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A New Housing Bubble? Some Cities Might Already Be on the Cusp

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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The housing market is heating up again. Home prices have risen faster than income growth in the past five years, and the combination of low housing supply and increasing demand is driving home values ever higher.

Could we be in danger of another housing bubble?

Economists don’t seem to be too worried about the national housing market.

Across the U.S., increases in home prices have outpaced income growth by 34 percent since 2012, driven by economic expansion. However, this percentage is less than half the pace seen between 1997 and 2006, according to a recent Urban Institute study.

For the most part, homes are still affordable relative to household incomes, experts say.

According to the Urban Institute, a Washington D.C.-based think tank that carries out economic and social policy research, a median-income household can afford a house that is $70,000 more expensive than the price of the median house sold on the market. In contrast, in 2006, there was a $22,000 shortfall between what the median household could afford and the median sales price.

“Yes, prices are high, yes, the market is expensive, and yes, housing is unaffordable for some people, but that does not mean we are in a bubble yet,” Nela Richardson, chief economist at  Redfin, a Seattle-based real estate and technology company, told MagnifyMoney. “Those attributes of a classic bubble are missing.”

By “classic bubble” attributes, Richardson is pointing to telltale signs of trouble, such as lax mortgage lending standards, rapidly rising mortgage rates and the levels of speculation in the housing market we experienced 10 years ago.

Even as home prices were skyrocketing, soft underwriting practices allowed a record number of people to purchase homes with very low down payments. As the crisis intensified, housing prices began to nosedive and borrowers who bought more home than they could afford eventually defaulted on mortgages.

In the wake of the Great Recession, the federal government implemented stricter mortgage lending regulations that have made it much harder for financially unstable borrowers to qualify for a mortgage loan.

“Any of the mortgages made today [are] just super clean” and there is a historically low default rate, Bing Bai, an Urban Institute researcher, told MagnifyMoney. “We are not in that kind of risk like the risk we had before in previous bubble years.”

Mortgage default rates have fallen to 3.68 percent for single-family homes, not quite as low as pre-recession levels but much better than the peak of 11.53 percent in 2010.

10 Metros at Risk of a Housing Bubble

 

So, the nation as a whole might not be facing an imminent bubble. However, Urban Institute economists have put certain cities of the country on the “bubble watch” list.

In the study, they analyzed 37 metro areas across the U.S. to find how much housing prices have gone up since their lowest point following the financial crisis and how affordable homes are based on the median income for that city. Below are the top 10 cities in danger of a housing bubble.

#1 San Francisco-Redwood City-South San Francisco, Calif.

#2 San Jose-Sunnyvale-Santa Clara, Calif.

#3 Miami-Miami Beach-Kendall, Fla.

#4 Oakland-Hayward-Berkeley, Calif.

#5 Portland-Vancouver-Hillsboro, Ore.-Wash.

#6 Seattle-Bellevue-Everett, Wash.

#7 Los Angeles-Long Beach-Glendale, Calif.

#8 Riverside-San Bernardino-Ontario, Calif.

#9 (tie) Denver-Aurora-Lakewood, Colo.

#9 (tie) Sacramento-Roseville-Arden-Arcade, Calif. 

California snags five of the top eight spots, led by the San Francisco metro area.

In San Francisco, for example, a family earning the median income for the area needs to dedicate at least 70 percent of income for a typical 30-year fixed-rate mortgage, Bai said. The median home sales price is $1.2 million in the Bay Area, according to Redfin and Trulia, an online real estate resource for homebuyers and renters.

The overheated housing situation in the Silicon Valley and Seattle is largely a result of the tech boom during the years of economic recovery, Richardson said. Yet demand is still going strong with healthy job increases despite stunning home prices.

“There’s a lot of money looking for a place to land,” Richardson added.

Some other cities seeing swelling housing prices are in Florida and Texas. Not coincidentally, the coastal real estate markets are where international investors have been pumping in large sums of money in recent years, pushing demand even higher. The Urban Institute reported that California, Florida and Texas are the top U.S. destinations for foreign buyers.

“It’s not just about the local economy in these markets,” Richardson said. “It’s about the global economy.”

Advice for home buyers in super expensive cities

The truth is, experts don’t see a sign of price decline in hot markets any time soon.

“Demand is still there, with low supply, [and] it’s just going to keep prices high,” Cheryl Young, senior economist at Trulia, told MagnifyMoney.

If you are looking to buy in cities where home prices are sky-high and competition is extremely fierce, here is what pros suggest you can do to bid for a desirable house:

Time it right

“Home buying is all about timing,” Young said. “We always say you shouldn’t rush to enter the housing market if you are not ready.”

If you’ve definitely decided to buy, the best time to start looking might be during the fall. Young said home prices are, in general, at their nadir in the wintertime, so you may want to start looking in the fall when prices started to dip as home supply is higher than they are at other times of the year.

Check out our story on why October’s the best time to start looking for your first home.

Come to the table prepared

When you are ready to start looking, you also need to save up for a down payment, Young said.

A good rule of thumb for a down payment is 20 percent. That way you could avoid paying for the additional cost of private mortgage insurance. But the reality is that it’s tough for buyers to put down that much money, especially if you are in a super-expensive market. It’s fine if you can’t save up for 20 percent, but of course the more you can scrounge up, the better.

Also recommended: Have all your financial statements ready and compare mortgage rate offers from several financial institutions to be sure you’re getting the best deal. Avoid these common mistakes homebuyers make before they apply for mortgages.

“Working with someone who knows the local area, who knows how to strategize how to make an offer that is as good as cash or almost as good as cash if you are in a competitive market is very important,” said Richardson.

If you can get preapproved for a mortgage, it will give you a competitive advantage.

“It’s really about showing the seller that you are ready when the opportunity comes up so that you can lock in the purchase,” Young said.

Shen Lu
Shen Lu |

Shen Lu is a writer at MagnifyMoney. You can email Shen at shenlu@magnifymoney.com

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Mortgage

The 5/1 ARM Mortgage: What Is It and Is It for Me?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

5/1 ARM mortgage
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Finding the right mortgage can be a confusing process, especially for first-time homebuyers. There are so many options that it can be hard for a consumer to know how to get the optimal rate and terms.

One way to get a better initial interest rate is by taking out a 5/1 ARM mortgage. Small wonder that many potential borrowers want to know what makes a 5/1 ARM mortgage so unique and whether it might be the right loan for them.

Below is a guide to how 5/1 ARM mortgages work, how they are different from traditional 15- and 30-year mortgages, and what pros and cons consumers need to understand.

How a 5/1 ARM works

A 5/1 ARM mortgage, as explained by MagnifyMoney’s parent company, LendingTree, is a type of adjustable-rate mortgage (hence, the ARM part) that begins with a fixed interest rate for the first five years. Then, once that time has elapsed, the interest rate becomes variable. A variable rate means your interest rate can change. Consequently, so can your payment.

The number “5” in “5/1 ARM” means that your interest rate is fixed for five years. The number “1” in “5/1 ARM” means your interest rate could change each year after the first five years have passed.

Interest rates are based on an index, which is a benchmark rate used by lenders to set their rates. An index is based on broad market conditions and investment returns in the U.S.. Thus, your bank can adjust its interest rates at any point that the benchmark rate changes or if there are major fluctuations in the U.S. stock market.

What’s fixed? What’s adjustable?

Fixed-rate mortgages have the same interest rate for the duration of the mortgage loan. The most common loan periods for these are 15- and 30-year.

Because a 15-year fixed rate mortgage is, obviously, for a shorter term than a 30-year fixed rate mortgage, you will likely pay much less interest over time. However, as a result, you will have a higher monthly mortgage payment since the loan payoff period is condensed to 15 years.

Adjustable-rate mortgages like the 5/1 ARM loan mentioned above have a fixed interest rate for the beginning of the loan and then a variable rate after the initial fixed-rate period.

The chart below shows an example of the same house with three different types of mortgages.

As you can see below, the 15-year fixed rate mortgage has a lower interest rate, but a much higher payment. The 5/1 ARM has the lowest interest rate of all, but once that interest rate becomes variable, the lower rate is not guaranteed. This is one of the cons of a 5/1 ARM mortgage, which will be outlined in the next section.

Mortgage snapshot

Here is an example of three different types of mortgage payments for someone taking out a $200,000 mortgage. The chart below makes the assumption that the fictional person this is for has a high credit score and qualifies for good interest rates.

 

Interest Rate

Monthly payment

Principal Paid
After 5 Years

Total Interest Cost
After 5 Years

30-year fixed

3.625%

$912.10

$20,592.12

$35,046.14

15-year fixed

3.0%

$1,403

$57,987.88

$26,263.08

5/1 ARM

2.875%

$829.78

$22,595.20

$27,191.90

The pros and cons of 5/1 ARM mortgages

The pros

The biggest advantage of a 5/1 ARM mortgage is that interest rates are typically lower for the first five years of the loan than they would be with a typical 15- or 30-year fixed-rate deal. This allows the homeowner to put more of the monthly payment toward the principal balance on the home, which is a good way to gain equity in the property.

The 5/1 ARM mortgage commonly has a lifetime adjustment cap, which means that even though the rate is variable, it can never go higher than that cap. That way, your lender can tell you what your highest monthly payment will be in the future should your interest rate ever reach that point.

The cons

As mentioned above, the con of a 5/1 ARM mortgage is the whole “adjustable” component. Once you get past the five-year term, there will be uncertainty. Every year after the fifth year of your mortgage, the rate can adjust and keep adjusting.

There is a way around this. You can refinance your mortgage after the five years and secure a new mortgage with a fixed rate. But be warned: Refinancing comes with fees. You will have to calculate on your own whether or not the savings you derive from a lower payment for five years is worthwhile as you measure it against the cost of refinancing to a fixed-rate loan.

That’s why it’s important to know how long you want to live in your home and whether or not you’ll want to sell your home when you move (as opposed to, say, renting it out).

A 5/1 mortgage is right for …

“For certain people, like first-time homebuyers, 5/1 ARM mortgages are very useful,” Doug Crouse, a senior loan officer with nearly 20 years of experience in the mortgage industry, tells MagnifyMoney.

Here are the types of people who could benefit from a 5/1 ARM mortgage:

  • First-time homebuyers who are planning to move within five years.
  • Borrowers who will pay off their mortgages very quickly.
  • Borrowers who take out a jumbo mortgage.

Crouse explains that with some first-time homebuyers, the plan is to move after a few years. This group can benefit from lower interest rates and lower monthly payments during those early years, before the fixed rate changes to a variable rate.

Mindy Jensen, who is the community manager for BiggerPockets, an 800,000-person online community of real estate investors, agrees. “You can actually use a 5/1 ARM to your advantage in certain situations,” Jensen tells MagnifyMoney.

For example, Jensen mentions a 5/1 ARM could work well for someone who wants to pay down a mortgage very, very quickly. After all, if you know you’re going to pay off your loan early, why pay more interest to your lender than you have to?

