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Mortgage Insurance: The Basics

Mortgage Insurance generally has a negative undertone when I discuss financing with clients.  Most new homebuyers pay mortgage insurance in some form, either monthly, as a single-premium, or as lender-paid.  Unless you are qualifying as a conventional loan with 20% down or are a VA borrower, you will pay mortgage insurance.  But how you pay it can be an advantage, saving you money in both the short term and long term.  If you must pay mortgage insurance, let’s use it to our advantage.

Fun Fact

Conventional loans with a loan-to-value (LTV) less than 80% must pay mortgage insurance and will typically have a slightly lower interest rate than a loan with 80% LTV.  As crazy as that sounds, it makes sense.  Here’s why:

Loans that have mortgage insurance go through a second underwriting process through the mortgage insurance company such as MGIC or National MI.  This is a third-party underwrite.  In addition, the loan itself is insured against potential losses to the bank in the event of a foreclosure or short sale on the home.  The bank purchasing the loan will price the interest rate better than 80% LTV because layers of risk were mitigated and insured.  Think about it, the bank lends on risk/reward.

3 ways to pay PMI with Conventional Financing

Mortgage Insurance, for conventional financing, is priced/scored based on the borrower’s FICO score and LTV or down payment.  The better the FICO score, the better the pricing.  Each option comes with a list of considerations before picking which option is the best.  A later blog post will outline these considerations.

  • Monthly PMI – The most common method for paying mortgage insurance because it’s the cheapest in the short term.  Many borrowers pay the monthly factor and refinance once their home appreciates to having 20% equity.  There is no additional fee added to closing costs to have monthly PMI.
  • Single-Premium PMI – Becoming more common when borrowers have high FICO scores and are putting 10% or more down to buy a home.  This option “buys out” the monthly PMI and is tax deductible through 2020, for now.  Visit the IRS site for additional details.  A borrower can also refinance with single-premium PMI and include the cost in their loan amount if it makes sense.
  • Lender-Paid PMI (LPMI) – With LPMI, the lender pays the single-premium mortgage insurance on behalf of the borrower with a higher interest rate.  The result is no upfront expenses and no monthly PMI.  As some point, the borrower will want to refinance to get a lower rate, provided the equity is at 80% LTV to avoid any PMI.  LPMI requires a thorough review of a borrower’s profile to understand how their payment is impacted. 

FHA vs Conventional

Borrowers should note that monthly mortgage insurance is not permanent on conventional loans like it is for FHA loans with less than 10% down or less than 10% equity.  The Homeowner’s Protection Act of 1998 (HPA) mandates that PMI (mortgage insurance) on conventional financing must drop once the loan amortizes to 78% LTV.  On FHA, you must refinance (or payoff your mortgage) to eliminate the mortgage insurance for any new loans originated today with less than 10% down. 

However, it is possible to request the Mortgage Insurance company to drop your PMI before your loan amortizes to 78% LTV if you have a conventional loan.  If the equity in your home has appreciated to 75% and you’ve held the PMI for 2 years, you can request the Mortgage Insurance company to perform an appraisal to show the value is 75% LTV.  Some of my clients have been successful in this approach.  They can keep their first mortgage terms such as the interest rate and remaining loan term.  A good mortgage advisor will be able to help you forecast expectations and plan reasonably for different considerations.

Summary

Mortgage Insurance enables First-time buyers and seasoned homebuyers to access homeownership without breaking the bank.  The overall cost of PMI is minimal compared to the equity gained over a short period of time.  It allows consumers to keep additional cash, otherwise used for the down payment, in their saving accounts and budget responsibly for homeownership. 

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When is a Good Time to Buy a Home?

The first time the idea of purchasing my first home came to light, it was my future father-in-law that made the suggestion.  This was 2 years before I became a loan officer in 2012.  I was working in retail finance, but had so much debt from school, the idea of homeownership never crossed my mind.  The suggestion from my future father-in-law came up because I needed a place to live.  It also may have been a plot to marry his daughter, my now lovely wife.  But we will move on from there.

Necessity vs Timing

Most of the time, people get the idea of purchasing a home because they have a lease coming due to either renew or move on to a new place.  This creates a necessity for maybe buying a home.  It feels convenient to start looking for a home to buy right away when these scenarios come up:

“I am paying $1700 to rent, my lease is coming due, I’d rather pay this money toward a home”. 

Or, it’s: “I am paying $1700 to rent, my landlord is selling the place, they are requiring me to move.” 

Finally, some scenarios playout like this: “I am paying $1700 to rent, my landlord is raising my rent to $2000, I need my own place”.

Everyone’s example of necessity is different.  I find that most prospective borrowers are not prepared for WHEN this time comes.  It’s never a matter of IF this happens but WHEN this happens. 

