You’re preparing to buy a home in Metro Detroit, Michigan. Maybe it’s in Novi. Or Northville. Or perhaps Ann Arbor or Birmingham. Wherever it is, few events in life are more exciting, particularly if it’s your first time. But whether it’s your first, your fifth or your 15th time, you need to take the correct preparatory steps to ensure you start the process on the right path. This pages lists the specific things you need to do to kick off your purchase process correctly:
- Select a lender
- Get pre-approved
- Determine how much you can afford
Once you complete these three steps, you will be well on your way to a fast, efficient and smooth purchasing experience!
1. Select a Lender
If we had to pick one topic in the world of real estate that is most consistently misunderstood, this would be it. Simply put, there is a LOT more to selecting a lender than just obtaining the lowest interest rate and or the lowest mortgage payment. As in most things in life, you “get what you pay for” in mortgages just like you do in most professional services. As in real estate, the sad reality is that there are MANY practitioners in lending that do not provide the level of service that we would expect of true professionals. Here is why you should select your lender very carefully:
- Because one of the most important things you can do to make your offer attractive to a seller is to be pre-approved by a reputable lender.
- Because next to the price you are offering, concerns over your financial wherewithal are paramount in both the eyes of the seller and the listing agent (offering a great price is somewhat meaningless if the seller or the listing agent are fearful of dealing with a “fly by night” lender).
- Because using a lesser lender may put you at a competitive disadvantage if you find yourself competing for a property against another prospective purchaser (and, even in a down market, this does occasionally happen on the better homes).
- Because we see many transactions made more difficult than necessary because of lender incompetence. In the last few months, we have seen the following instances of such ineptitude:
- A closing deferred at the very last minute because the lender’s funds did not arrive in time for the closing, AFTER the lender had repeatedly assured all parties involved that this would not happen that there would be “no problems”.
- A purchaser charged dramatically more for closing costs than the lender had disclosed on the government-mandated “Good Faith Estimate” that every lender is required to provide to every borrowing client (luckily, given our lack of confidence in this particular lender, we actually anticipated this occurrence and our client had extra funds with him at closing to cover this shortage).
- A lender that could not adequately summarize the mortgage-related costs for a client that needed to bring those funds to a closing that afternoon (we had to do this for the lender).
- Lenders that literally stopped returning phone calls from all parties to a transaction rather than report his inability to provide financing on the transaction in question.
- Lenders not being able to provide “final numbers” until literally the day of the actual closing (we see this one frequently; as a result, the already-stressful day of closing is made even MORE stressful, as you, the buyer, have to wait until the very last minute to obtain your funds for closing).
- Lenders actually changing the interest rate and not telling the borrower until the closing was in process.
- Lenders simply forgetting to do their jobs in a timely fashion, resulting in deferrals of otherwise routine transactions.
- A lender that could not be reached the day of a closing because he was at a professional golf tournament.
- A lender that jeopardized a transaction by interjecting its title company into a transaction at the last minute without the consent of the buyer, whom that lender was representing (this was particularly egregious, as the listing broker was so enraged that the entire transaction was nearly derailed)!
- “Mega” lenders that turn their clients over to their assistants after one interaction with a client (just as it is in real estate, this is one of the primary scourges of lending).
- There are no licensing requirements for individual lenders (there are for the companies themselves, but not for the individuals that originate the loans). Accordingly, there is virtually no barrier to entry. You or we could literally be selling loans tomorrow if we had the desire to do so. Given that mortgage origination can be very lucrative, there has been a huge influx of people into this industry in recent years. The end result is an overall degradation in the quality of service provided.
- A good lender is “invisible.” They go about their business behind the scenes, doing what needs to be done to ensure a smooth and satisfying experience for all involved in a given transaction. A bad lender can ruin an otherwise outstanding transaction.