“Homeowners who are looking to make very aggressive payments in order to be mortgage-free can use the 5/1 ARM” to their advantage, she explains. “The lower initial interest rate frees up more money to make higher principal payments.”

Another group that can benefit from 5/1 ARM mortgages, Crouse says, is those who take out or refinance jumbo mortgages.

For these loans, a 5/1 ARM makes the first few years of mortgage payments lower because of the lower interest rate. This, in turn, means that the initial payments will be much more affordable for these higher-end properties.

Plus, if buyers purchased these more expensive homes in desirable areas where home prices are projected to rise quickly, it’s possible the value of their home could soar in the first few years while they make lower payments. Then, they can sell after five years and hopefully make a profit. Keep in mind that real estate is a risky investment and nothing is guaranteed.

The 5/1 isn’t right for …

Long-term home buyers who plan to stay put for the long haul probably won’t benefit from a 5/1 ARM loan, experts say. “An adjustable-rate mortgage loan is a bad idea for anyone who sees their home as a long-term choice,” Jensen says.

Crouse echoes the sentiment: “If someone plans to stay in their home for longer than five years, this might not be the best option for them.”

Jensen adds that homeowners should consider whether or not they want to be landlords in the future. If you decide to move out of your home but keep the mortgage and rent a property, it won’t be so beneficial to sign up for a 5/1 ARM loan.

Questions to ask yourself

If, after reading this guide, you think a 5/1 ARM mortgage might be right to you, go through this list of questions to be sure. Remember, you can also consult with your lender.

  • How long do I want to live in this home?
  • Will this home suit my family if my family grows?
  • Is there a chance I could get transferred with my job?
  • How often does the rate adjust after five years?
  • When is the adjusted rate applied to the mortgage?
  • If I want to refinance after five years, what is the typical cost of a refinance?
  • How comfortable am I with the uncertainty of a variable rate?
  • Do I want to rent my house if I decide to move?

Hopefully these questions and this guide can aid you in reaching a sensible decision.

Cat Alford
Cat Alford |

Cat Alford is a writer at MagnifyMoney. You can email Catherine at cat@magnifymoney.com

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Mortgage, Personal Loans

Can You Use a Personal Loan for a Home Down Payment?

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

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Scraping together the down payment on their mortgage is the biggest challenge facing many would-be homebuyers. And lots of those would probably like to use a personal loan to top up their savings so they reach their lender’s threshold. But can they do that?

The short answer is that few lenders would give their consent to a borrower looking to use a personal loan for their down payment. You would be taking on new debt and then taking on even more debt on top of that…not exactly the greatest solution.

The good news is that there are lots of different options out there for low down payment mortgages and even assistance programs that can help you get together funds for a down payment.

How Much Do I Really Need For A Down Payment?

Let’s make sure you know how big your down payment needs to be. Because, if you are a bit fuzzy on that, you are not alone. And you could be in for some good news.

A survey of professionals at a 2017 conference hosted by the Mortgage Bankers Association revealed a persistent myth: Twenty-eight percent of respondents thought “consumers still mistakenly believe that a 20 percent down payment is a requirement for purchasing a home.” And another four in 10 respondents thought that even those who knew 20 percent isn’t necessary still believed they’d find it difficult to buy a home with less.

Those consumers couldn’t be more wrong. Creditworthy buyers can usually get approved for a mortgage with a down payment as small as 3 or 3.5 percent. And some (more than you may think) who qualify for specialist mortgage programs need put down nothing. Discover more about all those options below.

Here are the minimum down payments required for a selection of mortgages.

Remember: You may get a better mortgage rate if you increase the amount you put down.

The Best Mortgages for a Low Down Payment

Type of Loan

Down Payment Requirement


Mortgage Insurance

Credit Score Requirement

FHA

FHA

3.5% for most

10% if your FICO credit score is between 500 and 579

Requires both upfront and annual mortgage insurance for all borrowers, regardless of down payment

500 and up

SoFi

SoFi

10%

No mortgage insurance required

Typically 700 or higher

VA Loan

VA Loan

No down payment required for eligible borrowers (military service members, veterans, or eligible surviving spouses)

No mortgage insurance required; however, there may be a funding fee, which can run from 1.25% to 2.4% of the loan amount

No minimum score
required

homeready

HomeReady

3% and up

Mortgage insurance required when homebuyers put down
< 20%; no longer required once the loan-to-value ratio reaches 78% or less

620 minimum

homeready

USDA

No down payment required

Ongoing mortgage insurance not required, but borrowers pay an upfront fee of 2% of the purchase price

620-640 minimum

Conventional loans (one not backed by a government program)
A conventional loan is simply a type of mortgage loan that isn’t backed by a government program. Usually these loans require a 5 to 20 percent down payment, though that can be as low as 3 percent using offerings such as Fannie Mae’s HomeReady or Freddie Mac’s Home Possible mortgages. You will need to be reasonably creditworthy.

SoFi

SoFI offers mortgage loans for minimum down payments of 10 percent. You can borrow between $100,000 and $3 million. And you will not have to pay for private mortgage insurance (we’ll talk more about PMI below), even though you have not reached the usual 20 percent down payment threshold. But you will need to have good-to-great credit and sound finances.

Federal Housing Administration mortgage (FHA loan)

FHA mortgages require a 3.5 percent down payment if your credit score is 580 or higher. This can be good if your credit score is less than stellar, but it may be more costly than other options. That is because you will be liable for mortgage insurance premiums (MIPs), which will be added to your monthly mortgage payments.

U.S. Dept. of Agriculture mortgage (USDA loan)

USDA loans require no down payment, unless you have significant assets. There are various eligibility criteria, including your having a low to moderate income. And you must purchase in an eligible area, although those areas make up 97 percent of the nation’s land mass. You can check if you and your area qualify using a tool on the USDA website.

Veterans Affairs mortgage (VA loan)

VA loans also require no down payment. These are for veterans, those still serving in the military and related groups. You can check your eligibility on the VA website. If you qualify, it is highly likely this will be the best mortgage you can get.

Learn more by checking out our guide to The Best Mortgages That Require No or Low Down Payment.

3 Ways To Get Help With Your Mortgage Down Payment

Down payment assistance programs

Before exploring ways of borrowing to top up your down payment funds, you should definitely check out your eligibility under various assistance programs. These are typically targeted at middle- and low-income buyers, and you may have to use a lender that participates in the program.

Some programs provide outright grants or gifts that do not have to be repaid. And they are often available to both first-time buyers and existing homeowners.

Many of these down payment assistance (DPA) programs are state-based. You can click through to your local offering, if any, from the U.S. Department of Housing and Urban Development (HUD) website, which has a link for each state. You should also call your city or county to see if it operates a similar, parallel program.

Others are run across multiple states by nonprofits, such as the National Homebuyers Fund. Freddie Mac recommends a look-up tool on the private Down Payment Resource website as a way of tracking down DPA programs for which you might be eligible.

Finally, do not forget to check with your human resources department. Some employers offer help.

Using a gift from family or friends

Suppose you cannot get help from a mainstream DPA or your employer. Perhaps your parents or another close relative, fiancé, fiancée or domestic partner may be willing to give you a gift toward your down payment. Your lender should normally have no problems with this arrangement. But it is very likely to apply a couple of industry-standard rules:

  1. You must meticulously document the gift process and provide copies of the donor’s withdrawal slip or check, and the recipient’s deposit slip. If appropriate, a copy of the donor’s check to the closing agent is fine.
  2. You must provide a letter or form signed by the donor declaring that the payment is a gift and not a loan. This must include certain information and statements, and you can download a sample gift letter from the NOLO legal website.

Many lenders will allow this gift to cover 100 percent of the down payment. However, some may prefer you to provide some of the funds yourself.

Expect your loan officer to be mildly suspicious of large gifts. Some applicants try to sneak through money that is actually a loan in disguise, risking jail time or fines for mortgage fraud. If you raise any red flags, your loan officer can investigate the funds in great detail, including their ultimate source.

It is generally fine to borrow money from friends or relations for part of your down payment, providing you declare the loan(s) to your lender. It can then include your repayments when it assesses your ability to afford your mortgage.

Central to that assessment is your debt-to-income (DTI) ratio. As the name suggests, that is the proportion of your monthly income that goes out in debt payments, including minimum payments on credit cards and standard payments on instalment loans, such as auto, student and personal loans, as well as your new mortgage. You should also include any regular commitments for alimony or child support.

LendingTree, our parent company, has a DTI calculator that can help you determine yours. If you plan on borrowing for your down payment, include the payments on the loan(s) from your family or friends when you use it. It is unlikely a lender will allow your DTI to be higher than 50 percent. Some types of mortgage require 43 percent, and many lenders prefer it to be in the 30s.

Borrowing from yourself

One way to keep your DTI low is to borrow from yourself because not all lenders count repayments of such loans in your DTI, even if you have to make them. But you need to check your lender’s policy before you proceed, and either rule out this option or find a more sympathetic source for your mortgage.

How do you borrow from yourself? By raiding your retirement pot. You may be able to make a withdrawal or take a loan from your 401(k), IRA or Roth IRA to fund your down payment.

But, unless you are a tax accountant, you should take professional advice before doing so. No, really. This is a big step with lots of potential implications.

Potential implications of raiding your retirement funds

  1. Unless you use money in a Roth IRA, you could find yourself with significant tax liabilities if the loan isn’t repaid.
  2. If you withdraw money from your 401(k), your employer could demand immediate repayment in full if you switch jobs or otherwise leave.
  3. Some 401(k) funds have rules against this sort of borrowing.
  4. Whatever you do, there is a high chance your retirement fund will take a big hit.

As previously suggested, take advice from a trusted, reputable professional.

Advantages of making a 20 percent down payment

There’s a reason that 20 percent down payment myth survives. It may well be that, decades ago, your parents or grandparents had to find that much as a minimum.

And 20 percent remains an important threshold for borrowers. Put down that much or more, and you won’t have to pay for private mortgage insurance (PMI).

You have to pay the premiums for PMI (they are mostly wrapped up in your monthly mortgage payment, but you may have to make an upfront payment too), but the only benefit you get from them is an ability to borrow with a smaller down payment. If any claim is made on the policy, probably because you have defaulted on your loan, the payout will go directly to the lender.

The biggest downside to a low down payment: PMI

Like we mentioned, most mortgage loans that come with a low down payment requirement have a big caveat — the added cost of private mortgage insurance.