Take note, you may not be in the position to buy a home now, but it makes good financial CENTS to start preparing and planning for this later.  You then can take necessity and control it with your timing.  Preparation is the key to anything financial and puts YOU in control of your necessity.  Check out steps to pre-qualify for a home loan

Income, Credit, Assets

Perfect credit nor a six-figure income are necessary to purchase a home.  It’s true that your income, credit and assets determine how much you could pre-qualify for or afford for a mortgage payment.  Here are some general tips for when it’s a good time to buy a home:

  • INCOME – You should have a 2-year work history.  This simply means you should be able to show you have consistently earned some sort of income, generally in the same line of work.  There are many types of income considerations, especially for self-employed or variable income borrowers.  Stable and consistent are what the underwriting guidelines measure.
  • CREDIT – A 740 FICO is not required for qualifying for a mortgage loan, nor is perfect credit.  Government loan programs (FHA, VA, & USDA) have exceptions for certain types of credit from how low the scores can be to when a bankruptcy must be seasoned by.  I’ve had Buyers at 580 & 600 FICOs qualify and purchase a home.  Others had bankruptcies seasoned 2 years or less.
  • ASSETS – Down payments are not as scary as some people imagine and are much lower than people realize.  Veteran borrowers need $0 down (in most cases), FHA buyers need at least 3.5% of the purchase price and Conventional buyers can put either 3% or 5% down as the minimum, depending on their income profile.  See more about down payment sources

Market Influences

Have you heard in the last 10 years, “It’s a great time to buy a home!”?  This phrase has been used so much over the last 10 years that it frankly means nothing anymore.  Yes, it is still a good time to buy a home.  But we must ask ourselves WHY in the new decade.  The last 10 years included the recovery of the housing crisis from the recession of 2008.  Analysts are saying we’ve recovered from 2008 and are now where we should have been (hence why it’s called a recession).  So, what does that mean for the future?

The future of homebuying remains strong for most markets largely due to technology and how business is conducted.  Right now, the southwest is a hot market for new emerging and developing businesses and becoming a safe haven for year-round operations for manufacturing and call center business types.  Property taxes, land, and cost of living are much less in most parts of the Southwest and offer a lifestyle for employees that most of the country cannot compete with including year-round sun, Interstate access for distribution, and close proximity to places like California, Las Vegas, and Mexico.  Basically, housing in the Phoenix Metro area is going to continue to thrive, even in a recession because Arizona is what Governor Doug Ducey calls “open for business”. 

What does this mean for buying a home in our market?  Your property value will continue to appreciate even now.  There is a shortage of housing in Phoenix for homebuyers and renters alike.  As our market attracts more businesses, there is a need for housing all over the valley.  It’s basic supply & demand with housing and it’s expected to continue.  Your home will continue building wealth for your future.

Summary

Buying a home is personal and not always for everyone.  See Beyond the Numbers.  It takes some responsibility to understand the opportunity.  Only you can make that decision.  10 years ago, the decision was easy because home prices were extremely low.  Today, it’s a little more complex only in as much the level of preparation of the prospective buyer.  We are here to help in that preparation.

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6 Different Down Payment Sources

I speak with a lot of prospective homebuyers and nearly always get the question “where can my down payment come from”?  It’s a good question because there are specific sourcing requirements regulated by underwriting guidelines with FHA, VA, USDA, and conventional financing.  Down Payments, next to income sourcing, cause the most headaches.  Below is a general idea of where the down payment for your home can come from.

Income Tax Refunds

This time of year is notorious for people thinking of buying a home largely due to anticipated tax refunds.  Tax refunds open the doors for paying down large chucks of debt and/or putting at least the minimum down payment up for buying a home.  This is an acceptable source of funds for down payments.

However, you should have these funds in your possession before you shop for a home.  Unfortunately, you risk deposits and money paid up front for services like a home inspection and appraisal if you start shopping too soon. 

401k Loan & IRA accounts

If your company offers a 401k retirement plan, you should be contributing to it every paycheck.  Over time, your vested balance builds and helps create some sense of retirement savings.  The majority of plans allow you to borrow against your 401k, creating opportunities to consolidate debt at a lower rate or fund the down payment needed for purchasing a home.  Every plan is different, but typically you can borrow up to 50% of your vested balance.  Many homebuyers I speak with do not realize the power of this asset.

Your payments on the loan come directly from your paycheck each pay period and are based on a loan term you set.  In addition, there is no credit check for this loan, and it does not count against you when calculating how much you qualify for because the money borrowed is secured by the balance.  The downside to this is most of the time, the money your loan is backed by may not be invested in the market, causing you to lose earning potential. 

The IRS allows a one-time first-time homebuyer penalty free withdrawal from your traditional IRA account of up to $10,000 for a down payment to purchase a home.  You will likely pay taxes on the money withdrawn, but not the 10% penalty for being less than 59 1/2.   Visit the IRS site for more details.

Gift Funds

Many people are surprised to learn that a family member or spouse can gift you the funds needed for the down payment to purchase a home.  If purchasing a primary residence, that gift can be 100% of the funds needed when it’s a FHA, VA, USDA or conventional loan.  Jumbo financing allows a gift of funds, but usually 5% of the funds needed must come from the borrower. 

If you have a family member willing to gift you the down payment, make sure you speak with your Loan Officer about how they should transfer the funds.  The paperwork gets tedious if you do not follow instructions and can cause anxiety for the donor.  For information concerning taxes & gifts, consult your tax preparer.

Your Money Saved & Small Business Account

Funds that have been seasoned more than 60 days in a bank account can be used for the down payment on a home.  The bank views this as a compensating factor when determining your loan eligibility.  It does not mean you will be denied a loan with the other forms of down payment.  Simply that the bank considers your ability to manage money in your favor for having saved up to buy a home.

If you are self-employed, your business funds can be used as a down payment for a home.  Certain requirements must be met for this to work.  But it is possible.

Cash on Hand

Probably the most common question we get is “can I use my mattress money for the down payment”?  The majority of the time the answer is no.  However, if we can show a pattern of cash withdrawals that add up to the cash you have on hand, then yes, it is possible to use cash on hand.  Certain requirements must be met such as reviewing 12 months of bank statements (or more) to “find” the cash withdrawals.

Trust me, it’s much better to have the other methods serve you with the down payment than this option.  I’ve done it before, and it was extremely time consuming for both the borrower and the underwriter.

