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lifestyle
Financing Options When It's Time to Buy a Home
Buying a home is unlike buying anything else in your life – no one needs an agent to buy a taco or stacks of paperwork to agree over exactly how a pair of pants was made before they buy them. Tacos and pants also don’t cost most of your savings and tie up your money into a hard asset. That’s why it’s so important to know that there’s not just one type of loan available to buyers when you’re ready to buy a home. So, how do you start?
That’s why it’s so important to know that there’s not just one type of loan available to buyers when you’re ready to buy a home.
Get Pre-Approved
First, get pre-approved. When it’s time to get serious about buying, the first step is to talk to a lender. They’ll ask you to provide lots of background on your current financial situation, including tax returns, bank statements, and employment verification. Lenders will always check that you’ve filed your taxes and that you’ve got steady employment or income. Many people in DC are contractors and not considered “employees” – don’t worry, there are options for you that great lenders can walk you through.
While lenders will use their own informal methods to get some credit background information, they won’t necessarily do a hard credit pull until it’s time to get your loan together. You’ll also have a better idea of the interest rate you will be charged on the loan and, in some cases, you might be able to lock in a specific rate.
It’s important to choose a reputable lender that is well-known for their accuracy and quick turn-around time. Not all lenders are created equal, so ask your agent for recommendations (no, we do not get kick-backs!) on lenders whom they frequently work with and rely on to get pre-approvals in as little as a day or two; this speediness is critical when you’ve got a deadline on an offer for your dream home.
Tip: This is a bit different from getting pre-qualified, which is a term for the first informal step where you get initially screened by a lender. This step is useful to get you a ballpark estimate of what you can afford; good lenders are typically more accurate, but a pre-qualification won’t be taken seriously when it’s time to put in an offer.
With pre-approval, you will receive a conditional commitment in writing for an exact loan amount, allowing you to buy a home at or below that price level.
Choose Your Loan (or Cash!)
Well, it’s not that easy; there’s really no check box on the receipt indicating how you’d like to pay for your home that day. But you likely have more options than you think. A great agent and a reputable lender will both help you work out which is the best strategy for you to keep your finances safe and still make an attractive offer to the seller. Emotions run high. Don’t work with either an agent or a lender that allows you to make risky decisions with your money. You can’t take back a mortgage. (Come to think of it, it would be hard to take back the taco once you’ve eaten it, too.)
Now, most of us have heard of popular terms like “conventional loan” and “down payment” but it all swirls around in a jumble of words that mean “spend lots of money.” So let’s break it down to the four major ways to pay for your home:
Conventional Loans
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Widely considered the standard, this is what most people think of when considering a home loan. Loans are considered “conventional” if they’re backed by private lenders, not the government.
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They can ask for anywhere from 3-25% down payment; that’s a percentage of the total amount of the loan. So, if your loan is for $500,000, your down payment of 10% is $50,000. Usually, they’ll ask for closer to 10%-20% down. (You can save that amount! Yes, you can! Si se puede! I’d highly recommend talking to Maggie about how to do that… just a thought.)
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Your interest rate, set by larger market forces (look up “mortgage-backed securities” if you’re dying to know) is the percentage extra that you pay on the home loan (debt) that you’ve taken out. It’s just like paying interest on a credit card.
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Many will come with a 30-Year Fixed Term, but can be 10, 15, or 20 years, and interest rates do vary a bit between these terms. Shorter terms are considered riskier, often requiring more down and a higher interest rate paid on the loan.
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These generally require a good credit score* and a solid debt-to-income ratio of 43%**.
* What’s a good credit score? Many consider somewhere around 700-750 to be considered Good to Very Good. Anything above that is often considered Very Good to Excellent. I’m not a lender and different lenders consider different scores “Good” so make sure you connect with them. If you’re worried, you should absolutely talk to Maggie for tips on how to improve your credit score!
** What’s a solid debt-to-income ratio? It’s all your monthly debt payments divided by your gross monthly income. Your gross monthly income is the total amount of money you have earned before your taxes and other deductions are taken out. This number is a critical way lenders measure your ability to manage your mortgage payments and other debts. (Really, it’s time to talk to Maggie if this is also a concern for you.)
FHA Loans
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This is a mortgage loan insured by the Federal Housing Administration (FHA), which means it’s backed by the government.
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FHA Loans ask for as little as 3% down payment; that means on a $500,000 loan, your 3% down payment is $15,000. There aren’t technically any income limitations to qualify to put less down, but the way these loans are structured may ask you to put more down in certain zip codes. Talk to a lender!
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These loans require mortgage insurance***. These have can both be an upfront and monthly premium; that’s because these types of loans are riskier to the government. They’re smaller percentages and are added to your loan amount. You don’t pay those separately!
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Other great stuff about FHA loans: they are more flexible on your debt-to-income ratio, no penalties on lower credit scores below 740, allow for co-signers on the loan (to help your score look better), and allow gift funds for down payment.
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Before you ask for this loan, know this: there are various lender and loan restrictions, and the property you buy has to already be in excellent condition. That means The Man is looking to cut out any other risk besides loaning to you. These loans can also take more time to process.
*** What’s mortgage insurance? Your Up Front Monthly Insurance Premium could be 1.75% of your total loan amount, but the FHA will include it on top of your loan. That means you’re not paying that separately; it’ll just be added to your total loan and you’ll pay it over time in your mortgage. Your Monthly Insurance Premium is likely smaller and could be 0.85% (less than 1%) and is also included in your mortgage payment.
VA Loans
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This loan program is for members of the military, veterans, reservists and National Guard. It’s guaranteed by the Department of Veterans Affairs (VA). The program is very beneficial for those who are giving or have given service to their country. I salute you!
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These can ask for as little as 0% down payment (for qualified buyers), which are among the last available like this that aren’t considered “down payment assistance programs.” Even though they’re under 20% down, they don’t require Private Mortgage Insurance.
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Many times, borrowers with a VA Loan have no money due at closing.
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They’re also assumable, meaning if a seller with a VA Loan doesn’t finish paying their mortgage, a buyer with a VA Loan qualification can take it over for them. Which is awesome and nearly impossible to do with other loan products.
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They’ve got competitive interest rates, though they do charge a “funding fee” which is treated like a mortgage insurance payment – it’s rolled right into your mortgage. You’re not paying that separately.
Cash
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Did you know that 20% of all homes purchased in DC were paid for by cash in 2016? It can be hard to imagine, but some buyers can buy their homes in cash. Buyers with this type of money will simply provide “proof of funds” from their bank. That indicates to the seller that they could buy it in cash. A buyer can then get a mortgage after the deal closes.
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It’s no secret that having a cash offer is very favorable, but why is that? It’s because a cash offer is generally very “clean,” which means it can move very quickly and come with minimal (if any) contingencies. Does this mean that cash offers win all the time? Absolutely not, but they generally start with a leg up on the competition.
The loan isn’t the only thing you’re going to pay during the deal. There are also closing costs (fees to the lender, etc.) that can be anywhere from 3-5%. This doesn’t count for the case of wine you’ll likely buy as you go through this process. But it doesn’t have to be this stressful. Find yourself a crack team: the agent, the lender, the title company, and the home inspector. These people should be at the top of their game and have your interests in mind. They should try to protect you and teach you at every step. If you don’t have that now, talk to me! I’ll get you in the right spot.
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