Not Understanding Financing Options and Not Getting Pre-Approved For a Mortgage

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Home buyers need to search out and choose the best mortgage program given their resources.  This isn’t an easy task and is best left to a mortgage professional. 

They will be able to review your resources: the three “C’s’’ of homebuying:  Cash, Cash Flow (Income), and Credit.  Based on these they will be able to determine the right mortgage program for you as well as the amount of a mortgage that you can be approved for. 

It is important for you to know how much you can qualify for and/or be comfortable borrowing to determine the price range that you should be looking in.  This also will help you determine if your goals are in fact in line with reality. 

In other words, you need to know how much of a mortgage you plan on getting given your desired monthly mortgage payment and compare that to homes available in that price range to see if you are comfortable with what you get for your money.

Most people are qualified for a much larger monthly mortgage payment than they are comfortable with.  It really is important, especially for first time home buyers, that you stay conservative, buy your first home with a mortgage you can comfortably afford, rather than end up "house poor" as the saying goes.

Many different mortgage programs are available.  There are government-backed programs such as FHA, VA (Veterans Administration), and RHCDS (Rural Housing and Community Development Service, formerly known as Farmers Home Administration), and perhaps specialty state government backed programs.

In all these programs, the government provides a guarantee to the bank as an inducement for banks to lend money with lower down payments.

Other mortgage programs fall under the category of Conventional Loans.  There are many variations of Conventional Loans, each with there own unique qualifying requirements. 

Also included are special CRA mortgages.  CRA stands for Community Reinvestment Act.  Federally chartered banks and lending institutions must "reinvestment" a certain portion of their funds into low to moderate-income mortgages in their area of operation.  These loans often have lower interest rates, lower down payments, down payment and closing cost grants, and more liberal qualifying requirements than other loans.

Meeting with a mortgage broker should give you the most options. A mortgage broker corresponds with dozens of banks, knows the local and state special mortgage programs and therefore not only has more options but also the ability to shop the mortgage to get the best rate and closing costs.

Determining the amount of a mortgage you can qualify for is generally figured by applying debt to income ratios.  As a rule of thumb, conventional financing requires debt to income ratios of 28/36.  FHA and other forms of financing have their own requirements. 

The first ratio, 28% in our example, is the maximum percentage of your gross monthly income that the bank will allow you for your total monthly mortgage payment, including: Principal (the amount you pay back to the bank every month), Interest (the profit to the bank each month), Real Estate Taxes (the real estate property taxes due for your home in your local area), Homeowners Insurance (your fire and liability insurance on your home), and PMI (Private Mortgage Insurance - a monthly insurance fee required if the down payment is less than 20%). 

The second ratio, 36%, is the maximum percentage of your gross monthly income that the bank will allow you for your total monthly mortgage payment PLUS your other monthly debt payments.

Why get pre-approved? 

To make you a better buyer in the eyes of the seller, thus giving you greater leverage in negotiating for the best price and terms as well as knowing that you can afford and obtain mortgage financing.

A true mortgage pre-approval is an actual mortgage commitment subject to the buyer getting a home under contract and it appraising for at least the purchase price. 

A seller is taking their home off the market for typically 45 to 60 days, during which time the buyer applies for their mortgage financing commitment.  They don’t want to hear 45 days into the deal that you can’t get a mortgage.

A mortgage pre-qualification, on the other hand, is merely a personal opinion by a mortgage professional as to ability of a buyer to get a mortgage.  

A true pre-approval, however, is based on a more extensive credit report pulled from all three credit repositories with information verified, and a review of bank statements and other sources of funds, W2’s, pay stubs, etc. as well as verification of all information including employment.

TIP: Ask the mortgage professional to provide a pre-qualification initially but then file an application for a true pre-approval, or true mortgage commitment, with a lender at some point fairly soon after.  It gives you greater leverage when negotiating.

Make sure that you get a GFE, Good Faith Estimate, of closing costs when you apply for a mortgage.  As of the end of 2009, there are strict regulations with regard to the preparation of a GFE and the difference, if any, between the estimate and actual costs at closing.  They don’t include all costs.  You may also incur closing costs such as home inspections, personal attorney, title insurance, etc. in addition to the costs noted on a GFE.

There are some “fixed” costs that won’t vary between banks.  These would include items such as recording fees, transfer tax, mortgage tax, flood certification fee, and credit report fee.  Then there are “variable” costs that will differ between banks.  They refer to these by many different names such as:  commitment fee, settlement fee, underwriting fee, document prep fee, bank attorney fee, etc.

The federal government came up with a way to compare loans that takes into account these differences.  It is called the APR, or Annual Percentage Rate.  The APR will usually be higher than the “note rate”.  The “note rate” is the actual interest rate you are paying.  The APR uses that rate but adjusts it to include the closing costs for that loan. 

Although the actual APR calculation is a little more complex than this explanation, it should give you a basic idea of how it works.  Basically the way the APR is calculated is they take the amount you are borrowing and subtract off your closing costs to arrive at the actual net amount you in theory are borrowing.  They then take the monthly payment based on the note rate and term of the loan and recalculate the interest based on the new net adjusted balance they calculated.  In essence they back into a new interest rate.  That rate is the APR.  

When meeting with a mortgage professional do ask them for an estimate of closing costs so you know which one has the better deal.  This won’t be an official GFE, unless you actually apply for a loan, but you do need some sort of idea of your cash need for closing, including bank fees, down payment and other closing costs. 

Actual costs at closing should be very close to the estimates.  A variance of $100 to $200 is OK, but $500 to $1000+ is not.  As mentioned above a new law went into effect the end of 2009 which helps protect borrowers from huge differences between the official GFE estimate at application and the actual costs incurred at closing. 

Part of the closing process involves a review of a preliminary closing statement.  That is done to make sure that items don’t appear on the closing statement that didn’t appear on the estimate.  It also allows you time to review the individual items with your mortgage source in the event there are discrepancies. 

Many times the overages are in fact accidental and you have time in which to get these corrected before closing.  Trying to get a bank to refund money after the fact or attempting to get things changed at closing will be a very frustrating process.

Next; Not Having a Clear Idea of One’s Needs and Wants.