1031 Exchanges & Equity on Sale of Home

A 1031 exchange is a tax code that allows the Investor to use the equity of the sale of a home (usually investment property) as the down payment on another home (usually investment property) to avoid paying the capital gains tax on the equity.  In cases where a borrower is selling their primary residence home and the equity is above the maximum allowed where taxes would be due, they can also do a 1031 exchange on the home they are buying.

Most homebuyers won’t need to consider a 1031 exchange.  Yet, there are many circumstances you may decide to sell your current home and use the proceeds of that sale to purchase another home.  You may do this in a simultaneous closing scenario, meaning you do not need to have the cash in your account right away.  Certainly, your Real Estate agent will need to help prepare you accordingly.  But this is an option if you own a home and still need cash for purchasing a home.

 Summary

The list can actually go on with down payment types and sources.  This is a good chunk of the opportunity where a borrower might consider coming up with a down payment.  The amount of down payment needed will be discussed in another post but depends on the loan program, type of loan, investor requirements etc.  In addition, not mentioned are Down Payment Assistant Programs.  For now, use this as a general guide for understanding where you might be able to come up with a down payment.  Reach out if you have a scenario for us to run by!

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Beyond the Numbers

Owning a home can be as abstract as the American Dream.  It is what you make of it.  But I firmly believe there are fundamental values in Homeownership that go beyond the numbers.  I mention on my site, “a place to call home” as a bullet point of owning a home.  This is what I mean.

Homeownership brings families together

This idea is not the end all to solve all the world’s problems.  But it is a good start to promoting family values which in turn help contribute to good virtues in a culture.  These things can lead to economic development and a healthy outlook on life.  It’s that hope we long for in building our families and passing on a legacy to children.  Home is where traditions form or carry on which always help bring families together making our most precious commodity, time, of importance.  When we focus on our families in a comfortable setting, we are at home in some form.  In this case, it’s YOUR home. 

A voice in your community

A lot of attention today is focused on what is happening all around the world.  But what about your community or small neighborhood?  Homeownership has always promoted a vested interest in the community surrounding you; your neighbors, the local coffee shop or restaurant, High School athletics, small businesses, etc.  Who determines how the community is formed?  It’s always been the current Homeowners of today, not the owners of the past.  There is certainly a legacy to be honored with the past.  Continuing to maintain a community is also part of Homeownership. 

My personal experience with this has evolved in the last few years participating with the local Chamber of Commerce, events, and developing great relationships with my surrounding neighbors.  My reasons for being involved in some capacity were about creating a legacy for my kids and setting an example of what civic duty and responsibility looks and feels like.  The rewards have been abundantly great and created a vested interest in what happens with the future of the community we live in.

Homeownership & Stability

Owning your home certainly has its financial benefits.  Ways you can manage your equity can be found here.  Beyond the numbers it also promotes a sense of stability.  In times of a slow down with the economy or your business, your home may get you through the event because you developed good financial literacy in the process of ownership.  Your mortgage payment and overall household expenses are reasonable enough with budgeting and a slow period.  The added advantage is not needing to uproot your family because your lease is coming due or a Landlord wishes to sell the home to someone else.  While it’s not the ideal situation, selling might be what you need to gain new ground in starting over. 

None of us are immune to the risk of a slowdown.  In 2014, when I was beginning a new career, I sold my home to start over financially, using the equity to pay expenses.  While it was a difficult time, I was happy that I owned my home and had that opportunity.  Within 15 months, I bought a new home so that our family could have that sense of security once again.

Conclusion

Talking with people about the value of homeownership often brings about this kind of conversation.  The numbers can make sense to nearly everyone.  But the action of “taking the next step” is almost always because of a hope or dream of some kind.  It usually comes from the heart in the end.  That is truly beyond the numbers.

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3 Steps to get a Loan Pre-Qualification

When you first decide you are ready to buy a home it’s tough understanding what steps are needed to get started.  Having the right professionals to guide you and walk you each step of the process is crucial.  Your Real Estate Agent should have a good idea of what steps are needed and who can help you through each phase.  In this article, we will discuss the steps to getting pre-qualified for a home loan with a lender.

Something to Note:

Make sure to do your due diligence with lenders before releasing any personal information over the phone or electronically.  One of the many ways to verify a licensed Loan Officer is to request their NMLS number and look it up at NMLS Consumer Access where you can verify their name, company, and office location.

Step One – Speak with a Lender

This seems easy enough but if you are new to homebuying, you may not know what questions to ask or how the first conversation will go.  Here are some ideas and things the lender might discuss:

  • How long have you been renting/leasing?
  • What kind of monthly budget are you planning for?
  • Is this your first home purchase?
  • Are you self-employed or do you work for a company?
  • Are you married?

That first encounter with a lender is discussing basic background to get to know you and better understanding how they can help you with your financing.  These questions all serve a specific purpose in proposing the best loan program for you.

Credit Reports

The FREE credit score provided through banking and/or online sites is not an accurate representation for the FICO score pulled with a mortgage lender.  There are 2 types of credit reports a lender can pull; hard FICO Pull & soft FICO Pull.  Hard Pull credit reports will report a new credit inquiry on your FICO report where a soft pull does not show as an inquiry.  Unless abused, typically a hard pull for mortgage purposes does not have a substantial impact on your FICO score. 

The soft pull report is for informational purposes and typically cannot be used to make a true pre-qualification for a home loan. 

A true pre-qualification for a home loan should include a hard FICO pull so the lender can run the Automated Underwriting System (AUS) to determine loan eligibility.  The AUS review is crucial because it reads the income, credit and assets against underwriting guidelines to determine eligibility.