The amount you pay for PMI will depend on the type of mortgage you choose and maybe your personal circumstances:

  • Conventional loan — You will get a quote from your lender. Monthly payments are typically lower than on some other types of mortgage and will depend on your credit score and the size of your down payment. Your upfront payment is likely to be small or sometimes zero.
  • SoFi loan — There is no PMI and so no MIPs on these loans with a down payment equal to or higher than 10 percent.
  • FHA loan — This is often the most expensive type of PMI. But its costs are not affected by your credit score, and the size of your down payment tends to have less impact. So this is a good bet if your credit is iffy and you don’t have substantial savings. At the time of writing, in 2017, you can expect to pay 1.75 percent of the loan value as an upfront charge, and then anything between 0.45 percent and 1.05 percent annually, depending on how much you borrowed and the sizes of your original loan and down payment. Although calculated on an annual basis, ongoing premiums are spread evenly through the year and collected through your monthly payments. If you cannot afford the upfront payment, it may be possible to wrap it up in your overall loan.
  • USDA loan — This is similar to the FHA loan’s PMI model, but typically has lower upfront and monthly payments. As with FHA loans, if you cannot afford the upfront payment, it may be possible to wrap it up in your overall loan.
  • VA loan — You do not pay ongoing monthly premiums with one of these. However, you do pay an upfront cost, called a “funding fee.” For first-time buyers in 2017, these range from 1.25 percent to 2.4 percent, depending on your type of service and the size of your down payment. For regular military with a zero down payment, it is 2.15 percent. If you cannot afford that funding fee, you may be able to wrap it up in your overall loan.

Most sorts of PMI terminate (either automatically or on request) when your mortgage balance reaches 80 percent of the contract price or the property’s appraised value when you bought your home. However, that does not apply to FHA loans. You will likely be on the hook for PMI premiums for those until you move or refinance.

Should you wait to get a mortgage until you can avoid PMI?

By now you may be pondering a dilemma: Should you jump into the market now and swallow those PMI costs? Or might you be better off holding back until you have the whole 20 percent down payment, thus avoiding PMI altogether?

Your smart choice largely depends on the real estate market where you want to buy. It might also depend on the market where you are selling, if you are not a first-time buyer. And it is mostly down to math.

A matter of math

Research home-price trends in your target neighborhood to see whether they are rising (they are in most places) and, if so, how quickly. Bear in mind that some forecasting companies expect growth to continue, but more slowly. For example, CoreLogic calculated home prices grew 6.7 percent nationwide in the year ending July 2017, but expects that to slow to 5 percent by July 2018.

It makes sense to go ahead and jump into the housing market if you anticipate that the value of your home will increase sufficiently year after year to offset the added cost of PMI.

Once you have a feel for those price trends, use a calculator like MagnifyMoney parent company LendingTree’s mortgage calculator to model your options. It will itemize your PMI as part of your total monthly payment. Work out how much you could save by avoiding PMI, and compare that with how much you stand to lose in home-price inflation if you wait to save that 20 percent.

You are now in a position to make an informed decision over whether to buy now or carry on saving. Of course, if in the meantime you find the home of your dreams, you can always choose to go with your heart rather than your head.

For more information, read What Is PMI and Is It Really That Bad?

One last thing about personal loans…

There are lots of things to like about personal loans. They are easy, quick and relatively cheap (or often free) to set up. They almost always have lower interest rates than credit cards for equivalent borrowers. And they make budgeting simple, because you know how much you will pay each month, subject to rate hikes.

However, typically their rates are noticeably higher than secured loans, such as mortgages and home equity products. And you need good credit to get a low interest rate.

Some lenders advertise personal loans for as much as $100,000. Others have more modest caps. How much you will be able to borrow will depend on many factors, including how easily you can afford to repay it and your credit score.

Find out more at Shopping for Personal Loans.

Peter Warden
Peter Warden |

Peter Warden is a writer at MagnifyMoney. You can email Peter here

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Mortgage

Understanding the FHA 203k Loan

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Finding your dream home is hard.

Unless you have an unlimited budget, just about any home you buy will require compromise. The house that’s move-in ready might have fewer bedrooms than you’d like. The house that’s in the perfect location might need a lot of repairs.

Sometimes it feels like you’ll never be able to afford the house you truly want.

This is where the FHA 203(k) loan can be a huge help.

The FHA 203(k) loan is a government-backed mortgage that’s specifically designed to fund a home renovation. Whether you’re buying a new house that needs work or you want to upgrade your current home, this program can help you do it affordably.

Part I: Understanding the basics of 203(k) loans

What is a 203(k) loan?

The FHA 203(k) loan is simply an extension of the regular FHA mortgage loan program. The loan is backed by the federal government, which provides two big advantages:

  1. You can qualify for a down payment as low as 3.5 percent.
  2. You can quality with a credit score as low as 500, although better credit scores allow for better loan terms.

The additional benefit of the 203(k) loan over regular FHA loans is that it allows you to take out a single loan to finance both the purchase and renovation of a property, giving you the opportunity to build your dream home with minimal money down.

How a 203(k) loan works

A 203(k) loan can be used for one of two purposes:

  1. Buying a new property that’s in need of renovations, from relatively minor improvements to a complete teardown and rebuild.
  2. Refinancing your existing home in order to fund repairs and improvements.

The maximum loan amount is determined by the general FHA mortgage limits for your area, and the minimum repair cost is $5,000. But as opposed to a conventional loan, in which your mortgage is limited to the current appraisal value of the property, a 203(k) loan bases the mortgage amount on the lesser of the following:

  • The current value of the property, plus the cost of the renovations
  • 110 percent of the appraised value of the property after the renovations are complete

In other words, it enables you to purchase a property that you otherwise might not be able to take out a mortgage on because the 203(k) loan factors in the value of the improvements to be made.

And it allows you to do so with a down payment as low as 3.5 percent, which can be especially helpful for first-time homebuyers who often don’t have as much cash to bring to the table.

All of this opens up a number of opportunities that would otherwise be off limits to many homebuyers. For Pamela Capalad, a fee-only certified financial planner and the founder of Brunch & Budget, it was the only way that she and her husband could afford a house in Brooklyn, N.Y., which is where they wanted to live.

“Finding out about the 203(k) loan opened us up to the idea of buying a house that needed to be renovated,” Capalad said. “It was by far the most budget-friendly way to do it.”

Of course, the opportunity comes with some additional costs.

According to Eamon McKeon, a New York-based renovation loan specialist, interest rates on a 203(k) loan are typically 0.25 to 0.375 percentage points higher than conventional loans.

They also require you to pay mortgage insurance. There is an upfront premium equal to 1.75 percent of the base loan amount, which is rolled into the mortgage. And there is an annual premium, paid monthly, that ranges from 0.45 to 1.05 percent, depending on the size of the loan, the size of the down payment, and the length of your mortgage.

Additionally, McKeon cautioned that unlike conventional loans, this mortgage insurance premium is applied for the entire life of the loan unless you put at least 10 percent down. The only way to get rid of it is to refinance.

What renovations can be financed through a 203(k) loan?

Source: iStock

A 203(k) loan allows you to finance a wide range of renovations, all the way from small improvements like kitchen appliance upgrades to major projects like completely tearing down and rebuilding the house.

The U.S. Department of Housing and Urban Development provides a list of eligible improvements:

The big stipulation is the work has to be done by a contractor. You are not allowed to do any of the work yourself (though there is an exception to this rule for people who have the skills to do it).

According to McKeon, this is the most challenging part of successfully executing a 203(k) loan. He said the vast majority of the projects he sees go south have contractor-related issues, from underestimating the bid, to being unresponsive, to not having the correct licenses.

On the flip side, one of the benefits is that the bank helps you manage costs. They put the money needed for the renovations into an escrow account and only release it to the contractor as improvements are made and inspected.

For Capalad and her husband, this arrangement was one of the draws of the 203(k) loan.

“I liked knowing that the contractor couldn’t suddenly gouge us,” she said. “He couldn’t quote $30,000 and then come back later and tell us we actually owed him $100,000.”

Capalad suggested using sites like Yelp and HomeAdvisor, as well as references from friends, to find a contractor. She said you should interview at least four to five people, get bids from each, and not necessarily jump at the cheapest bid.

“We made the mistake of immediately rejecting higher estimates,” said Capalad. “We realized later that their estimates were higher because they were more aware of what needed to be done and how the process would work.”

Who can use a 203(k) loan?

A 203(k) loan is available to anyone who meets the eligibility requirements (discussed below) and is looking to renovate a home.

It’s often appealing to first-time homebuyers, who are generally younger and therefore less likely to have the cash necessary for either a conventional mortgage or to fund the renovations themselves. But there is no requirement that you have to be a first-time homebuyer.

The program can also be used to finance either the purchase of a home in need of renovation or to refinance an existing mortgage in order to update your current home.

3 reasons to use a 203(k) loan

There are a few common situations in which a 203(k) loan can make a lot of sense:

  1. Expand your opportunity: In a hot market, move-in ready homes often sell quickly and for more than asking price. A 203(k) loan can open up the market for you, allowing you to choose from a wider range of properties knowing that you can improve upon any house you buy.
  2. Upgrade your current home: If you want to add a bedroom, redo your kitchen, or make any other improvements to your current home, a 203(k) loan allows you to refinance and fold the cost of those upgrades into your new mortgage with a smaller down payment than other options.
  3. Increase your home equity: McKeon argued that anyone taking out a regular FHA loan should at least consider turning it into a 203(k) loan. With the right improvements, you could increase the value of your home to the point that you have enough equity after the renovations to refinance into a conventional mortgage and remove or reduce your monthly mortgage insurance premium.

What it takes to qualify for a 203(k) loan

Qualifying for a 203(k) loan is much like qualifying for a regular FHA mortgage loan, but with slightly stricter credit requirements.

“FHA may allow FICO scores in the 500s, [but] banks/lenders have discretion or are required to only go so low on the score,” McKeon said.

Here are the major criteria you’ll have to meet:

  • You have to work with an FHA-approved lender.
  • The minimum credit score is 500, though McKeon said a credit score of 640 is typically needed in order to secure the smallest down payment of 3.5 percent.
  • You have to have sufficient income to afford the mortgage payments, which the lender determines by evaluating two years of tax returns.
  • Your total debt-to-income ratio typically cannot exceed 43 percent.
  • You must have a clear CAIVRS report, indicating that you are not currently delinquent and have never defaulted on any loans backed by the federal government. This includes federal student loans, SBA loans and prior FHA loans.
  • The current property value plus the cost of the renovations must fall within FHA mortgage limits.

The 203(k) loan application process

McKeon said the process of applying for a 203(k) loan generally looks like this:

  1. Get preapproved for a mortgage by an FHA-approved lender.
  2. Find a property you want to buy and submit an offer.
  3. Find an approved 203(k) consultant to inspect the property and create a write-up of repairs needed and the estimated cost.
  4. Interview contractors, receive estimates, and select one to be vetted and approved by your lender.
  5. Obtain an appraisal to determine the post-renovation value of your house.
  6. Provide other information and documentation as requested by your lender in order to finalize loan approval.

Property types eligible for 203(k) loans

A 203(k) loan can be used for any single-family home that was built at least one year ago and has anywhere from one to four units. You can use the loan to increase a single-unit property into a multi-unit property, up to the four-unit limit, and you can also use it to turn a multi-unit property into a single-unit property.

These loans can be used to improve a condominium, provided it meets the following conditions:

  • It must be located in an FHA-approved condominium project.
  • Improvements are generally limited to the interior of the unit.
  • No more than 5 units, or 25 percent of all units, in a condominium association can be renovated at any time.
  • After renovation, the unit must be located in a structure that contains no more than four units total.