- Because the most common end result of lender incompetency is a deferral of your closing, and this can put you in an “out-of-contract” situation that could be dangerous for you. What we mean by this is that virtually every real estate contract has various deadlines that are specifically negotiated between buyer and seller. The most important one is the deadline for actually closing the transaction. Usually, this deadline represents the approximate date at which the purchaser believes they can be in position to close. That decision is based first and foremost on when the lender says that can have final loan approval. If the lender does not provide that loan approval in a timely fashion as promised, this can put you in the awkward position of having to request that the seller agree to defer the closing. The seller is NOT required to grant this extension. Legally, the seller could literally void the transaction or, worse yet, declare a forfeiture and attempt to retain your deposit. While we admit that this is extremely unusual, we believe that it is never wise to tempt fate or take any unnecessary risk of this kind. By working with a solid, honest, reputable lender from the start, this will never be an issue to worry about.
- As a company, we’ve done literally THOUSANDS of transactions and have cumulative sales in excess of $.5 Billion. You’d think after all that experience, we would have an extensive list of lenders that we could recommend to our clients. Guess what? WE DON’T! We do have a list of lenders that we can recommend with confidence, but that list is very short. Much shorter than you would expect.
We hope this open your eyes a little to this very important matter. We truly do not care who you use as your lender. We would simply ask that you make a wise decision.
Types of Lenders
How Banks and Mortgage Brokers Differ
When you’re looking for a home loan, you might work with an officer at a bank or other lending institution, or you might choose to work with a mortgage broker. The end result is the same, but the two types of jobs differ as follows:
- Bank Loan Officers – The loan officers at a bank, credit union or other lending institution are employees who work to sell and process mortgages and other loans originated by their employer. They often have a wide variety of loan types to draw from, but all originate from that specific lender. The loan officer takes your application and works to find a loan product that suits your needs. If your personal credit is approved, the officer moves forward to process the home purchase transaction.
- Mortgage Brokers – Mortgage brokers are professionals who are paid a fee to bring together lenders and borrowers. They usually work with dozens or even hundreds of lenders, not as employees but as freelance agents. Think of mortgage brokers as scouts. They find and evaluate home buyers, analyzing each person’s credit situation to determine which lender is the best fit for that person’s needs. The broker submits the home buyer’s application to one or more lenders in order to sell it, and works with the chosen lender until the loan closes. A good mortgage broker can find a lender for just about any type of credit. The mortgage broker working to secure your loan is earning a fee for that transaction. Shop around to make sure the terms are reasonable. Many of the mortgages advertised online are by mortgage brokers.
What Difference Does it Make?
Maybe none, but you should be aware of the differences between the two positions. A local or online mortgage broker may find you a lender in another part of the country. An online bank might not have a local office where employees can help you one-on-one. Some out of town lenders don’t understand the types of heating systems used in specific areas, they aren’t familiar with private septic systems, and they don’t immediately understand common classifications and terms used by local appraisers. Those are just a few examples of problems we’ve seen that caused deferrals of loan approvals provided by an out of town lender. Using a local bank can sometimes be a plus. Their underwriters generally understand the specifics of local properties, but a geographically remote lender that doesn’t may delay their approval until questions are answered. Mortgage brokers can often find a lender who will make loans that a bank refuses. Problem credit is one example. Loans for unique or commercial properties might be easier to secure through a broker. There is no overall “best” solution, as every buyer’s financing needs are unique.
Obtain Your Credit Reports
Order your credit reports and scores from all three major credit reporting agencies. Personal copies of current reports should provide enough detail for a bank or mortgage broker to give you an opinion of the types of loans they can offer you. The lender you decide to use will review your credit files, but taking your personal copies to the initial interview avoids multiple credit report orders that can lower your scores (requesting your own credit reports does not affect your scores).
You can obtain your credit report by contacting one of these major credit bureaus.
