Real estate is such a great investment! There is probably nowhere else where you can leverage so much with so little. You can purchase a $500,000 home with $15,000 (at least in some markets, some of the time!). If that home goes up in value $50,000 (or 10 percent) in a year, you’ve more than tripled your $15,000 investment (333 percent). Sound too good to be true? It’s not. People do it every day. The best place to start investing in life is in your personal residence. If you are considering renting— don’t do it! Renting is a losing proposition. All the money goes out and none comes back to you. As a homeowner, you get many benefits, including the tax advantage of deducting the interest portion of your payment. But for now let’s talk about how to get the majority of the money to buy your next home.
First, you need to find a lender. Make sure you have a lender that specializes in providing loans for the type of purchase you are making. If you are buying a home, you will use a residential mortgage lender, and if you are buying land, with certain exceptions, you will probably use a bank. A mortgage lender can do land loans if you are buying a lot and plan to build a home on it immediately. Many mortgage companies now offer what is called a one-time close, construction-to-perm loan, which will help you finance the land purchase, provide the construction financing and then provide the permanent financing once the home is built.
Although we discussed lenders in regard to the sale of your home, once you are ready to buy it is your turn to find financing with the best terms possible. Whether you use a loan officer at a bank, a broker or a mortgage lender recommended by your Realtor®, you will want to make sure that they work hard to get you the best deal they can. At the end of the day, when you commit to a loan, the lender makes a commission. Make sure that they earn it!
In all states, banks are regulated by various government agencies in their practice of providing home loans.
In California, mortgage brokers are licensed, but mortgage bankers do not have to be licensed. However, in Ken’s state of Colorado, mortgage lenders and mortgage brokers do not have to be licensed. This means anyone can get into the business, say they are a mortgage lender and do a lousy job, and you have no recourse through a licensing body. Even though many states require lenders to be licensed, lenders vary widely in honesty and integrity. Therefore, you still must be diligent in selecting your lender and loan officer; they can hold the key to your purchase. Be sure to ask your Realtor® about the licensing requirements for mortgage lenders, mortgage brokers and loan officers in your area.
A loan officer is much like a real estate agent: You may be referred to one by a friend, have a family member in the business or happen to meet one by accident. Just remember that not all loan officers are alike. A good Realtor® will have a short list of lenders and loan officers who have proven they know what they are doing, only make promises they can keep, don’t spring last-minute surprises, have a substantial menu of loans to cover most situations and have competitive rates and costs. You want to avoid last-minute surprises like finding out a day or two before you are supposed to close that the underwriter has a list of conditions which will be impossible to meet prior to closing.
Beware of lenders who advertise low rates in major newspapers or on the Internet. Purchasers have often started their loan applications before they met and retained a quality Realtor® to assist in their home purchases. In many cases where the clients stayed with that lender, they have regretted their selection. Typically, something goes wrong. The most common problems are interest rate increases, disregarding good faith estimates, hidden fees, processing delays and lost documents. Make sure to get a lender who is both local and has been referred by someone trustworthy, such as your Realtor®.
We keep lists of lenders who meet our criteria, and a good Realtor® will also be familiar with the basics of loan processing and the types of loans available so they can provide guidance as you work with the lender and can tell if the person you are working with is knowledgeable. However, many agents simply refer you to a lender and stay completely out of the process. We feel teamwork will get more deals done and we tend to stay involved and brainstorm unique possibilities with our buyers and their lenders.
In a contrasting example, a recent first-time homebuyer, whom we’ll call Bob, started out with a lender Mary had recommended. Then Bob found a “great” rate on the Internet and chose to go with the Internet lender instead.
Remember the earlier warning? Bob decided he wanted to switch his loan to the lender who quoted the lowest rates. Clients always have the right to choose their own lenders, but we do caution them when we are not familiar with a lender they choose. We cannot vouch for that lender’s service, competence or knowledge. Often we interview a lender to determine the viability of the loan program they’re offering and to get a sense of how well that lender can represent the client.
