If you're like most people, purchasing a home
is the biggest investment you'll ever make. If you're considering
buying a home, you're likely aware of the complexity
of the endeavor. Because of the numerous factors to
consider when purchasing a home, it's important to prepare as
best you can. Some common home-buying principles and caveats are
presented here for your consideration. By keeping them in mind,
you'll help create a successful and more enjoyable experience.
These Top Ten lists are by no means exhaustive. Since your
home could cost you 25 to 40 percent of your gross income,
it's important to conduct research, ask questions and study the
process carefully.
Buying a home
Looking for a home without being pre-approved.
As a potential buyer competing for a property, you'll have
a better chance of getting your offer accepted by being as prepared
as possible. Consider this hierarchy of preparedness:
Neither pre-qualified nor pre-approved
Pre-qualified
Pre-approved
The benefits available at each level can be easily understood
when viewed from the seller's perspective. Imagine you're a seller
in receipt of multiple offers to purchase your property. A complete
stranger (buyer) is asking you to take your property off the market
for at least the next two to three weeks while they apply for
a loan. As the seller, lets consider the type of buyer you'd prefer
to deal with.
Neither pre-qualified nor pre-approved
This buyer provides no evidence that they can
afford to purchase your property. You may wonder how serious they
are since they're not at least pre-qualified.
Pre-qualified
This buyer has met with a mortgage broker (or
lender) and discussed their situation. The buyer has informed
the broker regarding their income, expenses, assets and liabilities.
The broker may also have seen their credit report. The buyer provided
you with a letter from the broker stating an opinion of what the
buyer can afford.
Pre-approved
This buyer has provided a broker written
evidence of income, expenses, assets, liabilities and credit.
All information has been verified by a lender. As a result, much
of the paperwork for this buyer's loan has been completed. This
buyer will probably be able to close quickly. They provide you
with a letter (pre-approval certificate) from the lender. You're
as certain as possible that this buyer can close.
As a potential buyer, you can see that being pre-approved will
give you the best chance of getting your offer accepted. This
is critical in a competitive situation.
Making verbal agreements. If you're asked
to sign a document containing instructions contrary
to your verbal agreements--don't! For example, the seller
verbally agrees to include the washing machine in the sale, but
the written purchase contract excludes it. The written contract
will override the verbal contract. More importantly, your state
may require that contracts for the sale of real property be in
writing. Do not expect oral agreements to be enforceable.
Choosing a lender just because they have the
lowest rate. While the rate is important, consider the total
cost of your loan including the APR
, loan fees, discount and origination points. When receiving
a quote from a lender or broker, insist that the discount points
(charged by the lender to reduce the interest rate) be distinguished
from origination points (charged for services rendered in
originating the loan).
The cost of the mortgage, however, shouldn't be your only
criterion. Have confidence that the company you select is reputable
and will deliver the loan with the terms and costs they promised.
If in the final hours of the transaction you determine that
the lender has suddenly increased their profit margin at your
expense, you won't have time to start again with a different lender. Ask
family and friends for referrals. Interview prospective mortgage
companies.
Not receiving a Good Faith Estimate. Within
three business days after the broker or lender receives your loan
application, you must receive a written statement of fees associated
with the transaction. This is both the law and the best way to
determine what you'll pay for your loan. Bring the Good Faith
Estimate (GFE) with you when you sign loan documents. You should
not be expected to pay fees which are substantially different
from those contained in your GFE.
Not getting a rate lock in writing. When
a mortgage company tells you they have locked your rate, get a
written statement detailing the interest rate, the length
of the rate lock, and program details.
Using a dual agent--i.e., an agent who represents
the buyer and the seller in the same transaction. Buyers
and sellers have opposing interests. Sellers want to receive the
highest price, buyers want to pay the lowest price. In the standard
real estate transaction, the seller pays the real estate commission.
When an agent represents both buyer and seller, the agent can
tend to negotiate more vigorously on behalf of the seller. As
a buyer, you're better off having an agent representing you
exclusively. The only time you should consider a dual agent is
when you get a price break. In that case, proceed cautiously and
do your homework!
Buying a home without professional inspections.
Unless you're buying a new home with warranties on most equipment,
it's highly recommended that you get property, roof and termite
inspections. This way you'll know what you are buying. Inspection
reports are great negotiating tools when asking the seller to
make needed repairs. When a professional inspector recommends
that certain repairs be done, the seller is more likely to agree
to do them.
