What to Know When Starting Your Home Search
You’ve taken the big step of deciding to buy a home. Congratulations! One question though: how are you going to pay for it? Whether this is your first time buying or you’ve been through it all before, there’s much to know about your financing options, so here’s a quick primer to help you make informed decisions.
Finding a Lender
This is step one, as you will need to have financing mostly tied up when you’re making offers. There are plenty of lenders out there, and most can be grouped into these categories:
Direct Lenders
These run the gamut from mortgage-only companies with a strong local presence (such as Guild, Directors, or Fairway) to large national banks (BofA, Chase, etc), and big online lenders like Rocket Mortgage.
Mortgage Brokers
Mortgage brokers work independently by shopping for the best rates among various retail lenders.
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It is up to you to decide which approach you should take, as there are pros and cons to all of them. If you ask a Realtor for advice, that advice will most likely be to stick with the smaller local lender. They have local reputations to uphold, and their success depends on giving superior customer service. Yes, it might cost a bit more to you, so that’s something to consider. There is value though to having a loan officer who is local, knows your name, knows your file, and will answer the phone on a Sunday night.
Once you find a lender, it is imperative to get pre-approved prior to making any offers. Getting pre-approved is not a complicated step- the lender will review your credit scores, income, reserves, and debt and make a preliminary determination of how much they’re willing to lend you. A pre-approval letter can then be generated for any house on which you plan to write an offer. This will be a hard pull on your credit, but the good news is that you can shop for multiple approvals within 30 days and it will only count against you once.
The lender can discuss in detail which mortgage options are best for you (more on that in a moment), based on your circumstances. They will also estimate all of your closing costs so you can shop with a very specific idea of what it will all cost you. These closing costs typically run 2-3% of the loan amount, and you’ll need to bring this to closing (in addition to your down payment).
Any Realtor can give you a list of names of trusted lenders and brokers, and also discuss the various differences to consider when shopping for a loan.
Types of Financing
Cash
If you’re in the fortunate position of being able to pay cash for a home, great! Go ahead and take the rest of the day off, because none of this will be relevant to you. If you’re among the 80% or so of Portland home buyers who will be financing, read on.
Conventional Loans
The bread and butter of home financing. Upwards of 75% of homes purchased in the US are done so with a conventional loan. These will vary in terms- most common will be 30 years with a fixed rate throughout- but can also be sold as 15 year loans, or with an adjustable rate. An adjustable rate mortgage (or ARM) will be fixed for a period of time- say five to ten years- at a rate that is typically lower than the prevailing rate. After that, the interest rate will adjust to one that correlates to the current prevailing rates.
While a 20% down payment is required to avoid paying private mortgage insurance (PMI), conventional loans can be used with as little as 3-5% down. The qualifying standards for these loans are determined by Fannie Mae and Freddie Mac, which are the government-sponsored enterprises that will be bundling and selling these loans on the secondary market, freeing up capital for lenders to write more loans. In order to conform to their standards, the borrower will need to meet specific criteria in regards to their credit scores and debt-to-income ratio.
Government-Insured Loans
The most commonly-used government-insured loans are FHA and VA loans. These are still issued by traditional lenders but they are insured by the US government so they present less risk to the lender, and therefore allow more relaxed requirements.
FHA Loans
These can be used with as little as a 3.5% down payment, and borrowers can have a lower FICO score than conventional (albeit with a higher down payment). The debt-to-income ratios are also more flexible than with a conventional loan. The drawback is that mortgage insurance often must be purchased for the life of the loan, and it runs at a higher cost than the insurance on a conventional loan. Also, FHA loans require a bit more time and paperwork, and the appraisal process is a bit different than with other loans.
VA loans
VA loans are available to eligible active duty or veteran service members, as well as qualifying surviving spouses, and do not require a down payment. They also tend to have lower interest rates. There is no insurance mandate, but they do require a funding fee that will be a percentage of the total loan amount. This fee is waived for members with a service-related disability. Like FHA loans, VA loans do tend to take some more time and have more stringent appraisal standards.
Down Payment Sources
Assuming you don’t have stacks of cash burning a hole in your pocket or someone to give it to you, you’ll need to explore some alternate arrangements for putting together a down payment. There are a number of common ways to go about this.
Home Equity
If you’re not a first-time buyer, chances are you’ve got much of your life savings tied up in the house you currently own. There are a handful of ways you can use this equity to get yourself a suitable down payment. Bridge loans, home equity lines of credit, and cash-out refis are all options you can discuss with a lender.
Retirement Funds
There are circumstances in which you can either take a loan or withdrawal from your 401k or make an early withdrawal from an IRA in order to fund a down payment. A 401k loan is generally tax-free, so that can be an attractive option. Early IRA withdrawals are still subject to tax, but there is no penalty if it’s being used for a first-time home purchase.
Be sure to discuss these options with a tax professional and a lending expert, as everyone’s circumstances are different and there can be tax or loan qualification implications.
The Purchase
Once you have a lender’s pre-approval and a plan for down payment financing, you’re ready to go! When you write a purchase offer that gets accepted, the lender will lock in your interest rate at the prevailing rate (and yes, rates can change every day). After that, you will be in the underwriting process. The lender will be doing a deeper dive into your finances as well as the worthiness of the house you are buying.
Once the lender is satisfied that you’re an acceptable risk and that the house is suitable as collateral, you’ll hear the magic words: clear to close! You will then be invited by the title company that is handling escrow to come sit at a table and sign a whole lot of papers, after which the lender will release funds. Once that happens and the title company records the deed (all of this can happen within minutes or hours of signing), CONGRATULATIONS! You’re a home owner.
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Hopefully this all helps to answer some basic questions, and to make the initial process less overwhelming. There are a lot of moving parts but with real estate and lending professionals by your side, it all will feel easier. Good luck in your home search!
