Best Buyers' Market In 20 Years
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Homebuyer Facts
Find A COBA Member Who Can Help You Find A Home
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The Process
Buying a home is a complicated process, and it can be particularly daunting for the first-timer.
The following timeline starts one year before you hope to start seriously shopping for a home. This is an ideal; you can arrange your finances and buy a home in less time, if necessary, but you'd be smart to walk through all of the steps in order. The more time you give yourself for this process, the better. A year out (or as soon as possible)
The Credit Report
Get your credit reports. Errors on your reports can force you to pay a higher interest rate on your mortgage or even torpedo your chances of getting a loan. You can get free copies of your reports from the three major credit bureaus -- Equifax, Experian and TransUnion. Look for accounts that aren't yours, collection accounts for debts you don't owe and negative marks (other than bankruptcy) that are older than seven years.
You should be able to dispute errors with the bureaus and get them removed, but if the bureaus or the creditors balk, you may need to hire an attorney. (The National Association of Consumer Advocatescan refer you to lawyers with knowledge of the credit-reporting and debt-collecting laws.) Don't leave yourself in the position of having to pay a bogus collection account to get the loan you want or paying unnecessary interest because of credit-report errors.
Variety in mortgage offerings may ultimately be a boon to borrowers, but, at least at the start of the mortgage-shopping process, variety holds the potential for plenty of confusion. Here's a guide to some of the basics.
Always be aware that some lenders, in their desire to offer something the competition doesn't have, may offer loans that mix features in new -- and potentially confusing -- ways.
Mortgages
Local Contact - Oregon Association of Mortgage Professionals
30-year fixed rate mortgage
The traditional mortgage remains a favorite of borrowers. Although the interest rate is generally higher than the starting rates on other loan types, your interest rate and payment will remain fixed for 30 years with this type of loan, and that's a boon to planning your long-term finances.
A variety on this is a fixed-rate loan with a term of 15 or 20 years. Required monthly payments on these loans will be significantly higher than on a 30-year fixed, but you will build equity faster and, in the long term, pay much less in interest. Most lenders allow you to prepay principal on a 30-year loan, so you can retire the debt earlier. Some lenders also offer 40-year terms, which lowers the monthly payment, but stretches out your indebtedness significantly and boosts the total amount you will have spent on interest.
One-year adjustable-rate mortgage, or ARM
This is the original variety of an adjustable rate mortgage, commonly referred to as an ARM.
A one-year ARM has a 30-year term, but your interest rate will adjust every year. The interest rate will be determined by the index that your loan is pegged to, typically one-year Treasury rates or the LIBOR index (an acronym for the London Interbank Offered Rate) or the COFI index (Federal Reserve Cost of Funds Index). LIBOR and COFI indexes also are used frequently for mortgages that adjust their interest rates more frequently than once a year.
To determine your new interest rate each year, the lender will add a specific margin, say 2.75 percentage points, to that index. However, borrowers are protected from wild run-ups in interest rates by two important caps that are called for in most loan documents. Typically, your rate can rise (or fall -- it does happen) by no more than 2 percentage points each year, and over the life of the loan it can rise by no more than 6 percentage points. Most ARMs start with below-market "teaser" rates, so you should expect your interest rate will rise at its first and possibly second anniversary.
With any ARM, it is important to note how frequently the interest rate can adjust (it can be as frequently as every month with some varieties), plus the index and the margin used to set the new interest rate. Always check for annual and life-of-loan caps on the interest rate. If the loan documents talk about payment caps -- that means your interest rate changes are unlimited. If you pay only the capped payment, you might not be paying enough to cover the interest that is actually being charged on the loan. That unpaid interest gets added to your loan balance, a practice called negative amortization. Your loan balance grows even as you're making the required monthly payment, and that's a risky financial practice.
Hybrid mortgages
Sometimes called a "three-year fixed" or a "five-year fixed," these loans incorporate some of the features of fixed- and adjustable-rate loans. For example, a basic "3/27 hybrid" loan will offer you a rate that is fixed for the first three years and then converts to a one-year ARM for the remaining 27 years of the full 30-year term.
Similarly, a "5/25 hybrid" offers a fixed rate for the first five years and then converts to a one-year ARM for the remaining 25 years. These loans can be a money-saver for borrowers who are all but certain that they will move within three or five years and thus don't need to pay extra for an interest rate that is fixed for a longer period.
Watch the adjustments and caps
Some varieties of these loans, however, will adjust the interest rate every six months -- or even more frequently -- once the fixed-rate period ends. Pay close attention to those details -- and to whatever interest-rate caps will protect you from rapid changes -- before agreeing to apply for the loan, and again when reviewing your loan documents. Once again, look for interest-rate caps instead of payment caps, because the latter could cause your indebtedness to grow over time.
