How to shop for a home loan
Who to contact
It’s always best to work with a recommended lender. Do some research. Ask a trusted advisor or close friend. Financial institutions and mortgage banking companies are usually good sources for home loans. Your lender should be experienced, know the local market and have a solid reputation. Select the most knowledgeable, friendly and responsive lender – and a lender you believe you can trust.
Perform due diligence
After speaking to prospective lenders, perform due diligence. The NMLS may be a good place to start. NMLS stands for Nationwide Mortgage Licensing System. The NMLS regulates U.S. residential lenders. Each registered Mortgage Loan Originator (MLO) has a unique identifier number on their business card and website. Search the NMLS for their history. The Better Business Bureau also lists any complaints.
Keep all email communication
A common problem when obtaining a home loan is miscommunication. Make sure that you discuss the specifics of your loan request with your lender through email if possible and keep your email history. Your earnings, employment history, credit scores, verified assets for down payment, closing cost figures and information about the property – these are all critical details. You must be honest in all details, and so must your lender. If there are issues your email history could be vital and help resolve the problem.
Ask the right questions and get the facts in writing
Confirm your loan program, interest rate, rate lock-in period, closing costs and other details in writing. Underwriting standards have tightened in recent years and vary with each lender. More regulations and disclosures have impacted the process. Allow 45-60 days from loan application to loan closing. If someone quotes you 2 weeks to process and close your loan, they may be over-promising. Proceed with caution. Carefully review your Loan Estimate and Closing Disclosure – as these are key documents.
Loan terms and timelines should meet your contract provisions (if buying)
Verify that your lender can meet your contract financing contingencies and closing date. If you need a 96.5% FHA loan (3.5% down) and you need to close in 40 days, but the lender does not offer FHA loans and requires 60 days to close, that’s a problem. If you’re buying a home from a builder and you need a 180-day rate lock-in (to protect current low rates during construction) then you’ll need a lender that offers extended rate lock programs. The lender must meet terms & timelines stated in your contract.
Loans with pre-payment penalties
Avoid loans with pre-payment penalties. Make sure the initial Loan Estimate and final Closing Disclosure provided by your lender clearly state that there is no pre-payment penalty on your loan. You should have the option to pay a portion of the balance or pay the entire balance early without penalty.
Adjustable rate mortgages
Adjustable Rate Mortgages (ARM’s): Unless you are comfortable with potential rate increases in the future, consider a fixed rate mortgage. If you will own your home for a short period (i.e. 2-3 years due to a military assignment or a short-term corporate relocation), an ARM loan could be a favorable option to obtain a lower rate for the short-term stay. Even then, ARM loans are a higher risk financing option.
Risky loan terms – demand or balloon features
Avoid loans with a Demand Feature. This means the loan will come due or mature at some future date. These programs are often called "balloon mortgages". While balloon mortgages are taboo under the Dodd-Frank Financial Reform Bill and QM (Qualified Mortgage) guidelines for owner-occupied homes, some small banks offer these products as “Portfolio Loans”, not subject to all federal guides. Don’t accept a balloon mortgage unless you have the cash to pay off the loan.
Avoid loans with Mortgage Insurance (also called MI, PMI or MIP) if possible. Mortgage Insurance protects the lender in case you default. Don’t get this confused with Credit Life Insurance, which may pay off the loan in the event of death of a borrower. Mortgage Insurance is required on FHA loans, or Conventional loans with less than 20% down payment (equity). If you must pay Mortgage Insurance, select a Conventional Loan if possible (i.e. Fannie Mae), as the monthly MI premium may be removed in the future when your loan balance is paid down, and timely payments have been made.
Interim loans – proceed with caution
Interim loans are typically offered to finance construction of a home. Don’t confuse an Interim Construction Loan with a Construction-Permanent Loan (C-P loan). C-P loans are usually structured to “roll” into a permanent loan automatically when the home is complete. An interim loan is usually for 12 months and may have a demand feature. If something changes (i.e. loss of job or a serious issue arises with your builder), the home may not be complete or you may not qualify for a permanent loan.