Step Two – Send your Lender Documents to review

Your lender may request initial documentation to complete a pre-qualification review.  The documents include information that describe your income, assets and credit.  It is NOT a requirement to send a lender documents during the pre-qualification phase.  However, it is highly recommended to both save you time and money AND to give credibility to your pre-qualification when submitting offers on homes.

Your initial documentation can reveal opportunities for getting a better interest rate or qualifying for a higher loan.  Below is a sample of some of the initial documents a lender may request:

  • Last 2 years Tax Returns, W2 forms, and/or 1099 forms
  • Last 30 days Pay Stubs
  • Social Security and/or Pension Award Letter(s)
  • Most recent bank statement(s)
  • 2 forms of identification
  • DD 214 Member copy 4 (VA Loans)
  • Signed authorization to review credit

Most of the time, clients are working over the phone or email.  Just be sure you are sending everything securely to your lender.  Financial institutions do everything in their power to protect your information.  Request a secure way to send your documents if submitting electronically.

Step 3 – Review your Pre-Qualification

Your pre-qualification review should be a blueprint of your loan program and product when you enter into a purchase contract to buy a home.  The pre-qualification serves as credibility that you can secure the funds needed to buy a home from a seller.  The work put in upfront in this phase is preparing the way for when you find your dream home!

Conclusion

Pre-qualifying can take as little as a day to as long as a couple weeks depending on the client and/or sometimes the circumstances of the review.  No matter how long it takes, preparation is key for the success of any home loan closed.  Having the right team to support you in your home search can ensure that success.

A good Lender or Loan Officer is willing to take the time to answer your questions and discuss the lending process.  You do not need to commit to anything when you speak with a Loan Officer about your prospect of buying a home.  If you feel pressured into commitment, hang up and call someone else for guidance or elect to meet with the Loan Officer in the office.

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4 Ways to Manage Your Home’s Equity

Many people have asked me recently how they should manage their home’s equity now that the housing market has stabilized.  It’s a great question and one that signals signs of health and growth in the housing market.  Here are 4 ways to manage the equity in your home.

  1. Payoff Debt

Your home is like a bank where the value can be turned into cash for what you do not owe on the original loan, within reason.  Many of my clients are finding their home’s value is a great vehicle to manage their monthly cash flow and payoff their consumer debt such as credit cards or personal loans.  Remember that the interest on credit cards is not amortized to be “paid off” anytime soon and the interest you pay on revolving debt and most personal loans is much higher. 

Through a cash-out refinance on your first mortgage, you can take the equity and apply that money to paying off your debt.  We recently closed a loan with this very scenario and the borrower is saving $1400 a month on their expenses by consolidating their credit card debt into a refinance.  Their mortgage payment goes up, but their monthly cash flow goes down significantly.  See below:

2. Home Improvements

Home improvements can do a lot for your home’s value in the future, not to mention it’s resale value when you decide to upgrade or right-size your home. You can access the equity in your home for home improvements either through a cash-out refinance or Home Equity Line of Credit/Loan (HELOC).  Both offer their advantages depending on your goals.  You can also use a Renovation Loan through FHA’s 203k loan program or Conventional’s Homestyle loan program.  Check out my Blog Post on the Renovation loans.

Some banks and credit unions will consider a HELOC for home renovations at a greater loan-to-value (LTV).  For example, one institution goes up to 130% LTV for home improvements with a General Contractor bid.  Others will go up to 100% LTV on a HELOC.  But you MUST read your loan terms. 

HELOC’s are generally interest only payments for the first 10 years meaning you are not reducing any of the principle money owed.  This is why a HELOC is not a good option for debt consolidation.  You should have a strategy for paying off your HELOC or Equity Loan before signing the paperwork.  This can make doing a simple cash-out refinance more attractive because the risk is less involved only making one house payment vs two!

3. Sell your home & Payoff Debt

You’re kidding right?  Why would I sell my home and buy another when I’d be paying more for the house and a higher rate on my mortgage?  6 Reasons to Buy a Home

Great question!  It’s because if you are paying a lot of consumer debt you can payoff that debt from the sale proceeds and still put a down payment on a new home.  In the end, you can save on your overall monthly expenses and truly save that additional cash you’d otherwise be paying on debt.  It’s an opportunity if you are contemplating buying a new home and don’t know how it will affect your monthly expenses considering the mortgage payment may be higher than what you are paying.

Take the image above as an example.  This borrower can sell their home at market value, take the equity and payoff $35k in consumer debt totaling $1,274 in monthly minimum payments.  They will still have funds left over for a 5% down payment on a conventional loan and save $454 a month overall with a new mortgage on a new home. 

We can take it a step further and take the $983 they are saving through debt consolidation and apply that as a principle reduction on their mortgage every month.  They will pay off their mortgage in less than 15 years and ultimately save over $80k on interest.  Pair this with an Adjustable Rate Mortgage (ARM) product and you can understand the power of prepaying your mortgage.  Mortgage qualifying is more than the interest rate but the planning for wealth in the future.

Housing Strong Going into 2019

4. Sit & Relax

The last way to manage your home’s equity?  Do nothing at all and enjoy the appreciated gains.  Just because I love German Chocolate Cake doesn’t mean I eat it every day.  Sure, it’s not as much fun and you could do other things that aren’t limited to this list.  You can get creative and start a business, invest in other real estate, make principle reduction payments, or buy your vacation home. 

