How Much Home Can You Afford?

Prequalification vs. PreApproval

Prequalification and preapproval are two important real estate finance terms. Unfortunately, these terms often get confused. The difference is important as it describes a lender’s actual level of commitment to a home buyer. Interchanging these terms can create problems during the home buying process.

Prequalification Explained

Think of Prequalification as the initial first steps in The Steps to Buying a House. At the mortgage prequalification stage, you are trying to find out if you can get a loan to buy a house.

To do this, the lender needs to answer these three questions:

1. How does your credit look?
2. How much house can you afford?
3. What type of loan will you be using?

Credit will be the primary factor that determines which type of loan you can get and if you can get a loan at all.

The lender will start by pulling your credit report. The lender wants to see a score of 620 or higher for a conventional loan. Even with a 620 credit score, you’ll be paying a higher interest rate on a conventional loan. 770 is where the conventional loans interest rates start to look good.

Additionally, a conventional loan will in most cases require a larger down payment. This is why FHA loans are so popular. With a 620 credit score on an FHA loan, the borrower will see a lower interest rate while putting less money down.

Loan Limits

The downside to an FHA loan is they have limits. These limits are different for different MSA’a (metropolitan statistical areas) or Counties. Your lender and Realtor will know your upper loan limits.

The next limiting factor of an FHA loan is going to be property type. Not all Common Interest Communities, usually Condo and Townhome developments are FHA approved. So, if you are looking in a Common Interest Community, it’s important to make sure the community is on the FHA approved list. This is something your Realtor and/or lender will help with. The point is this, each loan has different limitations and requirements. The time to learn about these limitations is during the prequalification process.

When you finish getting prequalified, you should walk away knowing the following:

• What type of loan are you going to get? Conventional, FHA or VA.
• How much cash, if any will you need to put down.
• What’s the plan for paying closing costs.
• Any limitations on the type of property you can buy.

At this point it’s safe to start looking at houses. We like to see buyers move towards pre-approval at this point. Here’s why, when a home seller accepts an offer on their home, they’re actually taking the house off the market. If the loan does not end up getting approved, the sale will not close. Many home sellers get emotional about this and try to keep earnest money. If the Buyer’s Agent did their job, the earnest money will come back to the buyer but after a lot of stress and drama. The best practice is to move forward with Preapproval.

Preapproval

Pre-approval involves a full blown loan application. At this point the lender will:

• Take the application
• Request supporting documentation
• Begin the process of verifying all that data.

The lender has to make sure the loan file complies with the guidelines of the entity that will buy the loan. This would be a company like Fannie Mae, Freddie Mac or Ginnie Mae. Lenders sell their loans, thereby recouping money to re-lend. If the loan doesn’t comply, the auditor will send the loan back to the lender. This ends up decreasing the capital they ultimately have to lend.

Application Checklist

To complete the application, you will need the following:

✓ W2 from the past two years

✓ Pay stub for the past month

✓ Tax returns from the past two years

✓ Checking or savings bank statements for the past three months (this will likely have your down payment funds in them as well)

✓ Statements for all your other assets (stocks, bonds, retirement accounts) for the last two months

✓ Name and phone number of your landlord (if you are renting) or your current mortgage documents

✓ Divorce decree, if applicable

✓ For the self-employed: Your business tax returns for the past two years in addition to your year-to-date profit and loss statement and year-to-date balance sheet

✓ Credit Report and Credit Score

Pre-approval is the lender’s commitment that you qualify for a particular loan type and amount based on your income and credit.

If everything looks good, the lender will generate a pre-approval letter and a “Good Faith Estimate of Settlement Costs”. These are important documents to have when shopping for a home as they prove to both sellers and their agents that you have the means to buy their house. These documents are generally good for 60 to 90 days.

The approval letter is a letter from the lender stating that based on the information they have, you qualify for a loan. This letter also gives the amount of the loan you qualify for.

A good faith estimate is a standard form that outlines and discloses the fees associated with your loan. Lenders are required to provide this document, you can read more about it here: Good Faith Estimate

At this point, you are “pre-approved”. The lender waits for us to send them a contract for a particular property. At that point, they start to work on getting a full loan commitment. Full Loan Committmitment Requires:

• Contract on Property
• Appraisal on the property
• In some cases, the Inspection Report
• Updated paycheck stubs for the months before closing.
• Bank statements for the months before closing.

