but give you 1% of the loan as credit to help with closing costs.

13. Financing Dwellings, Other Than Single-Family Homes

Fixer Uppers

Earlier in this article we mentioned FHA 203k Rehab loans.  These loans provides enough money to allow borrowers to purchase a home and make needed repairs and renovations.  Like all FHA loans, they require mortgage insurance for life. Let’s look at how this type of loan can help you fix up a home in need of rehabilitation.

FHA 203k rehab loans are designed for borrowers who only have a small amount for a down payment or have average or slightly below average credit scores (requirements vary by lender) and want to purchase a home in need of rehabilitation. The loan covers the purchase price and price for renovations (up to $35,000) so the borrower only has to make one monthly mortgage payment.  You’ll need to have patience with this type of a loan because it can take up to 6 months to close.

The home must be livable, despite the need for renovations.  This loan has the same loan requirements of a FHA loan including a 3.5% down payment and standard FHA mortgage insurance.  The borrower’s credit score needs to be 640+. Be aware that interest rates can be higher than a standard FHA loan. Some 203k loans even include a provision that provides approximately 6 months of mortgage payments to allow the home buyer to live off-site while home repairs are being made.

Some 203k loans require a professional contractor to do the renovations, and only specific types of repair/renovation work are allowed, while other variations of the loan allow DIY work.  Talk to your lender to learn more about the amount of work that can be done by you vs. by a licenced contractor.

There are 2 versions of the FHA 203k loan, the standard and the limited 203k mortgage.  

The standard 203k loan can be used for most any type of repair or improvement when purchasing a home, with the exception of non-permanent changes or the addition of luxury amenities.  Borrowers can borrow more than the home is worth if repairs increase the appraised value (max 110%). This is not an ideal loan for borrowers needing to make repairs totalling a few thousand dollars or less.  

Some of the improvements covered in a standard 203k loan include the following:

• Structural modifications
• Reconstruction of a home that has been demolished (if the original foundation remains in good shape)
• Moving the house to a new location
• Connecting to public sewer or water
• Improve accessibility for the disabled
• Conversion of a 1-family home into a 2-, 3-, or 4-unit home or vice versa

Standard 203k loan qualifying factors include the following:

• Home must be 1+ years old
• Minimum repair cost is $5,000
• A 203k consultant must be hired
• Maximum loan amount must be below FHA mortgage limits for your area

203k consultants can be found on the HUD website and must be hired to determine if the project is financially feasible under their requirements.  Buyers can use an independent consultant who isn’t on the HUD website (ex. architect or engineer) for the feasibility analysis.

The consultant inspects the home and property, provides necessary architectural exhibits and a write-up of the project’s scope and specifications via a draw request form.  A detailed breakdown of the cost of estimated rehabilitation repairs, which must meet all HUD requirements for 203k Rehab mortgage insurance, will be included. These forms provide information to help mitigate program abuses. The consultant will also prepare lender packages and contractor bid packages. Once everything has been outlined and the write-up is complete, copies will be provided to the lender, contractor and borrower.

Next, the borrower takes bids from contractors, makes a decision on who will do the work, and must consult with their 203k lender to make sure the lender agrees with the choices.  Once a contractor is selected and terms of the loan are fulfilled, your 203k lender will schedule the closing. Once signed, the buyer will pay a retainer fee based on the cost of the proposed work.  This retainer fee will cover part of the consultant fee.

The higher the cost of the renovation, the higher the final consultant fee.  For example, if renovation work costs between $15,001-$30,000, the consultant fee would be $500; $75,001-$100,000 would result in a $900 consultant fee.  These fees are for a single-family home. Fees are higher for multi-family homes.

A limited 203k mortgage is designed for homes which require minor repairs, from cosmetic repairs to larger repairs like HVAC systems, but the home must not require structural modifications.  Cost of repairs is limited to $35,000.

