The ABC’s of Preparing to Buy Your First Home

iStock_000020110629XSmallBorrowers getting ready to buy their first home are often surprised…for different reasons. I find that some are surprised to learn that they do qualify for a home in their price range and some are disappointed to learn that they have a little work to do before they can buy a home. Getting preapproved with a mortgage professional helps take some of the “surprise” out of the process.

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How can a preapproval change?

MortgageWhen someone becomes “preapproved” for a mortgage, it boils down to they qualify for a certain mortgage payment based on their income and debts (DTI aka debt to income ratio).  A home buyer qualifies for the loan amount of the new mortgage and their funds available for down payment and closing cost determine the sales price.

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How much can Sellers contribute towards Closing Cost?

If negotiated in your purchase and sales agreement, a Seller may agree to chip in towards some or all of your bona fide closing costs, prepaids and reserves.  They cannot contribute towards your down payment.  The amount the seller can contribute varies depending on the program type and the amount of home buyer’s down payment. The percentage is based on the sales price and if the credit exceeds the closing cost, the mortgage originator can often use it towards discount points to buy down the interest rate.

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What Determines How Much Home You Qualify For – Part 2: Funds for Closing

piggybankbeltIn Part 1 of this series, I reveal that home buyers qualify for the mortgage payment first based on their income.  The next major factor is the down payment and funds for closing.  Some may say that the down payment more important than the mortgage payment, however the down payment actually can be a variable; one may be able to obtain gift funds to increase a down payment.  You cannot change your income unless you add more qualified borrowers.

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Buying a Condo or Townhome?

iStock_000061440694_MediumCondos come in many forms including high-rises, converted apartment buildings and even some town-homes may be condominiums depending on how they are legally described.  If you’re planning on buying a condo and not paying cash for your purchase, here are a few things to look out for where lenders may have an issue with.

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How Much Do I Need for Down Payment to Buy a Home?

When you buy a home, most loans require a down payment.  A “down payment” is the difference between the loan amount (what is being financed) and the sales price.   Down payment percentages are based on the sales price.  Be prepared for every dollar that is used for your down payment to be documented or sourced (including large deposits reflected on your statements).  In addition to the down payment, there may be closing costs and reserves.  

Closing costs can be paid by lender credit (via an increase in interest rate) and sometimes the seller can contribute to closing costs.  If the seller is paying for closing costs, there may be restrictions based on the program type and the amount of down payment you are making.  If the seller is paying your closing costs, it needs to be negotiated in the purchase and sales agreement.   Reserves are the savings the lender wants you to have in your account after closing typically measured by months of your proposed mortgage payments.   It’s safe to plan on at least two months of proposed mortgage payments to be in your bank after closing for “reserves” whether your lender or loan program requries it or not. 

Some home buyers select their mortgage based on down payment requirements.  Here are some different programs beginning zero down payment options for homes that are owner occupied/primary residence.

VA Loans.  If you served our country, thank you.  You may qualify for a VA loan which allows zero down payment and the seller is permitted to pay 100% of your closing costs.   Zero down payment is available up to the VA loan limit, which in King, Pierce and Snohomish county is currently $481,250.   If your loan amount is above the current VA loan limit, your required down payment is 25% of difference between the loan limit and the sales price.   There is no mortgage insurance, however VA loans do have a one time funding fee.

USDA loans.  Homebuyers who are willing to live in a rural area and who meet income guidelines can also buy with zero down payment.  Like VA loans, there is no mortgage insurance and there is a one time funding fee.  Again, USDA loans have income and geographic restrictions.

FHA.  Currently FHA will allow a down payment as low as 3.5%.  Current FHA loan limits in the greater Seattle area is $567,500.  FHA loans do have mortgage insurance (upfront and monthly).  Sellers can currently contribute up to 6% of closing costs and prepaids, however this (and possibly the down payment) guideline are expected to change.  A family member can gift the down payment requirement of 3.5% which would effective make an FHA loan “zero down” for the home buyer.