A 203(k) loan can also be used on a mixed residential/business property if at least 51 percent of the property is residential and the business use of the property does not affect the health or safety of the residential occupants.

It’s worth noting that the property must be owner-occupied, so a 203(k) loan is not an option for a pure investment property.

Within those limits, a wide variety of properties could qualify. McKeon noted that when he writes these loans, he doesn’t care about the current condition of the property. Everything is based on the renovations to be done and the future condition of the property.

Part II: Types of 203(k) loans

Standard vs. streamline 203(k) loans

A streamline 203(k) loan, or limited 203(k) loan, is a version of the 203(k) loan that can be used for smaller renovations. While there is no limit to the renovation costs associated with a standard 203(k) loan — other than the general FHA mortgage limits — a streamline 203(k) can only be used for up to $35,000 in repairs. There is no minimum repair cost.

In return, you get an easier application process. While a standard 203(k) loan requires you to hire a HUD-approved 203(k) consultant to help manage the renovation process, a streamline 203(k) does not.

However, there are limits to the kind of work you can have done with a streamline 203(k) loan. You can review the list of allowed improvements here and the list of ineligible improvements here, but here’s a quick overview of what isn’t allowed with a streamline 203(k):

  • The improvements can’t be expected to take more than six months to complete.
  • The improvements can’t prevent you from occupying the property for more than 15 days during the renovation.
  • You cannot convert a single-unit home into a multi-unit home, or vice versa.
  • You cannot do a complete teardown.

So when does a streamline 203(k) loan make sense over a standard 203(k) loan? Here is when it’s worth considering:

  • The property requires less than $35,000 in repairs and otherwise falls within the requirements for an eligible renovation.
  • You are comfortable scoping the work, gathering contractor estimates, and supervising the renovations without the help of a consultant.
  • You don’t expect the renovations to require an extensive amount of time.
  • You like the idea of minimizing paperwork and otherwise shortening the entire process.

Part III: Is a 203(k) loan the best option for you?

Alternatives to a 203(k) loan

Of course, a 203(k) loan isn’t the only way to finance a renovation. Here are some of the alternatives.

Fannie Mae HomeStyle Renovation Mortgage

The Fannie Mae HomeStyle Renovation Mortgage is a conventional conforming mortgage that, like the 203(k) loan, is specifically designed to finance renovations.

The biggest drawback is that it requires a 5 percent down payment as opposed to 3.5 percent. That can potentially require you to bring a few thousand dollars more in cash to the table.

But McKeon says that if you can afford it, it’s usually a better option. The biggest reason is that your monthly private mortgage insurance (PMI) is typically less, and it automatically drops off once your loan-to-value ratio reaches 78 percent, as opposed to a 203(k) loan where the PMI generally lasts for the life of the loan.

Home equity loan

If you’re looking to renovate your current home, one option would simply be to take out a home equity loan that allows you to borrow against the equity you’ve already built up in your house.

The advantages over a 203(k) loan would generally be a potentially lower interest rate and fewer restrictions around what improvements are made and who makes them.

The big downside is that your loan is limited to your current equity. If you purchased your home relatively recently, or if your home has decreased in value, you may not have enough equity to finance a sizable improvement. And if you are looking to purchase and renovate a new home, the 203(k) loan is likely the better option.

Title I property improvement loan

Like 203(k) loans, Title I property improvement loans are backed by the federal government. They allow you to borrow up to $25,000 for single-family homes, and up to $12,000 per unit for multi-unit properties, to improve a home you currently own.

This loan could be preferable to a 203(k) loan if the improvements you want to make are relatively small, you don’t want to refinance or don’t have the money for a down payment, and/or you’d like to avoid some of the requirements and inspections surrounding a 203(k) loan.

Personal savings

If you have the savings to afford the renovations yourself, or if you can wait until you do have the savings, you could save yourself a lot of money by avoiding financing altogether.

Of course, this may or may not be realistic, depending on the type of project you’re considering. For smaller projects that aren’t urgent, this is a worthy candidate. For larger projects or those that need to be addressed immediately, financing may be the only way to make it happen.

203(k) loans open up new opportunities

The FHA 203(k) loan isn’t for everybody. As Capalad found out the hard way, the money you save is often more than made up in sweat equity.

“I was making calls during my lunch break, and my husband was regularly stopping at the house to check in on things,” she said. “It really felt like our lives stopped for those 10 months.”

But McKeon said that if you have a creative eye and you’re willing to put in the work, you can end up with a much better home than you would have been able to purchase if you limited yourself to move-in ready properties, especially if you have a limited amount of cash to bring to the table.

In the end, it’s all about understanding the trade-offs and doing what’s right for you and your family. At the very least, the 203(k) loan expands the realm of possibility.

Matt Becker
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Matt Becker is a writer at MagnifyMoney. You can email Matt at matt@magnifymoney.com

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How to Get ‘Unstuck’ From Your Starter Home

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Source: iStock

Andrew Cordell bought his first home at the worst possible time — 10 years ago, right before the housing bubble burst.

He’s not going to make that mistake again.

“We had immediate fear put in us as homeowners,” says Cordell, 40. “We know how dangerous this can be.”

So the small “starter home” he purchased in Kalamazoo, Michigan back in 2007 now feels just about the right size.

“When we bought, we figured we’d get another home in a few years,” he says. “But the more we settled, the more we thought, ‘Do we really need more space?’ We don’t actually need a large chest freezer or a large yard. Kalamazoo has a lot of parks.”

Apparently, plenty of homeowners feel the same way.

It’s a phenomenon some have called “stuck in their starter homes.” Bucking a decades-long trend, young homeowners aren’t looking to trade up — they’re looking to stay put. Or they are forced to.

According to the National Association of Realtors, “tenure in home” — the amount of time a homebuyer stays — has almost doubled during the past decade. From the 1980s right up until the recession, buyers stayed an average of about six years after buying a home. That’s jumped to 10 years now.

Expected Median in Tenure in Home
Source: 2017 National Association of Realtors® Home Buyer and Seller Generational Trends

 

Other numbers are just as dramatic. In 2001, there were 1.8 million repeat homebuyers, according to the Urban Institute. Last year, there were about half that number, even as the overall housing market recovered. Before the recession, there were generally far more repeat buyers than first-timers. That’s now reversed, with first-time buyers dwarfing repeaters, 1.4 million to 1 million.

This is no mere statistical curiosity. Trade-up buyers are critical to a smooth-functioning housing market, says Logan Mohtashami, a California-based loan officer and economics expert. When starter homeowners get gun-shy, home sales get stuck.

“Move-up buyers are especially important … because they typically provide homes to the market that are appropriate for first-time buyers,” he says. When first-timers stay put, the share of available lower-cost housing is squeezed, making life harder for those trying to make the jump from renting to buying.

Getting unstuck from your starter home

There are plenty of potential causes for this stuck-in-a-starter-home phenomenon — including the fear Cordell describes, families having fewer children, fast-rising prices, and flat incomes. But Mohtashami says the main cause is a hangover from the housing bubble that has left first-time buyers with very little “selling equity.”

Buyers need at least 28 to 33 percent equity to trade into a larger home, and often closer to 40 percent, he says. Those who bought in the previous cycle might have seen their home values recover, but many purchased with low down payment loans, leaving them still equity poor.

That wasn’t such a problem before the recession, as lenders were happy to give more aggressive loans to trade-up buyers. Not any more.

“In the previous cycle you had exotic loans to help demand. Now you don’t. [That’s why] tenure in home is at an all-time high,” Mohtashami says. “Even families having kids aren’t moving up as much.”

Fast-rising housing prices don’t help the trade-up cause either. While homeowners would seem to benefit from increases in selling price, those are washed away by higher purchase prices, unless the seller plans to move to a cheaper market.

“You’re always trying to catch up to a higher priced home,” Mohtashami says.

Cassandra Evers, a mortgage broker in Michigan, says she’s seen the phenomenon, too.

“It’s not for lack of want. It seems to be the inability to afford the cost of the new home,” she says. “It’s not the interest rate that’s the problem, obviously because those are at historic lows and artificially low. It’s because to buy a ‘bigger and better house,’ that house costs significantly more than their current home. The cost of housing has skyrocketed.”

U.S. Homebuyers and Student Loan Debt (by Age)
Source: 2017 National Association of Realtors® Home Buyer and Seller Generational Trends

There’s also the very practical problem of timing. In a fast-rising market, where every home sale is competitive, it’s easy to lose the game of musical chairs that’s played when a family must sell their home before they can buy a new one.

“Folks are concerned about selling their current house in one day and being unable to find a suitable replacement fast enough,” Evers says.

Cordell, who lives with his wife and eight-year-old son, says the family considered a move a few years ago and briefly looked around. But they quickly concluded that staying put was the right choice.

“We looked at some homes and we thought, ‘I guess we could afford that. But we don’t want to be house broke’,” he says. “We don’t want to take on so much debt that ‘What else are we able to do?’ What if one of us loses our job? I guess you could say we have a Depression-era sensibility. … Who would want to get upside down on one of these things?”

The Urban Institute says this stuck-in-starter-home problem shows a few signs of abating recently. Repeat buyers were stuck around 800,000 from 2013 to 2014. Last year, the number pierced 1 million. But that’s still far below the 1.5 million range that held consistently through the past decade.

There are other signs that relief might be on the way, too. ATTOM Data Solutions recently released a report saying that 1 in 4 mortgage-holders in the U.S. are now equity rich — values have risen enough that owners hold at least 50 percent equity, well above Mohtashami’s guideline. Some 1.6 million homeowners are newly equity rich, compared to this time last year, and 5 million more than in 2013, ATTOM said.

“An increasing number of U.S. homeowners are amassing impressive stockpiles of home equity wealth,” says Daren Blomquist, senior vice president at ATTOM Data Solutions.

So perhaps pent-up repeat homebuying demand might re-emerge. Evers isn’t so sure, however.

“Most folks I talked with are no longer interested in being house poor and maxing out their debt to income ratios. They seem to be staying put and shoving money into their retirement accounts,” Evers says.

The Cordells are content where they are in Kalamazoo and plan to stay long term. If anything would make them move, it’s not growing home equity but a growing family.

“If we ended up with a second (kid), I suppose we’d have to look,” Cordell mused. “But we have no plans for that.”

4 Signs You’re Ready to Trade Up Your Home

  • YOU’VE GOT PLENTY OF EQUITY: Your home’s value has risen enough that you safely have at least 28 percent equity and, preferably, more like 35 to 40 percent.
  • YOU’RE EARNING MORE: Your monthly take-home income has risen since you bought your first home by about as much as your monthly payments (mortgage, interest, insurance, taxes, condo fees, etc.) would rise in a new home.
  • YOU STAND TO MAKE A HEALTHY PROFIT: You are confident that if you sell your home, you’d walk away from closing with at least 30 percent of the price for your new home — or you can top up your seller profits to that level with cash you’ve saved for a new down payment. That would let you make a standard 20 percent down payment and have some left over for surprise repairs and moving costs that will come with the new place. Remember, transaction costs often surprise buyers and sellers, so be sure to build them into your calculations.
  • YOU CAN HANDLE THE RISK: You have the stomach for the game of musical chairs that comes with selling then buying a home in rapid succession. Also, if you are in a hot market, you have extra cash to outbid others or a place for your family to stay in case there’s a time gap between selling and buying.