• Adjustable- or fixed-rate mortgage
• DIY work is allowed unless the repair is beyond the borrower’s level of expertise
• A home inspector will list recommended repairs/improvements
• Work must commence within 30 days of closing and be completed within 6 months
• Improvements must comply with HUD’s Minimum Property Requirements and meet local building codes

Unlike the standard 203k loan, the limited 203k loan allows borrowers to make DIY repairs, with some restrictions. Borrowers must provide documentation to their lender, supporting their knowledge, experience and ability to perform DIY repairs.  Repairs that qualify under this loan include the following:

• Kitchen and bathroom remodels
• Painting (interior/exterior)
• Energy-efficient improvements
• Roofs
• Gutters, downspouts
• Flooring
• Improvements for people with disabilities
• Septic or well systems
• New kitchen appliances or washer/dryer
• Among others...

With 203k limited loans, a 203k consultant is not required.  Instead, borrowers use the services of a licensed home inspector to outline recommended repairs and improvements.  These loans require a “buffer” amount up to 20% of the total bids (contingency reserve) to cover any costs above the bid amounts.  If the contingency fund isn’t needed, it’s credited back to the borrower.

Benefits of a FHA 203k loan include lower payments, gaining remodeling experience, and instant home equity.  For example, a house that’s potentially worth $300,000, sells for $260,000 and only needs $25,000 in repairs will result in $15,000 equity once the repairs/improvements have been made.  So if the borrower is patient and willing to tackle some projects, this type of loan may be a good fit.

Financing for Mobile Homes, Modular and Manufactured Homes

Mobile and manufactured homes are typically more affordable than site-built homes and a great option for those with low income or those living in rural areas where contractors and building supplies aren’t readily available.  

It’s important to understand the difference between mobile homes and manufactured homes.  Mobile homes are factory-built homes which were built before 1976. These homes didn’t require the safety standards that exist today, making it more difficult to get financing for them.

Manufactured homes, formerly called mobile homes, are factory-built homes built after 1976 and are required to meet HUD safety standards.  These homes are built on a permanent metal chassis and, although they can be moved, the move may affect financing.

Modular homes are not manufactured homes.  Modular homes are built indoors in a factory on non-removable metal chassis, are permanent structures and can be built on crawl spaces or basements (unlike mobile or manufactured homes).  Once the sections of the modular home are built, they are transported to the buyer’s preferred location then assembled by the builder. Sometimes called prefabricated homes, these homes require the same loans as site-built homes (see previous sections regarding financing for permanent home structures).

Start by getting bids from lenders who specialize in mobile home and manufactured home sales.  If you’re buying a new manufactured home, that company will likely work with and recommend their preferred lender but consider getting bids from other non-affiliated lenders too.  It’s especially beneficial to work with specialized lenders because they’re already familiar with the aspects of a manufactured home. In addition, you’ll need to work with this type of a lender if the manufactured home is on land you won’t own, isn’t attached to a foundation system, and/or it was previously owned or has been modified.  Consider talking to people who already own a manufactured home to get lender recommendations. Other factors to be aware of when looking to buy a mobile home or manufactured home are as follows:

• Lenders are more apt to give loans to those who purchase double-wide vs. single-wide mobile homes
• It’s harder to get financing for mobile homes that are older than 20 years
• New manufactured homes must include a 1-year manufacturer’s warranty
• It’s easier to get financing if the home sits on a permanent foundation and you own the land or will own it
• Homesites must meet established local standards and include water supply and sewage disposal facilities
• The current value of the mobile home or manufactured home will affect the amount of the loan
• A minimum down payment will be required (3.5% or greater)
• A poor credit history will greatly reduce the likelihood of getting approved for a loan

Chattel loans are secured loans used to finance the purchase of manufactured homes which are not permanently affixed to land (home-only loans; not for the home and land).  These homes typically sit on leased land, rental sites (ex. a park or manufactured home community), or family property. In some cases these loans will apply to borrowers who own the land or are still paying off.  These loans are considered personal property loans, not real estate loans, which can lead to a faster closing.

With this type of mortgage, a lender will hold a lien against the manufactured home which is used as collateral for the loan.  Once the loan is repaid, the lender will remove the lien. If the borrower defaults on the loan payments, the lien will protect the lender.  The lender can then repossess the home and sell it to pay off the debt.

