What you need to know and do to make the mortgage process easier.
When you buy a new home, images of beautiful kitchens, sumptuous master bathrooms, and abundant closet space may cross your mind, but you shouldn’t forget an important step called financing.
When you’re buying your dream home, the main questions to ask yourself at the start of your search include:
- Are my credit reports accurate, up-to-date, and correct?
- What information will I need to collect to apply for financing for my new home?
- What can I pay with a mortgage?
- What are my credit options?
- Where can I learn more about, and ultimately buying, a mortgage?
In many ways, financing a new home is like buying a resold home, but there is an important difference. When you buy a resold home, you research the rates and terms of banks, mortgage companies, brokers, and online lenders. You can do the same when buying a new home, but there is often an additional resource. Your builder can offer attractive financing packages, either through its own mortgage subsidiary, or through a subsidiary.
In addition to the financing offered by the builder, there are unique tools applicable to new homes (but not resold homes) that include bridge loans and construction financing. You can use these tools to finance the purchase and construction of a new home before selling your current home.
We’ll talk about each topic in detail, but first there are some important steps you’ll need to take to make sure you have all the information, documentation, and forms you’ll need.
Preparation
Someone once said that success is a combination of preparation and opportunity. Regardless of the type of lender or financing you select, it’s vital that you start preparing well before you apply. Here are some key steps to make the process simple and efficient:
Get your credit information: Long before you start looking for homes, you need to sort through your national credit files; ideally, it should be from the three credit bureaus (Equifax, Experian and Trans Union). Make sure you don’t find inaccuracies or outdated information. You can get your files for free once a year through www.annualcreditreport.com. Correct anything that is wrong immediately; Otherwise, you will delay the entire funding process. You must also order your FICO credit score from one or more offices. This will play a huge role in determining what kind of terms your lender will offer you.
Collect the key documents: Any lender will need to see documentation regarding your income, employment, two years of IRS returns if you’re a freelancer, bank accounts, 401(k) funds and other assets. It’s smart to start collecting this before you even start looking at financing options. It is also useful to have at least a vague idea of your current expenses in the home, since they will affect the amount you can get for mortgage and the maximum price of housing you can finance.
Determine how much you can afford: You can get a good idea about this ahead of time by using calculators that most lenders and builders have available on their websites. In the past, simple general rules were cited (such as, you can afford to afford a house worth two to two and a half times your gross annual income). However, the current rules are much more complex. Most lenders take your basic information and feed it into automated underwriting models that combine credit scores, debt-to-income ratios, and other factors to make decisions about loan size, rates, and fees.
In short, get in the habit of experimenting with different rates, down payments, loan terms (30 years, 15 years, fixed rate, adjustable rate) to see how your maximum mortgage amount varies and how this affects the maximum price you can pay for a new home.
The Many Nuances of Lending
Mortgage loans come in different shapes and sizes. Think of them in terms of their problem-solving features:
FHA Loans: If you only have a minimum amount of cash to make a down payment and your credit history has few blemishes, a government-backed loan is probably your best option. FHA (Federal Housing Administration) loans allow for down payments as low as 3.5% while offering generous credit subscription.
VA Loans:FHA Loans: VA loans don’t require down payments, but you must be a veteran to opt for them. USDA rural loans also allow for zero initial baseline, but are limited to areas with relatively small populations and may have restrictions related to income level. It should be noted that the FHA has recently increased its insurance premiums, which increases monthly payments. The VA has also increased its warranty charges.
Conventional loans: If you have more than 10% or 20% to pay a down payment, this may be your best option. Conventional loans are designed to be sold to Fannie Mae and Freddie Mac (the government-sanctioned mega-investors). The downside is that conventional underwriting rules are stricter and banks can impose additional fees on loans, increasing costs. Down payments of less than 10% are possible but require high private mortgage insurance premiums.
Construction Loan Financing
A construction loan can be helpful if you’re building your home yourself as a general contractor or if you’re working with a custom home builder. Most construction loans provide short-term funds designed so that you can get through the construction stage of your project (six to 12 months) followed by a conversion to a 30- or 15-year long-term permanent loan. The following are some of the main features to be aware of:
Sources: Construction loans are a niche specializing in the lending industry and are not as widely available as standard mortgages. Your best bet is to search among community banks that know the local or regional market, especially savings banks and savings institutions, although some brokers are promoted online and worth taking a look.