Bob Sullivan
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Bob Sullivan is a writer at MagnifyMoney. You can email Bob here

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4 Lessons We Learned from Buying Our House at an Estate Sale

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Newlyweds Laura and Chris Mericas, pictured above, stumbled upon their dream home at an estate sale in Houston, Texas. “We were never wanting to buy a brand new house,” Laura told MagnifyMoney. “We knew that whatever house we got, we would want to do work.” Photo courtesy of Laura and Chris Mericas.

Around a year ago, newlyweds Laura and Chris Mericas were eager to purchase their first home in Houston, Texas. It didn’t take long before they realized homes in the neighborhoods they liked were out of their budget, so they put home buying on hold. Laura and Chris aren’t alone — like other millennials, they’re being priced out of markets across the country. Homeownership among millennials is lower than decades past: For those under 35, 39% owned homes in 1995, compared to 43% in 2005 and just 31% in 2015, according to the U.S. Census Bureau.

On the off chance that he might come across a good deal, Chris, 26, continued to look at realtor websites. A year later, he happened upon a home in the Garden Oaks-Oak Forest neighborhood in Northwest Houston that piqued his interest. The property — a three-bedroom, one-bathroom fixer-upper — was listed as part of an estate sale, and it was within their maximum budget of $350,000. They made their move.

“We found the house on a Monday and had an offer accepted by Friday,” Chris says.

But the journey was far from smooth. Here’s what they learned along the way.

You can’t judge a house by its cover photo

Browsing through realtor photos of the house online, Laura wasn’t exactly impressed. Driven by the price point, however, they decided to give it a shot.

They were pleasantly surprised.

“Because it was an estate sale and because the people selling it weren’t super motivated [to stage the home for photos],” says Laura, 25. “For whatever reason, the pictures online were awful.”

The home had belonged to a man who was born in the house and purchased it after his parents died. He had rented the home out and planned on permanently moving into the house before he passed away. It was his children who decided to sell rather than continue renting it out.

Laura says she thinks because the home was a rental property, the children were even more eager to sell it. Brian Davis, a real estate investor, says family members eager to sell estate sale properties is common.

“The adult children typically want to sell the property as quickly as possible, since it will continue to accrue costs while it sits vacant,” he says. “Mortgage payments, taxes, insurance and maintenance all add up quickly. These adult children often don’t have as strong of an emotional attachment to the house as live-in owners do, and are less likely to be offended by low offers.”

Emotions will inevitably add complications

Despite the children not being attached to the home, Laura, a freelance journalist, and Chris, a mechanical engineer, still felt unsure how to act during negotiations.

“I think the fact that it was an estate sale made it different on our end,” Chris says. “In the negotiation phase, we were a little conflicted. We don’t want to belittle the fact that they just lost their father … but in addition to that, we wanted to play off the fact that they weren’t selling this house to buy another house. It was extra income that they weren’t expecting because their father died at a young age.”

There were other offers on the table, but most were from professional house flippers who were offering land value only, so theirs was accepted quickly.

A good home inspection is everything

Laura and Chris first found their new home in early March, and they closed on April 24. All in all, the whole process took around 50 days.

“It was a pretty stressful two weeks at the beginning, getting all of our paperwork and getting all of our employment records to get the loan,” Laura says. They both had strong credit scores and were already pre-approved for a mortgage because they had looked into buying a home a year earlier, which helped speed up the process.

But it wasn’t all smooth sailing.

“We had to scramble to get the inspection done,” Laura says. The couple initially asked for 10 days to get the appraisal done, but then asked for a two-day extension because a lot of inspection companies were closed for spring break.

After their initial offer was accepted, inspectors came to look at the home and found it was rife with problems: outdated and dangerous electrical wiring, plumbing troubles, and holes in the sewer line. The inspectors said it would cost around $20,000 for these repairs, so Laura and Chris sent a second offer that took these costs into consideration.

Their offer was accepted immediately.

Fixer-uppers require a lot of imagination — and cash

In most home sales, the property is tidy and beautifully staged. Laura and Chris discovered this wasn’t the case in their estate sale. “I feel like when people are trying to sell their house, they might try to spruce it up a bit in the months leading up to it,” Laura says. “There was definitely none of that. It was dirty. There was dog hair.”

So they used their imagination. Laura and Chris always envisioned purchasing a home in need of renovation and a little TLC, so the problems with the house didn’t faze them. “We were never wanting to buy a brand new house,” Laura says. “We knew that whatever house we got, we would want to do work.”

After completing around $20,000 in necessary home renovations after closing, Laura and Chris moved in early June. Although it’s been a whirlwind few months, the couple feels lucky to have swooped in on the estate sale at the perfect moment. They say every other comparable home they saw in the same neighborhood about $75,000 more than what they paid.

“We saw an opportunity to get into the neighborhood with a steal,” Laura says. “Down the street, there are people building enormous houses. We would never be able to get into this neighborhood at that price ever again.”

Tips for purchasing a home from an estate sale

Kevin Godfrey, an agent with Douglas Elliman and the owner of Henry Laurent Estate Sales, shares his advice for purchasing a home through an estate sale.

  1. Use the estate sale as the open house. Go into the rooms, check the water pressure, inspect the foundation, and discreetly take measurements. Take your time and make sure it’s what you are looking for. A standard open house lasts for two hours, while an estate sale lasts for two days — eight hours each.
  1. If you get in early enough, the owner won’t have an agent yet. Dealing directly with them and only using real estate attorneys to finalize the transaction can save the owner the typical 4% to 6% agent fee.
  1. As with any purchase of a home, you’ll still want to do all of the necessary inspections and search the property records for liens or encumbrances.
Jamie Friedlander
Jamie Friedlander |

Jamie Friedlander is a writer at MagnifyMoney. You can email Jamie here

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The Best Mortgages That Require No or Low Down Payment

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

If you’re considering buying a home, you’re probably wondering how much you’ll need for a down payment. It’s not unusual to be concerned about coming up with a down payment. According to Trulia’s report Housing in 2017, saving for a down payment is most often cited as the biggest obstacle to homeownership.

Maybe you’ve heard that you should put 20% down when you purchase a home. It’s true that 20% is the gold standard. If you can afford a big down payment, it’s easier to get a mortgage, you may be eligible for a lower interest rate, and more money down means borrowing less, which means you’ll have a smaller monthly payment.

But the biggest incentive to put 20% down is that it allows you to avoid paying for private mortgage insurance. Mortgage insurance is extra insurance that some private lenders require from homebuyers who obtain loans in which the down payment is less than 20% of the sales price or appraised value. Unlike homeowners insurance, mortgage protects the lender – not you – if you stop making payments on your loan. Mortgage insurance typically costs between 0.5% and 1% of the entire loan amount on an annual basis. Depending on how expensive the home you buy is, that can be a pretty hefty sum.

While these are excellent reasons to put 20% down on a home, the fact is that many people just can’t scrape together a down payment that large, especially when the median price of a home in the U.S. is a whopping $345,800.

Fortunately, there are many options for homebuyers with little money for a down payment. You may even be able to buy a house with no down payment at all.

Here’s an overview of the best mortgages you can be approved for without 20% down.

Type of Loan

Down Payment Requirement


Mortgage Insurance

Credit Score Requirement

FHA

FHA

3.5% for most

10% if your FICO credit score is between 500 and 579

Requires both upfront and annual mortgage insurance for all borrowers, regardless of down payment

500 and up

SoFi

SoFi

10%

No mortgage insurance required

Typically 700 or higher

VA Loan

VA Loan

No down payment required for eligible borrowers (military service members, veterans, or eligible surviving spouses)

No mortgage insurance required; however, there may be a funding fee, which can run from 1.25% to 2.4% of the loan amount

No minimum score
required

homeready

HomeReady

3% and up

Mortgage insurance required when homebuyers put down
< 20%; no longer required once the loan-to-value ratio reaches 78% or less

620 minimum

homeready

USDA

No down payment required

Ongoing mortgage insurance not required, but borrowers pay an upfront fee of 2% of the purchase price

620-640 minimum

FHA Loans

An FHA loan is a home loan that is insured by the Federal Housing Administration. These loans are designed to promote homeownership and make it easier for people to qualify for a mortgage. The FHA does this by making a guarantee to your bank that they will repay your loan if you quit making payments. FHA loans don’t come directly from the FHA, but rather an FHA-approved lender. Not all FHA-approved lenders offer the same interest rates and costs, even for the same type of loan, so it’s important to shop around.

Down payment requirements

FHA loans allow you to buy a home with a down payment as low as 3.5%, although people with FICO credit scores between 500 and 579 are required to pay at least 10% down.

Approval requirements

Because these loans are geared toward lower income borrowers, you don’t need excellent credit or a large income, but you will have to provide a lot of documentation. Your lender will ask you to provide documents that prove income, savings, and credit information. If you already own any property, you’ll have to have documentation for that as well.

Some of the information you’ll need includes:

  • Two years of complete tax returns (three years for self-employed individuals)
  • Two years of W-2s, 1099s, or other income statements
  • Most recent month of pay stubs
  • A year-to-date profit-and-loss statement for self-employed individuals
  • Most recent three months of bank, retirement, and investment account statements

Mortgage insurance requirements

The FHA requires both upfront and annual mortgage insurance for all borrowers, regardless of their down payment. On a typical 30-year mortgage with a base loan amount of less than $625,500, your annual mortgage insurance premium will be 0.85% as of this writing. The current upfront mortgage insurance premium is 1.75% of the base loan amount.

Casey Fleming, a mortgage adviser with C2 Financial Corporation and author of The Loan Guide: How to Get the Best Possible Mortgage, also reminds buyers that mortgage insurance on an FHA loan is permanent. With other loans, you can request the lenders to cancel private mortgage insurance (MIP) once you have paid down the mortgage balance to 80% of the home’s original appraised value, or wait until the balance drops to 78% when the mortgage servicer is required to eliminate the MIP. But mortgage insurance on an FHA loan cannot be canceled or terminated. For that reason, Fleming says “it’s best if the homebuyer has a plan to get out in a couple of years.”

Where to find an FHA-approved lender

As we mentioned earlier, FHA loans don’t come directly from the FHA, but rather an FHA-approved lender. Not all FHA-approved lenders offer the same interest rates and costs, even for the same type of loan, so it’s important to shop around.

The U.S. Department of Housing and Urban Development (HUD) has a searchable database where you can find lenders in your area approved for FHA loans.

First, fill in your location and the radius in which you’d like to search.