Interest rates tend to be higher on chattel loans compared to real estate loans and the terms may be shorter, impacting affordability.  Loan amounts and processing fees are up to 50% lower on chattel loans in comparison to mortgage loans, as indicated by a study done by the Consumer Financial Protection Bureau (CFPB).

The FHA has options for people buying manufactured homes which sit on land they own.  These options are the same options used by buyers of site-built homes. The manufactured home must meet certain qualifications outlined in the HUD Handbook (FHA Single Family Housing Policy Handbook).  Some of the qualifications are as follows:

• One-family dwellings only
• 400 square foot minimum
• Must have a HUD Certification Label
• Must have been built on a permanent chassis and remain on it
• Must have been designed to sit on a permanent foundation
• The home can only be transferred one time, from the manufacturer or dealer to the permanent site, and cannot be moved again.
• Borrower must occupy the home as their primary residence (not to be purchased as an investment property)

Typical of FHA loans, they have low down payments, based off of the borrower’s credit score.  With a score above 580, borrowers put down as little as 3.5%. Scores between 500-579 require a minimum down payment of 10%. Other requirements, which may vary by lender, include the following:

• Buyer must be able to afford the closing costs (usually between 2-7% of the purchase price of the home)
• Buyer must have enough cash saved to cover at least one monthly mortgage payment, after paying the down payment and closing costs
• Front-end ratio: typically a maximum of 31% of the buyer’s gross monthly income
• Back-end ratio:  typically a maximum of 43% of the buyer’s gross monthly income

New Construction

Building a new home is exciting and can give you the opportunity to choose every detail, down to the type knobs on your cabinets. If you need to take out a loan to build your new home, things can get pretty complicated.  New construction loans are very different from traditional loans and aren’t easily obtained. They are typically short-term and have higher rates than permanent mortgage loans. They differ from buying an existing home, which is based on the fair market value of the home as compared to recent home sales.  New construction loans are based on the projected value of the home once it’s complete. Also, construction loans are paid out in installments, as each phase of the building process is complete, vs. one lump sum with a traditional loan.

• More difficult to qualify for in comparison to a traditional mortgage
• Not offered by all banks or financial institutions
• Borrower must have good credit, stable income, low debt-to-income ratio
• Get pre-approved before working with a contractor

If you wish to build a home and obtain financing, first consider these steps to finding a reputable builder for your new home:

• Find homes that match your style
• Interview various builders
• Get builder references
• Talk to buyers who have purchased from the builder
• Look at a variety of homes built by the builder (new and older)
• Builder should be experienced with budgeting and scheduling

Anyone interested in investing his/her time and money in the construction of a new home can apply for a construction mortgage loan.  Construction loans can be used by a contractor, a small business owner, or a homeowner to finance the new build. It’s important to get pre-approved for a construction loan before you work with a contractor.  The blueprints and design of the home cost money and, if you have these created before getting pre-approved for a construction loan, you may be out hundreds or even thousands of dollars if you cannot get approved for a loan.

To qualify for a new construction loan, you will need to fill out an application and a loan underwriter will then analyze your income, credit history, and debts.  Then they will determine if you qualify, what the terms are and how much they’re willing to lend you. From there, the lender will need to see the construction timetable, detailed building plans, and your budget. They will also need to vet the builder. The down payment will vary by loan type and you can expect to pay a larger down payment for high-end custom home.  As you can see, there’s a lot involved in getting approved for a new construction loan. Many lenders consider constructions loan to be higher risk than traditional mortgages, hence the stricter requirements. Let’s take a look at two types of construction loans, construction-to-permanent (C2P loan or single-close loan) and stand-alone construction (construction-only loan).

Construction-to-Permanent Loan (C2P)

With C2P loans, you borrow the money to pay for the construction of your home and once the home is complete, your lender will convert the loan balance into a permanent mortgage (like a traditional mortgage), using the home as collateral.  These loans are often called 2-in-1 loans, or single-close loans, because the borrower only goes through one closing and doesn’t have to obtain a second loan to finish paying off the loan (see stand-alone loan below).