Pre-approval is the lender’s way of saying they are willing to loan this person X amount of money. It now depends on the house they want to buy. The appraisal, and in some cases the inspection report of the property, will determine if the lender is able to make a full loan commitment to the buyer. In other words, are they loaning on a good investment? If the buyer defaults and the lender has to take the property back, will the lender be able to resell it for the amount they loaned on it?

No matter what type of market, it’s always wise to start the home buying process with prequalification and preapproval. This path gives you, the buyer, more leverage.

Here are some really helpful articles from other Real Estate Professionals that discuss the importance of the loan process:

Luke Skar–What is a Mortgage Pre-Approval Vs Pre-Qualification?

Paul Sian–Why Every Home Buyer Needs A Mortgage Pre-Approval

Bill Gassett–Difference Between Mortgage Pre-approval vs Pre-qualification Letter

“By failing to prepare, you are preparing to fail.” ― Benjamin Franklin

Preparation is an essential element in any successful real estate transaction, especially when the unexpected happens, and it will. Loan problems constitute a good portion of what can go wrong in a typical real estate transaction. Loan qualification standards are complex and change often, so it’s good to have your financing in place as early as possible.

The first step on the road to buying a home is pre-qualification. This can be done in person, on-line or over the phone. Our preference is in person. Just as the lender is pre-qualifying you, you should be assessing whether or not you want to work with the lender. In the pre-qualification meeting, you will share some basic information with the potential lender about your overall financial picture, including your debt, income, assets and credit. After evaluating this information, a lender can give you an idea of the mortgage type and amount for which you might qualify.

Pre-qualification vs. Pre-approval

It is important to note that pre-qualification is different than loan pre-approval, a more involved process we will discuss in a future article. Pre-qualification is a good initial step that determines if you are going to be able to get a loan. It’s primary value is in preventing everyone from wasting time looking at houses they can’t buy.

Another benefit of pre-qualification is that it shows sellers that you are serious and in a strong financial position. So, in the event you find a house and there are competing offers, the stronger financial position usually wins.

As far as locating a lender is concerned, you can get suggestions and lender names from your Realtor. Realtors deal with different lenders on a daily basis and they know the good from the bad, so in many ways they are your best resource when it comes to finding a good lender. If you don’t trust your Realtor to act in your best interest, you should not be working with them.

Here is a list of what information you will need to give to the lender to get pre-qualified:

• • • Gross Monthly Income
    • Monthly Debt
    • Assets
    • Social Security Number (to pull credit)

Once you determine that you will work with the lender and decide to move towards the loan approval stage, you will be asked for additional financial information such as bank statements, tax returns, etc. to begin the loan process.

Video on Home Loan Prequalification

Interested in finding out your Mortgage Payment Amount? Try out our Mortgage Calculator.

You might be getting a mortgage for your new home, but did you know?  There are fees that you, the buyer, must pay prior to that new mortgage and prior to closing on your new home.  Buyers often ask “what money will I need up-front for this purchase?”  Here is what I tell them:

EARNEST MONEY

When you write a purchase contract for a home, there is deposit money usually required.  This is known as earnest money.  It tells the seller of the transaction that you are serious about this purchase and are willing to put some money at risk to secure it.  Think of it as a security deposit when you rent a home.  You make this deposit at the beginning of your lease, and typically you get that back when the lease ends.  Earnest money acts much the same way.  You make this deposit at the beginning of your purchase contract, and you typically get that back when you close.  The amount of earnest money usually depends on the price of the home.  While there is no set standard or amount for earnest money, we typically see it at about 1% of the purchase price.  Example…if you’re buying a $300,000 home your earnest money deposit could be around $3,000.   But sometimes that amount can be negotiated.

HOME INSPECTION FEES

Once you are under contract for a particular property, you will probably get a home inspection done.   A home inspection allows the buyer to inspect the condition of the property they are buying.  Since the buyer benefits from this inspection, the buyer gets to pay for the cost of it.  A home inspection usually runs $300-400 depending on the age and size of the home. There are additional options for inspection which can add to that cost.  For example, if you choose to get a Radon test during the inspection you will probably pay an additional $130 for that.   Inspection fees are paid at the time of service.

APPRAISAL

Once you are past the inspection phase, your lender will order a home appraisal to ensure your purchase price is at market value.  Lenders usually collect the appraisal money up-front from you, the buyer.   Typically the cost of an appraisal can run anywhere from $450-$675 depending on the type of financing you are getting.  Government appraisals, for example, usually cost more than conventional loan appraisals.  Why?  Because government loan appraisals are a bit more involved. (I’d like to make a joke here but I should probably leave politics out!)