If the seller agrees to make repairs, have your inspector verify
that they are done prior to close of escrow. Do not assume that
everything was done as promised.
Not shopping for home insurance until you
are ready to close. Start shopping for insurance as soon as
you have an accepted offer. Many buyers wait until the last minute
to get insurance and do not have time to shop around.
Signing documents without reading them. Whenever
possible, review in advance the documents you'll be signing.
(Even though some specifics of your transaction may not be
known early in the transaction, the documents you'll
sign are standard forms and are available for review.) It's
unlikely that you'll have sufficient time to read all the
documents during the closing appointment.
Not allowing for delays in the transaction.
In a perfect world, all real estate transactions close on
time. In the world we live in, transactions are often delayed
a week or more. Suppose you asked your landlord to terminate your
lease the day your purchase transaction was scheduled to close.
A day or two before your scheduled closing date, you discover
your transaction is delayed a week. In a perfect world, no one
is inconvenienced and your landlord is willing to work with you.
More likely, however, your landlord is inconvenienced and angry.
Will you be thrown out? Will you have to find interim housing
for a week or more? The eviction process takes a little time,
so the Sheriff won't immediately remove you, but this type of
stress-producing episode can be avoided. How? Terminate your lease
one week after your real estate transaction is scheduled to close.
That way, if there is a delay in closing your transaction, you
have some leeway. This approach might cost a little more, then
again, it might not.
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Refinancing your home
Refinancing with your existing lender without
shopping around. Your existing lender may not have the best
rates and programs. There is a general misconception that it is
easier to work with your current lender. In most cases, your current
lender will require the same documentation as other companies.
This is because most loans are sold on the secondary market and
have to be approved independently. Even if you have made all your
mortgage payments on time, your existing lender will
still have to verify assets, liabilities, employment, etc.
all over again.
Not doing a break-even analysis. Determine
the total cost of the transaction, then calculate how much
you will save every month. Divide the total cost by the monthly
savings to find the number of months you will have to stay
in the property to break even. Example: if your transaction
costs $2000 and you save $50/month, you break even in 2000/50
= 40 months. In this case you'd refinance if you planned to stay
in your home for at least 40 months.
Note: This is a simplified break-even analysis. If
you are refinancing considering switching from an adjustable
to a fixed loan, or from a 30-year loan to a 15-year loan, the
analysis becomes much more complex.
Not getting a written good-faith estimate
of closing costs. See item number four above.
Paying for an appraisal when you think your
home value may be too low. Have the appraisal company
prepare a desk review appraisal (typically at no charge) to provide
you with a range of possible values. Your mortgage company's appraiser
may do this for you. Do not waste your money on a full appraisal
if you are doubtful about the value of your home.
Using the county tax-assessor's value as the
market value of your home. Mortgage companies do not
use the county tax-assessor's value to determine whether they
will make the loan. They use a market-value appraisal which may
be very different from the assessed value.
Signing your loan documents without reviewing them. See item number nine above.
Not providing documents to your mortgage company
in a timely manner. When your mortgage company asks
you for additional documents, provide them immediately. They
are doing what's necessary to get your loan approved and closed.
Delays in providing documents can result in a costly delays.
Not getting a rate lock in writing. When
a mortgage company tells you they have locked your rate, get a
written statement which includes the interest rate,
the length of the rate lock and details about the program.
Pulling cash out of your credit line before
you refinance your first mortgage. Many lenders have
cash-out seasoning requirements. This means that if you pull cash
out of your credit line for anything other than home improvements,
they will consider the refinance to be a cash-out transaction.
This usually results in stricter requirements and can, in some
cases, break the deal!
Getting a second mortgage before you refinance your first mortgage. Many
mortgage companies look at the combined loan amounts (i.e., the
first loan plus the second) when refinancing the first mortgage.
If you plan on refinancing your first loan, check with your mortgage
company to find out if getting a second will cause your refinance
transaction to be turned down.
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Not knowing if your loan has a pre-payment
penalty clause. If you are getting a "NO FEE" home-equity
loan, chances are there's a hefty pre-payment penalty included.
You'll want to avoid such a loan if you are planning to sell or
refinance in the next three to five years.
