by Marti Kilby
Adjustable-rate mortgages (ARM) have interest rates that will adjust at certain periods. Generally, there is an initial fixed rate for two or five years, after which the interest rate will adjust every year according to a particular monetary index. For example, a 5/1 ARM is fixed for the first five years and then adjusts every year thereafter. The biggest advantage to an ARM is the initial fixed rate is always lower than a 30-year fixed-rate mortgage. This is especially attractive to buyers who anticipate an increase in income over the coming years, as this lower starting rate allows them to afford a more expensive house than they might otherwise be able to buy. This is also a smart choice for buyers who know that they will live in the home for a limited time period. The disadvantage of ARMs is that they’re confusing, and many borrowers have been caught off-guard when their loan adjusts, simply not being ready for an increase in payments. On the other hand, if rates decline, they will automatically benefit without the expense of refinancing.
Buying with a Reverse Mortgage
Most people, many real estate professionals included, are unaware that a person 62 years of age or older can utilize a reverse mortgage known as the Home Equity Conversion Mortgage (HECM) for the purchase of a property. Passed by Congress in 2009, a senior can use a non-recourse FHA reverse mortgage to buy a home and never pay another mortgage payment unless they want to.
Here’s an example of how this works: A 72-year-old homeowner wants to downsize and sells his home for $650,000, clearing $300,000 after commissions and expenses. He then finds a better-suited home for $550,000 and puts down $250,000. The reverse mortgage makes up the $300,000 difference, and the homeowner keeps the remaining $50,000 to spend as he chooses, and he never needs to make another mortgage payment.
The older the homebuyer, the less a down payment is required. Over time, the loan balance increases, and at the time the homeowner dies, the heirs have the option of paying off the balance of the reverse mortgage and keeping the home, or selling the home and pocketing the equity. Should the value of the home be less than the loan balance, the heirs can refinance or sell the home to pay off the loan at 95% of fair market value, not loan balance—FHA covers the deficiency, and there is no deficiency judgment against the heirs.
One important advantage of the program is that qualifying is much easier than for a traditional loan. Seniors often have very limited income, so a reverse mortgage is perfect, as there are no FICO guidelines and very limited income requirements. According to the US Census Bureau, of the 21.6 million homes owned by persons aged 65 or older, 65%—or 14.1 million homes—are owned free and clear. Thus, many seniors are house-rich but cash poor.
Loan Terms—How Long Will You Pay?
A basic rule of thumb is the longer the term of your loan, the lower your monthly payment, but the more interest you’ll pay over the life of the loan. So, for instance, a $300,000 loan at a fixed rate of 3.75% for 30 years is $1,389.00 a month, principle and interest. The total interest paid over 30 years is $200,165. To pay off that same loan in 15 years, the monthly principle and interest payment would be $2,181, and the total interest paid would be just $92,700—less than half as much.
For most first-time buyers, a longer term may be advantageous, as the monthly payments will be lower. This is also true for people who plan on a future move, where paying down the principle might not make much sense. On the other hand, if you have found your forever home, it might be a good idea to pay off your home early while you’re still working and then own it free and clear in retirement. Another scenario where it might make sense to accelerate your payments would be to gain 20% equity so you can eliminate PMI from your monthly loan.
If you’re interested in a shorter loan length, instead of applying for a 15-year mortgage, you might consider getting a 30-year mortgage and then making your payments based on a 15-year payoff, which is a calculation you can easily make online. In this way, if you have a month or two where you are unable to make the higher payment, you’re not in a position of possibly missing a payment or defaulting. Your interest rate might be slightly higher, but you have greater flexibility in determining your payments.
Please keep in mind these different types of mortgages work in combination with one another. For example, you could get a fixed-rate FHA loan or an adjustable-rate VA loan, or vice-versa; a fixed-rate conforming conventional loan or an adjustable-rate non-conforming jumbo loan. The real key to finding the right loan lies in finding a qualified loan officer who can help explain in detail the pros and cons of each loan type and help you select the mortgage best suited to your specific needs and long-term plans.
Savvy Shopper Tips: Make sure you discuss your plans for this home purchase with your loan officer, including the estimated time you plan to live in the home. It is also important to be very clear with your loan officer about the source of your down payment and exactly how much money you have available. If you are considering an ARM loan, make sure you thoroughly understand when your rate will adjust, how the adjustment is calculated, and approximately what you might be looking at in terms of a payment increase. Although we no longer see pre-payment penalties very often, do confirm that there is no penalty for paying off your loan before it is due. And finally, if you are 62 or older, I strongly suggest that you explore the HECM Reverse Mortgage for Seniors program.