MISCELLANEOUS COSTS

1. SLEEP   –   If you are normal, purchasing a home will probably cost you some sleep.  Most buyers tell me they wake up in the night anxious about their big purchase or excited to move in and decorate. So plan to lose some sleep while under contract.  You may find yourself wide awake in bed imagining where your furniture and wall hangings will go in your new home!

2. COUNSELING   –  Buying a home can be quite stressful.   Your emotions will be heightened.  I’ve even seen people argue or cry during this process.  You may end up in the self-help section of your local bookstore or on the couch telling a counselor about your home buying ordeal.

3. SPLURGES FOR THE NEW HOME   –   No matter who you are, whether you’ve owned a home prior or not, you will at some point find yourself purchasing shower curtains or paint or supplies for your new house.  Call it the nesting instinct.  We all do it.  When you buy a new home you buy some new stuff, too.

YOUR DAY OF CLOSING

On this wonderful, much anticipated day you finally get the keys to your new home.  All those up-front costs are a thing of the past, and you will now enjoy the rewards of home ownership.   You may look back on your purchase and think “this was a lot to go through.”    But hopefully, you can say like many of my clients have…”this was fun!”   If you have a good realtor/lender/inspector/team in your corner the process can and should be quite fun.

Qualifying for a mortgage can be one of the more frustrating aspects of the steps to buying a house, even if you have great credit. On the other hand, if you have bad credit or damaged credit, getting a loan will be even more difficult, but not impossible.

Bad Credit, Bankruptcy, Short Sale and Foreclosure don’t mean you’ll never be able to buy a house; they are merely setbacks that you can overcome. Armed with a little knowledge and a bit of patience, you can navigate the mortgage application and approval process, even with less than perfect credit.

Buying a House with Bad Credit

Bad credit or the idea that you have bad credit is the most common reason people don’t buy homes. It’s becoming increasingly difficult to even rent a home with bad credit. So, if you want more control over where you and your family live, repairing bad credit needs to be a priority.

If you’re looking to buy a home with bad credit and can’t wait to repair your credit, there are certainly private lenders out there that will make those loans. “Private Money Lenders” act like banks and much like a bank will require insurance on the property as well as their name on the deed. Of course, these loans have much higher interest rates and shorter terms than traditional loans because the risk is much higher. You the borrower will be paying a premium for this risk. Evidence that these investments are lucrative is the fact that there are even private money lenders that will loan with no credit check or loan amortization.

If you choose to pursue this method of financing, make sure you look at things like better business bureau ratings and online reviews. In the long run, you’re much better off repairing your credit before buying a house.

The idea is to get you to a point where your credit score is high enough to qualify for an FHA loan. FHA requires a FICO score of 580 to be eligible for their 3.5% down payment program.

We don’t have time to discuss all the merits of an FHA loan in this article. If you’d like to know more here’s a great read by Kevin Vitali: Should You Get an FHA Loan?

Before we worry about what your FICO score is, we first want to pull your credit report and see how that looks.

Rip that Band-Aid off

Good news or bad news, it’s important to know the status of your credit health. And if you’ve suffered some bumps in the road credit wise you may be hesitant even to take a look. This is understandable, but at the end of the day, you need to take this first step.

Federal law requires the three national consumer credit reporting companies – Equifax, Experian and TransUnion, give individuals a copy of their credit report for free every 12 months, all you have to do is ask for it. The best first step is to check your report at www.annualcreditreport.com.

Investigate

Once you have a copy of the report you’re going to want to comb through it and look for the following:

• Verify that all of the personal information on the report is correct. Check your name, address, Social Security Number, etc…
• Next, you’ll go through the individual accounts and loans to make sure they are correct as well. You want to ensure accounts from a person with the same or similar names don’t appear on your report.
• Another thing you want to look for is any accounts that were created as a result of identity theft.
• Check for Incorrect account statuses. You are looking for things like, closed accounts that are still being reported as open.
• Accounts that are incorrectly reported as late or delinquent
• Incorrect date of last payment, date opened, or date of first delinquency
• The same debts listed more than once ( perhaps with different names)

Dispute

It’s important to note that if you are already applying for a mortgage, you should not dispute any derogatory information on your credit report. If your report shows that you are in the middle of a dispute, your loan application will be rejected, or it will be referred to a person (instead of a computer) for a “manual underwrite,” which can take a very long time to resolve. Wait until your mortgage is approved and then dispute the report.

