Your Stafford and Fredericksburg Area Real Estate Expert

Most people do not, of course, have enough cash to pay for a home, so they must finance their purchase. Most people who buy homes do so with mortgage or deed-of-trust financing where the buyer of a home borrows money from a financial institution and in turn gives that lender a lien on the property. That lien secures the debt and gives the lender the right to foreclose. There are many different types of mortgage financing, and in addition, some sellers of real estate will finance a sale of their property themselves through something called a Contract for Deed. In this section, we will overview:

• Mortgage Repayment
• Down payments (Equity)
• Government Loans
  • FHA
  • VA
• Conventional Loans
  • Insured / Uninsured
• Mortgage Investors: The “Secondary Market”
• Qualifying for your Mortgage

Mortgage Repayment

PITI (Principal Interest Taxes Insurance)
Most lenders will loan money to a home buyer for a term, or length, of either 15 or 30 years. Some lenders will finance loans over different terms, such as 20 years. Most first-time home buyers choose a term of 30 years because the monthly payment will be smaller. Everyone interested in purchasing a home should understand how the lender calculates their payment, and where their payment goes:

Principal: Repayment to the lender of a portion of the amount you borrowed.

Interest: Payment to the lender for the use of the money you have borrowed.

Taxes: Every monthly mortgage payment you make will include approximately 1/12th of the yearly property taxes and special assessments on your home. The lender holds this money in an escrow account and pays the property taxes twice a year when due.

Insurance: Homeowner’s Insurance, to protect your home against losses, and also possibly mortgage insurance to protect the lender if you don’t pay your mortgage. The lender holds this money from your payments in an escrow account and pays the premiums when they are due.

In the early years of home ownership, most of your house payment goes towards interest. Over time, however, less and less of your money will go towards interest, and more towards reduction of principal.Ask Janet for a table that will help you to estimate principal and interest (P&I) on different mortgage amounts, and an amortization table that will show you how equity builds in your home.

Down payments (Equity)
Before a lender gives you a loan, you will have to “qualify” for that loan. Basically, you will qualify for loan if the lender determines that you are willing and able to pay the loan back. The lender will determine whether or not you qualify by looking at many things. One important thing the lender will look at is your down payment. Your down payment gives you “equity” in your home, which is basically the difference between the value of your home and the amount of money you owe on it. (For example, if you bought a $100,000 home with a $5,000 down payment using a mortgage loan to finance $95,000, you immediately have $5,000 equity in your home.)

Value of $100,000 - Debt of $95,000 = $5,000 equity

Your equity will increase every month as you pay your mortgage and reduce your debt. Once you choose a loan program, your lender can provide an amortization table that will show you how equity builds in your home.

Government Loans
There are several government agencies which sponsor loan programs, often geared towards low to moderate income borrowers, or to special groups of people such as veterans. The most common government loans are FHA and VA loans.

1. FHA Loans
The FHA, or Federal Housing Administration, was created by Congress in 1934 as part of the National Housing Act for the purpose of promoting home ownership and to generate jobs through construction activity. The FHA today is part of the Department of Housing and Urban Development (HUD).

The FHA is really a giant insurance company. It allows lenders to make more loans than they otherwise could because it insures lenders against losses caused by borrowers who default on their loans, meaning, of course, that they do not pay them back. Because of this insurance, lenders who make FHA-insured loans are comfortable making loans with fairly small down payments, usually less than the 5% down payment required by conventional lenders.

The cost of the insurance which the FHA provides to lenders is called the MIP or mortgage insurance premium, and it is paid by the home buyer. The MIP is paid in two parts: First, there is the “up front” MIP, which may be paid in cash at closing, or “financed,” meaning added on to the mortgage. Most buyers who use FHA loans will finance the MIP in order to keep their closing costs low. In addition to the up-front MIP, FHA borrowers also pay an annual premium. This annual premium is broken down into 12 payments and made monthly, as part of the mortgage payment.

The biggest advantage to FHA loans is that required down payments are very low, and closing costs can be kept low be financing MIP and sometimes other closing costs as well. In addition, it is sometimes easier to “qualify” for FHA loans than for conventional loans. (Basically, you are “qualified” for a loan if the lender decides that you are willing and able to pay the loan back.)

2. VA Loans
After World War II, many returning veterans had difficulty finding, and being able to afford, adequate housing. So the Federal government passed legislation (often referred to as the “G.I. Bill”) to help veterans buy homes. The VA guarantees lenders who make loans to veterans that the lenders will be repaid for a certain amount of their loss if the veteran defaults on the loan. This guaranteed loan program is administered by the Veterans Administration and is available to eligible veterans. The rules regarding eligibility are complicated, but if you have had active service in the US Armed Forces, or in some cases if you have served in the Reserves or National Guard, you may be eligible for VA financing. A loan officer can help you determine your eligibility.

The biggest advantage of a VA-guaranteed loan is that the government guarantee allows the lender to make the loan with a very low down payment, or in some cases with 0 down payment!