Chapter 5
The Cost of Buying: Where to Find Down Payment Help
For many people, especially first-time home buyers, one of the toughest things to do is save money for a down payment. Even with an FHA loan, a 3.5% down payment can be a lot of money. To purchase a $450,000 home with an FHA loan in San Diego County, you would need $15,750, plus money to cover closing costs. (We’ll talk more about closing costs in Chapter 11.) That is a tall order, especially when living in an area with expensive rents and an overall high cost of living.
Down Payment Assistance Programs
What most buyers don’t know is that there are over 2,000 different down payment assistance programs throughout the US, and at least one program is available in each of the country’s 3,142 counties. What’s more, over 2,000 counties have at least 10 programs available. One common misconception is that these programs are only available to first-time buyers when, in fact, qualification is primarily based on income level (which will vary according to the market and the needs of a specific area). For instance, the Department of Housing and Urban Development (HUD) provides states with block grants to fund the Neighborhood Stabilization Program, which is designed to revitalize the areas hardest hit with foreclosures and unemployment during the recession.
Down payment assistance programs basically fall into two categories: grants and second mortgages. Grants are funds that do not have to be repaid, provided you live in the home for a certain period of time. The second mortgages have very low or even zero-interest rates, and the payments are deferred over a certain period of time—or in some cases, the loan is cancelled. Many of these programs also allow the funds to be used in part to cover closing costs.
The best resource I’ve found for researching available programs is Down Payment Resource, an online aggregator of down payment assistance programs throughout the country. You can visit them here: http://downpaymentresource.com.
Gift Money
Another form of assistance is gifted money. Most lenders will allow gift money from a family member if the donor signs an approved gift letter stating that the funds are indeed a gift that does not have to be repaid. Family loans are generally not allowed, as the debt could become an additional lien on the property and would count against your debt-to-income ratio. The percentage of the down payment that can be a gift varies according to the type of loan, and the actual amount given may have tax implications for the donor. Currently, the IRS does not impose a gift tax on amounts of $14,000 or less, and a married couple who files jointly can gift up to $28,000 without being taxed.1 So, if your uncle wants to give you $5,000 to help you buy your first home, that should be fine. Just make sure you discuss wi
th your lender about any necessary paperwork, as well as when and how the funds should be transferred.
Before we wrap up this section on gift money, I’d like to share a story with you.
Several years ago, I had the pleasure of working with a young couple buying their first home in San Diego. They both had good jobs, but really didn’t have quite enough for the FHA down payment. The wife contacted her mother who lived in a small Eastern European village to ask for assistance. Her mom, who was quite old, said she would be happy to gift her daughter and son-in-law $8,000.
The problem we ran into was unexpected. At this point in time, her mom still used a passbook for the bank to manually record all of her deposits and withdrawals from her savings account. That passbook was her only record, as she received no monthly statements. The lender, in order to comply with anti-terrorist laws that require all funds to be sourced, was demanding a bank statement showing the funds legitimately belonged to her mom, but all she had was her passbook.
The whole deal nearly fell apart. The buyer’s mom was confused, and even though the bank made a photocopy of her passbook and managed to fax it to me, the lender was not satisfied as to the source of the money. Given the time difference for phone calls, and the age of her mother, my buyer was very concerned that this whole transaction was becoming too difficult for her mother. She was so upset that she ended up in tears, wanting to cancel the purchase.
Finally, I got through to a senior manager at the lender, and he was able to sign-off on the funds transfer, satisfied that this elderly woman was not a terrorist trying to launder money! What I learned from this is to always make sure gift funds are in order before writing an offer!
Seller Assistance
Another source of funds might be the sellers, depending on the amount of equity they have in the home and their plans after selling. If a seller owns a property outright, or has a large amount of equity, they might consider taking back a second mortgage at a reasonable interest rate. Again, this would be important to discuss with your lender, prior to writing an offer requesting any type of seller financing. You might also want to consider asking the seller to cover a certain amount of your closing costs. In some cases, it might make sense to pay a slightly higher price for the home if the seller covers some of your costs. From the seller’s perspective, they might be willing to cover some of your costs if the price is high enough to net the same amount as a lower price with no closing costs.
Borrowing from Your Retirement Account
There are definitely pros and cons to borrowing from your 401K account or liquidating your IRA, depending on the type of account you have. There may be age-related penalties and/or tax consequences. In any case, your lender will require documentation showing all terms and whether or not you plan to repay, or if you’re liquidating funds from the account. It you are borrowing from your retirement account, please remember that this new loan will be calculated into your debt-to-income ratio, meaning that you will be able to afford less on a monthly basis in terms of a mortgage payment.