If on the other hand, you are in the process of repairing your credit to get a loan, your next step is to address the incorrect or negative items on your credit.

If there is erroneous information or negative reporting based on late or missing payments on your credit report, you have a couple of options. The first option is to contact and pay a company to handle this for you. If you choose this option, be careful and seek references. We refer our clients to River Stone Law. This firm offers a deal of $199 for sign up and $99 per month for guiding you through credit repair; they’ll tell you what to do and how to do it, send out letters on your behalf, and get items removed from your credit that shouldn’t be affecting it.

On the other hand, if you decide that you would like to handle your disputes with the credit reporting companies yourself, here’s the breakdown.

You’ll need to contact the appropriate reporting company directly to handle any disputes. These disputes can be submitted online or by mail. Here are the sites you’ll need:

Online:

• Equifax-http://www.equifax.com/CreditReportAssistance/
• Experian-www.experian.com/acrdispute
• TransUnion-https://dispute.transunion.com

Additionally, the Federal Trade Commission has some great information about disputing items on your credit report.

Prequalification and Preapproval

Once you know the erroneous information items have been corrected, it’s time to move forward with the pre-qualification and pre-approval process. If you’ve done your homework and cleaned up your credit report, your lender will want to run your application through a system known as Desktop Underwriting.

Desktop Underwriting

To save time and alleviate frustration, you’ll want to seek pre-approval through Desktop Underwriter (DU), this is the quickest path through the mortgage maze. Desktop Underwriter is a software program used by mortgage lenders to qualify prospective home buyers using Fannie Mae and Freddie Mac guidelines. Although Desktop Underwriting is used for Conventional and FHA loans, VA has its own automated system as well “Automated Underwriting System” (AUS).

The counterpart to desktop underwriting is Manual Underwriting this is a long, arduous process. You must avoid manual underwriting unless it’s your only option.

Buying After Bankruptcy

Let’s go a step further and talk about another financial stress point many people think spells doom for their prospects of home ownership, Bankruptcy.

Bankruptcy. Yes, you can be approved for a mortgage even if you’ve declared bankruptcy. If you have declared a Chapter 7 bankruptcy (one in which all debts are forgiven), you must wait 2 years after the bankruptcy is discharged to qualify for an FHA or VA loan. For a Chapter 13 (when you agree on a repayment plan), if you have been making on-time payments for one year after the declaration, you may qualify for an FHA or VA loan. In either case, you must not have a single late or missed a payment during the post-bankruptcy waiting periods—if you do, the qualifying period will be reset close to the date of your missed payment.

For conventional (non-government insured) loans, the waiting period is 4 years after the discharge of a Chapter 7 bankruptcy and 2 years after the 1-year payment period for a Chapter 13 bankruptcy.

Short Sale and Foreclosure

If you go through a short sale (selling your home for less than the outstanding debt), your credit score will not be affected if the lender notates it as “Paid as agreed.” If your lender agrees to forgive a portion of your loan, you will most likely sign an unsecured note promising to pay back the agreed-upon amount. As with Loan Modification, have your lender give you written proof that “Paid as agreed” will be reported to the credit bureau. If you don’t take this step, and the lender notates “Settled for less than the full balance,” you will be dinged a whopping 105 points!

If you are experiencing foreclosure, in which the lender takes possession of the property due to non-payment of the loan, you will also want to negotiate with the lender about how he will report it. If the notation “Foreclosure” appears on the report, you will be dinged 110 points.

In both cases, with a potential short sale or foreclosure, speak to your lender as soon as you realize there may be trouble looming. Don’t wait until the situation becomes dire, as many lenders are now much more willing to negotiate help for homeowners than in previous years.

Additional Resources:

• Dan Barcelon-5 Tips to Get Financially Ready to Buy a Home: http://epirealestate.biz/real-estate-blog/5-tips-to-get-financially-ready-to-buy-a-home/
• Luke Skar-10 FHA Guidelines EVERY Home Buyer Should Know: https://www.madisonmortgageguys.com/fha-guidelines/
• Credit Reports and Scores: https://www.consumerfinance.gov/ask-cfpb/category-credit-reporting/
• Disputing Errors on Credit Reports: https://www.consumer.ftc.gov/articles/0151-disputing-errors-credit-reports

Don’t Bring Me Down

Mortgage prequalification is the essential first step buyers should take before even starting to look at houses. Here is a scenario we see all time: A Realtor meets with home buyer to discuss buying a house. The buyers are very excited and they’ve been looking at properties online and have a bunch they really want to see. The realtor asks if they have talked to a lender, they reply, no. The Realtor does a quick prequalification and finds out that the buyer actually can’t qualify for a mortgage on the houses they’ve already fallen in love with. This is really disheartening for the buyers as well as the Realtor.