Whatever you decide, just be smart in your decision and planning processes.  Get your own Homebot Report or read my latest Blog Post on Homebot.  The sit & relax approach is having the confidence knowing you have access to your home’s equity when you need it or when an opportunity arises.  If you are interested in a FREE report on how your Home Equity can be used, send me a message and we will discuss your options!  Thanks for reading.

-Chris

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The Hidden Cost of Renting

A long time ago, before I ever worked in mortgage finance, I moved 5 times in one year between apartments and friends homes.  I finally landed living with my Grandparents so I could finish school and afford my bills.  I struggled financially and was truly grateful for my Grandparents taking me in.  I finished school and later moved out shortly thereafter.  But all those moves taught me something valuable; renting and moving are expensive.

Granted, the average family is not moving 5 times in a year.  In fact, they may move once every year or two.  While my expenses added up much faster, it occurred to me that even the one move or continuing the rent cycle adds up overtime both in dollars actually spent and missed opportunity with rising interest rates and home value appreciation.

Convenience

Renting a home can be more convenient for a number a reasons; A Landlord takes care of major repairs, you are not committed to living there permanently, and sometimes it will be less expensive in the short term.  Yet, the same considerations for renting can translate into homeownership becoming a better option for convenience. 

As a homeowner, you are your own Landlord.  You will need to maintain your home.  But YOU maintain your home to YOUR standards, not sub-standards to save a couple bucks.  YOU control the level of work done with repairs and maintenance.  I have heard countless stories of how Landlords fixed a broken water heater or dishwasher with a used one as the replacement for the appliance to just give out on them a month later.  Another story involved a leaking roof that the landlord did not fix properly which later created black mold issues in the home.  While you are responsible for your home, the quality of life can be much better.

Rental Rates on the rise

According to an Inman article with CoreLogic data, rental rates increased 6.9% in 2018 in Phoenix and 3.1% Nationally due to job creation and limited supply for housing.  Phoenix is listed as one of the top markets for cost of living affordability and economic growth.  This means owning a home and/or buying a home in 2019 will still help you take advantage of an appreciating market when values increase. 

The housing demand is noticed locally in the Phoenix market with many new home projects underway.  That’s because both single-family homes and rentals are in such high demand for new families, growing families, college graduates, divorcees, and retirees.  Between rising rents, right-sizing and job growth, people are looking to fix their monthly expenses while leveraging wealth creation.

Looking at the Numbers

Let’s dig deeper at the numbers.  Take a 3 bed 2 bath single-family home valued at $250,000 in a neighborhood.  Rent is $1,600 per month.  Below are additional expenses:

Security Deposit: $500

Pet Deposit: $300 (if applicable)

First Month’s rent: $1,600

Moving: $1,500 – $3,000

Total: $3,900 – $5,400

Cost of Waiting

Your total cost of entry is nearly 75% of the down payment needed to purchase a home.  And, you “skip” a payment when the mortgage comes due.  When you try buying that home in a year or two, you will likely pay more for the home which will increase your cost of entry and the monthly payment due to rising rates and appreciation on the home’s value.  Appreciation occurs when the supply is lower than the demand.  Homes in this price point are hot in today’s market.  See below:

The chart above depicts the historical appreciation in Maricopa County.  The conclusion to consider is how much more you will pay for every year you decide to wait.  The appreciation of home values makes the cost of entry higher.  If rental rates are themselves expected to increase, why wouldn’t home values increase?  Remember, there is a supply and demand issue. 

Amortization is a way of spreading out the cost of something.  For housing, it means payments of money owned/borrowed (principle) and the cost of money (interest).

Looking at amortization (principle payments) and appreciation combined, you start to see how owning a home creates wealth.  The cart below depicts how overtime the money you are paying into a home works for you.  After year one, you would gain $15k in ownership.  This combines the money paid toward your principle and the equity gained.  In year two, that number doubles to $30k.  Paying $1,600 per month towards rent ($19,200 over 12-months) goes toward zero.

Summary

As a lender, it is obvious I am a proponent of homeownership.  Afterall, it’s my business.  I am not opposed to why someone will continue renting and in some cases, I may recommend that setup.  However, I wouldn’t be doing my job if I didn’t take the time to explore the numbers and overall breakdown of how and why homeownership is a better solution, even if the payment is a little higher than renting for the short term. 

Ultimately, any decision requires some emotional and rational thought process.  If you can afford a rent payment that equates to a mortgage payment, you are truly missing out on opportunity, even if it’s for the short term.

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Evaluating a Down Payment Assistance Program

When I first started as a Loan Officer, Down Payment Assistance (DPA) was all the rage.  Many prospective Home Buyer’s were coming out of the recession with great income and decent credit, but lacked the assets for a down payment.  In addition, home prices were so low that just about everyone could afford the monthly payments and the terms associated with DPA’s. 

Fast-forward to 2019, changes in DPA programs have altered it’s allure and now it’s important to consider how using a DPA will impact your financial future when purchasing your home.  In this post, we explore the various DPA programs, their requirements, the monthly payments, and future considerations.  It’s a lot of information, but well worth the read if you are considering a home purchase in the near future.

*Loan parameters are based on Rates and terms as of 2/1/2019.  Conventional Financing terms based on a 720 FICO score and the Fannie Mae Homeready Program with 3% down payment.  Program terms and rates consider coverage variations prescribed by Fannie Mae Homeready, HFA Preferred, Home In Five, and Home Plus.  FHA Financing terms based on a 660 FICO score. NMLS# 1074188 All Borrowers subject to credit qualifications. Not all borrowers will qualify as certain restrictions apply on all programs. The information contained in this material is not a guarantee to extend credit or lend. Terms & conditions are subject to change without notice.