Next, you’ll be taken to a list of FHA-approved lenders in your area.

Who FHA loans are best for

FHA loans are flexible about how you come up with the down payment. You can use your savings, a cash gift from a family member, or a grant from a state or local government down-payment assistance program.

However, FHA loans are not the best option for everyone. The upfront and ongoing mortgage insurance premiums can cost more than private mortgage insurance. If you have good credit, you may be better off with a non-FHA loan with a low down payment and lower loan costs.

And if you’re buying an expensive home in a high-cost area, an FHA loan may not be able to provide you with a large enough mortgage. The FHA has a national loan limit, which is recalculated on an annual basis. For 2017, in high-cost areas, the FHA national loan limit ceiling is $636,150. You can check HUD.gov for a complete list of FHA lending limits by state.

SoFi

For borrowers who can afford a large monthly payment but haven’t saved up a big down payment, SoFi offers mortgages of up to $3 million. Interest rates will vary based on whether you’re looking for a 30-year fixed loan, a 15-year fixed loan, or an adjustable rate loan, which has a fixed rate for the first seven years, after which the interest rate may increase or decrease. Mortgage rates started as low as 3.09% for a 15-year mortgage as of this writing. You can find your rate using SoFi’s online rate quote tool without affecting your credit.

Down payment requirements

SoFi requires a minimum down payment of at least 10% of the purchase price for a new loan.

Approval requirements

Like most lenders, SoFi analyzes FICO scores as a part of its application process. However, it also considers factors such as professional history and career prospects, income, and history of on-time bill payments to determine an applicant’s overall financial health.

Mortgage insurance requirements

SoFi does not charge private mortgage insurance, even on loans for which less than 20% is put down.

What we like/don’t like

In addition to not requiring private mortgage insurance on any of their loans, SoFi doesn’t charge any loan origination, application, or broker commission fees. The average closing fee is 2% to 5% for most mortgages (it varies by location), so on a $300,000 home loan, that is $3,000. Avoiding those fees can save buyers a significant amount and make it a bit easier to come up with closing costs. Keep in mind, though, that you’ll still need to pay standard third-party closing costs that vary depending on loan type and location of the property.

There’s not much to dislike about SoFi unless you’re buying a very inexpensive home in a lower-cost market. They do have a minimum loan amount of $100,000.

Who SoFi mortgages are best for

SoFi mortgages are really only available for people with excellent credit and a solid income. They don’t work with people with poor credit.

SoFi does not publish minimum income or credit score requirements.

VA Loans

Rates can vary by lender, but currently, rates for a $225,000 30-year fixed-rate loan run at around 3.25%, according to LendingTree. (Disclosure: LendingTree is the parent company of MagnifyMoney.)

Down payment requirements

Eligible borrowers can get a VA loan with no down payment. Although the costs associated with getting a VA loan are generally lower than other types of low-down-payment mortgages, Fleming says there is a one-time funding fee, unless the veteran or military member has a service-related disability or you are the surviving spouse of a veteran who died in service or from a service-related disability.

That funding fee varies by the type of veteran and down-payment percentage, but for a new-purchase loan, the funding fee can run from 1.25% to 2.4% of the loan amount.

Approval requirements

VA loans are typically easier to qualify for than conventional mortgages. To be eligible, you must have suitable credit, sufficient income to make the monthly payment, and a valid Certificate of Eligibility (COE). The COE verifies to the lender that you are eligible for a VA-backed loan. You can apply for a COE online, through your lender, or by mail using VA Form 26-1880.

The VA does not require a minimum credit score, but lenders generally have their own requirements. Most ask for a credit score of 620 or higher.

If you’d like help seeing if you are qualified for a VA loan, check to see if there’s a HUD-approved housing counseling agency in your area.

Mortgage insurance requirements

Because VA loans are guaranteed by the Department of Veterans Affairs, they do not require mortgage insurance. However, as we mentioned previously, be prepared to pay an additional funding fee of 1.25% to 2.4%.

What we like/don’t like

There’s no cap on the amount you can borrow. However, there are limits on the amount the VA can insure, which usually affects the loan amount a lender is willing to offer. Loan limits vary by county and are the same as the Federal Housing Finance Agency’s limits, which you can find here.

HomeReady

 

The HomeReady program is offered by Fannie Mae. HomeReady mortgage is aimed at consumers who have decent credit but low- to middle-income earnings. Borrowers do not have to be first-time home buyers but do have to complete a housing education program.

Approval requirements

HomeReady loans are available for purchasing and refinancing any single-family home, as long as the borrower meets income limits, which vary by property location. For properties in low-income areas (as determined by the U.S. Census), there is no income limit. For other properties, the income eligibility limit is 100% of the area median income.

The minimum credit score for a Fannie Mae loan, including HomeReady, is 620.

To qualify, borrowers must complete an online education program, which costs $75 and helps buyers understand the home-buying process and prepare for homeownership.

Down payment requirements

HomeReady is available through all Fannie Mae-approved lenders and offers down payments as low as 3%.

Reiss says buyers can combine a HomeReady mortgage with a Community Seconds loan, which can provide all or part of the down payment and closing costs. “Combined with a Community Seconds mortgage, a Fannie borrower can have a combined loan-to-value ratio of up to 105%,” Reiss says. The loan-to-value (LTV) ratio is the ratio of outstanding loan balance to the value of the property. When you pay down your mortgage balance or your property value increases, your LTV ratio goes down.

Mortgage insurance requirements

While HomeReady mortgages do require mortgage insurance when the buyer puts less than 20% down, unlike an FHA loan, the mortgage insurance is removed once the loan-to-value ratio reaches 78% or less.

What we like/don’t like

HomeReady loans do require private mortgage insurance, but the cost is generally lower than those charged by other lenders. Fannie Mae also makes it easier for borrowers to get creative with their down payment, allowing them to borrow it through a Community Seconds loan or have the down payment gifted from a friend or family member. Also, if you’re planning on having a roommate, income from that roommate will help you qualify for the loan.

However, be sure to talk to your lender to compare other options. The HomeReady program may have higher interest rates than other mortgage programs that advertise no or low down payments.

USDA Loan

USDA loans are guaranteed by the U.S. Department of Agriculture. Although the USDA doesn’t cap the amount a homeowner can borrow, most USDA-approved lenders extend financing for up to $417,000.

Rates vary by lender, but the agency gives a baseline interest rate. As of August 2016, that rate was just 2.875%

Approval requirements

USDA loans are available for purchasing and refinancing homes that meet the USDA’s definition of “rural.” The USDA provides a property eligibility map to give potential buyers a general idea of qualified locations. In general, the property must be located in “open country” or an area that has a population less than 10,000, or 20,000 in areas that are deemed as having a serious lack of mortgage credit.

USDA loans are not available directly from the USDA, but are issued by approved lenders. Most lenders require a minimum credit score of 620 to 640 with no foreclosures, bankruptcies, or major delinquencies in the past several years. Borrowers must have an income of no more than 115% of the median income for the area.

Down payment requirements

Eligible borrowers can get a home loan with no down payment. Other closing costs vary by lender, but the USDA loan program does allow borrowers to use money gifted from friends and family to pay for closing costs.

Mortgage insurance requirements

While USDA-backed mortgages do not require mortgage insurance, borrowers instead pay an upfront premium of 2% of the purchase price. The USDA also allows borrowers to finance that 2% with the home loan.

What we like/don’t like

Some buyers may dismiss USDA loans because they aren’t buying a home in a rural area, but many suburbs of metropolitan areas and small towns fall within the eligible zones. It could be worth a glance at the eligibility map to see if you qualify.

At a Glance: Low-Down-Payment Mortgage Options

To see how different low-down-payment mortgage options might look in the real world, let’s assume a buyer with an excellent credit score applies for a 30-year fixed-rate mortgage on a home that costs $250,000.

As you can see in the table below, their monthly mortgage payment would vary a lot depending on which lender they use.

 

Down Payment


Total Borrowed


Interest Rate


Principal & Interest


Mortgage Insurance


Total Monthly Payment

FHA


FHA

3.5%
($8,750)

$241,250

4.625%

$1,083

$4,222 up front
$171 per month

$1,254

SoFi


SoFi

10%
($25,000)

$225,000

3.37%

$995

$0

$995

VA


VA Loan

0%
($0)

$250,000

3.25%

$1,088

$0

$1,088

HomeReady


homeready

3%
($7,500)

$242,500

4.25%

$1,193

$222 per month

$1,349

USDA


homeready

0%

$250,000

2.875%

$1,037

$5,000 up front,
can be included in
total financed

$1,037

Note that this comparison doesn’t include any closing costs other than the upfront mortgage insurance required by the FHA and USDA loans. The total monthly payments do not include homeowners insurance or property taxes that are typically included in the monthly payment.

ANALYSIS: Should I put down less than 20% on a new home just because I can?

So, if you can take advantage of a low- or no-down-payment loan, should you? For some people, it might make financial sense to keep more cash on hand for emergencies and get into the market sooner in a period of rising home prices. But before you apply, know what it will cost you. Let’s run the numbers to compare the cost of using a conventional loan with 20% down versus a 3% down payment.

Besides private mortgage insurance, there are other downsides to a smaller down payment. Lenders may charge higher interest rates, which translates into higher monthly payments and more money spent over the loan term. Also, because many closing costs are a percentage of the total loan amount, putting less money down means higher closing costs.

For this example, we’ll assume a $250,000 purchase price and a loan term of 30 years. According to Freddie Mac, during the week of June 22, 2017, the average rate for a 30-year fixed-rate mortgage was 3.90%.

Using the Loan Amortization Calculator from MortgageCalculator.org:

Assuming you don’t make any extra principal payments, you will have to pay private mortgage insurance for 112 months before the principal balance of the loan drops below 78% of the home’s original appraised value. That means in addition to paying $169,265.17 in interest, you’ll pay $11,316.48 for private mortgage insurance.

The bottom line

Under some circumstances, a low- or no-down-payment mortgage, even with private mortgage insurance, could be considered a worthwhile investment. If saving for a 20% down payment means you’ll be paying rent longer while you watch home prices and mortgage rates rise, it could make sense. In the past year alone, average home prices increased 16.8%, and Kiplinger is predicting that the average 30-year fixed mortgage rate will rise to 4.1% by the end of 2017.

If you do choose a loan that requires private mortgage insurance, consider making extra principal payments to reach 20% equity faster and request that your lender cancels private mortgage insurance. Even if you have to spend a few hundred dollars to have your home appraised, the monthly savings from private mortgage insurance premiums could quickly offset that cost.

Keep in mind, though, that the down payment is only one part of the home-buying equation. Sonja Bullard, a sales manager with Bay Equity Home Loans in Alpharetta, Ga., says whether you’re interested in an FHA loan or a conventional (i.e., non-government-backed) loan, there are other out-of-pocket costs when buying a home.

“Through my experience, when people hear zero down payment, they think that means there are no costs for obtaining the loan,” Bullard says. “People don’t realize there are still fees required to be paid.”