Mortgage prequalification is that important first step to help you make sure that there’s nothing standing in the way of getting the home buying process started, and ensure that your Realtor is showing you houses within your price range. Prequalification is different than pre-approval; the prequalification process will let you know how much you can afford, what type of loan you’ll be using, and how your credit looks. Pre-approval is the next piece of the puzzle – that process includes a full blown loan application complete with all of the supporting documentation.

So if you’re just getting started on the home buying process, your very first step is to get prequalified with a lender. If you don’t know how to find a lender, just ask your Realtor – they’re here to help and know the best mortgage lenders! Here we’ll outline the process of prequalification, and what that means for you.

When you contact a lender, they will be looking at your credit, debts, and income. Based on those numbers, they figure out what purchase range you can afford.

First, a lender will pull your credit. When looking into a potential borrower’s credit history, they’re not only looking at debts but income as well. If you’re sitting at home trying to figure out exactly how much house you can afford before moving forward, unfortunately, there’s not going to be a quick, straight answer, but we’ll do our best to explain what each piece of the puzzle looks like to a lender when you’re applying for a loan.

Credit

As mentioned earlier, the first thing a lender will do when someone starts the prequalification process is pulling their credit. The minimum credit score to qualify for an FHA or conventional loan is 620. If a borrower doesn’t qualify through their credit score, the lender can often point them in the right direction to improving their credit enough to qualify.

Government loans, on the other hand, occasionally accept credit scores under 600, and the credit score won’t drastically change the rate. These loans look at credit history, debt, and income for the rate, not just your credit score, unlike non-government loans. With non-government loans, your credit score will play a large factor in the interest rate of your loan. The higher the credit score, the better the rate.

If more than one person is on the loan – a married couple, for example – then the lender will be looking at the mid score between them. When there is a single client, the lender will be looking at only their credit score.

As long as the borrower(s) meet the minimum credit score guidelines, they’ll qualify for the current rate.

How much can you qualify for?

When going through the process of prequalification, your lender will be using your credit, income, and long-term debt in order to figure out what you can afford. Ideally, the sum of your monthly mortgage payment combined with your long-term debt should be no more than 45% of your gross monthly income.

Like we mentioned, there isn’t going to be an exact answer for how much you’ll qualify for until you talk to a lender. But, if you’re sitting at home trying to get an idea of what you might be getting yourself into, we talked to Bobby White, a lender in Colorado Springs, and he gave us a general equation for how to look at the numbers.

To break it down, the best way to look at how much you qualify for starts with your gross monthly income, based on your pay stubs. Your gross monthly income is how much you make each month before taxes. At this point in the prequalification process, your lender will want two years of employment history, and a paystub or W2 so that they can accurately calculate your income. If you don’t know your gross monthly income off the top of your head, you can take your gross yearly income (before taxes) and divide by 12.

Your monthly mortgage payment should ideally be no more than 28% of your gross monthly income, so multiply your gross monthly income by .28, and the result will be the maximum monthly payment you can afford.

Next, look at your long-term debt. Your long-term debt is going to be the sum of all of your minimum monthly payments; for example, car payments, student loans if you have them, etc.

Once you have those two numbers, add your long-term debt (sum of monthly payments) to the maximum monthly house payment that you calculated earlier. Now take this sum, and divide it by your gross monthly income. Multiply the resulting decimal by 100. Now you have a percentage, and this is your Debt to Income Ratio. According to our lender, your debt to income ratio should not exceed 45%.

Here’s an Interview with our Lender Bobby White. This will help you understand the process:

Here’s an example with a $50,000 yearly income and $400 per month in long-term debt:

Gross Yearly Income = $50,000  (this should come from your most recent tax return).

• Gross Monthly Income = Gross Yearly Income divided by 12
• $50,000 / 12 = $4,166

Gross Monthly Income = $4,166

• To calculate your Maximum Monthly Payment, multiply Gross Monthly income by 0.28
• $4,166 x 0.28 = $1,166

Your Max Payment = $1,166

• Now, add your Monthly Debt to the Max Payment
• Monthly Debt = $400
• $1,166 + $400 = $1,566

Divide this number by your Gross Monthly Income to determine your Debt to Income Ratio

• $1,566 / $4,166 = 0.38
• Multiply by 100 to get a percentage
• .38 x 100 = 38%

Debt to Income Ratio = 38%

Debt to Income Ratio should not exceed 45%*

To take this formula one step further, we can figure out the maximum amount of debt the buyer could have in addition to their house payment.