• 2-in-1 loan
• Variable interest rate
• 20-25% down payment
• During construction, pay interest only on funds disbursed (draws) to contractor
• Upon completion of build, loan converts into a 15- or 30-year mortgage
• 1 closing saves you money

With a C2P loan, you pay interest only on the amount of funds disbursed during the construction phase.  You could be paying more or less depending on how much the prime rate fluctuates (variable rate) during construction.  Some lenders will let you lock in a maximum mortgage rate at the beginning of construction, and they will generally require at least a 20% down payment based on the expected amount of the permanent mortgage.

When using a C2P loan, the contractor will draw money to cover his/her expenses while working to complete various stages of the home.  In other words, the loan is used like a line of credit, in which the contractor takes draws to pay for different stages of construction (ex. framing, drywall, electrical).  A draw schedule is used to keep track of the draws being made and to avoid extending money to the contractor before work is completed. (If you are financing the project with cash, you will still want to use a draw schedule to avoid paying [or overpaying] for work that hasn’t been completed.)  Money is typically drawn in 5-7 payments, although the number of times can vary. The bank will distribute the payments, generally as work is completed.

Early on, the contractor will take a draw to pay for permits such as water and sewer hookup, excavation and backfill, among others.  Further into the project, draws will be taken for rough framing, trim out, drywall, etc. Finally, draws will be taken for substantial completion (ex. gutters and garage doors) where the homes is sufficiently complete, and you can move in as the final stage of construction is being wrapped up.  

Once construction is complete and the home has passed all inspections, your loan will be converted into a permanent loan (ex. 15-30 year mortgage).  You will have the option to choose a fixed or variable-rate mortgage, and you will be paying principal and interest that is fully amortized over the entire term of the loan.   

Keep in mind, once you close on a C2P loan, you are locked in.  If something were to go wrong during construction (ex. the construction crew skips town), you would still be responsible for the loan.

Stand-Alone (Construction-Only) Loan

A stand-alone loan funds the construction of your home and once construction is completed, you will be required to pay the loan off.  These loans are favored by existing homeowners looking to build a new home before selling their current home. With this type of a loan, you have two separate loans.  The first loan pays for the construction. The second loan is the mortgage to pay off the construction debt, which you receive when you move into your new home.

• 2 loans
• 2 closings
• Smaller down payment
• Variable mortgage rate
• Short-term repayment period

A stand-alone loan is for the construction portion of the process only -- you will not have permanent financing like you would have with a C2P loan.  It can come with a smaller down payment than a C2P loan but will come with a short-term repayment period too. You’ll owe the full amount of the loan once the construction is completed. Unfortunately, you pay for 2 closings: the construction loan closing and the permanent mortgage closing. In addition, you do not have an option to lock in a maximum mortgage rate so you may have to pay higher than expected interest rates on the mortgage loan.  

One of the main differences between a C2P loan and a stand-alone loan, is you aren’t guaranteed a permanent loan at the end of a stand-alone loan.  You will be forced to reapply for a loan. A lot can change over the period of time it takes to build a new home (ex. your financial status; injury that keeps you from working), which may keep you from qualifying for a mortgage loan.  Since you won’t be locked into an interest rate, you may end up paying higher (or lower) rates at the end of construction. A C2P loan provides a bit more security in comparison to a stand-alone loan, alleviating some of the stress you might experience at the end of construction.

Whichever loan you decide fits your needs, it’s important to make sure you have a strong credit score and have a sizable down payment.  As mentioned earlier, it’s important to talk to a variety of lenders to find the best rates and loan terms. Also, since these loans are considered more risky than traditional loans, not all banks and financial institutions offer them.  When you decide on the loan, make sure to have some cash reserves on hand in case unanticipated construction costs crop up (it’s likely they will).

