Q & A: About Real Estate Financing

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Q & A: About Real Estate Financing

Question: How do I qualify for a home loan?

Answer: Your real estate agent has information on lender loan requirements and will be able to calculate a rough monthly figure you can afford based on the maximum monthly payment for the loan, taxes, insurance, and any type of maintenance fees. This pre-purchase evaluation by the agent can save you a lot of time spent looking at properties you cannot afford. Lenders also routinely calculate what you can afford and can pre-qualify you for a loan even before you begin your home search. This way, you know exactly how much you can afford to buy. Lenders generally stipulate that you spend no more than 28 percent of your gross monthly income on a mortgage payment or 36 percent on total debts. Ultimately, the price you can afford to pay for a home will also depend on other factors besides your gross income and outstanding debts. They include the amount of cash you have available for the down payment, your credit history, current interest rates, closing costs and cash reserves required by the lender, and the type of mortgage you select.

Question: Should I lock in the mortgage rate?

Answer: Because the interest rate market fluctuates constantly and is subject to quick movements without notice, locking in a mortgage rate with a lender certainly protects you from the time your lock is confirmed to the day it expires. Lock-ins make sense in a rapidly-rising rate environment or when borrowers expect rates to climb during the next 30 to 60 days, which is typically the amount of time a lock-in remains in effect. A lock-in given at the time of application is useful because it may take the lender several weeks to prepare a loan application. These days, however, automated loan practices have cut the time quite a bit. Lock-ins are not necessarily free. Some lenders require you to pay a lock-in fee to guarantee both the rate and the terms. If your lock-in expires before you close on the loan, most lenders will base the loan rate on current market interest rates and points.

Question: When is the best time to refinance?

Answer: Many people flock to refinance while mortgage interest rates are low, particularly when rates are about two percentage points below their existing home loans. Other factors, like when to finance, will depend on how long you plan to hold on to your home and whether you have to pay considerable fees to refinance. It also will depend on how far along you are in paying off your current mortgage. If you expect to sell your home relatively soon, you are not likely to recoup the costs you incurred to refinance. And if you are more than halfway through paying your current mortgage, you probably will gain little by refinancing. However, if you are going to own your home for at least another five years, that is probably long enough to recoup any refinancing costs and realize real savings as a result of lowering your monthly payment. In fact, if it costs you nothing to refinance, you can gain even more. Many lenders will let you roll the costs of the refinancing into the new note and still reduce the amount of the monthly payment. Plus, there are no-cost refinancing deals available. Contact your lender, and its competitors, before you refinance.

Question: What if I am turned down for a loan?

Answer: Unless your credit is absolutely abysmal - with all kinds of judgements, liens, excessive delinquencies or non-payments, foreclosures and bankruptcies that show no attempt on your part to make progress - you can generally get a loan. More and more borrowers are finding ways to become homeowners despite past credit problems, a lack of a credit history, or debt-to-income ratios that exceed traditional limits. This is because a greater number of lenders are willing to take a chance with borrowers today that they once turned down for home loans. If you are denied a mortgage, ask the lender for a full explanation. If you feel you are creditworthy, then appeal the decision in writing.

Financing Your First Home

Determine what you can afford

Each buyer is unique - and we'll help you find out just what you can afford. Your income and your debts will typically play the biggest roles in determining your price range. It's simple to make an estimate, just run the numbers for yourself using our Affordability Calculator.

Figure out your funding

A range of mortgage options are available, and we'll help you determine which can work for you - some loans require little money down. You'll also need to consider closing costs and the escrow account for taxes and insurance. But don't get overwhelmed: it's a snap to figure out how much money you'll need using the Affordability Calculator.

Less-than-perfect credit report?

Don't worry, there are options that are ideal for those who have a few "dings" on their credit report. Work with your lender to develop an individual mortgage program based on your unique credit worthiness.

Loan Programs

Finding the best loan program for your needs depends on a number of factors, including:

How long you will stay in the home;
How much money you will put down;
How you will finance the closing costs...

Tax Benefits

You may be able to deduct the interest you pay on the mortgage loan and some of the financing costs of the home, such as points, and your property taxes could be deductible. You should consult your tax advisor for more information.

Financing Your Next Home

Determine What You Can Afford

Each buyer is unique - and we will help you find out just what you can afford. You already know that monthly income and financial obligations are most important in determining your price range.

Buying a Second Home

You'll need to identify sources for your down payment, since you're not selling your current house and using the proceeds, and you'll need to expect a larger monthly obligation for housing expenses. Work with your lender to create a customized loan program with the best combination of rate, points, and closing costs for your needs.