Gross Monthly Income x Max Debt Allowed=Total Debt including House Payment

• $4,166 x 45%=$1,874

45%-Maximum amount of allowable debt beyond house payment

• $1,874 – $1,166 =$708

The maximum purchase price you can afford is based on the monthly house payment and the percentage calculated above. If a borrower is well qualified (good credit, etc.), and hasn’t come close to meeting the 45% debt to income ratio, then they have the option to qualify for a larger loan if they choose to.

In other words, if your credit is good and the percentage you calculated with your ideal monthly home payment is significantly under 45%, you’ll have the option to qualify for a much larger loan.

Keep in mind that a down payment for a conventional or FHA loan has the borrower putting down 3.5% of the purchase price of the home, so you will need to have some money available to use for the down payment. On a $200,000 home, 3.5% is around $7,000. If you need help with the down payment, there are some great down payment assistance programs, which we will talk about in another article.

Here are some other helpful Mortgage Prequalification and Pre-Approval resources

• Being Prepared Means Being Pre-Approved
• Homebuying
• Love and Mortgage
• Mortgage Calculator

When purchasing a home, you know the sales price you have negotiated, but when you make it to the closing table your might be surprised at some of the other expenses involved in the process. Here is a detail explanation of all of the out of pocket expenses when buying a home.

Out of Pocket Expenses When Buying a Home

Earnest Money Expense

The first out of pocket expense that you’ll have is the earnest money. The earnest money shows the seller that you are committed to the purchase & aren’t out submitting offers on other properties. You give the earnest money check to your Broker or Title Company and it’s kept in escrow until the purchase is finalized. This money will go towards your closing cost or down payment at closing. There are instances throughout the buying process, where this is refundable to the buyer should the deal fall through.

Inspection Fees

The next out of pocket expense when buying a house are inspection fees. There are many types of inspections you may wish to have done on your home which might include:

• Basic home inspection to determine the condition of the home. Usually runs $300-400, depending on the size & age of the home.
• Radon Test. This determines if your home has unsafe levels of Radon gas. Usually about $175.
• Sewer Line Scope. To see if there are any issues with the current sewer line. Usually about $125- 200.
• Lead Based Paint Assessment. This determines if the home contains lead paint & applies to anything built prior to 1978. This usually runs about $300.
• Meth Lab Test. This will check to see if there has ever been methamphetamine in the home. This starts around $600 & can go to about $1200.
• Mold Test to see if your home contains dangerous mold. This usually runs about $300. There’s also Well & Septic testing if the home has them.

These fees are to be paid in full at the time of service.

Down Payment Expense

The next expense is your down payment. This is a percentage of the sales price of the home, which you pay at closing. VA loans do not require any down payment. There’s also first-time buyer programs that provide down payment assistance for buyers that qualify. The most common loan for first timers is FHA. This requires 3.5% down payment due at closing. Conventional loans start with a minimum of 5% down payment and go up from there.

Closing Costs

The last out of pocket expenses when buying a home is closing costs. These are fees paid at the closing of a real estate transaction. This pays for things like points, appraisal and title company fees, taxes, pre-paids and many other important items. Luckily, you will know what to expect ahead of time, because lenders will provide a cost analysis worksheet with estimated fees.

If you have any questions about out of pocket expenses when buying a home, please give me a call!! I’d love to help anybody that’s beginning or curious about this process.

The language of mortgage lending can be very confusing. There is a multitude of acronyms that make up a sort of mortgage lending alphabet soup. Terms like APR, ARM, COSI, FHA, VA and much more can make the mortgage lending process sound pretty intimidating. Our goal as realtors is to help simplify and streamline the entire home buying process, including obtaining a mortgage loan.

So, in the spirit of simplicity, let’s break down one of the most acronym-laden subjects in the industry, mortgage insurance. There are two primary mortgage types (Conventional and Government), so it makes sense that there are also two types of mortgage insurance. PMI (Private Mortgage Insurance) for Conventional loans and MIP (Mortgage Insurance Premium) for Government or FHA loans. A PMI policy is provided by private insurance companies while MIP is provided by HUD (Housing and Urban Development).

Although these policies are similar, they utilize different procedures and requirements, so we will talk about them separately.