There is no mortgage insurance on VA loans as there is on FHA loans because VA loans are guaranteed by the government, rather than insured. However, VA loans do require the borrower to pay a “funding fee,” which is usually 2% of the mortgage amount for first-time borrowers, and 3% of the mortgage amount thereafter.

3. Conventional Loans
A conventional loan is simply a loan made by a private lender, with no government agency involved. Because conventional loans are not backed by government insurance, as with FHA loans, or government guarantees, as with VA loans, they may require higher down payments, as discussed below. Usually the minimum down payment for a conventional loan is 5% of the sale price. However, sometimes conventional lenders offer more flexible terms.

Insured vs. Uninsured Conventional Loans
Equity is very important to conventional lenders because their loans are not insured or guaranteed by the government. Conventional lenders feel that the higher the down payment, or equity, which a home buyer has, the better qualified they are. On the other hand, conventional lenders feel that a home buyer with a low down payment may be more likely to default on the loan because they have less equity to lose.
For this reason, lenders who are making a conventional loan to a home buyer with less than a 20% down payment will usually require the home buyer to purchase something called Private Mortgage Insurance, or PMI. PMI serves the same purpose as MIP on an FHA loan. That is, it insures the lender against losses from default. However, PMI is not paid to the government, but instead to a private insurance company. PMI rates will vary depending on many things, including the borrower’s equity and credit rating.

Mortgage Investors: The “Secondary Market”
A mortgage loan is a type of investment, just like stocks or bonds, which can be bought or sold. The lender, which loans money to a home buyer, expects to get a return on its investment in the form of interest on the loan paid by the home buyer.

Investors who purchase real estate loans from lenders will pay the lender who made the loan a lump sum of money because the investor expects to make money from the home buyer’s payments of principal and interest. Most home loans are sold to investors. The investors who purchase mortgage loans make up what is called the “Secondary Market.” The Secondary Market promotes investment in real estate by making money available to lenders to originate, or make, real estate loans. Insurance Companies and pension plans frequently purchase real estate loans, but most of the secondary market is made up of three large agencies:

• The Federal National Mortgage Association (FNMA, often called “FannieMae”)
• The Federal Home Loan Mortgage Corporation (FHLMA, often called “FreddieMac”)
• The Government National Mortgage Association (GNMA, often called “GinnieMae”)

Here is an overview of the way in which mortgage dollars flow:

1.Mortgage money is given to a homebuyer by a lender in the “primary market.”
2.The mortgage is then sold to an investor (such as “Fannie Mae,” “Freddie Mac,” or “Ginnie Mae”).
3.The investor then creates a mortgage-backed security which is sold on Wall Street.
4. The funds which flow to the Investors from the sale of mortgage-backed securities are used to purchase more mortgages from primary lenders, resulting in more money to lend to home buyers.

The Secondary Market and Your Home Loan
Investors who buy real estate can only do so if the loans are “good” loans, which are very likely to be paid back. Remember, the investor has paid for the loan as an investment, and the loan must be repaid in order for the investment to earn a return. So, as mentioned earlier, before a lender will make a loan to you, the lender will have to determine whether or not you are qualified for the loan (that is, willing and able to pay it back). In addition, the lender will have to determine whether the property qualifies for the loan. The property serves as collateral, or security for the loan, so its value must support the loan. If the buyer defaults, the lender can foreclose and take the property back. If, for example, you want to borrow $100,000, and the lender determined that the home you wanted to buy was worth only $95,000, you would not get the loan.

The process by which the lender decides whether or not the buyer and the property qualify for the loan is called underwriting. If the lender plans to sell the loan to a secondary market investor, the lender will have to underwrite the loan according to the investor’s underwriting standards. Secondary market investors have established special underwriting standards to qualify the buyer and the property, in order to be sure that they only buy loans which are very likely to be paid back.

It is not important for a home buyer to know a lot about the secondary market. However, it is important to know basically what the secondary market does, because chances are very good that when you apply for a loan to buy your home, the lender will decide whether or not you and the property qualify for a loan according to the standards of the secondary market.

Qualifying for your Mortgage

Before a lender makes you a loan, the lender will go through the process of underwriting the loan to decide whether you qualify. That is, the lender must decide that there is a reasonably good risk that you will pay the loan back.

Underwriting standards will vary for different types of loans, and some programs designed for first-time buyers apply very flexible underwriting standards. Your loan officer can help you determine which types of loan programs are best for you.
However, no matter what type of mortgage loan you use, there are four factors you should be aware of which lenders will always look at when deciding whether you are qualified:

1. Your Income
2. Your Downpayment
3. Your Credit
4. The Property

As we look at these four factors, keep in mind that underwriting is not an exact science; a borrower’s weakness in one area may be offset by a strength in another. This section is intended only to give you general guidelines.

