One of the biggest and first decisions you will have to make when you have decided to buy a house is how you pay for it. If you are like most of us, you will need to borrow money and promise to pay it back to move into your new home. Here is a quick overview of what you need to know and down below, we have a couple local lenders we can recommend.
Financing Depends on Your Credit Score
Although it is not the only way banks determine whether you are a good credit risk, this score can GREATLY impact how much you will pay for you home whether you hold it for 5 years or 30 years. There are three main credit reporting agencies used by most lenders (Experian, Equifax, and Transunion). These companies report, compute, and store the credit histories of consumers. Each company varies slightly on the information they collect and how they calculate your credit score.
1. What goes into a credit score?
Even though we cannot tell you exactly what the secret sauce is behind your credit score, we can tell you the main factors all three of the companies evaluate when they are calculating your score.
- Payment history – Do you pay on time? Payment history makes up the biggest part of a credit score (35%).
- Total amount owed – How much revolving debt do you owe monthly, and do you use it all? This is approximately 30% of the score. It also takes into consideration the total amount of credit available and how much has been used, also known as credit utilization. If you have used all the credit available to you (100%) then the banks may feel you are not using credit wisely.
- Length of credit history – How long you have been responsibly handling your debts? This is approximately 15% of the credit score. If you have held the accounts for many years, you have a longer history of paying as promised and are less credit risky than if you have just opened all the accounts in the past year.
- Types of credit – What kinds of accounts do you have open? This is 10% of the credit score and takes into consideration whether you have only credit cards, or a mix of installment loans (like a car loan) and other credit debt.
- New credit – How new cards have you opened recently? This also counts for 10% of a person’s score. This part of the score also takes into consideration the number of inquiries, as how old the most recent account was opened. Many new accounts can signal more risk to lending institutions.
2. How a credit score impacts home buying
Lenders use this score to determine the likelihood that you will pay them back the money they are lending you. People with credit scores below 640 will have a difficult time qualifying for a mortgage and the mortgage that would be offered to you will be a subprime mortgage. Interest rates on subprime mortgages are often higher than conventional mortgages. Since these mortgages are at greater risk of default, banks charge a higher rate to cover their potential risk.
Those with a credit score of 700 or above are generally considered good risks for lending money, and they will receive lower interest rates. The lower interest rates means that borrower will spend less over the life of the loan. Scores over 800 are considered excellent and we have seen banks compete over these buyers by sweetening their offers. There are federal rules for lending that each bank, using federally insured or guaranteed, must follow. There are also bank or lender rules with fall on top of these rules – called overlays. Overlays vary from lender to lender. How banks computer your credit score can also vary (by a few points) and this too can impact what a lender can offer you in the mortgage’s terms and conditions.
If you do not have a credit score, you are an unknown risk to the bank, and they may not lend you money. If you think you may be purchasing a home in the next few year, open selective credit accounts and start establishing your credit score now.
|Credit Score Range|
3. How to increase your credit score
Sometimes credit can be established and/or corrected in a matter or months. Sometimes it will take years for a borrower to straighten out and raise their credit score. We are often asked about credit repair companies. Read the fine print carefully. Some can only guarantee a temporary improvement in your score, and most of what they are going to do for you can be done by yourself – free of charge.
- First, pull a copy of your credit report and read over it carefully. This can be done on several websites. The federal government passed a law that guarantees every consumer can have a free copy of their credit report once a year. If there is anything on there that is not your charge, contest it right away. Fraudulent charges can lower your credit score and be an easy way to raise your score.
- Pay your bills on time for at least six months. Timely payments are one of the biggest parts of your credit score and with six months of no late payments, your score will be significantly and positively impacted.
- Check with your credit card account holders about a credit increase. It is important NOT to spend this amount so that you can benefit from a lower credit utilization rate.
- Do no close credit card accounts, even if you are not using it. Depending on the age of the account and the credit limit not used, you may hurt your credit score if you close that account. Pay down debt, but do not close accounts.
- Credit repair companies will negotiate with your creditors to lower your monthly obligation or even your entire debt. This is something that any person can do for themselves, for free. If you do not have the time, or just prefer someone else to guide you through it, make sure you thoroughly investigate the company you choose.
4. Debt-to-income (DTI) Ratios
You will likely hear your lender mention DTI at some point during the process of buying a home. It is one way of the ways the lender will measure the risk in lending money to a buyer. The DTI is the total of all monthly debt payments divided by gross monthly income. The lower this percentage (or rate, or ratio) is the less likely the buyer will be to struggle making monthly mortgage payments. Research has shown that borrowers with high DTIs have more trouble meeting their monthly debt obligations.