LTV: Loan to Value Ratio

The primary factor that determines if you are going to need mortgage insurance at all is your Loan to Value Ratio (LTV). This is the ratio of the loan amount you are seeking from the lender in relation to the value of the property you are trying to purchase. As an example: the purchaser wants to borrow $180,000 to buy a $200,000 property. The LTV ratio is $180,000/$200,000 or 90% loan to value of the property. This means the lender has 90% of the risk in the deal compared to the borrower’s 10%. This puts the lender at a substantially higher level of risk than the borrower, so in an effort to minimize their risk, the lender will require a mortgage insurance policy.

MIP: Mortgage Insurance Premium

When you apply for an FHA loan, the lender will need to establish your LTV ratio. FHA loans will require the loan be insured by HUD for every loan no matter what the LTV is. If the LTV is higher than 90%, mortgage insurance is required for the life of the loan. If the LTV is 90% or less, the borrower is required to have mortgage insurance for 11 years.

Additionally, the borrower will be required to pay something called an “upfront fee”, as well as the additional monthly premiums. The upfront fee can be added to the loan amount.

The upfront fee, known as the upfront MIP or UFMIP equals 1.75% of your loan amount. The annual premium paid on a monthly basis is paid in one of two ways. If the LTV is higher than 95%, the rate is 1.35% of your loan amount. If your LTV value is less than 95%, the rate is 1.30% of your loan amount.

Please note that if you have been given an approval for an FHA loan, your MIP is also automatically approved.

Removing Your MIP

FHA mortgage insurance is permanent unless you can refinance it away. You will need to discuss this issue with the relevant agency, and they will give you their list of requirements for dropping the premiums. Generally, you need to have a certain amount of equity in your home for this to happen.

Please note that your insurance is discontinued only if the closing date of your loan is after December 31, 2000, and your case number assignment date is before June 3, 2013. If your case number assignment is on or after this date, your MIP cannot be removed from your monthly payments, even if your LTV value is really low. In this case, your insurance is terminated only when you have paid the full mortgage amount prior to the maturity date.

PMI: Private Mortgage Insurance

The conventional loan version of mortgage insurance is referred to as “Private Mortgage Insurance” (PMI). This policy gets its name because the policy is provided by private or non-government sponsored companies.

For conventional loans, your down payment needs to be 20% or more in order to avoid mortgage insurance. If on the other hand, you are putting less than 20% down, your loan can be insured by any private mortgage insurance provider. MGIC and RMIC are primary providers of this type of insurance.

Unlike MIP, in which there is just one approval for the loan, PMI involves two separate approvals. One is given by the lender and the other by the insurance provider. The possibility exists that you may be approved by the lender, but not the insurance provider. For the loan to close, you need both approvals, and until this is done, you will not receive a full loan commitment.

The rates offered for PMI policies vary with your chosen insurance provider but are generally between 0.3% and 1.15% of your loan amount. Please note that just like the interest amount of your mortgage, your mortgage insurance is also tax deductible. If you cancel coverage, you may be refunded a prorated premium amount.

There are two main types of PMI: the borrower paid the annual premium and the lender paid monthly premiums.

Borrower Paid Annual Premiums

In this type, you have to pay the premium amount for the first year after your loan closes. Once a year passes from this date, you will have to renew the premiums. This will be done at the original rate until the 10th year. In the 11th year, the premium rate decreases to 0.20%. If the previous rate was less than this, it will remain the same.

Fixed Rates and Non-Fixed Rates

Fixed rates are applicable when the first five years of the loan term are comprised of level payments only. If the payments are modified during this period, non-fixed rates will be applied.

Table 1 shows the fixed rates for the annual premium program. Table 2 shows non-fixed rates.

The above rates are based on your FICO scores and LTV ratio. Your LTV is calculated first, and then your credit scores are used to determining your classification.

Lender Paid Monthly Premium

When you take advantage of this program, your insurance premium is not added to your monthly payment. Instead, your lender will just pay it as an upfront fee to the insurance provider. However, this program is offered only with certain loan types. Your lender will be able to tell you if your mortgage falls into this category.

A lender paid monthly premium provides coverage as long as the premium amount is being paid. The renewal policy for this program is the same as the annual premium program.