Getting too large a credit line. When you get too large
a credit line, you can be turned down for other loans because
some lenders calculate your payments based upon the available
credit--not the used credit. Even when your equity line has a
zero balance, having a large equity line indicates a large potential
payment, which can make it difficult to qualify for other
loans.
Not understanding the difference between an
equity loan and an equity line. An equity loan
is closed--i.e., you get all your money up front and make fixed
payments until it is paid if full. An equity line is open--i.e.,
you can get numerous advances for various amounts as you desire.
Most equity lines are accessed through a checkbook or a credit
card. For both equity loans and lines, you can only be charged
interest on the outstanding principal balance.
Use an equity loan when you need all the money up front--e.g.,
for home improvements, debt consolidation, etc. Use an equity
line when you have a periodic need for money, or need the money
for a future event--e.g., children's' college tuition in the future.
Not checking the life cap on your equity line.
Many credit lines have life caps of 18 percent. Be prepared
to make payments at the highest potential rate.
Getting a home-equity loan from your local
bank without shopping around. Many consumers get their
equity line from the bank with which they have their checking
account. By all means, consider your bank, but shop around before
making a commitment.
Not getting a good-faith estimate of closing
costs. See item number four above.
Assuming that your home-equity loan is fully
tax-deductible. In some instances, your home-equity loan
is NOT tax deductible. Do not depend on your mortgage company
for information regarding this matter--check with an accountant
or CPA.
Assuming that a home-equity loan is always
cheaper than a car loan or a credit card. Even after
deducting interest for income tax purposes, a credit card can
be cheaper than a credit line. To find out, compare the effective
rate of your home-equity line with the rate on your credit
card or auto loan.
Effective rate = rate * (1 - tax
bracket)
Example: The rate of the home-equity line is 12 percent, your
tax bracket is 30 percent, your effectiverateis: .12 * (1 - .3) = .12 * .7 = .084 = 8.4
percent.
If your credit card is higher than 8.4 percent, the equity loan
is cheaper.
Getting a home-equity line of credit when
you plan to refinance your first mortgage in the near future.
Many mortgage companies look at the combined loan amounts (i.e.,
the first loan plus the second) when refinancing the first
mortgage. If you plan on refinancing your first, check with your
mortgage company to find out if getting a second will cause your
refinance to be turned down.
Getting a home-equity line to pay off your
credit cards when your spending is out of control! When
you pay off your credit cards with an equity line, don't continue
to abuse your credit cards. If you can't manage the plastic,
tear it up!
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Should
I refinance?
The most common reason for refinancing is to
save money. Saving money through refinancing can be achieved
in two ways:
By obtaining a lower interest rate that causes
one's monthly mortgage payment to be reduced.
By reducing the term of the loan, thus saving
money over the life of the loan. For example, refinancing from
a 30-year loan to a 15-year loan might result in higher monthly
payments, but the total of the payments made during the life of
the loan can be reduced significantly.
People also refinance to convert their adjustable
loan to a fixed loan. The main reason behind this type of
refinance is to obtain the stability and the security of a fixed
loan. Fixed loans are very popular when interest rates are low,
whereas adjustable loans tend to be more popular when rates are
higher. When rates are low, homeowners refinance to lock in low
rates. When rates are high, homeowners prefer adjustable loans
to obtain lower payments.
A third reason why homeowners refinance is to
consolidate debts and replace high-interest loans with a low-rate
mortgage. The loans being consolidated may include second mortgages,
credit lines, student loans, credit cards, etc. In many cases,
debt consolidation results in tax savings, since consumers loans
are not tax deductible, while a mortgage loan is tax deductible.
The answer to the question "Should I refinance?"
is a complex one, since every situation is different and no two
homeowners are in the exact same situation. Even the conventional
wisdom of refinancing only when you can save 2% on your mortgage
is not really true. If you are refinancing to save money on your
monthly payments, the following calculation is more appropriate
than the rule of 2%:
Calculate the total cost of the refinance––example: $2,000
Calculate the monthly savings––example: $100/month
Divide the result in 1 by the result in 2––in
this case 2000/100 = 20 months. This shows the break-even time.
If you plan to live in the house for longer than this period of
time, it makes sense to refinance.
Sometimes, you do not have a choice––you
are forced to refinance. This happens when you have a loan with
a balloon provision, but with no conversion option. In this case
it is best to refinance a few months before the balloon comes
due.
