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Learning Center Real Estate Articles Understanding the Financing Process
Learning Center Real Estate Articles Understanding the Financing Process| Understanding the Financing Process |  |  |
| We already know that the home buying process is a complicated process; and shopping for the right home is the fun part. It is the financing and closing the sale that is the most mysterious and stressful for the buyer. Therefore, we want to address the process and unravel some of the mystery. PRE-QUALIFICATION: A mistake that most inexperienced buyers make is they fail to find out exactly how much home they can afford. This affects almost every aspect of buying a new home - including how the Offer To Purchase is constructed. Real estate Agents are equally guilty because they start showing a buyer property without knowing if the buyer can afford the home they are looking at. It is generally recommended that the first thing a buyer needs to do is pre-qualify themselves so they know exactly how much they can afford to spend for their dream home and how much cash they will need for a down payment. Pre-qualification acts as a dry run for the loan application process. The mortgage lender will use details you provide about your credit, income, assets and debts to arrive at an estimate of how much of a mortgage you can afford. The whole process may take only minutes and there is usually no charge to the buyer. The pre-qualification is non-binding to the lender because the information you provide has not been verified. However, it serves as a good indication to the lender of your general creditworthiness. This also simplifies the pre-approval process which is the next step. In many cases, the buyer will be surprised because they have under-estimated their buying power. Pre-qualification is an easy process and can be done either on-line or with the assistance of a lending agent. Items considered when pre-qualifying for a mortgage loan are employment history, credit history and FICO (credit rating) score, and monthly income and expenses. PRE-APPROVAL vs. PRE-QUALIFICATION: You may be wondering what the difference is between pre-approval and pre-qualification. Pre-approval takes pre-qualification one-step further. The lender will actually contact your employer, your bank and others to verify your income, assets, debts and credit history, and then issue you a letter stating that your mortgage is approved for a certain amount within a certain timeframe. You may be charged a small fee to cover the cost of your credit reports and your application. This fee is often refunded at the time of closing. We always ask our clients to get pre-approved when they’re getting serious about making a purchase, because in today’s market a pre-qualify letter carries very little weight with savy sellers. KAIZEN Realty can assist you in getting pre-qualified or pre-approved. LOAN APPLICATION: The first step in applying for a loan is to understand the mortgage programs that you may qualify for, its advantages and disadvantages, so make a list of any questions you may have (i.e. Why choose a Fixed Rate Mortgage over an Adjustable Rate Mortgage?) Depending upon the economic climate at the time you are applying for a loan, you may want to lock-in the interest rate or float the loan's interest rate. Locking-in the rate means that the lender usually commits to the mortgage interest rate and terms (points and fees) at the time the loan application is submitted. Buyers who opt to "float the loan" believe interest rates and terms may become more favorable between the time (weeks or months) of the application and the closing. This means that the buyer can lock-in the interest rate anytime between the loan application date and closing. As you can imagine, this is a gamble because you take the risk that interest rates may rise instead of drop. In addition, the terms may not be the same, thereby increasing the mortgage payment. The next thing you want to think about is if you want to pay additional points to lower your interest rate. Each point is one (1%) percent of the mortgage loan payable in cash at closing. Read our article "Locking in the Rate" here. The following list itemizes most of the documentation you will need for your loan application:
Just because you have been approved for a loan doesn't mean that your financing is secure. The mortgage lender will most likely make a second credit check just prior to closing because the mortgage loan is only conditionally approved. The lender reserves the right to re-verify credit, income, assets and employment at any time prior to closing and may cancel the loan if there are any adverse changes to your qualification status. Red flags can disqualify you for the approved mortgage program. A red flag is any inquiry made regarding your credit worthiness. If you decide to purchase a big ticket item - like that Porsche roadster or sailboat you have wanted - prior to closing, you are at risking a red flag showing up on your credit report. Another thing you do not want to do is move your money around --- leave your bank and investment accounts alone until after the closing. Do not close accounts or change banks. A large withdrawal or deposit to any accounts will trigger a red flag. If a red flag is triggered, you may be asked to produce a paper trail tracking large withdrawals and/or deposits. Although your employment status also affects your credit worthiness, a change of jobs for salaried employees to one of equal or higher pay will not trigger a red flag. However, commissioned sales people should not change jobs prior to closing on their mortgage loan. Mortgage lenders typically average your commissions over the last two years to determine income. Changing employers eliminates the two-year commission history and places uncertainty on your income status. The bottom line is not to make any changes without first talking with your mortgage lender. PRE-PAYMENT PENALTY: Okay, you have your loan and you closed on your property on time with no problems so you are one happy camper. You have been enjoying your home for a few years but lower interest rates have you thinking about refinancing your loan. However, you failed to read the part in your loan agreement that addressed a pre-payment penalty. What can you do --- nothing! If it was in the agreement when you accepted the loan, you have to pay. But, what is a pre-payment penalty and why is it part of some lending agreements? We explained earlier how and why paying points as part of the loan package. However, consumers today are demanding cheap loans, meaning that they do not want to pay any points. Lenders are acquiescing to the market demand for cheap loans by offering to pay a mortgage broker a "yield spread premium". This presents a good argument for not using a mortgage broker and dealing directly with a bank. Do you really want to know what a "yield spread premium" is? Read our article on "Yield Spread Premium" here. Anyway, the reason for including a pre-payment penalty clause is because the lender is trying to protect themselves from making a cheap loan, usually an Adjustable Rate Mortgage (ARM) that the borrower intends to pay off or refinanced in a few months. Many states allows a lender to charge a pre-payment penalty but it must be clearly spelled out in the loan document. Most pre-payment penalties do not exceed three years, so a loan with a three-year-pre-payment clause may be constructed with the following terms: " Penalty of three percent of the outstanding loan balance if paid off in the first year; " Penalty of two percent of the loan balance if paid off in the second year; " Penalty of one percent of the loan amount if paid off in the third year. As you can see, the penalty lessens the longer the loan is held. Most lenders will allow up to 20-percent in additional pay downs of the balance of the loan principal per year without a penalty. Furthermore, many pre-payment penalties apply only to a pay off because of a refinance and will not affect the homeowner if he or she decides to sell the property within the pre-payment penalty period. As we think you can see, pre-payment penalties exist as a deterrent to what the financial market calls "refinance churning". In summary, it is important first to decide upon the mortgage product that best suits your needs. Ask the lender if the loan includes a pre-payment penalty for early payoff. After the details of the pre-payment penalty are explained, you can decide if the terms are agreeable to you. |
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