Single Family Homes - The No Risk Investment! - Part 16 FHA ARM interest rates are sometimes less volatile than conventional
adjustable rate mortgages and they often rise more slowly. If you found a bargain
property during a period of high interest rates you could buy with an adjustable
rate loan. Then wait until interest rates dropped to refinance into a conventional
mortgage. Talk to your loan broker for suggestions.
Documentation
All loans are approved or disapproved entirely based on documentation. For
those who have limited experience with the approval process for a home loan it can
seem a little overwhelming at first. But don’t worry! Here’s not only a list of
required documents the lender will ask for, but we going to give you the perfect
attitude when going through the process.
Let’s face it, lenders profit by making loans. The loan broker makes money
when you qualify for a loan. They really should make you feel like they are on
your side.
If you find a loan broker who makes you feel inadequate, find another loan
broker! It’s true, if your debt is too high and your income is too low, it’s going to
be harder to get a loan. But, if there’s a way, you want someone on your side who
is motivated to find that way. It may cost you more in interest, but it may be better
than the alternative.
Realize that no matter how much information they say they will ultimately
need from you, as the loan approval process continues, you will be asked for more
documentation. Don’t worry about that! Consider it a given. Expect it. It seems
like you will hear from the lender 2 or 3 more times requesting yet more
information. To add to the emotion of the situation, these requests are usually a
week or so before the expected closing of the escrow. Have you ever waited until
the last minute to do things? Of course, we all have.
Underwriters, the people that are looking at your paperwork and ultimately
approving or disapproving your loan, do it all the time.
It’s not procrastination. They have many loans they’re working on and the
priority is often determined by closing dates. Since so many loans close at the end
of the month, it becomes a mad dash for these underwriters to get all the
information they need.
This happens to them every month! It’s business as usual for them so don’t
get too stressed over the urgency of their message to you saying “we need this
information from you or the deal’s not going to go through and we need it NOW!”
They mean what they say and they do need the documentation but relax. Expect a
race for the deadline, because there’s a good chance this will happen.
These underwriters know how to make loans go through on time. For the
person who rarely goes through the home loan application process, this can be one
of the most stressful experiences of their life, because they don’t know this is
business as usual.
Now that you know what’s coming, laugh inside when the phone calls come
for more information. Just understand that when they ask for more information it’s
because they are working hard to get you the loan you want.
Your down payment cannot be borrowed or be a gift. The lenders want to be
shown that you at least have the ability to come up with the down payment money
on your own. It shows that you are responsible. The more money borrowers have
invested in a house, the more likely they are to take care of the house and continue
making payments responsibly. One has something to lose if their own money is
tied up in the property.
The way that lenders require you to prove the down payment money is yours
is for you to supply bank statements for the last 2-3 months. This shows them the
money is yours, liquid and has been there for a while. It shows a savings trend,
which helps them evaluate what amount of risk you represent.
If a recent lump sum deposit were listed for the amount of the down
payment, it would look suspicious, as if the money were given to you for the
purpose of the down payment. In some cases the lump sum deposit would be
legitimate, but an explanation would be necessary. If you don’t already save your
bank statements, begin today! You never know when a deal is going to pop up and
you will need the information.
Other documents you should have ready are:
Stockbroker account statements
Labor union accounts
Credit union accounts
401K statements
Pension savings
The more money you have the better, even if you’re not using it in the
transaction. Underwriters look at this kind of information. It shows that you have
the ability to save money. You are stable and responsible. Let’s face it, in today’s
world, many people are laden with more debt than they can pay back. People that
have savings stand out like a bright light in the lending world. Use it to your
advantage if you have those kinds of assets.
Income Documentation
The lender will send a form to your employer to verify that you’re gainfully
employed. This form will ask the length of your employment; your amount of
income on an hourly or salary basis; the amount of your last pay raise; the expected
amount of your next pay raise and when that might be; the likelihood of your
future with the company. Don’t worry if this seems like a lot of information for
your employer to be asked to divulge.