Builder Financing

When you decide on a builder to build your new home, you do not have to go with the financial package they offer. The builder may have wholly owned mortgage subsidiaries or affiliate relationships with independent mortgage companies.  In addition, they may offer affiliate title insurance and settlement services. As the consumer, you can choose to look at other options for your mortgage, title insurance and settlement insurance.  

In some cases, the builder’s bundle will save you, especially if incentives are built in.  In other cases, you may find more favorable terms on interest rates, for example, just by shopping around.  Learn about packages and incentives offered by your builder then consider looking around to see if you can get better rates while still utilizing your preferred builder.

Tax Breaks Associated With New Construction

If you took out a construction loan to build your new home, you can take advantage of deducting construction loan interest.  This applies to interest on the first 24 months of the loan, up to the first $1 million in total loan proceeds, including interest.  Also, the home must become your primary or secondary residence upon move-in (other restrictions may apply).

Depending on which state you live in, you may be eligible for new construction tax credits when you buy a newly built home.  Tax credits for new construction are designed to move existing new construction inventory. When there are a lot of newly constructed houses on the market but they aren’t selling, you can take advantage of the situation and earn tax credits.

An Energy Efficient Tax Credit is an example of the tax credit that can be earned on new construction. If you are your own contractor, you can claim a deduction for building an energy-efficient home (some restrictions apply). Federal “green” tax credits can cover 30% of your cost for qualifying fuel cells and microturbine systems.  At a state level, you may be able to take advantage of “green” tax breaks for installing energy-efficient solar panels, insulation, and water heaters, among others. Limitations exist for both federal and state tax write-offs. Check with your financial expert to determine whether or not you meet the standards for qualification. If you wish to take advantage of this type of tax credit, you will need an IRS Form 5695 to calculate the credit then transfer it to your 1040.   

Building a home can be a very exciting adventure, but there can be many unknowns and frustrations if you aren’t armed with knowledge of new construction.  Understand the building process, loan options, timeline, and the possibility of additional expenses. Talk to a lender about loan options, the payback term, if builder financing is a good option, and if you can get tax breaks.

14. Good to Know

Neighborhood Assistance Corporation of America (NACA)

Resources are available for those seeking more information about mortgage and lending institutes.  The Neighborhood Assistance Corporation of America (NACA) is a nonprofit community advocacy and homeownership organization.  This HUD-certified program provides affordable homeownership options for those with low-to-moderate income and for those seeking to purchase in low-to-moderate income communities.  NACA mortgages are an ideal option for those who have been discriminated against.

NACA doesn’t require a down payment, there are no closing costs, fees or PMI.  They offer below market fixed interest rates on 15- and 30-year loans. Buyers do not have to have perfect credit and there is no income limit. NACA offers a workshop designed to educate buyers on the program and provides post-purchase counseling.

The downside of a NACA mortgage is a higher mortgage payment, and buyers will likely only qualify for a lower priced home.  Buyers are required to participate in programs to give back. This might include referring friends and family to the program, volunteering at NACA offices and workshops, educating others about NACA, and/or participating in campaigns or ballot initiatives.  Visit their website to see if the program is offered in your area.

HomeFundIt

HomeFundIt will help you raise money for a down payment through crowdfunding and/or shopping with UpIt.  Create an account, get pre-qualified online, create your campaign, build your story, and start earning funding pledges for your down payment.  

With HomeFundIt, you can utilize a community of friends, family, and strangers, who make monetary contributions towards your campaign.  Users can market their needs through social media, email, and word of mouth then receive multiple, small, tax-free gifts to help pay for the down payment.  In turn, users not only generate money for a down payment, they save money by avoiding higher rates and PMI.

With crowdfunding, you get pre-qualified beforehand (online) and must buy a home within 12 months of accepting the first gift.  Utilizing this option allows you can buy a home quickly. Prospective homeowners also have the opportunity to get a $1,500 Closing Costs Grant , after completing free homebuyer education and counseling classes (some restrictions apply).  

A fundraising coach will help you plan your strategy so you can maximize the funds you need to raise.  A mortgage expert will help answer your financial questions and guide you through the process.