Interest-only mortgages
As the name implies, these loans, usually an ARM or a hybrid, allow a borrower to make interest-only payments during the first five years or so. After that, borrowers are expected to repay principal and interest in order to pay off the loan within the remaining 25 years of its term.
Borrowers can be in for a big payment shock once the interest-only period ends because they have to pay off the entire amount borrowed in only 25 years, compared to the typical 30. Rising interest rates will exaggerate that shock. Typically this type of loan works best for a borrower who is certain he or she will be selling the home or refinancing within the interest-only period and is simply seeking to keep his or her house payment temporarily at its rock-bottom low. If combined with a low down payment, these can be very risky loans for borrowers because they may not find it as easy to refinance out of this loan as they had anticipated, especially if the value of their home has not grown enough to give them a good equity stake.
Payment-option loans
They come by different names, usually incorporating the words option or choice. These loans offer borrowers a choice of two or three payments each month, but their complexity grows right along with those choices.
1. |
Make full payment of principal and interest. |
2. |
Pay more than a full payment. |
3. |
Pay only the interest due for the month. |
4. |
Pay only a portion of the interest. |
The first two choices are fairly straightforward: You can pay the full amount of principal and interest owed that month, just as you would with a traditional mortgage, or you can choose to pay even more and pay off a 30-year-loan on a 15-year schedule. However the other two choices can get borrowers in over their heads if they aren't careful. In any given month, a borrower can opt to pay only the interest that is due that month, or the borrower can choose an even smaller minimum payment, an amount that covers none of the principal and only part of the interest that is owed. To make things even more complicated, these loans often have interest rates that adjust as frequently as every month. And payment caps could allow your minimum payment to rise by as much as 7.5 percent in a given year.
Risk factors
If borrowers choose to make the minimum payment frequently, these loans can set the borrower up for a huge payment shock after just a few years. At the end of five years, or whenever the borrower's outstanding loan balance has grown to 10 percent or 15 percent above their original loan amount, the loan will be recast. That means the lender will draw up a new payment schedule designed to get the loan paid off on time, and the minimum payments can grow dramatically. There are no caps on how high the payment can go at these recast periods. Only the most financially sophisticated borrowers (perhaps those few who already understand from personal experience how hedge funds and arbitrage work) should consider these very complicated mortgages.
Sticking points on any type of mortgage
There are two other options that can be added on to almost any loan, and it's worth your time to look for them in the fine print.
Prepayment penalties, which can amount to six months of interest, restrict borrowers from refinancing out of a mortgage within the first few years. Some even apply if you were to sell the home. Avoid them unless the lender is giving you a very deep discount on the interest rate as compensation.
Also check for balloon payments. These can be called for in some ARMs that have easy terms in the early years. If your loan calls for a balloon payment, that is payment of all the money outstanding, at year 10, you'd better have good plans lined up for refinancing that loan -- or a lot of cash on hand.
Consider a credit-monitoring service. Normally, I think these are a waste of money for folks who aren't at high risk of identity theft. But given how important your credit and credit scores will be in buying a home, you might appreciate the early warning if a collector tries to post a bogus debt.
Deal with your debt. Most people needn't pay off their student loans, auto loans or other generally low-rate debt before getting a mortgage. What you want to eradicate is "toxic" debt: credit card balances and payday loans. These are signs you're living beyond your means. If you don't get your overspending problem fixed before you buy a home, your problems will likely just get worse because homeownership typically involves plenty of big costs (property taxes, insurance, maintenance, repairs, improvements, decorating). Get your act together before you house shop.
Save, save, save. Stop eating out. Drop your cable-TV subscription. Do everything you can think of to put as much money aside as possible, using your desire to be a homeowner as a motivator. (Read "Could you stop spending for a month?" for inspiration.) In today's market, it's best to have at least a 5% down payment; boost that to 10% and you'll have even more financing options. Ideally, you'll also have enough left over after you get your mortgage to cover the payments for two or three months.
Put your bills on automatic. A single 30-day late payment can knock 100 points off your score, and it can take many, many months to recover. Make sure every bill gets paid on time. If you don't have a reliable bill-paying system, consider using automatic debits, so payments come directly from your checking account, or an online bill-payment system's recurring-payment feature.
6 months out
Sort through your mortgage options. A lot of people are losing their homes today because they didn't understand what kind of mortgage they had or they accepted bad advice. The low teaser payments that allowed them to buy a more expensive house have jumped skyward, leaving them unable to pay. It's up to you to understand the risks of the different types of mortgages and to select the right one for your family. My 2 cents: Stick with traditional, fixed-rate mortgages. If you can't commit to a 30-year version, at least use a hybrid loan with a rate that's fixed for as long as you plan to own the home.
