Your Guide to Financing a Home
Although a newcomer to the Houston region, you may not be new to the homebuying process. Even so, it’s helpful to review all the steps involved as well as Houston-area resources and conditions. Since Houston has a relatively healthy real estate market, finding the right type of mortgage for your home is made simple by the abudance of property choices. With the proper research and the help of a reliable real estate professional, purchasing your Houston home should be a rewarding experience.
As you prepare to purchase a home and seek financing, it is best to first have a realistic view of the all the steps involved. The financing process can take anywhere from 15 to 45 days, but typically runs 30 days. Your agent should be involved throughout the process to help it run smoothly. The basic timeline for what will happen along the way is as follows and is covered more thoroughly within this chapter. For additional expert articles about financing and obtaining a mortgage in Houston, visit www.RelocatingToHouston.org.
NAVIGATING THE FINANCING PROCESS
You submit the completed 1003 application and any required supporting documentation to the lender.
The lender orders an appraisal of the property and your credit report and begins verifying your employment and assets.
The lender provides a good-faith estimate of closing and related costs, plus initial Truth in Lending disclosures, which by federal law must be provided by your lender within three days of first pulling your credit report.
The lender evaluates the application and your supporting documents, approves the loan and issues a letter of commitment.
You sign the closing loan documents and the loan is funded.
The lender sends its funds to escrow.
All appropriate documents are recorded at the County Recorder’s Office, the seller is paid and the title to the home is yours.
HOW IS YOUR CREDIT? Before you even begin applying for a mortgage loan, you’ll need to evaluate the state of your credit. There are three major credit-reporting agencies in the United States that maintain records of your use of credit: Equifax®, Experian® and TransUnion®.
These records are called credit reports, and lenders will want to check your credit report when you apply for credit. Generally, lenders also will want to know your credit score. A credit score is a number that summarizes your credit risk based on a snapshot of your credit report at a particular point in time. A credit score helps lenders evaluate your credit and estimate the risk of lending to you. By reviewing this report beforehand, you can identify any issues that are due to fraudulent activity and work toward correcting them.
To request a free copy of your credit report once a year, call (877) 322-8228 or visit www.annualcreditreport.com. For more information on credit reporting, visit the Federal Trade Commission at www.FTC.gov.
The most widely used credit scores are FICO® scores, created by Fair Isaac Corporation. Lenders can buy FICO® scores from all three major credit-reporting agencies. Lenders use FICO® scores to help them make billions of credit decisions every year. Fair Isaac Corporation develops FICO® scores based solely on information in consumer credit reports maintained at the credit-reporting agencies.
Your credit score influences the credit that’s available to you and the terms (interest rate, etc.) that lenders offer you. It’s a vital part of your credit health. Understanding your FICO® score can help you manage your credit health. By knowing how your credit risk is evaluated, you can take actions that may lower your credit risk—and thus raise your credit score—over time.
— Why Do You Want a High FICO® Score? According to Fair Isaac Corporation, the difference between a FICO® score of 620 and 760 often can mean tens of thousands of dollars over the life of your loan. A low score can cost you money each month or even stop you from refinancing at a rate you know other people are getting.
— How Are FICO® Scores Calculated?
Different credit data are collected to determine your credit score. These data can be grouped into five categories weighted at different percentages that reflect how important each of them is in determining your FICO® score. The FICO® score is based on your credit history and is a compilation of several factors including payment history, outstanding credit, length of credit history, new credit you’ve acquired or applied for and types of credit used.
Payment History: The first thing any lender would want to know is whether you have paid past credit accounts on time. This is also one of the most important factors in a FICO® score. Your payment history accounts for approximately 35 percent of your score.
Amounts Owed: The number of accounts you hold with balances represents approximately 30 percent of your FICO® score. Note that even if you pay off your credit cards in full every month, your credit report may show a balance on those cards. The total balance on your last statement is generally the amount that will show in your credit report.
Length of Credit History: In general, a longer credit history will increase your FICO® score. However, even people who have not been using credit long may get high FICO® scores depending on how the rest of the credit report looks. Credit history accounts for approximately 15 percent of your FICO® score.
New Credit: Many factors of new accounts impact your score. It considers how many of your accounts are new, how long it has been since you opened a new account and how long it has been since credit-report inquiries were made by lenders. Re-establishing credit and making payments on time after a period of late payment behavior will help to raise a FICO® score over time. Your new credit accounts make up for 10 percent of your FICO® score.
Types of Credit Used: Approximately 10 percent of your FICO® score is based on your mix of credit cards, retail accounts, installment loans, finance company accounts and mortgage loans. Your FICO® score also takes into account the kinds of credit accounts you have. Have you had experience with both revolving and installment accounts or has your credit experience been limited to only one type? Your FICO® score also looks at the total number of accounts you have and how many of each kind. The appropriate number and mix varies depending on your overall credit picture.