Trans Union – 800.916.8800
Experian – 888.397.3742
Equifax – 800.685.1111
Shop Around
All loans are different. Fees and rates vary depending on the lender and you own financial situation. Look around. Find a lender that’s right for you. Ask friends and family for recommendations. Your Professional One Real Estate agent can also help you. Talk with a few lenders. Make sure you get all the information about what services they offer and the fees associated with them. You’ll also want to make sure you’re getting a decent interest rate, however don’t sacrifice a good rate for bad service and high fees. How’s your credit look? Double check your credit report. This report can weigh heavy on the approval of your loan. Make sure it is free of errors. It’s good to identify and fix any problems before you talk to lenders.
2. Get Pre-Approved
Once you’ve selected a reputable, quality lender from which to obtain your financing, the next step in the process is for you to obtain a “pre-approval letter” from that lender. Before we get to that, it is important to note that there is a big difference between “pre-qualification” and “pre-approval.” Most homeowners don’t understand that there is a difference, but the difference is dramatic and not realizing this could have a significant impact on the outcome of your home buying efforts. Here is a brief explanation of the two processes:
- “Pre-qualification” does not guarantee you a loan. It merely establishes how much you are capable of paying for a house, based upon what you tell a lender. Most lenders will provide a pre-qualification letter to almost literally anyone that calls them. Accordingly, sellers and listing agents view “pre-qualification” letters with a healthy degree of skepticism. As one very experienced agent stated it succinctly, “pre-qualification letters are not worth the paper they’re printed on”
- “Pre-approval,” on the other hand, is a much more exhaustive process in which a lender will inspect your credit and financial situation in detail. This process guarantees you a specific loan amount. It also determines the types of loans for which you may qualify, your interest rate, your monthly payment amount, etc.
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Why You Must Get Pre-Approved
- Because you need to understand your price range BEFORE you begin looking at houses. Simply put, you do NOT want to look at $400,000 homes if your upper price point is $350,000. Why? Because it is difficult to be content with a lower priced home if you’ve gotten used to homes beyond your financial reach.
- Because we will need to provide the pre-approval letter along with any offer that we submit on any property, so you need to have the letter in hand at the onset of the home search process. The pre-approval letter is viewed as an integral part of any offer, and sellers and listing agents expect us to provide this. The absence of such a letter will be perceived quite negatively, and imply a lack of preparedness on your part – and on ours.
- Because lenders can detect potential problems that might make obtaining a loan difficult. Credit report errors, high debt balances and an insufficient down payment may be corrected if discovered in a timely fashion. If credit problems are significant enough to keep you from obtaining conventional financing, it’s better to learn about it before you invest time in this emotional and often time-consuming process.
3. Determine How Much You Can Afford
How much can you really afford? The concise, classic answer to this question is as follows:
- Your monthly mortgage payment (including principal, interest, real estate taxes and homeowner’s insurance), should not exceed 28% of your gross monthly income
- Your total monthly debt (e.g., car loans, child support and alimony, student loans, condo association fees, etc.), INCLUDING your mortgage payment as per the prior point, should not exceed 36% of gross monthly income
Mortgage lenders look at your ability to repay the mortgage loan by reviewing:
- Your credit history
- Your monthly gross income
- How much cash you can accumulate for a down payment, which is usually 10% – 20% of the sale price
For details on checking your credit history, see Credit Basics from bankrate.com.
The following chart may help you ascertain your maximum monthly debt load based on your annual gross salary:
|
Gross Income
|
28% of Monthly
|
36% of Monthly
|
|
$50,000
|
$1,167
|
$1,500
|
|
$75,000
|
$1,750
|
$2,250
|
|
$100,000
|
$2,333
|
$3,000
|
|
$125,000
|
$2,917
|
$3,750
|
|
$150,000
|
$3,500
|
$3,500
|
It’s also important to note that the price you’ll pay for your next home isn’t just a mathematical computation. Assess your own lifestyle, deciding what amenities you’ll need (and which ones you can live without to cut costs) and how long you plan to live in the home.