What is a DPA & what types are offered?

The DPA programs mentioned here are offered in Maricopa County Arizona.  They grant certain percentages of the purchase price on a home in the form of a silent second lien towards the down payment needed.  Home in Five offers special incentives for Teachers, First Responders, Veterans, Military, and Nurses.  Home Plus allows additional funds as a down payment towards your purchase.  Below is a brief list:

  • Home in Five Program
  • Home Plus Program
  • Pathway 2 Purchase
  • Neighborhood Stabilization Program (NSP) – Through a respective City
  • Matthew Hensen Program (tied to NSP)
  • Chicanas Por La Casa

For the sake of time and popularity, we will discuss only the Home in Five and Home Plus programs. 

Home in Five

The Home in Five will grant up to 4% assistance to cover the down payment and/or closing costs on your new home.  The 4% is the max allowed provided you meet the requirements for credit and qualify for the special incentive.  There is a maximum income limit allowed of $99,169 unless you are using the Fannie Mae HFA Preferred portion of the program which is $69,100.  The maximum debt-to-income ratio allowed is 45%.  That means your total obligation (including your proposed house payment) cannot exceed 45% of your gross income used to qualify for a mortgage loan.

Your assistance is calculated off the BASE loan amount after a down payment would be applied.  For example, Buying a home at $275,000 with FHA at 3.5% down using this program, the BASE loan amount is $265,375.  If your max assistance is 3%, the grant will be 3% of $265,375 or $7,961.25 as your grant.  You would still need $1,663.75 for the remaining down payment which can be a gift or come from your own funds.

Source: https://www.ehousingplus.com/wp-content/uploads/PMIDA-HOME-IN-5-FINAL-Guide-01-09-19.pdf

The grant is now considered a forgivable silent second mortgage loan or lien.  There are no payments due on this second lien for 36 months.  You will be required to pay back the pro-rated portion of the silent second loan if you payoff the original first mortgage before 36 months; i.e. a refinance, selling your home, etc.  After the 36 months, the silent second lien drops and you no longer owe those funds.

Finally, the interest rate for the Home in Five program is pre-determined for you regardless of your FICO score.  The program administrator and master servicer set the terms for the rate.  As of 2/1/2019, the rate was 5.625% for the FHA and 5.75% for Conventional & VA.

Home Plus

Home Plus is very similar to Home in Five except the debt-to-income ratio allows up to 50% and the down payment grant can go from 0% – 5%.  However, the more you receive, the higher the pre-determined interest rate.  In addition, the income limit is much lower, $66,100.  Both programs do NOT require you to be a first-time buyer and you are allowed to own other property.  You must occupy the home you are purchasing as your primary residence within 60 days when using either program.

Source: https://lenders.housing.az.gov/

Quick Fact

You may be wondering (or not in which case skip to the next section) what is HFA Preferred?  House Finance Authority is a designated department of a State government agency in charge of administering and managing grants for homeownership.  Fannie Mae & Freddie Mac give a special discount on mortgage insurance when you originate your loan through a HFA.  Arizona’s HFA is represented through the Industrial Development Authority of Maricopa County.  True homebuyer grants must come through government entities.  To learn more click here to be directed.

That’s Nice: How do these programs affect my payment?

I am so happy you asked!  In fact, thank you for staying with me to this point.

Most of my borrowers discover they will be paying more per month on their mortgage payment using a DPA program than if they had the capacity to fund their own down payment.  It’s important to be educated to know your options and work with a Lender who takes your best interest as their own.  Many lenders shy away from discussing the differences for fear of losing you as a client and potentially their referral partners. 

Let’s review using a FHA loan with the Home in Five and Home Plus programs compared to using your own funds or a gift as a down payment source.  The purchase price is $275,000 and the down payment requirement is 3.5% or $9,625.  This scenario is based on a 660 FICO without the special incentive.  I did not use the special incentive in this case because not everyone will qualify for that advantage.  If you do, you will simply get an additional 1% in assistance.  See below:

There’s no free lunch

Most lenders will tell you to refinance this loan later.  If you’re buying a home getting instant equity at the purchase, then this is a good strategy because ultimately you will build value much faster.  But what if you don’t get that instant equity?  You are stuck paying that additional $166 for the next 36 months.  That adds up over time, $8,080 in interest with less money going towards principle.  Go back to the beginning when I described your grant proceeds on $275,000, the total was $7,961.25.  Essentially, you are still paying for your down payment over the course of 3 years.  It’s a borrowed grant.

Here is a look at a conventional loan scenario taking into consideration the HFA Preferred mortgage insurance rates and the Homeready program.  This is the same purchase price at 3% down.

In this scenario, you’re paying $7,990 in additional interest over 3 years and less towards your principle during that time.

Starting out with Negative Equity

I had a client recently hit a Homerun out of the park using a DPA.  Their home apprised $40,000 higher than the contract purchase price.  Even though they have a forgivable silent second mortgage, we are going to refinance them this summer and lower their payment.  They will have to pay back the grant, but it comes out of the equity they already have.  They will be saving substantially each month and over the life of their loan.

However, for many borrowers using a DPA, they may not get that kind of sweet.  It’s rare for that kind of value to come in and it takes a great Realtor to make something like that happen.  You need to be aware that you will start out in a negative equity position when you use this program because of the silent second lien. 