According to Fair Isaac Corporation, a FICO® score takes into consideration all these categories, not just some of them.Lenders also look at other factors when making a credit decision, including your income, how long you have worked at your present job and the kind of credit you are requesting.
Your score considers both positive and negative information in your credit report. Late payments will lower your score, but establishing or re-establishing a good track record of making payments on time will raise your FICO® credit score.
Visit www.myFICO.com to select credit calculators to compare loans, determine mortgage payments, see whether a fixed or an adjustable loan makes sense, determine closing costs and assess whether renting or buying is the better option for you.
SAVING FOR THE DOWN PAYMENT
It is recommended to pay about 20 percent or more of the cost of the home for the down payment. This is known as an 80-percent loan-to-value (LTV) ratio. If you put down less than this you will be required to pay private mortgage insurance (PMI), which protects the lender in the event you default on the loan. PMI is not tax deductible and can cost anywhere from $25 to $65 per month for a $100,000 loan. The amount is determined by the size of the down payment, the type of mortgage and amount of insurance; it is paid monthly with the mortgage. Under the federal law, the lender is required to cancel the PMI once the LTV ratio reaches 78 percent or when your mortgage has amortized to 78 percent of the original value of the house. The borrower must be current on all mortgage payments, and the lender must tell the borrower at closing when the mortgage will hit that 78 percent mark.
GETTING YOUR LOAN APPROVED
Being preapproved by a lender can put you in a much stronger negotiating position because it shows the seller that you are a qualified, ready-to-buy buyer, financially capable of buying the property and more likely to close on it. Getting preapproved also allows you to understand your financial condition and how much you can afford before you begin your home search.
Preapproval is different from prequalification, which is merely an estimate of what you may be able to afford. Preapproval occurs when the lender has reviewed your credit and believes that you can finance a home up to a specific amount based on collected preliminary information. However, neither preapproval nor prequalification represents or implies a commitment on the part of a lender to actually fund a loan.
ANTICIPATING YOUR COSTS
Review the information that follows to anticipate your costs involved in buying a home. It is only a partial list; for more detailed costs, ask your real estate agent to help you create a worksheet that can be updated as necessary.
— Estimating Buyer’s Fees
Whether called a loan origination or a loan service fee, buyer’s fees can be up to 3 percent of the loan amount and can include the following:
Loan application fee
Lender’s credit report
Lender’s processing fees
Lender’s documentation-preparation fees
Lender’s appraisal fees
Prepaid interest on loan (prepaid per day until the end of the month in which the closing occurs)
Lender’s insurance escrow (up to 20 percent of the cost of a one-year homeowners insurance policy)
Lender’s tax escrow (depending on the time of year you close, this can be up to 50 percent of the yearly property taxes)
Lender’s tax escrow service fee (to set up the tax escrow)
Premium mortgage insurance (PMI)
Title insurance cost for lender’s policy (depending on location, a portion or the full amount may be paid by the seller)
Special endorsements to the title (lender may require the buyer to pay special endorsements, such as an environmental lien or location)
House inspection fees (any that remain unpaid)
Title/escrow company closing fee
Recording fees for the deed or the mortgage
Local city, town, village, county or state transfer taxes (vary by location)
Flood certification fee (to determine whether the home is in a flood plain)
Buyer attorney’s fee
Association transfer fee
Condo move-in fees
Co-op apartment fees (to transfer shares of stock in the property to the buyer)
Credit checks by the condo or co-op board
Many people shopping for home loans forget to inquire at credit unions. There are two major differences between a traditional bank and a credit union. One difference is that credit unions are member-owned, meaning that if you have an account at a credit union, you’re part owner in the enterprise. Being a member can translate into better service since you are more than a customer. The other difference is that credit unions are not-for-profit, which explains why mortgages and interest rates tend to be notably better. Becoming a member is easier than typically believed; you can use the credit union search tool at www.JoinACU.org to find a local branch.
Types of mortgages include the following:
— Fixed-Rate Mortgage
A fixed-rated mortgage comes with an interest rate that remains the same for the life of the loan. The life or term of a mortgage is 30 years by industry standards, but 15- and 20-year-term loans are also available.
Shorter-term loans come with cheaper interest rates. A 15-year mortgage interest rate is typically one-quarter to one-half percent lower than a 30-year mortgage. Both the cheaper rate and the shorter term mean you also pay less during the life of the loan than you would if you borrowed the same amount of money with a long-term loan. However, monthly payments of a shorter-term loan are generally higher than the same loan for a long-term because the larger payments of the short-term loan are necessary to repay the debt sooner.
A long-term loan with smaller monthly payments can be easier to budget, but if you have a stable salary that allows you to afford the larger monthly outlay, the shorter-term loan could be to your advantage. Whatever term you choose, fixed-rate mortgages protect you from the risk of rising interest rates. Of course, since you are locked in to a given rate, you could end up with a rate higher than necessary should rates fall.