Because Bob found his lender on the Internet, the lender was from another state and therefore was not familiar with California’s appraisal procedures. The lender was supposed to order the appraisal but never did, thinking that it was Bob’s responsibility. Unfortunately this was not discovered until the day before closing. The closing had to be postponed and of course by this time Bob’s rate lock had expired. Not only could Bob have lost the house, he also incurred the risk of owing penalties for defaulting on the purchase. But thanks to Mary’s connections, she was able to get him a new loan through the original lender with a similar rate to the original loan’s and in the end everyone was happy.
A good faith estimate is a form your lender provides you that shows the lender’s regular charges, along with the other anticipated closing costs involved with the loan. It utilizes those figures to estimate the total amount of cash you will need to buy your house and calculates your approximate monthly payment. Some lenders will insist they cannot provide a good faith estimate until you have a property under contract or in escrow. That’s just not true. Good faith estimates are simply that—estimates—and they can be prepared quickly and easily. In fact, some lenders we work with will prepare several, one for each loan scenario they are discussing with you. It assists you in comparing those loans so you can decide which one to take.
It also gives you something to compare with other lenders if you happen to be shopping for the best rates and costs. If one lender charges, for example, a $450 loan processing fee, and another charges $150, and the rates and other fees are the same, you might want to spend more time with the lender who charges less. But do not let these fees be the only reason for selecting a lender. Consider what happened to Bob. A good mortgage broker is worth their weight in gold.You should also get a good faith estimate on two other occasions: (1) when you have a property under contract, and your Realtor® provides a copy of that contract to the lender; and (2) when you change loan programs, either because you don’t qualify for the one you started with, or you decide on a different plan. Once you are under contract, many of the items that were estimated on the first good faith estimate are known, so the estimate is more accurate and closer to reality.
Occasionally, one of our clients decides to use a lender we haven’t recommended. In one case, a couple decided to work with a lender who was renting a home from one of their parents. The lender promised to cut his origination fee in half because of the relationship.
Usually, lenders charge a 1.0 percent loan origination fee. That fee is generally split between loan officers and the mortgage company they work for. In this case, the lender either gave up their portion of that fee, or worked it out with their boss to discount the deal. At any rate, when Ken compared his good faith estimate with other lenders, the reduced fee made the difference. Their loan was going to be about $140,000, so a 1.0 percent fee would have been $1,400. They saved $700 by going with this lender, all other things being equal.
Ken met with the lender and told him if he really took care of the clients, he would get other referrals from him. The lender was just getting established in the area, and he was eager for the new business. However, it took him longer to process the loan than he thought, and Ken did not have a settlement statement until the actual day of closing. Ken called him and the title company to bring something to their attention—the fact that there was a 1.0 percent loan origination fee on the statement rather than 0.5 percent—and asked for a correction. But this loan officer insisted he had met with the clients, and because they had not locked in their rates, and rates had gone up somewhat, he took a full origination fee rather than increase the rate.
Ken asked to see the new good faith estimate that he should have provided if this were true. He said he did not provide one, but the clients understood the new loan terms. The clients insisted there was no such agreement, and at the closing table they were faced with a dilemma. They had to close with the charges as they appeared, or get the lender to write them a check for the 0.5 percent difference or walk away and refuse to close on the home. They closed, and did not get a refund from the lender. They were angry with him but happy to be in their new home. That lender has never received a referral from Ken, and within a few months he was out of business, or at least gone from the area. He certainly does not rent from the clients’ parents anymore.
Loan Types and Interest Rates
There are a variety of loan types available, and the loan program you select will depend first on your ability to qualify and then on your right to select one over another.
A starting place regarding your ability to qualify for a mortgage loan is the quality of your credit report. Every lender uses the FICO score, which stands for the company that created the scoring formula: Fair Isaac Company. It is a third party that provides the score to a potential lender. The lender does not calculate the score, but uses it to establish a borrower’s credit worthiness. Until recently, the components of this scoring system were kept secret, but it’s been announced that consumers will be able to get information about their score at www.myFICO.com. In general, they use different models and adjust the score depending on various factors, such as the amount of credit, the level of credit cards with no balances, cards with high balances, bankruptcy, payment patterns and so on.
