The Beginning of the Homebuying Process
I forget which book started out, “Where should I begin?” The answer was, of course, “At the beginning.” The beginning of the homebuying process should begin well before you think about getting serious about buying a home. Ideally, at some point in time you say to yourself, “Some day I’d like to own a home.” That is the beginning.
It used to be that the requirements for being a homeowner were that you had to have a job, good credit, and a down payment. First-time homebuyers concentrated on these three aspects of the process because it took a long time. Just because it is easier today, however, doesn’t mean that you shouldn’t devote energy to preparation.
Back then no one even thought about buying a home unless they had a good job and could afford the payments. This was easier because the job market was far more stable then it is today. In the old days, we didn’t have a credit scoring system where each report had to be reviewed, item by item. It was simpler because we were not a nation of credit junkies the way we are today.
The down payment was the hardest part because it was difficult to save a 20% down payment. Piggyback loans were not all that common but with Private Mortgage Insurance (PMI) or seller provided financing, you could buy a home with 10% down. I put down $5,000 on my first home. That may not sound like a lot, but my salary at the time was $18,000 per year.
These ingredients are not absolutely necessary with today’s lax underwriting standards. That said, the process will certainly be more fun if you meet all of those requirements. First, let’s briefly talk about credit.
There is an enormous amount of information available at Credit.com about this topic, so I won’t spend much time here other than to make this important point: THE BETTER YOUR CREDIT, THE LOWER YOUR RATE. It’s that simple. Even if your credit is GOOD, you can likely save money if your credit is EXCELLENT. For example, there are programs that offer a .25 point bonus if your credit score is higher than 780. So, while 720 is a good score, if it were 780, you’d save $1,000 on a $400,000 loan.
Next comes the down payment. You are obviously aware that there are lots of 100% LTV (Loan-to-Value) financing programs today. Whether these are done with PMI or as a piggyback 80% 1st loan and a 20% 2nd, there are pricing penalties that your lender will probably not tell you about. Buried in the quote 6.25% and 1 ½ points may be a pricing hit of .5, meaning it would be 6.25% and 1 point if your credit score were higher. That’s another $2,000 on a $400,000 loan.
You are much better off getting a gift from the Bank of Mom and Dad for at least 5% or even 10% down. If they have the money available for this purpose, you’ll save money. Even though this is supposed to be a gift and that a statement on the Gift Letter says, “No repayment is expected,” we all know that 90% of these “gifts” are going to be repaid. If you are willing to pay the going rate of 8%, that is a lot higher than your folks are getting at the bank. If you have to pay that much anyway, why not to someone you love?
Another feature of 100% financing programs is that they almost universally require that you have some reserve funds in the bank after closing. A typical requirement is that you have two or three months’ payments in the bank. Payments are defined as the mortgage payment plus the monthly property tax bill, the monthly insurance, and, possibly, the Homeowners Association dues if it’s a condo. That is a considerable sum of money.
The good news is that you can count the balances in your retirement accounts for this purpose. Hopefully you would not actually have to liquidate your IRA to make your house payment if things got dicey, but if it were absolutely necessary, you would, wouldn’t you?
Finally, don’t consider this little essay the “be all, end all.” This is, as advertised, just the beginning. Mortgage financing is a complicated subject. I hope I have convinced you that the stakes are high enough so that you may study more. There are entire books written on the subject! Even if you aren’t much of a reader, such an investment will pay off and will probably save you hundreds of times the cost of the book.
A high credit score often equals savings on loans and credit cards.
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