Home Buying Power

by Marti Kilby

  One note of caution about debt settlement programs. If you have a lot of unsecured debt (credit cards), it may be tempting to employ the services of a debt settlement company thinking this will be a good way to restore your credit. Basically, you stop paying your creditors and you make one payment a month to the debt settlement company. They then negotiate a settlement payment with each of your creditors. These programs generally take 18–48 months to complete, and in the meantime, your credit is ruined because you’ve stopped making payments to your creditors. If your debt is substantial and you see no way out, it might be wise to consult a bankruptcy attorney and put home buying on the back burner.

  However, one relatively quick fix to boost your score if you don’t have a lot of derogatory items is to pay down the balance on your credit cards to less than 30% of your credit limit. What you don’t want to do, however, is close accounts, especially old ones. Better to keep it open with a zero balance, or just use it and pay it off occasionally. This helps maintain a favorable ratio of total debt to available credit. If you close accounts, your ratio becomes less favorable.

  So, how high of a score do you need to qualify for a home loan? Lenders make interest rate determinations based on tiered rate sheets: As scores go down, rates go up. 580 is generally considered on the low end for an FHA loan, and 620 is the minimum for conventional financing. 760 is considered a great score with very low risk to lenders, so with scores upwards of 760, interest rates don’t really get that much better. There are loans available for very low scores, but these are generally termed “hard money” loans and require at least a 30% down payment. They also charge at least 2 points (1 point = 1% of your loan amount), and they carry very high interest rates. It should be noted, though, that every lender has slightly different guidelines and rate sheets, which is why it pays to shop for your loan, as you may get a better deal with one lender over another. More on this in Chapter 3.

  Disputing Items on Your Credit Reports

  All three major credit report bureaus have systems for consumers to dispute items on their credit reports, and that includes specific forms they ask you to complete. Please note they will not review your disputed items over the phone, so don’t waste your time. The best way to make sure you have the most up-to-date information regarding the dispute procedures for each bureau is to Google them. For instance, use the keywords “Experian disputes” or “TransUnion disputes.” Then make sure the link is pointing you to the website of the actual credit bureau in question. Each bureau will outline for you exactly what form to submit and how the procedure works.

  Before you contact them, make sure you have a current report from each bureau, as they will request the file number of the report. If you see something you think is inaccurate, such as a late car payment, it would be a good idea to first try to resolve the issue with the creditor by contacting them to dispute the payment date. This could be done by providing bank statements or online payment confirmation numbers.

  Here are the addresses for sending dispute forms:

  Experian

  P.O. Box 4500

  Allen, TX 75013

  Experian also has an online form you can fill out: https://experian.com/consumer/upload/

  TransUnion Consumer Solutions

  P.O. Box 2000

  Chester, PA 19022–2000

  Equifax Information Services, LLC

  P.O. Box 740256

  Atlanta, GA 30374

  Savvy Shopper Tips: Check your credit reports from all three major credit reporting bureaus 9 to 12 months prior to when you want to start looking for a home. If you find inaccuracies, take the time to contact each bureau and dispute the information. If you are unsure about how to proceed to remove certain items, consult with a reputable credit repair organization and retain their services if needed to clean up derogatory items. It is worth spending some money now to improve your score, as it will allow you to save money for years with a lower interest rate on your mortgage.

  Chapter 3

  Loan Pre-Approval: Time to Get Real

  The next step in the home-buying process has nothing to do with searching online for the home of your dreams. It actually begins with a reality check as you go through the pre-approval process and learn exactly how much you can really afford. There is absolutely no value in looking at homes that are outside your price range, as it’s just a waste of everyone’s time and a source of disappointment and discouragement.

  About a year ago, the adult child of one of my dear friends gave me a call and said that he was ready to start looking for a condo to purchase. I was so excited for him to be taking this big step! We talked about what he could afford, and he mentioned that he’d already been to his credit union. They had run the numbers and pre-qualified him for a zero-down-payment loan of up to $325,000. He had a credit score close to 800, so the loan officer said everything should be fine. We were both excited and started our search. After just a couple of weeks, I found a wonderful condo that was close to his work and in a very desirable area—it really felt more like a single-family home. We wrote an offer and with very little back and forth, our offer was accepted! We were so excited. Everything was submitted to the lender and my buyer continued by signing property disclosures and even paying for a full property inspection.

  Then, everything unexpectedly fell apart. Even though my buyer was currently making more than enough to qualify with his current debt-to-income ratio, he worked on commission and did not have enough time showing that he could maintain that level of income. They looked only at his last two years’ income tax returns, and based on that, he did not make enough to qualify. We were both crushed!