Escrow accounts for real estate taxes and home insurance
You may be required by your lender to pay into an escrow account for real estate taxes and homeowner’s insurance. The escrow is collected with your monthly principal & interest payment. Unless your loan plan requires this (as with FHA loans), you may want to pay these expenses on your own. If you have 20% down (or 20% equity in your property in the case of a refinance loan), you should have the option to pay taxes and insurance expenses separately. This is commonly called an “escrow waiver”.
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Financing a New Home
Whether a new home appeals to you because you want a property built for today’s lifestyle and up to today’s standards or you just like the concept of being the first owner of a home, your financing options are similar to purchasing an existing home. You can use government-backed loan programs such as FHA and VA loans or conventional financing, but you also have the option of working with a lender designated by your builder.
Similarities to financing a resale
Before you start visiting model homes and deciding which features are the most important in your new kitchen, you need to take a step back and get ready to finance your home – just like you must do if you are buying an existing home.
Key steps along the way to buying a home include:
- Deciding how much you can afford to spend.
The most important first step before you buy a new home or an existing home is to determine how much you can comfortably afford. While a lender can tell you how much you qualify to borrow, it’s essential for you to take all your expenses and your overall financial plans into consideration to come up with your personal monthly housing budget. For instance, if you want to save more for retirement or college tuition or enjoy a weekly round of golf, those are expenses that your lender won’t know about when qualifying you for a loan.
Don’t forget that your housing payment includes principal and interest, property taxes, homeowner’s insurance and possibly mortgage insurance and homeowner association dues. You can use a mortgage calculator to get an estimate of what you can afford at various interest rates.
- Checking your credit profile and credit scores.
Your next step for a new home or an existing home is to check your credit report and your credit scores. Visit www.annualcreditreport.com to request a credit report from each of the three bureaus (Equifax, Experian and TransUnion) and read it carefully. A recent study found that one in four credit reports had some type of error. Start the process to correct mistakes as soon as you can because it can take months depending on the issue. If your credit score is lower than 740, see if there are changes you can make to improve your score because scores above that limit garner the lowest interest rates on conventional loans.
- Check out your resources for a down payment.
Determine how much cash you have available for a down payment and other purchase costs. If you make a down payment of less than 20 percent, you’ll need to pay private mortgage insurance, which will increase your housing costs. Keep in mind that your buying power could be greater if your builder pays for closing costs on your behalf.
- Gather your documentation and information.
You’ll need two recent paystubs, bank statements from your checking and savings accounts as well as 401k and investment accounts, employer information and your recent addresses. If you’re self-employed, you’ll also need two years of tax returns. Have a general idea of your budget for household expenses that don’t appear on a credit report such as child care costs, insurance premiums and daily living expenses.
- Meet with a lender to estimate your borrowing power.
The first lender you consult doesn’t have to be the one you work with to finance your home. In fact, it’s best to shop around to compare lenders and loan programs. Regardless of whether you are buying a new home or resale, your loan approval will be based on your creditworthiness, your income and assets, your job history and your debt-to-income ratio. Your debt-to-income ratio, which compares the minimum payment on all your ongoing debts including your mortgage with your gross monthly income, generally must be 43 percent or lower to qualify for a loan.
Compare loan products
Part of your estimation of how much you can afford to spend on a home depends on the loan term and the type of loan you choose.
- Loan terms: While the majority of first-time buyers opt for a 30-year fixed-rate loan in order to keep their monthly costs as low as possible, mortgages are also available for 20, 15 and 10-year terms. The shorter loan term has advantages such as a lower interest rate and the ability to build equity faster and pay off your house in full more quickly. However, the monthly payments will be higher since the loan repayment period is shorter. You can also look into adjustable rate mortgages (ARMs), which have a lower interest rate for a determined period such as 5, 7 or 10 years and then adjust periodically. Check out your options for each of these loan terms to determine which meets your current and future needs best.
- Loan types:
- Conventional loans. If you have good credit and the cash for a down payment of five percent or more, a conventional loan often has the lowest interest rates. Some conventional loan programs are available with a down payment requirement as low as three percent. Keep in mind that mortgage insurance is required on these loans if you make a down payment of less than 20 percent.
- FHA loans. Loans insured by the Federal Housing Administration require a down payment of just 3.5 percent and have more lenient credit standards, so if you have some credit challenges this may be best for you. Keep in mind that you must pay mortgage insurance on these loans for the entire time you keep the mortgage.