Whatever you choose to do, consulting with a
seasoned mortgage professional can often save you time and money.
Make a few phone calls, check out a few web sites, crunch on a
few calculators and spend some time to understand the options
available to you.
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Should I pay points? Does a zero-point/zero-fee loan really exist?
The best way to decide whether you should pay
points or not is to perform a break-even analysis. This is done
as follows:
Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000.
Calculate the monthly savings on the loan as
a result of obtaining a lower interest rate. Example: $50 per
month
Divide the cost of the points by the monthly
savings to come up with the number of months to break even. In
the above example, this number is 40 months. If you plan to keep
the house for longer than the break-even number of months, then
it makes sense to pay points; otherwise it does not.
The above calculation does not take into account
the tax advantages of points. When you are buying a house the
points you pay are tax-deductible, so you realize some savings
immediately. On the other hand, when you get a lower payment,
your tax deduction reduces! This makes it a little difficult to
calculate the break-even time taking taxes into account. In the
case of a purchase, taxes definitely reduce the break-even time.
However, in the case of a refinance, the points are NOT tax-deductible,
but have to be amortized over the life of the loan. This results
in few tax benefits or none at all, so there is little or no effect
on the time to break even.
If none of the above makes sense, use this simple
rule of thumb: If you plan to stay in the house for less than
3 years, do not pay points. If you plan to stay in the house for
more than 5 years, pay 1 to 2 points. If you plan to stay in the
house for between 3 and 5 years, it does not make a significant
difference whether you pay points or not!
Zero-Point/Zero-Fee Loans
Whatever happened to the conventional
wisdom of waiting for the rates to drop 2% before refinancing?
You have a 30-year fixed loan at 8.5%. A loan
officer calls you up and says they can refinance you to a rate
of 8.0% with no points and no fees whatsoever.
What a dream come true! No appraisal fees, no
title fees and not even any junk fees! Is this a deal too good
to pass up? How can a bank and broker do this? Doesn't someone
have to pay? Whose money is being used to pay these closing costs?
No––this is not a scam. Thousands
of homeowners have refinanced using a zero-point/zero-fee loan.
Some refinanced multiple times, riding rates all the way down
the curve in 1992, 1993 and, more recently, in 1996. Some homeowners
used zero-point/zero-fee adjustable loans to refinance and get
a new teaser rate every year.
The way this works is based on rebate pricing,
sometimes also known as yield-spread pricing, and sometimes known
as a service-release premium. The basic idea is that you pay a
higher rate in exchange for cash up front, which is then used
to pay the closing costs. You will pay a higher monthly payment––so
the money is really coming from future payments that you will
make.
You can also think of this as negative points!
For example, a 30-year fixed loan may be available at a retail
price of :
8.0% with 2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points
On a $200,000 loan, the loan officer can offer
you 8.75% with a cost of -1 point, which is a $2,000 credit towards
your closing costs. A mortgage broker can use rebate pricing to
pay for your closing costs and keep the balance of the rebate
as profit.
What are the benefits of a zero-point/zero-fee loan?
The main benefit is that you have no out-of-pocket
costs. As a result, if the rates drop in the future, you could
refinance again even for a small drop in rates. So if you refinanced
on the zero-point/zero-fee loan to get a rate of 8.75% and if
the rates drop 1/2%, you can refinance again to 8.25%. On the
other hand, if you refinanced by paying 1 point and got a rate
of 8.25%, it may not make sense to refinance again. Now, if the
rates drop another 1/2%, a zero-point/zero-fee loan can drop your
rate to 7.75%, whereas if you paid points, you may have to do
a break-even analysis to decide if refinancing will save you money.
The zero-point/zero-fee loan eliminates the need
to do a break-even analysis since there is no up-front expense
that needs to be recovered. It also is a great way to take advantage
of falling rates.
Some consumers have used zero-point/zero-fee
loans on adjustable loans to refinance their adjustables every
year and pay a very low teaser rate.
What are the disadvantages of a zero-point/zero-fee loan?
The main disadvantage is that you are paying
a higher rate than you would be paying if you had paid points
and closing costs. If you keep the loan for long enough, you will
pay more––since you have higher mortgage payments.