Your employer may not have answers to all the questions. That’s fair as
well. The lender is required to acquire all kinds of paperwork for the loan to
ultimately be approved. They have done their part by sending the letter. As long as
your employer answers honestly and it does not contradict the statements you’ve
made to the lender there should not be a problem.
Tax Returns
You will be required to provide copies of your last 2 years tax returns. This
means your entire return with all the paperwork including W2 statements.
Income Verification
If you receive paychecks with stubs, be sure to start saving them and put
them where you can find them. They can be computer generated or typed. The
lenders want to see the company’s name and business information along with your
name and information on these stubs.
They’re also looking for any year to date income numbers that may be found
on the stubs.
The lender will usually request 1-2 month’s worth of pay stubs. Not all of
us receive pay stubs. Others receive checks that are hand written. Some don’t
receive pay stubs. Like we said earlier, lenders want to do what it takes to make
deals go together, so don’t worry if you don’t fall into the cookie cutter mold of the
perfect applicant.
When I told my lender that I don’t receive pay stubs, they told me to have
my accountant write them a letter stating what my income was along with my year
to date gross income. That was simple. You may be thinking, “but I don’t have an
accountant”. What about a letter from your human resources or billing department?
If you have none of these things explain that to the lender and ask what they
suggest. They will work hard to find a way!
Self Employed
It’s true there’s more paperwork required if you’re self-employed or have
more than a 20% interest in a company. That’s not enough reason to be
overwhelmed though. It just means you must supply more information that you
already have or can get. A hassle, yes - A problem no. Along with the information
above, you’ll be asked to supply year to date financial data of the company. This
will include balance sheet and income statements, corporate and partnership tax
returns.
Credit Rating
Here’s a subject that brings some people much discomfort. Don’t despair! If
you have less than desirable credit, the times we live in work in your favor. The
majority of people have some kind of blemish on their credit report. The fact of the
matter is it’s almost become the norm. While that’s not the best commentary on
American culture, it’s still the truth. There used to be a time when if someone had
a bankruptcy on their record, they were almost blackballed from future credit
acquisition.
Today we have huge portions of society choosing bankruptcy as a means to
take back control in their financial lives.
The relevancy is that lenders have had to adapt to this. When society’s credit
rating levels dropped in recent years, lenders had to become more flexible.
So if you are faced with this situation, at least you will be viewed as a
potential client instead of outcast. If you have pretty good or excellent credit, you
will stand out greatly. It’s interesting to view the lender’s reaction when they
realize one has good credit. It speaks volumes.
If you find yourself with less than stellar credit, there are books out today
giving advice on how to improve your credit and credit report. One thing that has
proven helpful is a letter of explanation. These can be supplied to the lender or
added to your credit report. When you write these, be sure to take responsibility for
the problem. It looks worse if you give reasons why it’s someone else’s fault. This
is your chance to say, “I made a mistake. I have learned from this and it will never
happen again. Here is what I’m doing to correct the situation.” That show’s the
lender that you’re mature and trying to improve.
If you have many late pays, repossessions, an eviction or a time frame
where you didn’t make timely payments, explain the situation. Many times people
get into financial peril due to divorce. With the divorce rate being 50%, this is now
a common situation and lenders are aware of it.
It would be easy to say it was entirely your spouse’s fault. If you were the
lender, how would you view a person with that excuse? Would you think that this
person was truly a victim and their spouse is terrible? Or, would you think that no
one is perfect and this applicant isn’t telling you everything? This is the “real
world” we’re talking about here.
What if you were to say, “It was a rough time in my life and I wasn’t
thinking as clearly as I usually do. I made some bad decisions that I now regret. I
never want to go through that experience again because I went through great
emotional and financial strain. Here’s what I’ve been doing to correct the
situation.” Does that sound like a responsible person who has learned from the
school of hard knocks and is now a better person? You get the idea.
You’re trying to convince the underwriter that you’re credit worthy. Take
your time with this. Prepare a well thought out and conscientious letter. You can
even ask the loan broker or representative for their input and suggestions. They are
not the underwriters.