Provisions: You can expect a schedule of withdrawal installments in any credit agreement. Although always negotiable, a typical schedule might establish an initial disposition of 15% of the total loan amount to prepare the ground and foundation stage; a second provision of another 15 to 20% for the structure, and additional provisions during the remaining months for plumbing, electrical systems, interior carpentry, installation of appliances, etc. Before each disposition or withdrawal is paid, the bank will send an inspector to the site to report on the progress of the site and determine whether the site complies with local building codes and regulations.
Down payments: Most banks that offer construction financing want to receive a substantial down payment, typically at least 20% to 25%. However, some lending institutions have specialized programs that link permanent FHA-insured loans to short-term construction loans. So, let’s say you plan to build a house that is expected to be valued at $400,000 by the time it’s ready, on land you already own. A local commercial bank may offer you a nine-month loan for $300,000 to build the house, calculating $100,000 as the value of the land, and ask for a down payment of $80,000 (20%) based on the projected value of the appraisal by the time construction is complete. At the end of the construction period, you would end up having a permanent loan of $300,000.
Interest rates: Typically, the short-term segment of the construction period financing package will carry a prime interest rate plus a prime-plus. If the prime rate of the short-term bank loan is 3%, the loan for the construction period could be set between 4.25% and 4.5%. The permanent portion of the package with a 30- or 15-year term will usually be close to the regular mortgage rate; Let’s say 4.25 to 4.5% on a 30-year fixed loan. Rates can be significantly lower on adjustable-rate options, such as the popular “5/1” ARM, in which the rate is fixed for the first five years of the loan, but can vary each year thereafter, usually within a pre-specified range.
Bridge Financing
So-called “bridge” loans can also be important tools for you. These short-term (six to nine months) financing is designed to help you get through a temporary economic hardship, such as when you’re buying a new home but haven’t sold your current home yet and don’t have all the cash you need.
The lender, which may be a local bank or a subsidiary of your builder, agrees to give you a cash advance using the asset you have in your current home as collateral.
Let’s say you’re $50,000 short of a down payment you need to buy your new home. Your current home is for sale, but you don’t have a buyer yet. However, you have $250,000 of net mortgage guarantee on your current home and only a small first mortgage. A lender or lender may be able to give you the $50,000 advance you need, either by placing a second mortgage on your current home or paying off your existing mortgage balance and taking the position of priority lien, well secured by the rest of your estate. Once your home is sold, part of the proceeds will pay off the bridge loan.
Keep in mind that bridge loans are strictly short-term, and things can get complicated if your current home doesn’t sell within the contract period. Bridge loans also have higher rates than regular mortgages, often at least two percentage points above the latter.
Builder Financing
Most large and medium-sized construction companies have mortgage subsidiaries owned by them or affiliate relationships with outside mortgage companies. This allows builders to offer different financing options to qualified buyers.
Your builder may also offer affiliated title insurance and settlement services. Sometimes, the entire financing package comes with sales incentives on new housing, such as improvements and price reductions. Since builders’ financing packages can offer significant value, you should consider the offer carefully. However, you should also know that federal law allows, even encourages, consumers to shop around the market and make use of any mortgage, title insurance, and settlement services they choose.
The financing offered by the builder can reduce the time required to proceed from the time of application to settlement, given that the entire process is essentially under the control of the builder himself. It can also give you a slight advantage over the approval of your financing application and can save you money on the total incentive package you are being offered (on the home in combination with mortgage and closing costs).
On the other hand, the mortgage terms of the builder (interest rate, fees, and variety of loan types) may not be the most favorable available in the market, and this can only be known by informing yourself in several sites and comparing the total package they are offering you with that of other competing sources.
Summary
Once you’ve collected all the documentation upfront, with knowledge of your credit score and different financing options, the process of finding the best financing for your new home based on your unique needs will be faster, easier, and more efficient.