Personal loan providers will usually be laxer on this ratio and allow a higher DTI ratio that mortgage lenders. Each lender can set their own requirement for the DTI ratio. While a DTI of 20% or less is considered low, the Federal Reserve considers a DTI above 40% a sign of financial stress. Most lenders want a DTI lower than 43% to qualify a buyer for a home loan. The required debt-to-income ratio for student loans varies by lender, and type of loan, and buyer’s credit score.
As a rule, it is a good idea to keep your debt-to-income ratio at less than 36%. In this range, new lines of credit will be easy to obtain. If your DTI is between 36% and 42%, lenders may be concerned about your ability to repay. Consider paying down your debt. At this level, you can likely do this yourself. If your DTI is over 43%, paying off debt may be extremely difficult. Some creditors may decline your application for more credit. At this level, it may be worth looking into a debt management or a nonprofit credit counseling agency. There are several online options and many local options as well.
If You Put Down Less, You Must Pay Private Mortgage Insurance Monthly
If you put down less than 20% of the sales price of the home, you will be required to pay for private mortgage insurance (PMI). PMI protects your lender in case you default on your loan. The cost varies based on your loan type, your down payment size, and your credit score. Usually, the cost of the PMI is added to your monthly mortgage payment (along with insurance, taxes, and interest). Some buyers will pay it as an upfront fee at closing and others will agree to a higher percentage rate in lieu of PMI. How a buyer chooses to pay for PMI is a matter of running the numbers and deciding what works best in your situation. You can ask your lender to give you some options and review them with your accountant to help you decide.
Once you have reached at least 20% equity in your home, you can contact your lender to start the process to drop the PMI from your monthly payment. You will likely need to pay for an appraisal for the bank to confirm your home’s current market value.
What’s the Difference Between Pre-approval vs Pre-qualification?
It is possible to receive a mortgage prequalification letter with a lender relatively easily. It is quick estimate of what mortgage you will qualify for based on your income and stated debt. These are relatively easy because generally, the lender is not going to double check your numbers or verify the accuracy of your income or debt.
Sellers will prefer to see a preapproval letter over a prequalification letter. A mortgage preapproval generally ensures the seller that the lender has looked at and verified income, assets, credit history, rental history (if applicable) and debts. These letters usually take the banks a couple days to get back to you. It also helps prevent surprises when it comes to mortgages. There is enough stress selecting and negotiating your next home, without wondering whether the bank is going to find something unexpected that blows up the deal after the contingency period.
What Types of Lending Is Available for Tallahassee Buyers?
There are many different loan options out there. Talk to 2-3 lenders to see what they suggest for your situation. Here’s a quick overview of the most common types of loans your lender will likely cover with you.
1. Conventional Financing
A conventional mortgage is not guaranteed or insured by the federal government, and these types of loans may provide the bank and the consumer (buyer) more options. Most conventional loans are ‘conforming’ loans, which means the bank can sell the mortgage on the secondary market. Selling those mortgages to Fannie Mae or Freddie Mac provides the bank with more capital to lend to more buyers. Those government sponsored companies then sell those bundled mortgages to investors.
Conventional mortgage can also be non-conforming which means that they do not meet Fannie Mae or Freddie Mac’s guidelines and cannot be sold on the secondary market. Because they do not need to conform there is no single set of requirements for borrowers to meet. In general, conventional loans require a higher credit score and down payment than government backed loans like FHA or USDA loans. Most cases you need at least a 700 credit score and a DTI less and 45%
2. FHA Financing
The Federal Housing Administration insures mortgages at the federal level. These mortgages are intended to help people live in their own home. Strictly speaking, these loans are not available for ‘investment properties.’ However, you may use an FHA loan to purchase a four-unit quadplex and live in one of the units.
These loans start with a minimum down payment of 3.5% and if you put down less than 20% you will be required to purchase private mortgage insurance (PMI) to protect the lender from loss in case you default.
3. 203K (FHA) Financing
The loans are the same as above, except they are designed to allow the buyer to borrow money for repairs, rehabilitation and/or remodeling. This allows the buyer to make those changes to the home they desire and roll those costs up in the monthly mortgage payments. These loans have a slightly higher interest rate than regular FHA financing.