At the current time, a score over 700 is excellent. Scores of 620 or above would normally allow you to qualify for A or A+ quality loans. These have the lowest interest rates and the most favorable terms. If we hypothetically use mortgage rates of 7 percent as the best available, a person with a score over 620 would qualify for that rate. Scores below 620 would normally put you in what is called a “sub-prime” category, also called “B” or “C” loans. The interest rate would depend on a variety of information specific to your credit report, but could be as high as 14 percent in today’s market. The rules vary considerably between lenders on sub-prime loans.
In addition to the money the borrower would pay for doing a credit check, getting title insurance and paying escrow charges and appraisal fees, there is a cost to get most mortgage loans: points. Points refer to the cost of purchasing a loan. One point represents 1 percent of the loan balance. On a $400,000 loan this would be $4,000 to purchase the loan. If a credit score puts someone in the B or C range, the points could rise to 4, meaning it could cost up to $16,000 to purchase a loan. Other fees could rise from $275 to process the same paperwork for a typical A borrower to $650 for a B or C borrower.
Certain loans are specially targeted for first-time homebuyers and offer features such as low down payment (as little as nothing down), competitive interest rates and the ability to have a cosigner or receive down payment assistance from another source. There are so many loan variables that it would be impossible to discuss them all here.
At the time of this writing, second-home loans are available for 10 percent down with interest rates as low as on primary residences. Investment loans can be obtained for as little as 10 percent down (though 20 percent or more is most common), and the interest rates are somewhat higher.
The general rule is that the more risk you ask a mortgage company to assume, the tougher the rules will be. Government guaranteed loans (e.g., FHA, VA) take some of the burden off the lender, so they can keep the rules easier for you to meet. But conventional loans (anything not guaranteed by an agency of the federal government) tend to follow this formula: The more money you put down, and the better qualified you are to repay the loan, the more likely the mortgage company will be willing to give you good terms and rates.
Interest rates are around the lowest they have been in more than 20 years. The political and economic climate in this country have conspired to produce 30-year fixed rates that have hovered in the 6.0 percent to 7.5 percent range since 1998. It’s at the point where nearly anyone with decent credit and a job can buy a home. You can’t always get exactly what you want the first time, but owning, saving and taking advantage of a growing market may give you the ability to take your increased equity every couple of years and trade into a better home. And maybe you are someone who is doing just that.
As discussed above, in the past it was hard to be an informed consumer in the mortgage arena, because much of the personal credit information used by lenders was unavailable to you. You couldn’t find out either your credit score or the criteria used to develop these scores. Consequently, consumers were unable to take proactive steps to improve their credit. Luckily, in the very recent past this has changed. The federal government has now passed a law that requires credit bureaus to release both your three-agency credit report score (FICO) and the bureaus’ rating criteria upon requests from consumers. For a small fee you can now obtain this information, or as discussed previously you can contact www.myFICO.com.
There are also credit repair agencies that work with consumers to raise their FICO scores. These agencies work with credit companies regularly, so they understand how to fix mistakes and how consumers can rearrange or repair their own credit, possibly raising their scores as much as 40 to 100 points. This process can even be as quick as a few short weeks for people who need quick credit fixes.
There are also many federal agencies designed to help home buyers. They can help with home loans, credit counseling and even down-payment assistance. But beware of nonprofit credit counseling services. Although these services can consolidate debts for people who have trouble paying their bills, credit counseling is often looked at in the same light as bankruptcy when it comes to credit bureau scoring.
Mary and I had corresponded via e-Mail for quite a while before my husband and I made the decision to sell our home in Los Gatos, California. I was impressed with her professional tone and the informative data that she provided without pressing her sales pitch. As soon as I met her in person, my instincts were validated. She came across as straightforward, genuine and very knowledgeable.
It didn’t take us long to select Mary as our agent and we were not disappointed. She acted with complete integrity throughout the process. Mary helped us establish a realistic price, played up the strong points of our home in her advertising and really took pains to mitigate the obstacle of our home being close to a freeway. Consequently, the house was sold in just over a month at a price acceptably close to the listing price.
In addition, Mary facilitated all the necessary inspections and reports and provided many other services to help us move out of our house. (She even commandeered her husband to help dispose of some old paint cans from our garage!) We were on a very tight schedule to close escrow and she maneuvered the process flawlessly.
From start to finish, I was consistently impressed with Mary’s level of professionalism and service. I would not have any hesitation recommending her services to anyone.
—Judy and Ian Walker