According to Bullard, those fees include:

  • Inspection: $300 to $1,000, based on the size of the home
  • Appraisal: $375 to $1,000, based on the size of the home
  • Homeowners insurance premiums, prepaid for one year, due at closing: $300 to $2,500, depending on coverage
  • Closing costs: $4,000 to $10,000, depending on sales price and loan amount
  • HOA initiation fees

So don’t let a seemingly insurmountable 20% down payment get in the way of homeownership. When you’re ready to take the plunge, talk to a lender or submit a loan application online. You might be surprised at what you qualify for.

Janet Berry-Johnson
Janet Berry-Johnson |

Janet Berry-Johnson is a writer at MagnifyMoney. You can email Janet here

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How to Buy a House With a Friend — The Right Way

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

It’s completely possible for you to purchase a house or other property with someone who isn’t your spouse, like a friend or family member.

“It’s a beautiful occasion, but it’s also a complex business transaction,” says Senior Managing Partner of New York City-based Law Firm of Kishner & Miller, Bryan Kishner. “There are tremendous positives to the overall thing, but people need to be careful with the unforeseen items, and a lot of people say they didn’t think about that.”

For friends who are unable to afford a home in their area on a single income, or cohabiting couples, buying a home together can help both parties boost their net worth or simply achieve a goal of becoming a homeowner.

That being said, purchasing a home with a friend can be more complicated than buying a house with your spouse. The key to a successful co-homeownership arrangement is to set yourselves up for success from the get-go.

Choose the Right Joint Homeownership Structure

When you buy a home, you’ll get a title, which proves the property is yours. The paper the title is printed on is called a deed, and it explains how you, the co-owners, have agreed to share the title. The way the title is structured becomes important when you need to figure out what happens when a co-owner needs to part with the property.

These are the two most common ways to approach joint homeownership:

1. Tenants in Common

A tenants in common, or tenancy in common, is the most common structure people use when they purchase a property for personal use. This outlines who owns what percentage of the property and allows each owner to control what happens if they pass away. For example, a co-owner can pass their share onto any beneficiaries in a will, and that will be honored.

The TIC allows co-owners to own unequal shares of the property, which can come in handy if one owner will occupy a significant majority or minority of the shared home. For example, if two friends decide to buy a multifamily home, but one friend pays more because one friend’s space has much more square footage than the other friend’s space, they can split their shares of the home accordingly.

Kishner says to make sure you “reference and evidence your intent to use the tenants in common structure on the deed,” as it’s the primary evidence of your ownership — meaning you would write who owns what percentage of the property on the deed and note the parties chose a TIC structure.

The Pros of a TIC structure

Ownership can be unevenly split

You can own as much or as little as you want of the property as long as the combined ownership adds up to 100%. So, if you’re putting up 60% of the down payment, you can work it out with the other co-owner(s) to own 60% of the property on the title.

You don’t have to live there

You can own part of the property without living there. This is relevant for someone who simply wants to be a partial owner, but doesn’t want to live at the property.

You get to decide what happens to your share after you pass away

The TIC allows you the flexibility to decide what happens to your interest in the property in the event you pass away. You can decide if it will go to the other co-owners or to an heir. Regardless, the decision is yours.

The Cons of a TIC structure

Co-owners can sell their interest without telling you

Co-owners in a TIC can sell their interest in the property at any time, without the permission of others in the agreement. However, if they are also on the mortgage loan, they are still on the hook to make payments, says Rafael Reyes, a loan officer based in New York City.

2. Joint Tenants with Rights of Survivorship

This arrangement is different from a tenants in common arrangement in that in the case of one co-owner’s death, the deceased party’s shares will be automatically absorbed by the living co-owners. For this reason, this type of structure is more common among family members or cohabiting partners looking to purchase property together.

If, for example, you are purchasing with a family member and would like them to automatically absorb your portion in case you pass away unexpectedly, this is the option you’d go with. Even if the deceased has it written in their will to pass their interest to a beneficiary, that likely won’t be honored.

A joint tenants agreement requires these four essential components:

  1. Co-owners must all acquire the property at the same time.
  2. Co-owners must all have the same title on assets.
  3. Each co-owner must own equal interests in the property. So if you buy with one friend, you’ll own 50%, but if you buy with two friends, you’d own one-third of the property. This may be an important consideration if co-owners will occupy different amounts of space in the property.
  4. Co-owners must each have the same right to possess the entirety of the assets.

The Pros of a joint tenants agreement

Everyone owns an equal share in the property

There’s not arguing over shares if you go with a joint tenants arrangement, since it requires all co-owners to have an equal interest. So each co-owner has the same right to use, take loans out against, or sell the property.

No decisions to make if someone dies

There’s nothing for co-owners or family members to fight over after you pass away. Your ownership shares are automatically inherited by the other co-owners when you pass away, regardless of what might be written in a will.

The Cons of a joint tenants agreement

Equal ownership

Equal ownership can be a con as much as it’s a pro. If you’re going to occupy more than 50% of the space, or put up more of the mortgage or down payment, you may want to own more than your equal share of the property. If that will bother you, a TIC agreement is best.

How to Create a Co-ownership Agreement

Before you even start the mortgage lending process, it’s recommended to work out an agreement on how you’ll split equity in the home, who will be responsible for maintenance costs, and what will happen in the event of major life events such as death, marriage, or having children.

“You are more or less going into business together” when you purchase a home with a friend or relative, says Kishner. And like any smart business owner, you’ll want to protect yourself in case things go south down the road.

A real estate attorney can help you set up an official co-ownership agreement.

Kishner recommends each person in the agreement get their own attorney, who can represent each party’s personal concerns and interests during negotiation. Rates vary by location, but he estimates a good real estate lawyer would charge around $1,000.

Ideally, Kishner says, this agreement is created and signed before closing the mortgage loan. That way, if simply going through all of the what-ifs scares someone off, they have the opportunity to pull out.

3 Questions Every Co-ownership Agreement Should Answer

The co-ownership agreement you draft and sign will need to address many issues. Here are three common scenarios the experts offered us:

1. What happens if someone wants out?

Your agreement should outline an exit plan in case one or more of you want out of the property. This could be because of a number of reasons but is the area where things can get extremely complicated. For example, what if one of the co-owners wants to be bought out by the other co-owners?

Let’s say you’ve got three people on a mortgage and on the title to a property. If the other two can come up with the money for the equity, you’ve solved that problem.

But if someone wants to sell their interest in the property, for example, Reyes says they can’t just take the cash and walk away, since they’ll still have some financial obligation to the home if they are on the mortgage. So you’d need to also refinance the mortgage to get them off of it, and that could affect the other co-owner’s financial picture. The only way to relieve someone of their financial obligation to the mortgage is to refinance with the lender. That’s because if they leave and decide to stop making mortgage payments, that will affect your credit score.

Be prepared. When you refinance, the remaining co-owners will need to qualify again for the mortgage. If you decided to add a co-owner because you couldn’t originally qualify for the property based on your income, you might not qualify to own after a refinance.

If you can’t refinance, you all may decide to arrange for the departing member to rent out their living space in the household … then you’d need to deal with the issues surrounding finding a roommate or having a tenant. However you all want to go about handling this kind of situation should already be outlined in the co-ownership agreement, so you’ll have one less thing to argue over in a split.

2. What happens if a co-owner loses their job?

You want to be prepared to fulfill your financial obligations if someone loses their income. That’s why it’s recommended to create a shared emergency fund, which you can draw from in the case that one of the owners runs into financial issues (or, of course, to handle any maintenance needs). You can establish the contributions and rules surrounding a shared emergency fund in your co-ownership agreement.

Reyes advises putting away about six months’ worth of the property expenses into a shared savings account.

“That six-month reserve, at least, is important because ultimately, God forbid, if there is some kind of financial turbulence like job loss, they can cover the mortgage or they could sell the home within six months in this market,” said Reyes.

3. How will you pay bills and taxes?

The co-ownership agreement also needs to address how you all will split up housing costs. Kauffman says you should set up a joint account and agree on what each party should contribute to the fund each pay period.

You should consider the repairs, maintenance, and upkeep on the house, as well as things that could increase over time such as property tax and homeowner’s insurance, too, Kauffman adds. In the event those costs exceed what you’ve set aside to pay for them in escrow accounts, the co-ownership agreement needs to outline how the extra bill will be paid.

Applying for a Mortgage as a Joint Homeowner

If you want to purchase a home with a friend or relative, you’ll first have to decide whether or not both of your names will be on the mortgage.

A lender will consider both of your credit scores during the underwriting process, which means a person with a lower credit score could drag down your collective credit score, leading to higher mortgage rates.

Kauffman strongly advises reaching out to figure out your financing before applying for a loan with friends.

“Each of them might understand what they can afford on their own, but they may not be aware of how their purchasing power changes,” Kauffman says. You may find you qualify for more or less house than you thought you could afford.

He adds there are some serious things to consider when you decide to enter into an investment with other people that you’re not necessarily tied to. Carefully consider your personal relationships with the people you’re going into homeownership with.

“You’ve got to really consider who you’re getting into it with and really consider all of these things that are bound to happen when you have [multiple] lives,” says Kauffman.

It can also be potentially awkward when friends or colleagues realize they must reveal aspects of their finances that they might prefer to keep private, such as their credit score, credit history, and total income.

“Oftentimes people learn a lot about their [co-owner] through a credit report, and it becomes embarrassing and uncomfortable sometimes,” says Rick Herrick, a loan officer at Bedford, N.H.-based Loan Originator.

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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7 Reasons Your Mortgage Application Was Denied

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

There are few things more nerve-racking for homebuyers than waiting to find out if they were approved for a mortgage loan.

Nearly 627,000 mortgage applications were denied in 2015, according to the latest data from the Federal Reserve, down slightly (-1.1%) year over year. If your mortgage application was denied, you may be naturally curious as to why you failed to pass muster with your lender.

There are many reasons you could have been denied, even if you’re extremely wealthy or have a perfect 850 credit score. We spoke with several mortgage experts to find out where prospective homebuyers are tripping up in the mortgage process.

Here are seven reasons your mortgage application could be denied:

You recently opened a new credit card or personal loan

Taking on new debts prior to beginning the mortgage application process is a “big no-no,” says Denver, Colo.-based loan officer Jason Kauffman. That includes every type of debt — from credit cards and personal loans to buying a car or financing furniture for your new digs.

That’s because lenders will have to factor any new debt into your debt-to-income ratio.

Your debt-to-income ratio is fairly simple to calculate: Add up all your monthly debt payments and divide that number by your monthly gross income.

A good rule of thumb is to avoid opening or applying for any new debts during the six months prior to applying for your mortgage loan, according to Larry Bettag, attorney and vice president of Cherry Creek Mortgage in Saint Charles, Ill.

For a conventional mortgage loan, lenders like to see a debt-to-income ratio below 40%. And if you’re toeing the line of 40% already, any new debts can easily nudge you over.