- VA loans. If you are a veteran or active duty military person, a VA loan is an excellent option because it requires no down payment at all and no mortgage insurance. You will need to pay a funding fee that can be wrapped into the loan.
- USDA loans. If you meet income requirements and are buying a home in a designated rural area, this loan program could be ideal since it has looser credit standards and no down payment requirement.
Builder financing options
The main difference between buying a newly built home and an existing home is that your builder, particularly if the company is a regional or national builder, is likely to have an affiliated mortgage company or a list of preferred lenders. Many builders offer buyers incentives to work with their lender such as the payment of closing costs or free options such as a finished recreation room or a sunroom addition. Builders want buyers to work with their lenders so they can be certain that the loan will go to settlement at the right time and that the lender has experience with the construction process. Financing your home with the builder’s lender isn’t required, although often the incentives are valuable to buyers. However, the fees and interest rates offered by the builder’s lender may not be as low as those offered by other lenders. It’s best to shop around a little and compare loan programs, rates and fees before deciding how to finance your home. Chances are the builder’s incentives are enough to entice you to work with the preferred lender, but it’s best to make an educated decision.
Determining when to lock in your rate
Another major difference between financing a resale or a new home involves timing. Typically, a resale purchase will close within 30 to 60 days of going under contract and a lender will lock-in your interest rate for that time period. Building a home takes four to nine months or longer in some cases, so you’ll need to lock in your rate after the home is partially built. A lender with experience with new construction can advise you when to lock in your rate and for how long. Lenders will charge you a fee for a longer lock-in, but some will refund the fee at the closing.
Financing for custom home building
If you plan to build your own home as a general contractor or hire a custom builder, you’ll need specialized financing in the form of a construction loan. Typically, a construction loan has two parts: an initial loan of one year or less to pay for the actual construction process followed by a permanent loan that finances your home for a period of 15 or 30 years like a standard mortgage.
Construction loan tips:
- You’ll generally need excellent credit to qualify for a construction loan. Lenders view these loans as riskier since the loan is being made on a property that has yet to be built.
- A down payment of 20 to 25 percent is usually required on a construction loan, but in some cases lenders have special programs that allow you to make a smaller down payment.
- Not all lenders offer construction financing, so you may need to search a little, particularly among local or regional banks and credit unions, to find a lender. Custom homebuilders can often recommend a lender with whom they have experience.
- While some lenders offer the option of converting your construction loan into a permanent loan, others require two separate closings for the loans– each with closing costs to pay.
- Keep in mind that you’ll need to pay for appraisals and inspections for your custom home. Construction loans usually have an installment schedule of draws from the loan balance to pay for various phases of the building process. Your lender will usually require inspections at each of those phases to make sure everything is completed and meets building codes before disbursing the funds.
Loans for move-up buyers
Negotiating the transition from one home to another can be tricky, particularly when you have some uncertainty about exactly when your newly built home will be complete. A bridge loan can be a useful financing tool for this period. If you lack the cash for a larger down payment on your new house, but have enough equity in your current home, a lender can offer you a bridge loan for the down payment on your new home. Bridge loans typically require excellent credit and are short-term loans that carry a higher interest rate than traditional loans. You’ll need to qualify for the payments on your current mortgage as well as the bridge loan payments and the payment on your new mortgage, although lenders understand that this is a short-term situation that only occurs until your current home sells. You’ll use the proceeds from that home sale to pay off your current mortgage and your bridge loan.
Local lenders are usually best for bridge loans since they understand the market dynamics and can evaluate how quickly your home will sell with the help of a local real estate agent.
Discuss your financing options with several lenders, preferably with experience financing new homes, so you can evaluate your many options and make an educated choice.
Michele Lerner is an award-winning freelance journalist and author based in Washington, D.C. who has been writing about real estate and personal finance for more than two decades. She writes for consumers, Realtors and investors. Her work appears regularly in The Washington Post, New Home Source, Bankrate, Fox Business, MSN, Yahoo, The Motley Fool, REIT magazine, Realtor.com, HSH.com and numerous Realtor association publications. She is the author of "New Home 101: Your Guide to Buying and Building a New Home" and "HOMEBUYING: Tough Times, First Time, Any Time."