Are you considering buying a home but feeling overwhelmed by the complex financial aspects involved? Understanding the vocabulary and fundamental concepts related to home buying can help demystify the process and make it more manageable. In this blog post, we will explore key financial fundamentals and the home-buying process, presented by Matt Marynik.
Vocabulary!
Let's start by familiarizing ourselves with some important terms:
- DTI – Debt-To-Income Ratio: This ratio compares your monthly debts to your income. It assesses what you make versus your monthly financial obligations.
- Front end: Refers to the percentage of your income that goes toward housing payments only.
- Back end: Refers to the percentage of your income that covers your new payment plus debts on your credit report.
- LTV – Loan-To-Value: This term represents the amount of equity in your home translated into a percentage. For example, if you own a $100,000 home and owe $75,000, the LTV is 75%.
- AUS – Automated Underwriting System: A scorecard system that determines if you qualify for a loan or not. It reads and analyzes your digital file to assess your eligibility.
- Manual Underwriting: Used as a backup plan when there are errors or typos in the digital file, preventing the AUS from reading it correctly. It is also utilized when underwriting for "Extenuating Circumstances" such as bankruptcy, major derogatory credit, or unforeseen events like cancer, major illness, or death of a wage earner.
Loan Basics - Types of Loans
Now, let's delve into the different types of loans commonly used in home buying:
- FHA – Federal Housing Administration: This loan program allows for financing with the least amount of risk outside of VA loans. It requires as little as a 3.5% down payment and offers down payment assistance options. However, FHA loans are exclusively for primary residences, and if you put less than 10% down, you'll have permanent mortgage insurance.
- VA – Veterans Affairs: Exclusive to veterans and active duty personnel, VA loans require a 0% down payment. They have no monthly mortgage insurance, except for a funding fee. VA loans are also unique because they allow sellers to pay off debt through the transaction.
- Conventional: These loans require a minimum of 3% down payment and carry less risk compared to FHA and VA loans. Conventional loans include those offered by Fannie Mae and Freddie Mac. They have different mortgage insurance options, and the monthly mortgage insurance cancels at specific loan-to-value ratios.
Down Payment Assistance
If you need financial assistance for your down payment, various options are available. However, it's important to note that these programs typically have income and credit score requirements. Some options include:
- Municipal Options: Many municipalities, such as Aurora, Douglas County, and Adams County, offer down payment assistance programs. These programs often have additional underwriting requirements on top of FHA, VA, or conventional loan requirements.
- Statewide options: CHFA (Colorado Housing and Finance Authority) is a statewide program that requires a minimum contribution of $1,000 from the buyer. While all other costs can be covered, it doesn't guarantee that you'll only bring $1,000 to closing. CHFA follows FHA requirements, excluding credit score and DTI requirements.
Credit Scoring
Understanding credit scoring is essential for securing a favorable mortgage. Here are key factors that impact your credit score:
- Payment History (35%): Your payment history includes late payments, collections, judgments, and tax liens.
- Types of Credit (10%): Having diverse types of debt and managing them successfully can positively impact your credit scores.
- New Credit (10%): Opening numerous new credit accounts within a short period can lower your scores.
- Length of Credit History (15%): Your credit score may start lower and improve over time as you build a longer credit history.
- Amounts Owed (30%): High balances or maxed-out credit cards can significantly harm your credit score. Even without late payments, having maxed-out credit cards and various kinds of debt can result in mid-to-low 600s scores.
What-If Simulator
If your credit scores are not where they need to be, utilizing a what-if simulator can help estimate potential changes in your credit score and how long it might take to improve. This tool allows you to plan and strategize to buy a home shortly or secure better pricing when under contract.
How Much Can I Afford?
Determining how much you can afford is crucial for a successful home purchase. Several factors affect your financing:
- Debt-to-Income (DTI): Your DTI ratio compares your monthly income debt or expenses to your gross monthly income.
Step 1 - Understanding Your Budget
To begin, build a budget that considers the following factors:
- Ensure a significant margin between your current affordability and what you could afford if your income decreased.
- Remember that a mortgage is a long-term commitment. Prepare for hard times by ensuring you can make payments even during financial challenges.
- Aim to save at least 10% of your paycheck, separate from employer retirement contributions.
- Involve your spouse or significant other in the conversation and determine the maximum monthly payment together.
Step 2 - Understanding Your Budget
When preparing for a mortgage consultation, gather and bring the necessary documents outlined in the welcome packet. Remember to be honest and transparent about your financial situation. It's essential to be prepared for the possibility of receiving a "Not Yet" response and developing a game plan to work towards homeownership, which may take 1-2 years.
Step 3 - Mortgage Consultation
During the mortgage consultation, you will go through the application process, credit pull, and review documentation. The automated underwriting system (AUS) will be utilized to assess your eligibility. The consultation can result in either a pre-qualification or a pre-approval. Pre-qualification is based on a conversation with a lender and does not require documentation, while pre-approval involves verified documentation and takes more time.
Step 4 - Shopping for A Home
When you start shopping for a home, it's important to understand your price point and market conditions. Homes tend to sell quickly, often within 48 hours, so be prepared to act fast. Trust your agent's expertise and follow their guidance when writing an offer. Ensure you have a lender letter from your mortgage officer, and remember that a conventional offer is often perceived as stronger than FHA or VA financing due to stricter qualification requirements.
Step 5 - Escrow or Under Contract
Once your offer is accepted and you enter the escrow or under-contract phase, you will need to provide an earnest money deposit. This deposit demonstrates your commitment to the transaction and ensures you meet the agreed-upon deadlines. Additionally, you will receive loan disclosures and review and sign the necessary documentation.
Step 6 - Inspection
The inspection allows you to identify any issues with the home. You can negotiate with the sellers to fix the problems or provide monetary credit. Health and safety issues take precedence during this stage. It's important to note that the lender is not involved in the inspection process.
Step 7 - Appraisal or Processing
After the inspection, the lender will order an appraisal to determine the value of the home and the surrounding properties. The appraisal is crucial, as a low appraisal may require a price adjustment or place the transaction at risk. Meanwhile, the loan processing stage involves preparing your loan file for underwriting, which may require updated documentation.
Step 8 - Underwriting
The underwriter's role is to review your loan file and ensure compliance with documentation requirements. They may request additional documentation or conditions that need to be satisfied for the "Clear To Close" status.
Step 9 - Clear To Close or Closing Disclosure
Upon receiving conditional approval, the initial closing disclosure is issued. This document must be signed three days before closing. While it doesn't contain the final numbers, it is necessary for balancing with the title. The final closing disclosure, which includes the precise figures, is issued after the loan is cleared to close.
Step 10 - Closing
The closing takes place at the title company and typically lasts up to two hours. Bring a cashier's check or arrange a wire transfer for the necessary funds. Be prepared to sign multiple documents, and once everything is completed, celebrate your successful home purchase!
Conclusion
Understanding the financial fundamentals and home buying process is crucial for a smooth and successful home purchase. By familiarizing yourself with key terms, loan types, down payment assistance options, credit scoring, and the step-by-step process, you can navigate the complexities of home buying with confidence and make informed decisions. Good luck with your home-buying journey!