  Pre-Qualification vs. Pre-Approval

  First, it’s important to know the difference between pre-qualification and pre-approval. A pre-qualification is usually done by a mortgage broker or lender, either in person or over the phone. You provide information regarding your income, debts, assets, and potential down payment. The lender will then probably run your credit. Feeding this information into specialized software, the lender will provide you with a ballpark figure for the size and type of loan for which you would likely qualify. There is no commitment, but a pre-qualification will at least give you an idea of the price range you can afford and the types of programs and interest rates offered by that lender. In the case of my friend noted above, the loan officer seemed to think that his high score would do the trick, but she had neglected to ask him how long he had been making commission at his current level.

  A pre-approval, on the other hand, carries more weight, as all of your information is verified and often run through Desktop Underwriting (DU) software, which provides a written approval, subject to certain conditions, including the appraisal and title report. Although every lender is slightly different, here are the basic items you will need to provide to get pre-approval:

  Signed authorization form supplied by your lender to run your credit report.

  A signed loan application created by your lender.

  2–3 months’ pay statements.

  W-2s for the last two years.

  Signed federal tax returns for the last two years.

  Bank and/or retirement account statements (all accounts, all pages, even if blank) for the last 2–3 months.

  Letters of explanation for any derogatory items that appear on your credit report.

  If you are self-employed, you may need to supply 1099s and profit and loss statements.

  Working with a Lender

  When submitting your documents to the lender, it is best to scan the items as separate PDF files or send them as separate faxes. Submitting original bank statements and tax returns will slow down your approval process, as a loan processor will have to scan and organize everything into files that can be uploaded to the underwriters.

  Another thing to keep in mind is that you are not committed to working with a lender simply because they did a pre-approval for you. By the time you have submitted all of your information, it may be much sim
pler to stay with them, but you should always shop at least one other lender to see who can provide the best rate and terms. Often times, if you get a better quote, you can go back to your original lender and see if they can match it.

  You may want to consider your bank or credit union, as they often offer a small interest rate discount if you elect automatic payment for your mortgage from your existing bank account. On the other hand, a mortgage broker represents a number of different lenders and may have a wider variety of loan products from which to choose.

  And, of course, there are many online options, such as LendingTree or Quicken Loans. What you might not understand, however, is that these companies are basically lead generators for mortgage brokers. This means that when you complete an online application, your information is sold and instantly delivered to several different companies. You will be immediately contacted by phone and email… over and over again. This is not all bad, as they truly are competing for your business. But if you are going to go this route, just pick two companies and let them bring out their best quotes.

  One concern about shopping for a loan is that it will harm your credit score to have your credit run several times. The good news is that if your credit is run within a short period of time, say three times in one month by three different lenders, it is unlikely that there will be any negative impact on your score, as it is obvious that you are shopping for a loan. However, multiple inquiries are a problem when you’re applying for several different store credit cards or a variety of credit types in a short period of time, such as a car loan, a Visa or MasterCard, and a mortgage. Avoid applying for any other type of credit during the home purchase process; this includes applying for credit to buy appliances right before closing. The added inquiries and debt could be enough to disqualify you from your home loan!

  By the time you get to the pre-approval stage, you should have been working on improving your credit score, as described in Chapter 2, and you should be ready to go. Your pre-approval letter is an important tool used by your real estate agent as part of any offer to purchase, as it provides proof that you are qualified to complete the transaction. It will include information about the type of loan, the loan size, and the price point at which you can purchase. It will also include information about the other conditions that must be met for final approval, such as clear title and sufficient appraised value.

  Generally, it is a good idea to know your maximum loan amount, but you’ll want to have a pre-approval letter written specific to the amount you are offering. For instance, if you are qualified for a $400,000 loan with a 20% down payment, that would mean you could purchase a home for $500,000. But let’s say you find a great home and want to offer $425,000. That would mean your loan amount would be $340,000. From a negotiating point of view, it may be better to submit a pre-approval letter for a $425,000 purchase price with a $340,000 loan amount and not reveal how much more you could actually spend. There is no need for the seller to know that you could actually afford another $75,000! Talk to your loan officer about this and make sure they are willing to provide customized approval letters based on the price you are offering.

  First-time buyers frequently ask if they can get a loan for more than the amount needed to purchase the home and use the excess funds for upgrades, remodeling, or new appliances. Generally speaking, the answer is “no.” The house is collateral for the lender, and in case of default, the bank wants to make sure it can sell the home and recoup its funds without a loss. That is why an appraisal is so important. The bank needs assurance that the sales price is not artificially inflated, such as what we saw before the housing crash. The exception to this is a rehab loan, where the bank is actually lending on the value of the home as it is estimated to be after repairs. This is a more complicated loan process and not recommended for first-time buyers.