Less-than-perfect credit report?

New Home Appraisals

Some situations may qualify for a more streamlined loan process. Your credit history will help determine if your loan application can be completed without an appraisal.

Private Mortgage Insurance (PMI)

Loan programs for down payments of 20% or less require you to purchase Private Mortgage Insurance (PMI).

Selling Your Current Home

You may qualify for a new loan without even selling your current home. You may also want to discuss a bridge loan with your mortgage company.

New Construction

If you are working with a builder within a sub-division or development and just making carpeting, lighting and appliance selections for a brand-new home, you can probably obtain a standard mortgage loan. But if you're hiring contractors, electricians, plumbers, and painters, you probably need a construction loan, which provides funds to pay subcontractors as work progresses. For more information on construction loans, contact your real estate professional or your mortgage company.

Loan Programs

Fixed-Rate Mortgages

A fixed-rate mortgage means the interest rate and principal payments remain the same for the entire life of the loan. (Taxes, of course, may change.)

Advantages include consistent principal and interest payments make this loan stable your rate won't change, so you don't need to worry about market fluctuations. A good choice if you are likely to stay in this house for a long time.

Disadvantages include a possibly higher cost - these loans are usually priced higher than an adjustable-rate mortgage. Keep in mind that, on average, most people move or refinance within seven years. If rates in the current market are high, you are likely to get a better price with an adjustable-rate loan.

30 Year Fixed-Rate Mortgages offer consistent monthly payments for the entire 30 years you have the mortgage. So if the market is good, you can benefit from locking in a lower rate for the full term of the loan. The best choice if you're looking for a long-term, stable loan - for instance, if you're planning on staying in your house for some time.

20 Year Fixed-Rate Mortgages allow you to make a consistent monthly payment throughout the 20 years you have the mortgage. The shorter term means you pay the loan off more quickly, and therefore pay less interest. And you'll build equity faster than you would with a 30 year loan. (But remember the shorter term means higher payments, when compared to the 30 year fixed-rate mortgage.)

15 Year Fixed-Rate Mortgages mean consistent monthly payments for all 15 years you have the mortgage. By building equity even more quickly than with a 30 year or 20 year loan, and paying less interest, you'll save money in the long run. It is an ideal option if you can handle the higher payments and if you'd like to have the loan paid off in a shorter period of time - for instance, if you plan to retire.

Adjustable-Rate Mortgages

An adjustable-rate mortgage (ARM) means that the interest rate changes over the life of the loan - according to the terms specified in advance. With ARMs:

The initial interest rate is usually lower than with a fixed-rate mortgage.
The monthly repayment would also be lower.
The interest rate may be adjusted (up or down) at predetermined times.
The monthly payment will then increase or decrease.

Most ARM programs do offer "rate cap" protection, which limits the amount the rate can be increased, both each year and over the life of the loan. All ARMs are amortized over 30 years.

Advantages include lower costs - ARMs are usually priced lower than fixed-rate mortgages so you can increase your buying power and lower your initial monthly payments. If interest rates go down, you'll enjoy lower payments. Usually an ARM is the best choice for homeowners who plan to relocate (for example, with their company or the military), or for those who are purchasing their first home and plan to be in the property only for three to five years. Remember that, on average, most people move or refinance within seven years.

Disadvantages include the possibility of increasing monthly payments if interest rates go up. Keep in mind that ARMs are best for homeowners who aren't planning on staying with a property for a long period. If you're on a fixed income, an ARM (especially a short-term ARM) may not be your best choice.

10/1 Adjustable-Rate Mortgages provide a fixed initial rate of the loan for the first ten years of repayment. After 10 years, the rate adjusts every year thereafter for the remaining life of the loan. The loan is amortized over 30 years, so you'll enjoy the stability of a 30 year mortgage at a lower price than a fixed-rate mortgage of the same term. But an ARM is likely not the best choice if you're planning on owning the same property for more than 10 years.

7/1 Adjustable-Rate Mortgages offer an initial rate that is fixed for the first seven years of repayment, then the rate adjusts every year thereafter for the remaining life of the loan.

5/1 Adjustable-Rate Mortgages mean the initial rate remains fixed for the first five years of repayment, and then adjusts every year thereafter. Remember that your rate and monthly payments may go up after only five years, so this choice is best if you're expecting to sell or refinance the property within that period.

