You’re fed up with renting, want to upsize your home to accommodate a growing family, relocating for a new job, downsizing or are planning for your final retirement home. These are all great reasons to consider a new construction.
You might be worried. Can I qualify for a home loan? Many first time home buyers give up before even trying. The truth is, there are many types of mortgages, grants and down payment assistance programs available. Even if you are facing financial challenges, a mortgage broker or loan officer can help you determine which home buying loan program is right for you.
PREPARING FOR A NEW HOME LOAN
YOUR FINANCIAL SITUATION
One of the best things you can do to prepare for the home buying process is to check your credit rating. The three major credit bureaus: Equifax, Experian, and TransUnion will typically provide your overall credit score. You’ll want to clear up any errors that may appear on those reports as soon as possible. You should also consider consolidating any debt you may have. The goal is to have your total debt less than 38% of your total income. Your credit score is an important factor in determining how much you are qualified to borrow, so make sure you do your homework and find out where you stand.
Mortgage lenders prefer to lend to borrowers who have worked for the same employer for at least two years. For first-time buyers, this can often be a problem: Many first-timers are young professionals who are still building their careers and may have to move from job to job at a quick pace. Fortunately, most mortgage lenders are flexible on the employment issue. Many will overlook a short job history if borrowers can show that they still have a steady source of income that is high enough to cover their mortgage loan payments comfortably.
Being self-employed is a much more complicated. You will be required to show evidence of continued ability to earn income for a sustained period and be able to continue to make and build those earnings in the future. Lenders will scrutinize every facet of your business and if you are in good standing with the IRS.
LESS THAN PERFECT CREDIT?
Good credit is ideal, but we all know that unfortunately in this market many of us don’t fall into that category. The good news is that there are many types of mortgages for those with not-so-perfect credit, and chances are you may still be able to qualify for home financing.
Before you begin to look for a home, your first step must be to get preapproved. The preapproval will give you the confidence to look for a new home, know how much you qualify to borrow and better understand your different home financing options. Having a preapproval will alleviate much of your stress. Now you need to choose. Who will get you preapproved?
MORTGAGE BROKER OR LOAN OFFICER?
Typically a large production builder will have a preferred lender. They will often offer an incentive to use their bank. But, will that motivation lead to the best mortgage terms for you? You may find that getting your lender, may offer better terms than the incentives afforded by the builder.
Finding and choosing a qualified and competent Mortgage Broker or Loan Officer is important, especially for a first-time mortgage. A Mortgage Broker is an independent licensed agent that works to find the best lending terms and rates within an assortment of lenders that best fit your risk factor. Your risk factor determines your credit score, income, and many other factors. The Broker will be paid by the lender you choose. A Loan Officer works for a bank or company that directly provides mortgage funding. Whoever you decide to work with will come to know a lot about you, and will be involved in one of the biggest decisions you will ever make. It’s important that they are trustworthy, make themselves available to answer your question and are knowledgeable on all the different loan products available.
Be ready to provide documentation for all of your finances, including proof of income (paystubs), copies of W-2s, and copies of asset information. Your lender will help you prepare, so you’ll be confident about your decision to buy a new home and relieve any fears about the process. You will be educated on the different type mortgages available and go through the preapproval and final approval process.
Buying a home for the first time can prove to be a challenging task. First-time buyers often don’t know the meaning of real estate and mortgage terms. The amount of paperwork needed to close a mortgage loan sometimes overwhelms them. And the sum of money they need to put together to purchase a home can be intimidating. First-time buyers, though, can make the process less stressful by understanding and recognize some of the more common challenges that novice home purchasers face.
WHAT TYPE OF LOAN IS BEST FOR YOU?
There are several types of loans available to buyers, such as fixed-rate mortgage, adjustable rate mortgage (ARM), FHA mortgage, and Veteran’s Affair (VA) mortgage.
A Fixed-Rate Mortgage is a mortgage where the rate of interest is fixed for the duration of the loan. These loans come in 10-, 15-, 20-, and 30-year durations. The shorter the length of the loan, the higher your payment will be, but the time to pay off the loan will be shorter, and the amount of interest paid will be less.
An ARM is a mortgage where the interest rate adjusts throughout the loan period. People tend to want these types of credit when they want a lower payment now and do not care if the amount goes up later because they will have a higher income to pay for the loan. With this type of loan, you could afford to buy a higher priced home now instead of later. But, beware because the interest rate could jump as much as 2 percent in a given year depending on the stipulations of the loan and economic conditions.
An FHA Mortgage is not a credit but a program sponsored by the federal government to encourage homeownership. The FHA will provide assurances of payment on your behalf to lenders that would otherwise not approve you. Meaning that if you do not pay the loan, FHA will step in and pay it to the creditor, but in turn, they will take your house from you. When you have an FHA loan, you need to pay PMI as part of your monthly payment because it is usually less than 80 percent LTV. That is how the FHA will cover the lender in the event you default on the loan. The cost of PMI will vary with the outstanding loan amount each year and is only payable until the loan reaches 80 percent of value. In some cases with an FHA loan, your down payment can be a little as 3 percent of the price of the home. You do have to apply to the government, and there are usually some income restrictions.
A VA mortgage is a loan given to any person and eligible spouses who have ever served in the military. Private lenders provide VA Home Loans. VA guarantees a portion of the loan, enabling the lender to provide you more favorable terms (http://www.benefits.va.gov/homeloans).