If you refinance or sell your home, you need to pay off your home for at least to total of your mortgage liens.  For example, take the same $275,000 house using FHA.  The total lien amount will be $277,980 when you purchased the home at $275,000.  For conventional, the total lien amount will be $274,752, which is a little better, but nearly 100% loan-to-value (LTV).  My point to this is your appreciating value of your home will take longer to realize if you want to consider a refinance or selling your home for the shorter future.  You must have some equity for a refinance to make sense.

Down Payment Alternatives

The down payment on a home is not limited to have a large saving account or waiting years to buy a home with 20% down.  In fact, many borrowers have been savings all along and don’t realize they have the resources available to purchase a home.

Your 401k through your employer is a solution.  Most 401k plans allow you to borrow against your plan up to 50% of the vested balance for any purpose.  The money is not taxed and is paid back through payroll deductions.  Some plans even allow the interest you pay on the loan to go back into your 401k or the payments are made pre-tax.  You will need to check with you plan provider.

An IRA can be leveraged if you are a First-Time Homebuyer purchasing your primary residence.  Up to $10,000 can be withdrawn without the penalty if you are withdrawing before you turn 59 ½.  You will still pay taxes on the $10,000 distribution (if a traditional IRA or Roth IRA when the $10,000 exceeds your initial contribution).

Immediate family can also gift you the down payment to purchase a home.  Many times borrowers let their family know their plans and it comes up that they can help contribute to their future.

I want to use the DPA

There is absolutely nothing wrong with using the DPA programs described here.  In fact, if this is the only option for purchasing your home, it is a good solution because ultimately, you still build wealth and fix your overall monthly expenses for the future.  It is just important to understand the differences and how it can affect your overall monthly payment IF you have the capacity to qualify for a home loan without using these programs.  We have not turned anyone away wanting to use these programs and will always make sure to do our best giving borrowers access to homeownership.

Conclusion

If you made it this far, I thank you whole-heartedly.  I have these conversations daily and wanted to make a post about DPA’s for a while to help educate and explain the basics.  The decision to buy a home is not something to take lightly and should be treated with attention to detail.  Fortunately, working with our team, we will manage the details for you so all you need to think about it which home you like best.  Happy House Hunting!

Chris Gonzalez

480-442-4494

Contact

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Creative thinking saves Client $200k

Saving my client from writing a $200,000 check

We run into a lot of interesting scenarios in the mortgage industry to help people get home loans. After a while, they blend together because trends come and go. However, this scenario was unique and challenging. We recently closed a mortgage loan for a high income earning client saving them from writing a $200k check to their ex-spouse.

Before we continue, I must point out that our client is not avoiding any due payments but instead following the advice of their financial adviser in the timing of payments.  Without too much detail, a large sum had been paid out prior to this $280k described later on.  We simply were attempting to help lesson the financial hit all at once with saving the borrower the $200k upfront.  The borrower is fulfilling their roll as we speak.

Learning from the Past

This wasn’t our first rodeo with our borrower. A year earlier we worked together helping them purchase an investment property with 30% down. The credit score was 620 and to top it off, there were several late payments on their existing mortgage loan. You might ask, “why would a high income earning professional be late and have a low score?”. The answer: It was not their fault.

Life happens, and the borrower was in the middle of separating from their spouse, who was living in the home with the late mortgage payments. They made an agreement that the spouse would pay the mortgage. However, payments were missed, and it adversely affected our client’s credit in a big way, dropping his FICO score to 620. Our client of course brought the mortgage current and managed the payments moving forward.

We finalized the loan on the investment property but spent a lot of time sorting out details and collecting all the necessary paperwork for their loan. Some loan approvals can be messy, but they were approved and now have a great income producing property!

The Scenario

Fast forward to 2018, our client was interested in purchasing a new home. From our last experience, we both knew everything had to be right this time around. We are in a seller’s market and the last thing we needed was to waste time and lose money.

It’s always serious business when buying a home. In this case, we were preparing for a purchase of $920k and working to make the payments affordable while building a loan application around guidelines favorable to the client for an approval.

We collected our client’s financials, reviewed their credit and discussed our strategy. For everything to work, the divorce had to be finalized. Last year, the couple was in mediation working out the details. They had just filed their petition with the court around the time we began the pre-qualification for the new home.

In addition, there was a lingering item on credit holding back our client. He had a high FICO of 780, but his mid-score was showing 650. We referred him to our credit expert and for $100, the negative item was removed, and his score jumped to 750. Beautiful! It should be noted the negative item was not his and he had proof to show it. We just helped him remove it faster.

So far, we are moving smoothly recalling last year and the issues we struggled with. Our homework was paying off and we were ready to start shopping for homes. We were moving along so well; our client went under contract and we agreed to push for closing before the actual close of escrow (COE). This is not something we promise in scenarios as complex as this, but we felt confident in the opportunity.

Our Challenge

Understanding how loan guidelines work, it’s important to have your plan for getting an approval defined from the start. You should also maintain a back up plan if the first one doesn’t work. We had a plan B and used it.

Our client’s jumbo loan was not going well because the investor had a pass/fail approach to their credit. Remember those mortgage late payments from last year? Well, the investor didn’t like the fact that they occurred within the last 24 months. The kicker was, we provided over 2 years of financial reserves and accounted for their requirements that the reserves be 70% of the balance to account for time and the vesting style of those funds. In addition, our debt-to-income ratios were well within limits.

Plan B was to split the mortgage into a first and second. Our first mortgage needed to be $453,100 to conform to Fannie Mae loan limits (for 2018) and we financed a portion of the down payment in the form of a second mortgage at $236,900. Our client came in with $230,000, 25% of $920k, their original commitment. The “plan A” mortgage payment was roughly $120 less then the plan B solution, but the second mortgage could be paid off sooner with no penalty effectively lowering their housing expense without refinancing. For borrowers with high incomes, this solution can be favorable as a low maintenance solution.