3/1 Adjustable-Rate Mortgages provide three years at the initial fixed-rate, then the rate adjusts every year for the remaining life of the loan. A good choice if you expect to move or refinance in a relatively short period of time. But a much shorter fixed-rate period means your interest rate (and therefore monthly payments) may begin to fluctuate after three years.

Frequently Asked Questions

Question: Can I refinance after bankruptcy?

Answer: Refinancing may be prudent but could be difficult after a bankruptcy. If you're considering bankruptcy, you may want to go to your current lender first and explain the situation. If you have been current on your payments, the lender may be accommodating and refinance your loan, easing your financial situation.

Question: How bad is a previous foreclosure on credit?

Answer: A property foreclosure is one of the most damaging events in a borrower's credit history. In terms of the effect on credit history, a deed in lieu of foreclosure or a short sale is not as adverse an event as is a forced foreclosure.

Question: How do you clear up bad credit?

Answer: There is no fast and easy way to repair damaged credit that took months or years to occur. The law allows negative information to appear on an individual's credit record from 7 to 10 years. Now, many states have specific timeframes if you challenge a credit blemish.

The first step is to check your existing credit record. Anyone can obtain copies of their own credit report free of charge if they have been turned down for credit recently. For a fee, people can request copies of their own credit report from the three major credit reporting agencies: Experian at (800) 311-4769, Equifax at (800) 685-1111 and Trans Union at (312) 408-1050. The bureau also should provide instructions on how to read the report and how to dispute any inaccuracies it contains.

If the credit report is correct, take care of any outstanding delinquent obligations first.

Resources: * "Rebuild Your Credit: Law Form Kit," Nolo Press, Berkeley, Calif.; 1993.

Question: How long do bankruptcies and foreclosures stay on a credit report?

Answer: Bankruptcies and foreclosures can remain on a credit report for seven to 10 years.

Some lenders will consider an borrower earlier if they have reestablished good credit. The circumstances surrounding the bankruptcy can also influence a lender's decision. For example, if you went through a bankruptcy because your employer had financial difficulties, a lender may be more sympathetic. If, however, you went through bankruptcy because you overextended personal credit lines and lived beyond your means, the lender probably will be less inclined to be flexible.

Question: What can I do if I have bad credit?

Answer: While some people have rebounded from a foreclosure to buy another home within several years, credit problems stemming from a foreclosure can continue much longer for others.

Real estate experts say you should be candid with your lender in discussing these issues. If your bankruptcy resulted from losing your job due to your employer's financial difficulties, a lender probably will look upon your situation more favorably than if your bankruptcy was caused by overextended credit cards.

Question: What can I do if I have bad credit?

Answer: While some people have rebounded from a foreclosure to buy another home within several years, credit problems stemming from a foreclosure can continue much longer for others.

Question: What options are there after Chapter 11?

Answer: A previous bankruptcy can remain in a credit file for seven to 10 years.

Depending on when the bankruptcy was discharged and what kind of credit a borrower has reestablished since then, it needn't be an obstacle to obtaining loan approval. The longer ago the discharge occurred, the better off a loan applicant will be.

Many lenders also will take into account the circumstances surrounding a bankruptcy. For example, they may look more favorably upon you as a borrower if your bankruptcy was due to financial reverses you suffered due to your employer's own financial difficulties. On the other hand, if you declared bankruptcy because you overextended your personal credit lines and lived beyond your means, a lender probably won't be as forgiving.

If you are in the latter category, you may want to contact a mortgage broker who may qualify them for a "b" or "c ," loan, which usually comes at a higher interest rate.

Question: Do I have to disclose a parent's gift?

Answer: Having generous parents is nothing to hide. An estimated one-third of first-time buyers purchase their home with a loan or a money gift from their parents.

Lenders will ask for a gift letter stating that no repayment of the "gift" is expected. In addition to the letter, a lender can ask for two or three months' worth of statements for the account where the down payment funds are located. If the money was recently placed into that account, the lender may ask where it came from and request verification of that source as well.

Question: What is a gift letter?

Answer: If someone is willing to make a gift of funds in order for you to purchase a home, lenders will ask for a gift letter stating that no repayment of the "gift" is expected. The amount of the gift and the date funds were transferred should be spelled out in the letter, along with the donor's name, address, telephone number and relationship to the borrower.

In addition to the letter, a lender can ask for two or three months' worth of statements for the account where the down payment funds are located. If the money was recently placed into that account, the lender may ask where it came from and request verification of that source as well.

Gifts -- with the proper documentation -- can be from relatives, friends, an employer, church, municipality, or nonprofit organization. Lenders often have stricter restrictions on gifts from friends and relatives other than parents.