They will try to give the underwriter what is necessary for the loan to be
approved. As mentioned before, they should be on your side.
Miscellaneous Fees
Here is a listing of fees you may be required to pay. On some, I will list a
price range from low to high. These numbers came from a pro in the business.
Please realize that the high price ranges are rare but do exist. When you're
choosing a title company to handle the escrow of your transaction, ask about some
of these fees. The title business is competitive and you will see a fluctuation of
charges for services. While not all of these fees go to the Title Company, the ones
that are can vary from company to company. It's good business practice to choose
companies that provide affordable, reliable service. This includes lenders, property
inspectors, appraisers, realtors, etc. Here's the list:
Application fee - some lenders charge this and others don't.
Appraisal - $200-$500
Credit Report - $25-$75
Title Insurance - $100-$500 (tied to mortgage amount)
Recording fees - (deeds, mortgages, etc.) $25-$75
Inspections: Roof, Pest, electrical
Document Preparation: ("pocket liner") $50-$400
Underwriting fee: $50-$400
These fees could easily reach 1% of your purchase price.
Negotiate
Yes, you can negotiate some of these fees. Always ask. But there is another
way and most buyers often overlook it.
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When you're writing up your original purchase contract, specify that the
sellers must pay a portion of the closing costs that the buyer would “normally” pay.
You can decide how much you want to ask for, but the point is "ask"! They can
always counter your offer but what if they don't?
Lenders don't care who's paying the fees as long as they're paid. If you're
including other demands as well in your original offer (refrigerator, lawn furniture,
washer dryer, etc.) you can give up some to try to receive others. The bottom line
is it just makes good business sense to ask for more things than you are really
interested in. You never know what you'll end up getting!
Timing the Closing
You may wonder why the closing date is relevant to financing. There's a
reason most deals are closed at the end of the month. Mortgages are paid in arrears.
When you make your payment, it is for the month just past - unlike rent, which is
for the upcoming month.
Let's say you close a deal on August 31st. Your first payment would not be
due until October 1st…. you would have no payment in September!
However, if you were to close on August 15th, you would be required to pay
the interest amount for August 16th-31. That's 16 days worth of interest and that
would be due at the closing on August 15th. Your first mortgage payment would
still not be due until October 1st.
Considering that each mortgage payment for the first 25 years is
predominantly interest vs. principle, 16 days prepaid interest is something to avoid.
The moral to this story is to schedule the close of your escrow for the last day of
the month to avoid an extra interest payment.
Fixed Rate vs. Adjustable Rate
As I mentioned at the beginning of this chapter, it’s important to listen to the
numbers because they are definitely telling you something. Many people feel fixed
rate mortgages are better than adjustable rate mortgages. This is because most
people favor the security of the fixed rate, as it will not fluctuate.
That theory is sound. The question is, does this line of thinking work in
every situation? The answer is “no”.
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If you know you’re going to own a home for many years, say at least 10-15,
chances are a fixed rate mortgage will benefit you the most. It will also be the one
that will allow you to sleep comfortably at night, which is worth a lot too.
If you are going to own a home for 5 years or less, it may be wise to
consider an adjustable rate mortgage (ARM). ARMs have a beginning interest rate
that’s usually around 1% -1 ½% lower than a fixed rate mortgage. There’s a
maximum to how much the interest rate can go up in a year; if it’s going to go up
at all.
Most ARMs are tied to an index, which fluctuates. When the index amount
is added to a number specified in the ARM contract (the margin) you get the
interest rate for the ARM. Margin amounts are different on different loans so
compare them, because it makes a very big difference. For example, let’s say the
Treasury bill index is 5%. Add to that the ARM 2% margin. You have a 7%
interest rate.
With some ARMs you’ll pay less each month the first couple years than you
would with a fixed rate. For example, let’s say you knew you were going to own a
house for only 3 years and then you planned on selling it.