With HomeFundIt, you can also earn money for a down payment simply by shopping through the UpIt app.  You, your friends, family, and even strangers, can shop with UpIt, and as much as 10% of each transaction will go toward your campaign.  With the UpIt option, funds can be raised for years in preparation for buying your first home, unlike crowdfunding which requires funds to be used within a year.  Prospective homeowners can use UpIt and crowdfunding simultaneously or start with UpIt then add crowdfunding later.

With this program, first-time home buyers no longer need to save personal funds for years or borrow money for a down payment.  With HomeFundIt, you can raise money for a down payment and you don’t have to pay it back. Suddenly one of the biggest obstacles in buying a home, saving for a down payment, is no longer an obstacle. (Some employers offer this program as a benefit.)

Homestead Exemption

After the death of a homeowner's spouse, a homestead exemption protects a home's value from property taxes and creditors. Primarily, homestead exemptions are meant to provide physical and financial protection for the surviving spouse, in association with their primary residence.  In some states homestead protection is automatic, but in other states a claim must be filed then re-filed if you move. Some states do not offer homestead exemption. In those that do, the degree of protection can vary by county. The cost of a homestead exemption is very affordable and worth looking into when buying a home.  Talk to your real estate agent for more information or look into the statutes or the constitution of your state.

Finding a Mortgage Lender

• Take the time to talk to a variety of lenders to get the best rates (visit many lenders just like you would visit many houses to find the right one; a difference of 0.5% over the life of the loan can result in significant savings)
• Go through final lender costs and fees to ensure charges are correct
• Don’t be afraid to tell your lender you don’t want to overpay (ex. Junk fees) and you may see a reduction in some fees

Visit A Lot of Houses

I know it seems logical to visit numerous homes to make sure you find the one that most closely matches your needs, but there are other reasons for this practice.  When you first start looking at homes, you may focus on unimportant factors that won’t make a difference, or much of a difference, in the long run. For instance, the wallpaper (it can be removed), clutter on top of the refrigerator (it will be gone by the time you move in), decor (theirs not yours).  The more houses you look at, the more you’ll be able to look past these superficial things.

Property Abstract  

Whenever a purchase agreement is authorized, your title company or attorney will research all recorded records related to the property you’re buying and prepare a written history.  A property abstract, or Abstract of Title to the Property, is a condensed history of the property which includes the ownership record (owners from as far back as you can imagine). It illustrates everything recorded at the county courthouse regarding the property you’re about to own.  Some states do not use property abstracts. The following may be included in the abstract:

• History of the property
• Original land information
• Plat map
• Lot & block diagram
• Subdivision restrictions
• Recorded deed
• Recorded mortgage
• Legal actions/suits filed

It used to be common that abstracts were required to examine the title.  With the introduction of title insurance and preliminary title reports, abstracts are not as commonly used in the home buying process.  Although most of the information in an abstract can be found online, if the seller possesses the abstract, providing it to the title company, or attorney, before any property research is done can save valuable time.

The title is important because it establishes the condition of the property, enabling you to buy title insurance.  When you hear the term “title search”, it is simply the process of searching the property in order to make sure there are no issues with the title.  If there are defects in the title, abstracting will identify and fix these problems. The following are examples of issues that may be discovered when researching the property:

• Surveys and notes (ex. encroachments on your property)
• Easements (ex. utility easements allowing power lines can be managed)
• Liens (ex. mechanical liens:  When a general contractor doesn’t pay a supplier who installed something during a remodel, the supplier puts a lien on the property to ensure they get paid)
• Tax liens (ex. when the previous owner did not pay property taxes)
• HOA liens (ex. when HOA fees were not paid by the previous owner)
• HOA restrictions and covenants (CC&R’s:  covenants, conditions and restrictions -- set of rules created by the developer, or HOA restricting things like pets or noise levels)
• Eminent domain (ex. property is part of an older district that wants to make way for a new project and you’re forced to sell and accept whatever price is presented)

Although a title report may have a lot of the same information as a property abstract, it doesn’t prove that the property is clear from liens, encumbrances, encroachments, and claims.  When you buy title insurance, it usually covers any unknown title defects. Once the title has been thoroughly researched and examined and no liens or other issues have been found (free and clear title), it’s time to sign the contract.