Also, if you put less than 20 percent down, some lenders may require that a portion of the down payment be your own cash, not a gift. If you want to use a gift as part of your down payment, check with individual lenders to learn the restrictions of specific private or government-insured mortgage programs.

Question: How do you qualify as a first-time buyer?

Answer: In general, lenders define a first-time home buyer as someone who has not owned any real estate -- whether a personal residence, vacation home or investment property -- during the past three years.

Lenders verify an applicant's status by examining their income tax returns, checking to see that the individual did not take any deductions for mortgage interest or property taxes.

Question: What can I afford?

Answer: Know what you can afford is the first rule of home buying, and that depends on how much income and how much debt you have. In general, lenders don't want borrowers to spend more than 28 percent of their gross income per month on a mortgage payment or more than 36 percent on debts.

It pays to check with several lenders before you start searching for a home. Most will be happy to roughly calculate what you can afford and prequalify you for a loan.

The price you can afford to pay for a home will depend on six factors:

gross income
the amount of cash you have available for the down payment, closing costs and cash reserves required by the lender
your outstanding debts
your credit history
the type of mortgage you select
current interest rates

Another number lenders use to evaluate how much you can afford is the housing expense-to-income ratio. It is determined by calculating your projected monthly housing expense, which consists of the principal and interest payment on your new home loan, property taxes and hazard insurance (or PITI as it is known). If you have to pay monthly homeowners association dues and/or private mortgage insurance, this also will be added to your PITI.

This ratio should fall between 28 to 33 percent, although some lenders will go higher under certain circumstances. Your total debt-to-income ratio should be in the 34 to 38 percent range.

Question: What do I do if I get turned down for a loan?

Answer: Increasing numbers of loan applicants are finding ways to buy their own home despite past credit problems, a lack of a credit history or debt-to-income ratios that fall outside of traditionally acceptable ranges.

Ask the lender for a full explanation, then appeal the decision in writing.

Question: What is the first step when looking for a home loan?

Answer: Most experts recommend that you should get prequalified for a loan first. By being prequalified, you will know exactly how much house you can afford. Almost all mortgage lenders now prequalify and preapprove customers, and many of them can even do it on the Internet. You also can do your own affordability calculations; most recent consumer books on home buying include steps to doing so, as do various real estate Internet sites.

Question: How do I drop PMI?

Answer: In some states, the loans have to be at least two years old, and the borrower cannot have made any late payments in the last year in order to drop private mortgage insurance. In addition, the loan-to-value ratio must be less than 75 percent. Some state disclosure laws require lenders to notify borrowers after the close of escrow whether the borrower has the right to cancel private mortgage insurance. Under the new federal law - The Homeowners Protection Act - lenders must drop PMI if the loan closed after July 29, 1999 AND the loan-to-value ratio reaches 78 percent of the home's original value.

Question: Is PMI always required on low-down home loans?

Answer: A growing number of private lenders are loosening up their requirements for low-down-payment loans. But private mortgage insurance, or PMI, usually is required on loans with less than a 20 percent downpayment. The Homeowners Protection Act states PMI must be dropped on any loan originated after July 29, 1999 IF it has a 78 percent loan-to-value ratio.

Question: What does PMI cost?

Answer: PMI costs vary from one mortgage insurance firm to another, but premiums usually run about 0.50 percent of the loan amount for the first year of the loan. Most PMI premiums are a bit lower for subsequent years. The first year's mortgage insurance premium is usually paid in advance at the closing.

Question: What is PMI?

Answer: Private mortgage insurance, or PMI, insures the lender against a default. It is required when the borrower is making a cash down payment of less than 20 percent of the purchase price.

PMI costs vary from one mortgage insurance firm to another, but premiums usually run about 0.50 percent of the loan amount for the first year of the loan. Most PMI premiums are a bit lower for subsequent years. The first year's mortgage insurance premium is usually paid in advance at the close of escrow, and there is usually a separate PMI approval process.

Lenders generally turn to a list of companies with whom they regularly work when lining up private mortgage insurance.

In most cases, PMI can be dropped after the loan to value ration drops below 80 percent. The Homeowners Protection Act requires PMI to be dropped when the loan-to-value ratio reaches 78 percent of the home's original value AND the loan closed after July 29, 1999. For other loans, find out from your lender what procedure to follow to have PMI removed when your equity reaches 20 percent.

For homeowners who have improved their properties and believe that their equity has increased as a result of these improvements, refinancing the property at a loan-to-value ratio of 80 percent or less is another possible way of eliminating PMI payments.

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