The Solution & Result

The jumbo loan idea was scrapped to give us a chance of closing before the intended COE. We turned around a loan approval for the first mortgage at $453,100 within 24 hours and submitted for the second mortgage approval in that same time. After another 24 hours, we received the second mortgage approval with some conditions.

One of the conditions for the final approval, issued by the second mortgage firm, required proof that our borrower completed the lump sum alimony payment to his ex-spouse as described in the divorce decree. What made this condition problematic was the divorce decree did not describe how or by when the payment needed to be completed. It was one sentence with no clear direction.

Equalization Payment

a. (Client) shall pay to (ex-spouse) the sum of Two Hundred Eighty Thousand Dollars ($280,000) as a non-taxable equalization payment for the division of property.

Our underwriting team (first mortgage at All Western Mortgage) did not require this to be paid prior to the loan approval. In most cases, alimony payments & child support are added to a borrower’s monthly debt obligations because there is a clearly defined payment and date for the payment to be received. However, this kind of payment is treated as a contingent liability and is NOT required to count in the borrower’s recurring debt obligations per Fannie Mae guidelines. See below:

Writing a check for the remaining $200k he owned, upfront, was something he was not prepared for, especially since the funds were tied up in specific stocks which had penalties if liquidated too soon.

Fortunately, our client already paid out $80k towards this balance owed ($280k) in the last 45 days. They were clearly paying to chip away at this total. Anytime a liability is less than 10 months away from being paid off, the lender can choose to omit the debt/liability from the application if the debt does not adversely affect the borrower’s ability to make their mortgage payment.

Based on our client’s assets, their payments towards the $280k owed to their ex-spouse, and their reserves, we presented the case that the remaining $200k will be paid off in less than 10 months, given the rate the borrower paid thus far and other factors. Our client was approved with the clear-to-close on the second mortgage because of this presentation.

Conclusion

The client was grateful and happy that everything worked out. They were phenomenal despite our challenges. Not to say it wasn’t stressful. It’s worthy to note that our client’s Realtor, Liz Lovett, was fantastic and amazing to work with and my Processor played a huge roll in the approval.

Most lenders want the quick and easy loan to close. Despite the difficulty and challenges, I am grateful for the opportunity for growth it presented. But most importantly, I am humbly appreciative of the Client, their Realtor, and my Processing team for trusting & helping us through this file.

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Mortgage Planning – 2-1 Buy Down can save for the future

Many new products and programs have come down into our product offerings at All Western Mortgage.  With some of the new products we now offer, we can approach our clients with better solutions for their home mortgage when they are buying a home.  In this blog, I go over a unique product called a 2-1 Buy Down.

2-1 Buy Down for FHA and Conventional Purchase Loans

The name of this product sounds like one of those loans from pre-2008 but is far from that family of products.  A 2-1 Buy Down allows a borrower to lock an interest rate 2% below the Note rate for the first year, then the rate increases by 1% the second year.  Once years one and two are complete, the interest rate becomes the true Note rate that was locked.  This is a 30 year “fixed” rate loan.  See below for a quick example:

Initial Note rate locked 5.875%

1st year interest rate 3.875%

2nd year interest rate 4.875%

 

Sample Scenario Conventional Loan scenario

Purchase Price: $350,000

Loan Amount: $332,500 (5% down payment)

Principle & Interest Payments:

$1,563.54 @ 3.875%

$1,759.62 @ 4.875%

$1,966.86 @ 5.878%

Summary: What You can do

The savings on the payment between year one and year three is nearly $400 a month.  Then it comes down to $200 a month.  A borrower must qualify on the actual Note rate, which in this example is 5.875%.  But getting away with a lower monthly payment is not why someone will use this product.  In fact, if this is your motive, I would not recommend this.  The advantage of this product allows a borrower to pay that “savings” toward reducing the principle of the loan or money borrowed.  Come year three, the borrower will want to refinance into a new mortgage to eliminate the mortgage insurance.  Between the equity appreciation and reduced principle on the loan, they will eliminate mortgage insurance on the new appraised value.

See the example of the equity gained and built:

$400-savings year one x 12 months = $4,800 additional principle reduction year one

$200-savings year two x 12 months = $2,400 additional principle reduction year two

 

Total additional Principle Reduction first 2 years: $7,200

Estimated Equity Appreciation by year three at 3% – 4% appreciation: $30k – $40k

Total principle reduction from P&I payments first 2 years: $11,200

Down Payment when purchased $17,500

Grand total: $65k – 75k Equity built, earned, & paid

Why this is helpful

Remember you must have 20% equity to refinance without paying any kind of mortgage insurance on a conventional loan.  With the original purchase price at $350,000, a 20% down payment would mean $70,000.  In 2 years, using a 2-1 Buy Down, you can leverage the lower initial rate to make your regular mortgage payment, applying funds to reduce the principle owned, and refinance into a lower payment by eliminating the mortgage insurance on the loan.  If this were FHA, the same idea applies.  The Note rate may be higher than today’s rates but remember we cannot predict the future and it’s possible the note rate is the same, lower, or higher than the market down the road.

Conclusion

With interest rates on the rise, I believe consumers should look at products that give them better overall value.  You can plan your financial future a little easier with something like this and prepare your mortgage payment with more clarity with a product like the 2-1 Buy Down.  Request a customized review for your purchase plans before committing to this program.

 

-Chris

 

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Chris Gonzalez

480-442-4494

Contact