  Savvy Shopper Tips: Shop around to at least two lenders to see who will give you the best rate and terms. Submit all of your documentation to your selected lender, and ask for a full pre-approval—not just a pre-qualification—so you know the maximum loan amount for which you qualify to avoid any surprises or disappointments. When submitting documents, don’t send a bunch of originals unless it can’t be avoided. Don’t apply for other types of credit during the home purchase process. When writing an offer, submit a pre-approval letter with the approved loan amount being specific to your offered price.

  Chapter 4

  Finding the Loan

  That’s Right for You

  Back in 2006, at the height of the housing market, I was working as a loan officer. As we know, it was a crazy time in the world of lending, when even the most conservative banks would underwrite a loan for basically anyone with a pulse. People were using their homes like ATM machines. As home values continued to climb, some owners were refinancing and draining their equity as fast as it accumulated.

  One of the craziest loans popular at that time was the negative amortization loan (NegAm). This loan allowed the borrower to make a minimum payment each month that was less than an interest-only payment. The amount of the unpaid interest was added to the principal amount owed so that each month, instead of paying down the loan, the debt actually increased up to a certain threshold above the original loan amount. With the availability of a loan that allowed one to make a minimum payment at a starter rate as low as 1%, it was very tempting to buy a home that was more expensive than one could really afford.

  When the housing bubble burst, the people with NegAm loans got a one-two punch. Not only had home values dropped by as much as 50%, but they had increased the amount they owed by tens of thousands of dollars. The people who successfully rode out the storm and managed to keep their homes were the ones who did not drain all of their equity, and if they did refinance, had selected a traditional loan.

  Although safeguards are now in place to help prevent the kind of disaster we saw in the housing crash, selecting the loan that is right for you is still one of the biggest decisions you’ll make when buying a home. In this chapter, I take you through the various loan products and their key characteristics to help you in the decision-making process.

  Government-Insured and Conventional Loans

  Government-insured loans are backed by the U.S. Government, meaning that the government insures the lender against loss in case of default. Government-insured loans include FHA, VA, and USDA. Conventional loans, on the other hand, are not insured by the government.

  FHA Loans

  The primary advantage of an FHA loan is that the buyer can have a down payment as low as 3.5% of the purchase price, which makes home buying more accessible to a larger number of people. The disadvantage is that you will pay an upfront monthly mortgage insurance premium (MIP) until you have paid down the amount you owe and have 20% equity in the home. At that point, you will probably have to request that your lender remove the MIP, as this is not something that automatically happens. This insurance premium is added to your monthly mortgage payment, increasing your overall monthly payment.

  VA Loans

  VA loans are available only to military service members and their families. They offer a huge benefit in that no down payment is required. You will be required to pay a funding fee of 1.25–3.30%, but that is generally written into the loan amount.

  USDA Loans

  USDA loans are offered by the U.S. Department of Agriculture to encourage homeownership in rural areas. These loans also have low down-payment requirements, but they’re only available in specific areas, and buyers must meet income requirements. USDA loans can be a good choice if you’re in a designated rural area and have a modest income.

  Conventional Loans

  Conventional loans are simply loans that are not insured by the government. Generally speaking, they require a minimum 5% down payment, and you will likely be required to pay private mortgage insurance (PMI) if your down payment is less than 20%. As noted in the discussion about FHA loans, the mortgage insurance is paid until there is 20% equity in the property.


  Conforming and Non-Conforming (Jumbo) Loans

  The terms “conforming” and “non-conforming” (or jumbo) relate primarily to the maximum size of the loan amount. Conforming loans meet the underwriting guidelines of Fannie Mae and Freddie Mac, which are government-controlled corporations. Fannie and Freddie basically buy loans and re-sell them in the secondary market on Wall Street. In order to sell these mortgage-backed securities and reduce the risk to buyers, they have established specific underwriting criteria, including limiting the size of a loan. The baseline maximum conforming loan limit for most counties across the US is $453,100. For areas with higher housing costs, such as New York, San Francisco, San Diego, and Washington, DC, the limit is higher.

  Non-conforming or jumbo loans exceed the maximum loan amounts of conforming loans and do not necessarily adhere to the Fannie and Freddie underwriting guidelines. As these loans represent a great risk to the lender and the ultimate buyer of the loan, they are offered at a higher interest rate.

  Fixed- and Adjustable-Rate Mortgages

  Fixed-rate mortgages have the same interest rate and monthly payment over the entire length of the loan. They are fully amortizing, so at the end of the loan term, the principal amount and all interest charges are paid in full. A fixed-rate loan is good in the sense that there are no surprises or changes. However, in a period where interest rates are declining, a borrower would have to bear the cost of refinancing in order to take advantage of the declining rates. The rates are also slightly higher than adjustable-rate mortgages, as you are in essence buying the stability of no rate changes.