Rick Herrick, a loan officer at Bedford, N.H.-based Loan Originator told MagnifyMoney about a time a client opened up a Best Buy credit card in order to save 10% on his purchase just before closing on a new home. Before they were able to close his loan, they had to get a statement from Best Buy showing what his payments would be, and the store refused to do so until the first billing cycle was complete.

“Just avoid it all by not opening a new line of credit. If you do, your second call needs to be to your loan officer,” says Herrick. “Talk to your loan officer if you’re having your credit pulled for any reason whatsoever.”

Your job status has changed

Most lenders prefer to see two consistent years of employment, according to Kauffman. So if you recently lost your job or started a new job for any reason during the loan process, it could hurt your chances of approval.

Changing employment during the process can be a deal killer, but Herrick says it may not be as big a deal if there is very high demand for your job in the area and you are highly likely to keep your new job or get a new one quickly. For example, if you’re an educator buying a home in an area with a shortage of educators or a brain surgeon buying a home just about anywhere, you should be OK if you’re just starting a new job.

If you have a less-portable profession and get a new job, you may need to have your new employer verify your employment with an offer letter and submit pay stubs to requalify for approval. Even then, some employers may not agree to or be able to verify your employment. Furthermore, if your salary includes bonuses, many employers won’t guarantee them.

Bettag says one of his clients found out he lost his job the day before they were due to close, when Bettag called his employer for one last check of his employment status. “He was in tears. He found out at 10 a.m. Friday, and we were supposed to close on Saturday.”

You’ve been missing debt payments

During the loan process, any recent negative activity on your credit report, which goes back seven years, can raise concerns. The real danger zone is any activity reported within the last two years, says Bettag, which is the time period lenders play closest attention to.

That’s why he encourages loan applicants to make sure their credit reports are accurate and that old items that should have fallen off your report after seven years aren’t still appearing.

“Many things show on credit reports beyond seven years. That’s a huge issue, so we want to get dated items removed at the bureau level,” Bettag says.

For first-time homebuyers, he cautions against making any late payments six months prior to applying for a mortgage. They won’t always be a total deal-breaker, but they can obviously ding your credit, and a lower credit score can lead to a loan denial or a more expensive mortgage rate.

Existing homeowners, Bettag says, shouldn’t have any late mortgage payments in the 12 months prior to applying for a new mortgage or a refinance.

“There are workarounds, but it can be as laborious as brain surgery,” says Bettag.

You accepted a monetary gift

Your lender will be on the lookout for any out-of-place deposits to your bank accounts during the approval process. Bettag advises homebuyers not to accept any large monetary gifts at least two months or longer before you apply, and to keep a paper trail if the lender has any questions.

Any cash that can’t be traced back to a verifiable source, such as an annual bonus, or a gift from a family friend, could raise red flags.

This can be tricky for homebuyers who are relying on help from family to purchase their home. If you receive a gift of money for a down payment, it has to be deemed “acceptable” by your lender. The definition of acceptable depends on the type of mortgage loan that you are applying for and the laws that govern the process in your state.

For example, Bettag says, the Federal Housing Authority doesn’t care if a borrower’s entire down payment comes as a gift when they are applying for an FHA loan. However, the gifted funds may not be eligible to use as a down payment for a conventional loan through a bank.

You moved a large amount of money around

Ideally, avoid moving large sums of money about two months before applying.

Herrick says many borrowers make the mistake of shuffling too much cash around just before co-signing, making themselves look suspicious to bank regulators. Herrick says not to move anything more than $1,000 at a time, and none if you can help yourself.

For example, If you’re considering moving money from all of your savings accounts into one account to deliver the cashier’s check for the down payment, don’t do it. You don’t need to have everything in one account for the cashier’s check for your closing. You can submit multiple cashier’s checks. All the lender cares about is that all of the money adds up. You may be able to simply avoid some of this hassle by arranging to pay using a wire transfer. Just be sure to schedule it in time.

You overdrafted your checking account

If you have a credit issue already, says Bettag, overdrafting your checking account can be a deal-breaker, but it won’t cause as much of an issue if you have great credit and offer a good down payment. Still avoid overdrafting for at least two months prior to applying for the mortgage loan.

You may be the type to keep a low checking account balance in favor of saving more money. But if an unexpected bill could risk overdrafting your account, try keeping a few extra dollars in the account for padding, just in case.

You forgot to include debts or other information on your loan application

Your loan officer should carefully review your application to make sure it’s filled out completely and accurately. Missing a zero on your income, or accidentally skipping a section, for example, could mean rejection. A small mistake could mean losing your dream home.

There’s also the chance you accidentally omitted information the underwriter caught in the more extensive screening process, like money owed to the IRS. Disclose all of your debt to your loan officer up front. Otherwise, they may not be able to help you if the debt comes up and disqualifies you for your dream home later on.

If you owe the IRS money and are in a payment plan, Bettag says your loan officer can still work with you. However, they want to see that you’ve been in a plan for at least three months and made on-time payments to move forward.

“Can you imagine not paying your IRS debt, getting into a payment plan, and then not paying on the agreed plan? Not cool for lenders to see, but we do,” says Bettag.

The Bottom Line

There is no hard and fast rule on how long before you begin the mortgage process that you should heed these warnings. It all varies, according to Bettag. If you have excellent credit and a strong income, you might be able to get away with a recently opened credit card or other discrepancies — minor faults that might totally derail the application of a person who has bad credit and inconsistent income.

Whatever the case may be, Bettag encourages prospective homebuyers to stick to one general rule: “Don’t do anything until you’ve consulted with your loan officer.”

Brittney Laryea
Brittney Laryea |

Brittney Laryea is a writer at MagnifyMoney. You can email Brittney at brittney@magnifymoney.com

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More Rich People Are Choosing to Rent Than Ever Before — Here’s Why

The editorial content on this page is not provided by any financial institution and has not been reviewed, approved or otherwise endorsed by any of these entities.

Renting a home or condo has become a status symbol for some wealthy Americans.

Karen Rodriguez, an Atlanta, Ga., real estate agent, says people frequently contact her who are interested in condos renting for $10,000 to $15,000 a month in properties such as the Ritz-Carlton Residences, which have floors of condos above upscale hotel rooms.

“I do see a lot of high-net-worth renters,” says Rodriguez, with Berkshire Hathaway HomeServices Georgia Properties. “They have the disposable income to pay top dollar.”

Renter households increased by 9 million during 2005-2015, reaching nearly 43 million in 2015, according to the State of the Nation’s Housing report, an annual study by Harvard University’s Joint Center for Housing Studies that analyzes U.S. Census Bureau data. Of those, 1.6 million renter households earn $100,000 or more, representing 11% of all renters.

“Indeed, renter households earning $100,000 or more have been the fastest-growing segment over the past three years,” the report stated.

Here are four reasons why high earners are choosing to rent.

They’re frustrated with market trends.

stock market numbers and graph

Rob Austin, a biotech account manager in the Los Angeles area with a household income of over $350,000, rents a 1,700-square-foot townhome with his wife and two children.

In the last 10 years, 1.2 million households that earn $150,000 became renters, up from 551,000 in 2005. Using data from the U.S. Census Bureau’s 2015 American Community Survey, RentCafe.com reported in late 2016 that “wealthy households” that earn more than $150,000 annually increased by 217%, compared to an 82% rise in homeowners in the same income bracket.

The $150,000-and-up dollar amount served as the benchmark for “wealthy” renters because that’s the top of the bracket used in the American Community Survey to identify renters and homeowners.

Even when they had their second child in 2016, Austin says they were more steadfast to keep renting the two-bedroom, two-and-a-half bath townhome instead of buying. Prices are increasing so much that they’re “priced beyond perfection,” he says.

“It’s gotten worse,” he says. “Everything is mispriced at this point.”z

They want the next best thing.

Some buyers’ mindset is, “I don’t love it, so I’m just going to go rent a house,” says Atlanta, Ga., real estate agent Ben Hirsh.

Some may be bored with what’s on the market and are holding out for a home or condo with even more extravagant features or amenities. “They’re not happy with what’s out there,” says Rodriguez, also founder of Group Kora Real Estate Group, which sells new and luxury condos.

If they’re in a location or price range that’s hot, they could get more for their home if they sell now. Some wealthy homeowners take advantage of the resale market by going ahead and selling a home or condo and biding their time while renting. For example, if they’re sold on news about ultraluxe condos that have been announced, but are not under construction, they don’t mind renting in the interim.

“People think there’s more coming,” Rodriguez says.

Some clients have so much wealth that they’re willing to pay for the entire year up front for an unfurnished condo, she adds. Investors also have noticed the market trends and are buying condos for $1 million to $2 million with the intention to rent them out.

They don’t want a long-term commitment.

retirement retire millionaire happy couple on the beach

Some wealthy homeowners are ready to sell their million-dollar estates for a lock-it-and-leave-it lifestyle, but aren’t sold on townhome or condo living.

Instead, they’re willing to spend what can amount to the down payment on a starter home for monthly rent to experience the luxury condo lifestyle with privacy and ritzy amenities, like 24/7 room service and spa access.

“They want to test out a high-rise,” Rodriguez says. “They are people who definitely can afford to buy.”

A 2016 report by the National Association of Realtors identified the top 10 markets in the U.S. with the highest share of renters qualified to buy. The study analyzed household income, areas with job growth above the national average, and qualifying income levels (a 3% down payment in each metro area’s median home price in 2015) in about 100 of the largest U.S. metro areas. The markets that are above the national level (28%) were:

  • Toledo, Ohio (46%)
  • Little Rock, Ark. (46%)
  • Dayton, Ohio (44%)
  • Lakeland, Fla. (41%)
  • St. Louis, Mo. (41%)
  • Columbia, S.C. (41%)
  • Atlanta, Ga. (40%)
  • Columbus, Ohio (38%)
  • Tampa, Fla. (38%)
  • Ogden, Utah (38%)

The short-term mentality also may be the nature of the industry that brings people to a city. Some prospective renters whom Rodriguez meets are planning to live in Georgia for a couple of years because of work, such as jobs in the growing entertainment sector. Films such as the “Avengers” and TV shows such as “The Walking Dead” shoot in metro Atlanta.

They don’t want to live out of a suitcase in a hotel and have the income to afford high-priced rentals, joining political figures and international executives who also are among those making the same choice, Rodriguez says.

They want cash in the bank.

Townhomes sell for about $800,000 in Austin’s neighborhood in California. To make a 20% down payment, he’d have to shell out $160,000 up front.

“Why would I want to tie up $160,000 in cash in an asset that most likely is not going to go up a lot more — and more than likely has topped and has nowhere to go but down in the next cycle?” Austin asks.

Austin says he’s not wavering from his decision, although he’s “taking heat” from friends since he has the income to purchase a home.

“We’re bucking the trend by saying, ‘No thanks, we don’t want to play (the real estate market),’” he says. “We’ll just wait.”

Lori Johnston
Lori Johnston |

Lori Johnston is a writer at MagnifyMoney. You can email Lori here

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