4. USDA Financing
While conventional and FHA loans are available for all properties. USDA loans are only available for properties considered to be rural. In Tallahassee, that generally means outside of Capital Circle. These loans also have income limits, and the lender will consider the income of all individuals in the household (not just the ones whose names is on the loan application). USDA loans to not require a down payment and they do not require the borrower to purchase private mortgage insurance. They do require a guarantee fee that is similar to PMI. This fee can be paid at closing and it is generally 1% of the loan amount, or it can be paid monthly with the mortgage payment. This fee is generally less than the PMI for an FHA loan.
5. VA Financing
These loans are the golden ticket for our military members. VA loans are only available to veterans, active-duty military members, and their surviving spouses. These loans do not require a down payment nor private mortgage insurance. You cannot use a VA loan for a second home or investment property. There are also limits on the amounts a veteran can borrow, as well as funding fee. This funding fee is often paid by the buyer in Tallahassee and rolled into the mortgage payment. The funding fee helps keep the program alive for other veteran borrowers and it not required for all borrowers. Certain groups are exempt from paying the fee, which ranges from 1.25% to 3.3% depending on branch, down payment and loan amount. Those groups include Purple Heart recipients in active duty, surviving spouses, and those on VA disability. There is also the requirement that the seller provide a ‘clear’ WDO report for the veteran borrower. This can give sellers heartburn in multiple offer situations.
6. Hard Money Loan
This option is most often seen for investor purchasing investment properties. The ‘hard money’ is a loan that is lent from a private company or interest for a short term investment. These loans are typically closed within 3-6 years and used primarily by investors ‘flipping’ homes. The house is the collateral for the loan and these loans can be obtained relatively quickly for the experience investor. These loans also have much higher interest rates than the typical mortgage packages, sometimes even double the going interest rate.
7. Private Mortgage
Like the hard money loans, these are private companies or people providing the money for the mortgage. The last one we closed was great deal for all involved. The grandparents paid cash for the house and with the closing attorney set up the mortgage and payments for the young couple. These are relatively quick and easy to work out and usually involve family members. The closing attorney can help you get all the details ironed out in writing before the house is closed on.
8. Home Equity Loan
If you already have equity in a piece of real estate, it may quicker and easier to use that as collateral for your next mortgage rather than taking out a whole new loan. The bank will usually lend up to 90% of the value of your existing property, minus the current mortgage.
9. Owner Financing and/or Lease Purchase
This question comes up often. Buyers may be having trouble coming up with a down payment or they do not qualify for a mortgage, or they are expecting a payout from a settlement soon. In this seller’s market, most sellers do not want to mess with the details and risks that come from owner financing. The lease purchase is different in that the buyer agrees to rent the home for a year or possibly two and then obtain a mortgage and pay the seller off. Usually the buyer/renter, pays a higher than market value on the rent to build up a down payment and/or closing costs that the seller will pay for them at closing. The downsides are that there are two contracts in play and it can be easy for a buyer to default and lose not only the down payment they were building, but also the roof over their head.
Last on the list, since it is not financing is cash. There are some areas of Florida where cash offers are the norm and outnumber the sales that involve a mortgage. Tallahassee is not one of those places, but buyers will often find themselves competing against cash offers in many price points. The beauty of cash for the seller is the lack of a financing contingency. This often means closing can be completed within two and half weeks and after the inspections are completed. These buyers often opt out of an appraisal which can also help ease a seller’s mind.
Choose Your Financing Team Wisely
Choosing a lender is a pretty important step when buying a home. If you don’t get it right, you may lose a lot of time AND money. Some lenders spend a lot of money to advertise and you will see them over and over again through this process. Yes, they are cyber stalking you. That does not mean that they are qualified to get you to the closing table with the least amount of hassle. I have worked with most of those big online mortgage companies, and the trouble they run into is that they do not know Tallahassee real estate and what they do not know can cost you time and money. One of those big guys has asked the seller for an extension six times in the past seven times I have worked with them. Guess what? The seller does not have to grant an extension because of the lender mistake. They can say no, pocket your deposit money, and go back to the market and find a different buyer. It is too important of an investment to leave it to someone you cannot even meet in person.
Some information on lenders – it is in your benefit to shop your mortgage around. There are federal lending rules and sometimes banks add their own rules on top of those rules (called overlays). Since the rules can be different from bank to bank, you can find that some banks have options that other banks do not (for example, some lenders do not have renovation loans, construction loans, mobile home loans, in-house financing, etc.).
I recommend that you talk to at least two-three lenders about purchasing a home and evaluate what they are offering you.