Deeds and Property Transfer

A deed is a legal document proving ownership of a property that has been transferred from the seller to the buyer, protecting the buyer.  When a property is transferred to a new owner it’s known as conveyance. Deeds commonly used in real estate transactions include warranty and quitclaim deeds but others exist.  Deeds can vary by state so some will be of no concern to you or your agent when it comes time to close on a home.

General warranty deeds are most common in residential real estate transactions.  These deeds transfer ownership of the property to the buyer and warrants that the seller holds good title to the property, free and clear of any liens or other issues.  This protects the buyer against prior claims and title challenges. General warranty deeds include the following covenants as part of their guarantee:

• Covenant of Seisin:  gives the new owner the right to the entire property
• Covenant of Quiet Enjoyment:  the new owner has the right to enjoy the property free from disturbances or challenges
• Covenant to Defend Title:  if anyone challenges the title, the seller will defend all claims against the title and help the new owner, including compensating him/her for any losses or damages

Special warranty deeds not only warrant and defend the title against claims, as stated above, they warrant that the seller received the title to the property and didn’t do anything to create a defect while holding the title.  In other words, only defects that arose during the seller’s ownership of the property are warranted. As a result, the special warranty offers less protection than the general warranty.

Grant deeds guarantee the property hasn’t been sold to another person and there are no liens/issues that haven’t been communicated by the seller.  This deed also assures the buyer that there are no third parties claims to the property and no taxes owed on it. With this deed, there are no promises made concerning what former owners might have done.  This type of deed doesn’t guarantee the seller is transferring a good title.

Quitclaim, or quick claim, deeds also transfer ownership of the property from the seller to the buyer but because of unknowns, there could be problems with the title.  These deeds are most commonly used when transferring property between divorcing spouses, transactions between friends or family, or to clear up problems with a title.  These deeds make no promises or guarantees about the title being good or what the ownership interest is. It merely states that the owner owned the property and the title may or may not be good.  Title companies are less likely to provide title insurance to real property when associated with a Quitclaim deed. Consider asking the seller why he/she is using a quitclaim deed, as there’s reason to be apprehensive.  You can always talk to your real estate agent about cancelling the purchase agreement if you have concerns about this type of deed.

Bargain and sale deeds are usually used in the case of a tax sale, estate sale, or foreclosure.  This type of deed isn’t used in many states. It can be associated with common defects like unpaid HOA dues or violations, unpaid taxes, or various liens (see the title information above).  

Other forms of deeds exist for special purposes.  These are typically associated with court proceedings, in which the deed is from a person acting in some type of official capacity.  For example, an executor’s deed is used when a homeowner dies and the executor’s deed is used to convey the title to the new owner.

Regardless of the type of deed, both parties will be included on the document along with a legal description of the property and any covenants.  The seller will sign the document and get it notarized.

Real Estate Transfer Fees

In the majority of states in the U.S., you will be hit with a “stamp” tax, transfer tax, or conveyance tax when buying a home.  This tax is based on a percentage of the purchase price but varies per state. For example, the state you live in may charge a 0.02% transfer tax.  This means you’ll pay 2 cents per $100 of the purchase price. That might not be the end of it. Some states charge an extra transfer tax which could have you paying thousands more.  In some cases, you can split the tax with the seller.

Housepoor

Someone who spends the majority of their earnings on their mortgage, taxes, utilities, repairs, etc, leaving them with very little to cover other expenses, are termed housepoor.  The mortgage payment that was once affordable is now overwhelming. This can happen when a homeowner’s income suddenly drops but their housing expenses don’t. Reasons might include any of the following, among others:

• Major illness resulting in extensive hospitalization
• Major expense, like a roof collapse or natural disaster
• Loss of a job

Most homeowners start out paying approximately 25-30% of their take-home pay towards their mortgage and related expenses.  When you end up paying closer to 50-60% towards your house payment, you become housepoor. Say you were earning $5000/month and making a $1250 payment toward your mortgage and taxes. Now you’re only bringing home $2500 but still have to make the same $1250 payment. That’s half of your take-home pay, leaving very little for other expenses like groceries, gas, car payments, etc.  