Fixed rate mortgages were being offered at 8%. A FHA ARM had a starting
interest rate of 7% and could only go up a maximum of 1% per year for 5 years
(5% cap meaning your ARM could never go higher than 12% interest).
Let’s say that you chose the ARM. The worst-case scenario would be that
the first year you paid 7%, the second year 8% and the third year 9%. That
averages out to 8% over three years. You would have paid just as much as if you
had chosen the fixed rate. If the interest rate had gone down you would have been
paying less than the 8% average, thus saving money over the fixed rate. If your
starting interest on the ARM had been less than 7% it would have been that much
better. Or, if you had sold before 3 years you would have paid less in interest than
the fixed rate.
Let’s say you chose the ARM and within the 3 years interest rates dropped
considerably. You could then refinance into a fixed rate giving you the best of both
worlds. As you can see, choosing between a fixed rate and adjustable rate
mortgage depends on the time horizon of ownership along with future market
conditions.
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Consult with the loan representative as to your best option. Ask them to
calculate how each loan would effect you monetarily so you can better make your
decision.
Down Payment Amount
Different loan packages require different down payment minimums. As
mentioned earlier, FHA loans can have as little as a 2.75% minimum down
payment requirement (as of the date this was written). Conventional loans usually
require at least a 5% minimum down payment. If you’re purchasing a rental
property, you will often be required to put down as much as 10% or more. Be
honest with the loan representative as to the use of the property when purchasing
and ask what loan programs are available for you to choose from.
How Much Money Can You Qualify For?
This is the first item people wonder about and for good reason. You can only
be interested in housing price ranges you can afford. The lender determines the
loan amount you can qualify for by considering 3 things:
Value of property
Credit worthiness of buyer
Ability to repay
Sounds simple enough. One rule of thumb says you can qualify for a home
priced at 2-2 ½ times your annual gross income. Here’s where the numbers that
represent your income and credit history tell the lender a story. The amount you
can borrow boils down to a simple math equation. The lender bases the amount of
the loan on monthly payment guidelines. Here is how the guidelines are
determined:
The lender takes the borrowers gross monthly income and divides it by the
entire monthly payment of the loan. That payment would include principle,
interest, taxes, and insurance, private mortgage insurance and homeowner
association fees. The rule of thumb is the amount of your gross income divided by
your monthly payment should not exceed 28% of your gross income.
There’s one more equation the lender considers:
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The borrower’s gross monthly income divided by the entire monthly
payment of the loan plus all monthly revolving debt. That would include credit
card bills, car payments etc. The rule of thumb here is the amount of your gross
income divided by your monthly payment plus your revolving debt should not
exceed 36% of your gross income.
It’s important to realize these numbers, 28% and 36% are not written in
stone. These are guidelines lenders use. You may have extenuating circumstances
that could encourage the lender to consider higher numbers than these. These
circumstances might include:
You have no debt
Job stability; you’ve worked at your job for many years.
Excellent credit
Lots of money in savings you’re not using in the transaction.
You’re supplying a large down payment. The more money you have in the
property, the more you stand to lose if you go into default. This makes the lender
feel more comfortable, because you’re less of a risk when you have more to lose.
The monthly payment on the loan is the same or lower than the one you’ve
been making where you currently live. This won’t be as dramatic for the lender but
it will show them you have the capability of making the payment.
Shop Around
Remember, if one lender turns you down try another lender! Just because
one says “no” doesn’t mean another will not say “yes”. Lenders are in the business
of making loans. Good loan representatives and loan brokers should be doing all
they can to find a way for you to get a loan. When interest rates are low, loan
brokers get busy. If one is too busy to give you the full attention you deserve, find
another! There will be one that has the time and motivation to help you reach your
goal if at all possible. This document and accompanying materials are designed to provide authoritative information in regard to the subject matter covered in it. It is for illustration purposes only and presented with the understanding that the author and publisher are not engaged in rendering legal, accounting or other professional opinions. If legal advice or other expert assistance is required, the services of a competent professional should be sought. |