Conventional.  Conventional programs are Fannie Mae and Freddie Mac programs.  If you’re putting down 20% or more, you avoid private mortgage insurance.   Any purchase with less than 20% down payment will most likely have private mortgage insurance.  Seller contributions towards closing costs and gifts from parents vary depending on your amount of down payment.

Private mortgage insurance rates and guidelines vary based on the loan to value (the amount of your down payment), credit scores and programs.  The lower your down payment, the more expensive the cost and the tougher the guidelines are because the loan is more risk for the private mortgage insurance company.

Fannie Mae Homepath.  Fannie Mae’s Homepath allows home buyers to purchase a foreclosed home owned by Fannie Mae with as little as 3% down payment, with no private mortgage insurance and no appraisal.  Fannie Mae often offers additional “special” incentive programs, including contributing towards closing cost.  This program is limited to specific homes that Fannie Mae currently owns.

Non-conforming/Jumbo loans. In the Seattle/King County area, any loan that is over $567,500 is a “jumbo loan”.   The loan limit varies depending on what county the home is located in.  For homes that are not in a designted ”high cost” area, a non-conforming loan amount is any loan $417,001 or higher. 

Plan on at least 20% down payment and having roughly six months reserves after closing depending on how many properties you currently own.  

I do have other resources that will allow a lower down payment of 10% down with a loan limit of $600,000 and “self insurance” (slightly higher rate in lieu of private mortgage insurance). 

What happened to piggy-back mortgages?   Every once in a while I’m contacted by a borrower who is interested in an 80-10-10 which would allow a borrower to put 10% down payment, using a second mortgage to make up for the difference between the first (primary) mortgage and the down payment.   Currently, most lenders are offering a maximum loan to value of 75 or 80% 85% which rules out the 80/10/10 scenario.  UPDATE August 25, 2011: Some of the lenders we work with are offering second mortgages up to 85% loan to value to well qualifed borrowers.

If you are considering buying a home located in Washington state, I’m happy to review your down payment options with you and help you develop your home purchasing plan.

Related post:

How to Buy a Home with $10,000

How Much Home Can I Afford?

How to Buy a Seattle Home with $10,000

NOTE: Mortgage rates quoted in this post from April 2010 are outdated and no longer valid. For a current mortgage rate quote for a home located anywhere in Washington, please click here. Also, other programs available since this post was published. 

I recently had someone getting ready to buy their first home ask me if $10,000 would be enough for a down payment.  If she had served in the military, she could possibly qualify for a zero down VA loan; this was not an option for her.  USDA loans also offer 100% financing but the area she’s considering is not classified as rural. 

An FHA loan will currently allow her to buy a home with as little as 3.5% of the sales price.  Until this summer*, sellers can contribute up to 6% of the sales price towards allowable closing costs and prepaids (*in a few months, this will be reduced to 3%).

So how much with $10,000 buy?  How about a sales price of $285,000.   Here’s how that pencils out.

$285,000 x 3.5% required minimum down payment = $9,975.  This is the buyers minimum required investment if utilizing an FHA insured loan.   A parent can gift funds towards this amount, but the seller cannot.

The rate (as of writing this post 4/28/2010) for an FHA insured 30 year fixed mortgage is 5.000% assuming we’re closing in 30 days (APR 5.620) and priced with zero points to help keep the closing costs down.   Pricing the loan with zero points means that you’re asking the seller to contribute $2,750 less than they would if your rate was priced with a point (1% of the loan amount).  This may make your offer more acceptable.

Based on this scenario, if the Seller contributes $5,500 towards allowable closing cost and prepaids, you’ll wind up needing approximately $10,000 for your down payment and remaining closing costs.