— Adjustable-Rate Mortgage
Adjustable-rate mortgages (ARMs) come with interest rates that adjust up or down, depending upon current economic trends and are based on a money market index. The one-year U.S. Treasury bill is commonly used because its yield is similar to the 30-year U.S. Treasury bill used to set rates on 30-year fixed-rate mortgages. ARMs also might be tied to other indexes, including certificates of deposit (CDs) or the London Inter-Bank Offer Rate (LIBOR) among other regularly published indexes.
To come up with the ARM rate, the lender will add to the index a “margin” of usually two to four percentage points. Initially, the ARM rate is lower than the fixed rate, from about one-quarter point to two points or more, depending on the economy. The date when the first adjustment occurs (from six months to many years) and how often the rate adjusts depends on the terms of the loan. After the first adjustment occurs, subsequent adjustments can occur every six months, once a year or at longer intervals. The adjustment period is disclosed in the specific loan.
ARMs generally have limits or “caps” on how high it can adjust during each adjustment period as well as for the life of the loan. The caps protect you from drastic market changes, but ARMs don’t offer the stability of a fixed-rate loan. ARMs’ lower initial rate, however, can help you qualify for a larger loan or start you off with smaller payments than you’d have to pay for the same mortgage with a higher fixed rate. If index rates fall with an ARM, so does your monthly mortgage.
ARMs also could be a good choice for someone who knows that his or her income will rise and at least keep pace with the loan rate’s periodic adjustment cap. If you plan to move in a few years and are not concerned about the possibility of a higher rate, an ARM could be a sound solution.
Most lenders now are requiring that buyers use an escrow account. The lender automatically places a portion of the homeowner’s monthly note into an account specifically designated to pay for insurance and taxes. From that account, the lender is responsible for paying the annual bills.
Types of loans can include the following:
This is the traditional 15- or 30-year home loan. Variations include jumbo loans (loans for more than $417,000), conforming loans (loans under $417,000) and ARMs.
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development (HUD), administers various mortgage loan programs. FHA loans have lower down-payment requirements and are easier to qualify for than conventional loans, but FHA loans cannot exceed a statutory limit. Reasons cited by FHA for pursuing this option, include the following:
Easier qualification: Because FHA insures your mortgage, lenders are more willing to give loans with lower qualifying requirements.
Less-than-perfect credit: Even if you have had credit problems, such as bankruptcy, it’s easier for you to qualify for an FHA loan than a conventional loan.
Low down payment: FHA has a low 3-percent down payment, and that money can come from a family member, employer or charitable organization. Other loans don’t allow this.
Lower cost: FHA loans often have competitive interest rates because the loans are insured by the federal government. Always compare an FHA loan with other loan types.
— Veterans Administration (VA)
VA loans partially are guaranteed through the U.S. Department of Veterans Affairs (VA). The VA recently expanded its qualifying criteria to include more veterans so all veterans should contact the VA for the most current information at www.homeloans.va.gov.
Title insurance is a contract in which the title insurance company, in exchange for a one-time premium at close of escrow, protects against future losses resulting from defects in the title to real property that exist at the time of purchase but are unknown or undisclosed.
Title insurance is significantly different from homeowners insurance and other casualty insurance. Homeowners insurance provides protection from losses due to unknown future events, such as fire or theft for a specified period of time (e.g., an annual premium for a year of coverage). Casualty insurance reduces the homeowner’s liability should someone be injured on their property.
Title insurance provides protection with a one-time premium for an indefinite period of time from future losses because of events that already have occurred (e.g., claims of ownership). Because of this, title insurers eliminate risks and prevent losses in advance through extensive searches of public records and thorough examination of the title.
There are two types of title insurance policies: the owners and lenders. The owner typically will purchase the standard coverage form in the amount of the purchase price of the property. It does not cover increases in value unless you purchase an endorsement, but it covers the buyer’s interest in the property for as long as the buyer or the heirs have an interest in the property, subject to certain limitations.
The lender typically will purchase the extended coverage form equal to the mortgage loan. It covers the lender’s interest in the property for the life of the loan and provides additional coverage, such as unrecorded easements and boundary discrepancies, not found in a typical owners policy.
Owners may elect to purchase a homeowners policy of title insurance instead of the standard coverage form. Introduced in the 1990s, this policy includes the standard coverage of a typical owners policy and additional coverage, such as forgery occurring after the policy’s effective date and increases in the property value.
A title insurance policy protects you from financial loss due to covered claims against your title, pays your legal costs if the title insurance company must defend your title against covered claims and pays successful claims against your title.
Claims typically covered under an owner’s title insurance policy are the following:
Someone other than the insured who owns an interest in the property
Forgery, fraud, undue influence, duress, incompetency, incapacity or impersonation
Defective recording of a document
Undisclosed liens due to a deed of trust, unpaid taxes, special assessments or homeowners association charges
Unmarketability of title
Lack of access to and from the land
Ask your title insurance agent to explain what is and is not covered under your title insurance policy.
Financing is always a complicated process, but it can run smoothly if you know what to look for and enlist the help of the right knowledgeable professionals.