One way to avoid becoming house poor is to start out with a house payment that provides a bit of wiggle room.  By doing this, you’ll have more money to set aside for unforeseen medical expenses, daycare, or car repairs, for example.  Remember, just because you qualify for $X amount on the purchase of a new home, you don’t have to purchase a home at that price.  Sit down with your agent or lender to determine what you can comfortably afford while still growing your emergency fund and enjoying other aspects of your life (ex. hobbies, date night, vacations, etc).

If you find yourself in a housepoor situation, you’ll need to take a look at whether or not you can continue on this trajectory until your financial situation improves or if you should consider selling.  If you feel the situation is temporary, up to 3 years at the most, you may be able to cut back on extraneous expenses to get ahead -- no vacations, eating out, movie nights, tv service, etc. If you have 2 vehicles, you might consider selling one of them and using public transportation more often.

To make ends meet, consider picking up extra work.  A second job, freelance work, or renting out a room in your home may provide enough income to get you through this difficult time.

When you’re financially strapped and cannot see any end in sight, it’s best to put your house on the market sooner rather than later.  You don’t want your situation to become so dire that foreclosure becomes your only option. If it’s a seller’s market, you may find yourself in a favorable situation (ex. favorable price point, quick sale, multiple offers, etc).  Talk to your real estate agent about your next step: finding a home that meets your financial limitations or opting for a rental.

Short-Term Interest Rates

Your real estate agent may bring up short-term interest rates and their effect on the price of homes.  Short-term interest rates are basically the cost of money as determined by an institute within the Federal Reserve.  These rates define all other interest rates in the financial industry in America. If the Federal Reserve boosts short-term interest rates, mortgage rates are likely to increase as well (although they are not tied together).  Since the federal institute meets 8 times per year, the outcome of these meetings may have an adverse effect on the price of homes throughout the year. Talk to your real estate agent about how short-term interest rates may affect the cost of your future home.  High mortgage rates and high short-term rates will slow down the housing market, making  it expensive to buy a home.

APR vs. Interest Rate

As you look into buying your first home, you may run into terms like interest rate and APR.  These terms may have similarities but it’s important to learn how they’re different. The interest rate is the cost you’ll pay to borrow money (percentage of interest), and it determines your monthly payment.  Interest rates are fixed or adjustable (ARM). Interest rates are affected by your credit score -- the higher your credit score, the lower the interest rate.

There are many other fees associated with your home purchase like origination fees, closing fees, and other finance charges which leads us to APR.  

APR, annual percentage rate, is determined by the lender and provides more of a comprehensive look at the annual fees you’ll pay when borrowing money.  APR is essentially the total price of borrowing money and it’s conveyed in terms of an interest rate. With APR, you’re paying for the cost of interest along with additional fees, like origination fees.   Due to extra fees, your APR will most likely be a quarter or even a half point higher than your interest rate.

Lenders determine APR by looking at the loan, credit history, debt-to-income ratio, annual income, and job history, among other factors.   

Shop around for the best APR and interest rate to meet your financial needs.  If you aren’t finding favorable rates, talk to your lender to learn how you can improve your credit score or debt-to-income ratio to get the best rates. Keep in mind, APR will vary depending on the type of loan you choose and whether you get a fixed-rate or ARM.

15. Conclusion

This insider’s guide provides a tremendous opportunity to learn everything there is to know about financing your first home.  After reading the information, we hope you feel like a financial master, prepared to confidently purchase your first home. Congratulations on being one step closer to becoming a first-time homebuyer. We wish you the best of luck in finding the home of your dreams.

To learn more about your financial options, talk to your real estate agent, city/state housing and financing agencies, local non-profit housing organizations, employer, lender and/or friends that are homeowners.