I did use 6 months for property taxes, which will vary depending on when your first mortgage payment is due.  And I used 15 days of prorated interest which is based on closing in the middle of the month.   Closing towards the end of the month reduces the prorated interest (your cost)…of course the trade off is that you don’t own the property until it’s closed.

The total monthly payment, including PITI and mortgage insurance, is going to be around $2,000 (depending on interest rate, taxes and home owners insurance).  My scenario has a payment of $1981.  

In addition to your down payment, you may be required to have reserve funds after closing of at least two months proposed mortgage payments.  Based on this scenario, that would be around $4,000 in the bank (stocks, 401k, etc) after closing. 

Also of note, your first payment will not be due until the month after closing unless you close on an interest credit.  This is a great opportunity to “pay yourself” by putting that mortgage or former rent payment into your savings account.  Owning a home does come with expenses…some not always planned.

If you are interested in buying a home located in Washington state, I’m happy to help.   Please contact me or apply on-line by clicking the tab at the top this page.

Gifts from the Bank of Mom and Dad – Part 2: Conventional Financing

Often times when gifts from family members are involved, borrowers my opt to use FHA financing since the guidelines are (currently) more flexible than conventional with regards to gifts.   With FHA, a gift from a family member can go towards to borrowers minimum required investment with conventional financing, it cannot.

Here’s an example.  Let’s say we have a sales price of $265,000 with 10% down payment creating a loan amount of $238,500.  Once you factor in estimated closing costs of $2,400 and and prepaids/reserves of $3,100; the amount due at closing is roughly $32,000 (10% down = $26,500 + $2,400 + $3,100).   The borrowers also have a $5,000 contribution towards closing costs from the seller.

At this loan to value, with conventional financing requires that the borrower invests a minimum of 5% of their own personal funds into the transaction.  Unlike FHA, these funds cannot be gifted from the family members.   NOTE: if the gift is 20% down or more, the 5% rule for conventional financing does not apply (the whole down payment can be gifted).

Staying with our example, this means that the borrower must contribute 5% of $265,000 of their “seasoned” funds = $13,250.

With the amount due at closing at $32,000, the borrower must contribute at least $13,250 (5% of the sales price) of their own funds towards the $32,000 (10% down payment).  This leaves $18,750 remaining “due at closing”.   The borrowers earnest money check (if sourced – meaning documented as being their own funds) can count towards the 5% investment requirement and so can deposits with the mortgage company.   For example, the our borrowers submitted an earnest money check in the amount of $5,000 with their purchase and sales agreement, they would have $8,250 remaining to invest into the transaction of the 5% requirement ($13,250 – $5,000 = $8,250).

Once the borrower meets the 5% down payment, the gift and any seller credits can be applied towards the transaction.   A seller contribution can only go towards allowable closing costs and prepaids.  With this scenario, that totals $5,500 ($2,400 + $3,100).  The seller cannot contribute more than $5,500 (actual closing costs and prepaids).  

Unlike a seller contribution, the gift from parents can be applied towards down payment or closing costs/prepaids, once the borrower’s 5% investment is met.  If your gift from the parents is larger than the remaining amount due at closing, you can either reduce your loan amount or not use the entire gift.  NOTE:  Your parents may want to check with tax adviser regarding possible tax implications with gifting funds.

With FHA financing, their is also a minimum required investment from the borrower, which is currently 3.5% of the sales price.  A gift from parents CAN be applied towards the borrowers minimum required investment (the 3.5%).

When parents provide a gift with conventional or FHA financing, they need to be prepared to provide documentation of where the funds came from.  They will sign a gift letter and provide a recent bank statement showing that the funds are available.  There also needs to be a “paper trail” documenting the transfer of the gift funds (photo copy EVERYTHING–you’re better off having too much paper work to provide your mortgage originator than not enough).

If you have questions about financing a home located in Washington State, please contact me, I’m happy to help!  We have both FHA and conventional programs available.

Related post:  Gifts from the Bank of Mom and Dad – Part 1: FHA