Removing Your PMI

You can eliminate the premium amounts from your monthly payments if the equity in your home is more than 80% of the borrowed amount. Usually, this happens after two years. You can prove this in any of the following ways:

• Your loan is decreased to 78%
• You get an appraisal that shows the appropriate value of your home.
• You provide your lender with a Broker’s Price Opinion from a realtor.
• Refinancing can also help you if you have enough cash to pay a 20% down payment or if your appraisal report proves that you have 20% equity in your home. This option not only cancels your premiums but also provides you with a lower interest rate.

Avoiding Mortgage Insurance Altogether

Mortgage insurance is required only if your down payment is less than 20% of your home value. If you want, you can avoid paying premium amounts altogether. Here are some methods for this.

• This one is really obvious. A down payment that is 20% or greater means you do not require any insurance.
• You can apply for a VA loan, but not everyone meets the requirements.
• Apply for a combination loan of 80/10/10. You have to pay a down payment of 10%. Your first mortgage is equal to 80% of the home value, and the second mortgage amounts to 10%.

If you’re thinking of buying a home in the Colorado Springs area, and you’re not paying cash (and how many of us are doing that?), you will need to know your FICO score.

The FICO score is the most widely used measure of credit worthiness in the U.S. and it is the primary factor lenders consider when you apply for a mortgage. FICO was first introduced in 1989 by the Fair Isaac Corporation—hence the acronym.

FICO scores range from 300 to 850—the higher your score, the more credit worthy you are. Your score is calculated by a mathematical equation that takes into account the weight of many different factors on your credit report. There are actually 27 different scoring models with three main ones used for mortgages, auto loans and credit cards. A median score for a mortgage is 679. The general breakdown is as follows:

• 50% of your score is based on payment history and length of payment history. This includes loans for cars, homes, tuition and other long-term loans.
• 30% on the amounts you currently owe
• 10% on the types of credit you have been extended in the past
• 10% on new credit.

However, the weight of these factors may vary depending on the length of your credit history.

A sample profile of a high credit score would include at least 2 installment loans with balances (auto, student loans, mortgage); 3 revolving credit cards with balances of less than 30% of the card’s maximum, and no record of collections or late payments. Although it may seem counterintuitive, it is a good idea to keep accounts open, even when you have paid off the balances. Closing accounts tends to negatively affect your score.

The mortgage interest rate for which you qualify is based on your FICO score. Generally, the higher your score, the lower the interest rate and vice versa. Whether or not you are required to have mortgage insurance, the rate may also be based on this score, as well as the amount of your down payment.

If you are applying for a conventional mortgage, the lender will determine what minimum score will make you eligible for the loan, in addition to the price of the home and other financial obligations. Fannie Mae, Freddie Mac, FHA and other government loans have established minimum FICO score requirements.

If you are interested in learning more about FICO scores, visit www.myfico.com.

<<–Back to the Home Buying Process

As part of your Colorado Springs home buying process, you will mostly likely be applying for a mortgage. And one of the most important components lenders will consider is your FICO credit score. There are many factors that contribute to that score—some of them seemingly counterintuitive. For example, when you open a new account, your score is negatively affected—the same thing also happens when you close an existing, but non-used account. Also, when you apply for credit and the company searches your report, you are negatively affected as well.

So, if you’re thinking of buying a home in the Colorado Springs area, do you need to worry that your credit score will suffer when a mortgage lender pulls up your credit report? The answer, fortunately, is no.

When the mortgage lender pulls your first credit report, there is a 45-day window in which other people can search your report without hurting your score. This is called a “soft pull.” If, however, you apply for 3 credit cards in one month, you will experience 3 “hard pulls” which will cause major “dings” in your report.

However, you can take steps to improve your score. Here are some tips to help you make sure that your credit report is in the best possible condition before you start your home search:

• Don’t co-sign loans. If your co-signer defaults, you will be responsible for the payments. If you can’t pay, your credit report will show you to be in default.
• Keep old revolving accounts open, even if you have paid them off or no longer use them.
• Avoid “same as cash” credit offers (often available at appliance and big box stores). These offers usually give you a credit limit for the amount of purchase, so you will immediately max it out. You will be “dinged” when the store does the credit search and then again when you close the account after payoff.
• Keep your credit card balances at a maximum of 30% of the total allotted credit.
• Don’t open new accounts or make large purchases in the six months before you plan to apply for a mortgage, unless absolutely necessary.
• Monitor your credit report frequently at www.annualcreditreport.com to check for errors.
• Pay your bills on time. Even one late charge or missed payment can negatively affect your score.
• If you have not previously established any credit, sign up for a secured credit card. You will prepay a set amount and then receive a card with a spending limit of that same amount—you can then use the card as you would a regular credit card.