Savvy Shopper Tips: Explore your down payment options with your loan officer and real estate agent as part of your pre-approval process. That way, you know the source of your funds before you set out on your home search. If looking for a down payment assistance program, keep in mind that the application process might take more than 30 days. If using gifted funds from a family member, make sure to confirm with your lender the exact gift letter form that must be used and when and how funds should be transferred. If trying to secure funds from the seller, ask your real estate agent to research the balance on what the seller still owes on the home to see if a seller contribution is even feasible. Keep in mind that in order for your offer to be competitive, you may need to offer a higher price to off-set any seller contribution. If looking to use your retirement account, always walk through the numbers with your accountant to see if this is a wise move.
US Tax Center, “7 Things You Should Know About Gift Tax,” US Tax Center, October 07, 2014, accessed June 2018, https://www.irs.com/articles/7-things-you-should-know-about-gift-tax.↩
Chapter 6
Your Secret Weapon: A Killer Agent
In an age when there seems to be an app for everything, including finding homes, some might say that the role of the real estate agent is becoming obsolete. After all, with public access to local MLS searches and home value websites, who needs an agent to help them buy a home?
You do. Buying a home is not like buying a pair of shoes, or even a car. This is a huge investment that you will be paying off for years. The home purchase transaction is rather like an iceberg; what you see above water may seem manageable, but it’s what lies below the surface that can send a deal crashing. Here are just a few of the services a qualified buyer’s agent will provide you:
Send you online listings of all the homes that fit your parameters.
Keep you updated when new homes come on the market.
Research market value so that you don’t overpay.
Write a compelling offer.
Negotiate the sales price and terms on your behalf.
Suggest questions to ask about a property, such as permits or zoning.
Negotiate for repairs on your behalf.
Provide referrals for trusted inspectors, painters, and other contractors.
Make sure that all disclosures and other legal paperwork are completed properly.
You pay nothing! The seller pays the buyer’s agent at closing. You benefit from all of their expertise at no cost to you!
Finding an Agent
So, how do you select the best real estate agent to assist you in your home-buying quest? Here are a few tips and questions to ask before making a final decision:
Ask your friends for referrals. Who have they worked with who they felt did a great job for them?
Do not call the listing agent on a property that you’d like to view and ask them to represent you. Their primary obligation is to the seller, so their ability to negotiate on your behalf may be conflicted. (More on dual agency later in this chapter.)
Whether you find a real estate agent online or through a personal referral, be sure to Google any prospective real estate agent. There should be several results, with perhaps a website and blog, as well as profiles on sites like Realtor.com, Zillow, Trulia, Facebook, LinkedIn, and Yelp. In an age when internet marketing is key, you need an agent who is at least fairly tech savvy.
Meet with them in person as soon as possible, at their office or a coffee shop, before viewing homes. This is a professional relationship, but you want to make sure you feel comfortable with one another, as trust and compatibility are important. This will also give you an opportunity to measure the agent’s professionalism, as well as their openness to really listen to your needs and desires. If all they do is talk about their personal success, this is probably not the agent you want.
If you know the part of town where you hope to purchase, make sure your agent is familiar with the area. You want to be sure they can offer constructive information about the various neighborhoods.
Ask them if they are a full-time agent. This is a very competitive market, and you want to be working with an agent who is on top of the latest listings and getting you into those new properties as quickly as possible. Hot properties are often gone within hours, so working with someone who is only working part-time definitely puts you at a disadvantage.
Ask how long they have been licensed. As with most professions, experience is important. That being said, there are many good agents who are relatively new in the business. If their experience seems minimal, ask them about the type of brokerage support that’s available in case you have questions they can’t answer or a problem arises.
What is their protocol for responding to your calls, emails, or texts? What is their average response time? Will you be working with them directly throughout the process, or will they be sending someone else to show you properties? Nothing is worse than being in the middle of your hou
se hunt or transaction and feeling like your agent has abandoned you.
Ask any prospective agent for testimonials from past clients. You should also check for reviews on Yelp, Trulia, Zillow, and Google. However, while some real estate agents are very good about remembering to ask clients to leave feedback, a real estate agent isn’t necessarily less qualified just because they have few reviews.
Are they a REALTOR? In California, licensees are either salespersons or brokers, often referred to as agents. REALTOR is a designation used by salespersons and brokers who are also members of the National, State, and Local Association of REALTORS. It is not mandatory to join the associations, but members do subscribe to a code of ethics and may spend more time on their professional education.
Check their license status. In California, you can look up any licensee at the Department of Real Estate (www.dre.ca.gov). Here you can check to make sure their license is current and whether it has ever been suspended or revoked. You can also see if there has ever been any disciplinary action or fines. Other states have similar online services.