If you’re planning to live in the house less than five years, it should be looked at as an investment. Accordingly, resale value is of paramount importance. Your Professional One Real Estate agent can help you assess the strengths and weaknesses from this, and every other, perspective that relates to helping you make your final home buying decision.
To determine your target purchase price you’ll need two figures:
- The down payment
- The mortgage amount
How much of a down payment can you afford?
Most home buyers underestimate the down payment they can make, much to their future detriment. Aside from money you’ve already saved to buy the house, you might be able to borrow from family members, or better yet, convert your “non-performing assets.”
What might those be? Don’t scoff at holding a yard sale, taking clothes and furniture to consignment shops, or selling appreciated works of art or other valuables that no longer interest you. In our consumer-oriented culture, most of us have more of this than we realize, and much of it has value. We know a number of people that have converted such items into nice little nest eggs since the advent of eBay.
Then there’s your pension and deferred compensation plans. An Individual Retirement Account can now be tapped for all of your contributions and up to $10,000 of earnings you’ve accumulated penalty-free for the down payment of a first home ($20,000 if you buy in Washington, D.C.). Or borrow from your 401(k) or 403(b) and pay yourself back. And if you’re only a small amount away from your goal, the credit card can come in handy.
The question as you consider these options is: should you take such drastic measures to make a high down payment? If the home is a bargain, just barely out of your reach, our answer is yes. Most young couples “under buy” and soon find themselves ready to move. Frequent moving is a huge financial strain. If you find a place that will serve you for a few decades, you’ll be a winner in the long run, even if you went “house-poor,” for a while.
With interest rates so low right now, you might want to consider the opposite belief. You can now qualify to buy a home valued at a higher price than you could have bought only two or three years ago. If you put yourself on a tight financial budget, you leave little room for savings, investments or even your own extracurricular enjoyment. Think about your lifestyle and if the home truly is worth the tradeoffs you’ll have to make.
Remember that the down payment is just the start of your costs.
Mortgage interest expenses, despite the tax deductibility aspects, cost a fortune. For every down payment dollar you make, you have a dollar less to finance. While a whopping 97 percent of new home buyers don’t put down 20%, it’s costing them all. If you make a 10% down payment or less, the lender will require private mortgage insurance (PMI), which adds about another $45 a month to your mortgage payment for every $100,000 borrowed. A down payment of 20% or more won’t require such insurance.
That has led some borrowers to seek out “piggyback loans,” in which they essentially take out a second loan for a shorter time period to avoid the insurance payments. An example might be an “80-10-10,” in which you borrow 80% of the required purchase from one lender and another 10% from a second lender. Meanwhile, you supply the remaining 10% in your down payment.
And remember that one-time closing fees may eat into your down payment, so you may need to stretch a bit no matter what.
How much of a mortgage can you afford?
You’re not the only arbiter of what you can spend for a home. Your lender uses a set mathematical formula. Lenders apply two calculations to judge how much you can afford to pay monthly and base their loan limit on the lesser of the two.
Together, the two percentages are known as the “28/36 Rule.” The 28% figure is simply your mortgage payment as a percentage of your household gross income. The 36% figure adds in your monthly debt payments (e.g. credit cards, auto loans, personal loans, etc.). Your lender will do both calculations and give you a mortgage based on the lower of the two results.
If you want a more expensive house, and therefore need a larger mortgage, take these steps before you apply: Pay off all of your debt so you can qualify for a larger loan and, if you can, increase your down payment. But keep in mind that lenders today will allow you to borrow far more than you can comfortably afford.
How can you buy a more expensive home?
Another way to buy a bigger house or one in a better neighborhood is to buy a house that needs some repairs. If you were born with a hammer in your hand and know how to pick a neighborhood, don’t pass up all the potential profit. Fix it up and refinance it since lenders typically are very conservative in how they value homes needing repairs. But the financial rewards can be high since the government now allows you to keep up to $500,000 in profit per couple from the sale of a home every two years.