Qualifying Factor #1: Your Income

Because you must be able to show the lender that you will have enough money coming in the future to pay the loan back, the lender will want to look at your history of income. For example, a person with a high income who had only been employed for a few months would have less chance of getting a loan than someone with a lower income who had held steady employment for a long time, because that income is more likely to continue in the future. The term lenders use to describe what they are looking for is stability of income. Most lenders will look for a two-year history of income in order to count that income as stable, but this does not mean that you must have held the same job for two years. You should not have gaps in your employment, and if you have changed jobs, the lender will want a satisfactory explanation of the reason why. It is important to understand that because of the lender’s requirements of income stability, lenders may not count part-time income without a 2-year history because part-time work tends to be more temporary in nature.

Because the lender will be counting on your income in deciding whether to make your loan, your income must also be verifiable. As part of the qualification process, the lender will order verifications directly from your employer, or from a government agency if you receive public assistance. In many cases, lenders will also want to look at your income tax returns and pay stubs. This means that before you apply for a loan, you should know exactly what your income is, and you should understand that you will need to discuss your income openly and honestly with your loan officer. Although some people are uncomfortable discussing their income, the loan officer needs this information in order to help.

Qualifying Factor #2: Your Down Payment

Different types of loans require different down payments, but despite what you may hear, you must usually have some money in order to buy a house.  FHA down payments can be very low, VA down payments can be zero, and conventional programs vary greatly. Some conventional programs require no money down as well, but generally the less money invested in a home, the higher the interest rate will be.

Remember, the down payment is only one thing the lender looks at in deciding whether you are qualified. Most first-time buyers use minimum down payments, but a larger down payment could be used to compensate for other weaknesses, such as lower income or higher debt than is usually acceptable.

LTV
The way lenders describe their down payment requirement is the “Loan-to-Value Ratio” or “LTV,” which is the ration of the loan or mortgage amount to the value (usually the same as the sale price) of the home.

For example, if a lender tells you that their program is 95% LTV, this means that they will loan up to 95% of the value of the home, requiring a 5% down payment. IF you wanted to buy a $100,000 home with a 95% LTV program the lender would loan you up to 95% of the home’s value, or $95,000. This means that your down payment would have to be the remaining 5%, or $5,000.

Source of Down Payment
One part of the lender’s down payment requirement which many people don’t understand is that the lender will ask and want to verify where the down payment came from. The reason for this is that lenders feel that a home buyer who has saved and put their own money into a home will be more likely to stay in the home and pay the loan back than a home buyer who received their down payment as a gift or borrowed it. This does not mean that you can’t use a gift or sometimes even borrowed money for your down payment. But it does mean that at least some of the down payment may have to come from your own money, or you may have to show that you have some savings to use as cash reserves. Because the lender needs to verify where the down payment came from, it is important that you keep your savings in a savings institution which can provide this verification. Lenders will look for a savings history of at least three months, and will usually average your savings balance on past months’ balances.
If you are getting a gift towards the down payment, the gift must usually be from a relative and will have to be documented. Using borrowed money for the down payment is often very restricted. You normally cannot use cash advances on credit cards or unsecured lines of credit. Some lenders and agencies have special programs which will lend you part of the money for your down payment.

Qualifying Factor #3: Your Credit

Because a lender needs to know that you are willing and able to pay back a loan, the lender will want to review your credit history to see if you have paid your previous and current bills, and your rent on time, and to make sure than you do not have so much debt that you can’t make all your payments. The way in which a lender reviews your credit history is by examining your credit report. Your credit report is created by you! It is a record of how you have paid your bills, over (usually) a 7-year time period. Your credit report will include information from many different types of businesses, and will also include public information about you such as judgments, tax liens, and bankruptcy filings. Although most credit information is kept on your credit file for seven years, and bankruptcies are often kept for ten years, lenders will usually only concentrate on the past two years, unless you have had repeated and serious financial trouble before that. If you are a first-time home buyer, some special programs will focus primarily on the past one year of your credit history.

Tips on Re-Establishing Credit
1. Don’t wait for an emergency to contact your creditors
2. Do contact creditors where you have paid off accounts earlier.
3. Do accept offers for pre-approved credit cards, if the terms are acceptable to you.
4. Do consider offering security on an account, i.e. car, or any valuable property.
5. Do consider secured credit cards.
6. Do consent if a co-signer is required, but limit the time and amount for which the co-signer is liable.

Three large agencies maintain credit information on individuals, and there are several different ways to pull credit information from those agencies. You may review your credit report individually with your loan officer. You may find that there are problems or issues on your credit report which could make it difficult for you to get a home loan. A general discussion follows of some common credit barriers to home ownership, and their solutions. In addition, your loan officer can help you with your specific credit problems by helping you set up a corrective action plan, or in some cases by referring you to a credit counseling agency. Please note that no one but you will see your credit report unless you let them. However, you need to understand that before you will get a home loan you will need to authorize the lender to look at your credit report, and will have to pay for that credit report.

Whether you are ready to buy a home, or just ready to make a plan to prepare for homeownership, Janet and her team can help. Contact us anytime, and we will show you all the homes that meet your needs; not just our listings. If you are not yet ready to buy, we will put you in touch with those who can help.