COSTS ASSOCIATED WITH YOUR PURCHASE
Buying a new home requires a few different up-front costs. Be prepared for what you will spend on a new home by understanding why and when you’ll need to have cash ready:
Earnest Money: Money you put up front to show that you’re serious about purchasing.
Down Payment: Money that’s paid toward the total of the home’s price, usually 5-20%, but you can get it as low as 3% if you qualify for certain types of mortgages. Saving money is a top priority for a home buyer. Saving as much as you can or having equity in your current home will ensure a substantial down payment and the potential to lower your interest rate and monthly payment. Almost all home loans require a down payment somewhere between 3% and 20% of your home’s purchase price. The down payment is typically the largest cost of your home purchase, especially for buyers looking for a first time mortgage. Providing this much cash must be taken seriously, and you need to start saving if you’re going to buy the home you want.
HOW MUCH SHOULD YOU PUT DOWN?
The amount of money to put down depends on your particular situation and loan you choose. Some loans require that you pay a higher down payment than others. For example, you can get a Federal Housing Administration (FHA) loan for 3–4 percent down, while a conventional loan usually requires a minimum of 20 percent down. A couple of things to keep in mind is; if your loan-to-value (LTV) is less than 80 percent, you will be required to pay “private mortgage insurance (PMI)” as part of your monthly payment until the Loan to Value (LTV) reaches 80 percent. My recommendation is that if you have the money available for a down payment, use it to avoid paying interest in the long run and avoid paying the PMI.
Another option is to get two loans, a conventional loan for 80 percent of the price which will be long term, and a shorter term loan which will be your 20 percent down payment. This option is recommended if you are waiting for money from the sale of another home or another asset.
Gift monies can also be used to purchase a home. If you are planning a wedding, it is not uncommon to find wedding registries that include cash gifts to help you plan for a home purchase.
If you are currently a homeowner and are selling your home, the equity or net sale from your home sale can provide the required down payment or more.
Closing Cost: Expenses associated with a home loan, such as processing fees charged by the Lender, Title Company, the local government and anyone else involved with the home sale. The lender is required to provide you with a “Good Faith Estimate” (GFE) which gives you an estimate of all the closing cost fees ahead of time.
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Alternative Ways to Finance Custom Built Homes
If you choose to go with a custom home construction, financing gets much more challenging. Typically a custom home builder is smaller, and the financing must be procured by you the buyer. There are custom builders that have a cooperative arrangement with a lender. If you have to go it alone, this is what you can expect.
A New Custom Home Construction Can Get Financed in Three Ways.
- The builder finances construction, and when the house is complete the buyer obtains a permanent mortgage.
- The customer gets a construction loan for the period of construction, followed by a standing loan from another lender, which pays off the construction loan.
- The client obtains a single combination loan, where the construction loan becomes permanent at the end of the construction period.
Builder financing is the simplest approach with significant advantages to the buyer, including not having to worry about the builder’s financial capacity or the complexities involved in the alternatives discussed below.
Separate Construction Loans and Permanent Mortgages
The obvious downside of two loans is that the buyer shops twice, for very different instruments, and incurs two sets of closing costs.
Construction loans usually run for six months to a year and carry an adjustable interest rate that resets monthly or quarterly. The margin will be well above that on a permanent ARM. In addition to points and closing costs, lenders charge a construction fee to cover their costs in administering the loan. (Construction lenders pay out the loan in stages and must monitor the progress of construction). In shopping construction loans, one must take account of all of these dimensions of the “price.”
Some lenders (primarily commercial banks) will only make construction loans. Others will only make combination loans. And some will do it either way.
Note: Interest on construction loans is deductible as soon as construction begins, for a period up to 24 months, provided that at the end of the period you occupy the house as your residence.
The permanent loan is no different from that required by the purchaser of an existing home, or by the buyer of a new house on which the builder financed construction. Indeed, the advantage of the two-loan approach about the combination loan discussed below is that the purchaser retains freedom of action to shop for the best terms available on the permanent mortgage.
Combination Construction/Permanent Mortgages
The major talking point of the combination loan is that the buyer only has to shop once, and has to pay only one set of closing costs. The danger, however, is that the buyer will overpay for the permanent mortgage because the arrangement has limited his options.
Lenders offering combination loans typically will credit some of the fees paid for the construction loan toward the permanent loan. The bank might charge 4 points for the building loan, for example, but apply 3 of the points toward the permanent loan. If the borrower takes the permanent loan from another lender, however, the construction lender retains the 3 points. It ‘s hard to compare combination loans with the two-loan alternative.
For example, suppose the buyer wants to compare the cost of the construction loan offered by the combination lender cited above with an independent construction loan offer at the same rate plus 2 points. The buyer can get the construction loan for 1 point provided he also takes the permanent loan, or for 2 points while retaining his freedom of action to shop for the best deal on a permanent loan. Which is the better deal depends on how the combination lender prices the permanent loan with the competition.
This is not easy to determine. While you can compare current price quotes on permanent loans by the combination lender with quotes from other lenders, these don’t mean much. The actual price is set after the house is complete, and at that point, the combination bank has an incentive to overcharge. In my example, he can over-charge by up to 3 points, because that is the amount he retains if the buyer goes elsewhere.
You should not take a combination loan unless A) the current combination price quote is at least as good as the best quotes from separate construction and permanent loan lenders. B) the combination bank is willing to index the price of the permanent loan so that you know exactly how it will be when the time comes.
If the combination bank insists that you will get the market price, it is time to bail out and go with two loans.