In the scenario where you plan to stay in the house for more than
5 years, and if rates never drop for you to refinance, you could
wind up paying more money. If, on the other hand, you plan to
stay at a property for just 2-3 years, there really is no disadvantage
of a zero-point/zero-fee loan.
Whose money is it?
Since you are being paid "cash" up-front in exchange
for a higher rate, it really is your own money that will be paid
in the future through higher payments. Investors who fund these
loans hope that you will keep the loans for long enough to recoup
their up-front investment. If you refinance the loans early, both
the servicer and the investor could lose money.
To summarize, zero-point/zero-fee loans in many
cases are good deals. Make sure, however, that the lender pays
for your closing costs from rebate points and NOT by increasing
your loan amount. So if your old loan amount was $150,000, your
new loan amount should also be $150,000. You may have to come
up with some money at closing for recurring costs (taxes, insurance,
and interest), but you would have to pay for these whether you
refinanced or not.
Zero-point/zero-fee loans are especially attractive
when rates are declining or when you plan to sell your house in
less than 2-3 years.
Zero-point/zero-fee loans may not be around forever.
Lenders have discussed adding a pre-payment penalty to such loans,
however few lenders have taken steps to implement such a measure.
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What is a FICO score?
A FICO score is a credit score developed by Fair
Isaac & Co. Credit scoring is a method of determining the likelihood
that credit users will pay their bills. Fair, Isaac began its
pioneering work with credit scoring in the late 1950s and, since
then, scoring has become widely accepted by lenders as a reliable
means of credit evaluation. A credit score attempts to condense
a borrowers credit history into a single number. Fair, Isaac &
Co. and the credit bureaus do not reveal how these scores are
computed. The Federal Trade Commission has ruled this to be acceptable.
Credit scores are calculated by using scoring
models and mathematical tables that assign points for different
pieces of information which best predict future credit performance.
Developing these models involves studying how thousands, even
millions, of people have used credit. Score-model developers find
predictive factors in the data that have proven to indicate future
credit performance. Models can be developed from different sources
of data. Credit-bureau models are developed from information in
consumer credit-bureau reports.
Credit scores analyze a borrower's credit history considering numerous factors such as:
Late payments
The amount of time credit has been established
The amount of credit used versus the amount of credit available
Length of time at present residence
Employment history
Negative credit information such as bankruptcies, charge-offs, collections, etc.
There are really three FICO scores computed by
data provided by each of the three bureaus––Experian,
Trans Union and Equifax. Some lenders use one of these three scores,
while other lenders may use the middle score.
Frequently Asked Questions (FAQs)
How can I increase my score? While it
is difficult to increase your score over the short run, here are
some tips to increase your score over a period of time.
Pay your bills on time. Late payments and collections
can have a serious impact on your score.
Do not apply for credit frequently. Having a
large number of inquiries on your credit report can worsen your
score.
Reduce your credit-card balances. If you are
"maxed" out on your credit cards, this will affect your credit
score negatively.
If you have limited credit, obtain additional
credit. Not having sufficient credit can negatively impact your
score.
What if there is an error on my credit report?
If you see an error on your report, report it to the credit bureau.
The three major bureaus in the U.S., Equifax (1-800-685-1111),
Trans Union (1-800-916-8800) and Experian (1-888-397-3742) all
have procedures for correcting information promptly. Alternatively,
your mortgage company may help you correct this problem as well.
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What is the difference
between pre-qualifying and pre-approval?
A pre-qualification is normally issued by a loan
officer, who, after interviewing you, determines the dollar value
of a loan you can be approved for. However, loan officers do not
make the final approval, so a pre-qualification is not a commitment
to lend. After the loan officer determines that you pre-qualify,
he/she then issues you a pre-qualification letter. This pre-qualification
letter is used when you are making an offer on a property. The
pre-qualification letter indicates to the seller that you are
qualified to purchase the house you are making an offer on.
Pre-approval is a step above pre-qualification.
Pre-approval involves verifying your credit, down payment, employment
history, etc. Your loan application is submitted to an underwriter
and a decision is made regarding your loan application. If your
loan is pre-approved, you are then issued a pre-approval certificate.
Getting your loan pre-approved allows you to close very quickly
when you do find a house. A pre-approval can help you negotiate
a better price with the seller, since being pre-approved is very
close to having cash in the bank to pay for the house!
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