Start calculating how much house you can afford. Once you've settled on a type of mortgage and have a rough idea of your down payment, you can start using online calculators like these to see how much house you can buy. Consider buying less home than the absolute maximum you can afford; if you keep your housing expenses (mortgage, taxes and insurance) to 25% of your gross income, you'll be able to live more comfortably and have money left over for things like retirement savings, vacations and the kids' college educations.
Research all the costs of owning a home. Your mortgage will be just the start. You'll have to pay property taxes and insurance on the home. There may be homeowners- or condo-association fees as well. You may face higher utility bills, and you'll take on maintenance and repair costs as well. Decorating your new house can cost a pile of money as well -- have you shopped for window coverings lately? Your home-owning friends and a friendly real estate agent or two can help fill you in so you know what to expect.
Adjust your savings strategies. What you've learned so far may inspire you to boost your savings. A bigger down payment, for example, can result in a larger home or a lower mortgage payment. Or you may simply want to build up your emergency fund so unexpected home expenses don't knock your finances off the rails.
3 months out
Reduce your credit utilization. The FICO scoring formula is sensitive to how much of your available limits you're using on your credit cards and other revolving lines of credit. The less, the better. It doesn't matter if you pay your balances in full every month; the figure the scoring formula typically uses is the balance that shows on your most recent statement. Try to keep that balance below 30%, or even lower. If you can't -- because you charge a lot for work-related travel, for example -- make a payment before the statement's closing date to reduce the balance reported to the bureaus. Just be sure to make a second payment after the closing date, so you don't get reported as late.
Don't open or close any accounts. Until the mortgage process is completed and you've moved into your new home, continue to avoid actions that could potentially harm your credit, such as opening credit accounts or closing old ones.
2 months out
Get an idea of the mortgage rate you can expect. Order a fresh set of FICO credit scores -- don't worry, checking your scores doesn't ding them -- and talk to some mortgage lenders about what rates you might qualify for. (You'll find current national averages here.) Don't apply yet or give permission for your credit to be pulled; you just want to get a feel for what you can expect.
Understand the effect of mortgage-shopping on your score. You want to get the best rate and terms possible, which means you'll need to shop around, but how does that affect your credit score? Here's the lowdown: Every time you give a lender permission to check your credit, a "hard inquiry" appears on your credit report, and that can ding your score a bit. Fortunately, the FICO scoring formula lumps all mortgage-related inquiries made within a specified period and counts them as one. (The period used to be 14 days, but the most recent versions stretch that to 45 days.) Furthermore, the scoring formula ignores any inquiries made in the previous 30 days. So you want to do your serious mortgage shopping in a fairly concentrated period of time, typically after your offer on the home you want is accepted.
Get approved for a mortgage ahead of time. Pre-approval, in which a lender gives a commitment to make you a loan, is different and more valuable to sellers than pre-qualification, which merely gives you an idea of the size of the mortgage you might afford without making any commitments. You don't have to get a loan from the lender that offers you a pre-approval letter. Getting a pre-approval does involve giving permission for a hard credit inquiry, but the small potential ding on your credit is worth it because you'll be in a stronger position with sellers.
Find A Realtor
To Find a Realtor who is a member of COBA click here, and then click on Advanced Search at the upper right of the directory.
Consider a mortgage broker. Once your offer is approved, you can shop for a mortgage on your own, but if you want a lot of hand-holding through this process or your credit is particularly troubled, you might benefit from the services of an experienced, ethical mortgage broker. Get referrals from family and friends; you can also get a referral from the Oregon Association of Mortgage Professionals.
Begin researching neighborhoods and look for an agent. Check Internet listings, attend open houses and find an experienced guide to help you refine what you're seeking.
Once you've found your home and your offer is accepted
Shop for a mortgage. There are thousands available, and sorting through the possibilities can be overwhelming. You may want to start at your bank, but don't stop there. Check the COBA Directoryhere to find a mortgage professional who is a member of COBA. You'll need to move fairly quickly to secure the loan, because the full approval process typically takes four to six weeks.
Arrange for an appraisal, a home inspection and a walk-through. The appraisal is required for your loan to be approved. An inspection isn't necessarily required, but don't skip this essential step, which can alert you to serious problems before the deal closes. The walk-through is usually done within 24 hours of the deal closing, so you can make sure that the home sellers have performed any agreed-upon repairs and the place is in move-in condition.
Get homeowners' insurance. Mortgage lenders require this coverage, and you'll need to prove you have it at closing.
Confirm how much money you'll need at closing. "Closing" is when you sign all the paperwork and pay agreed-upon amounts, which can include your down payment and your share of legal fees, paperwork costs, property taxes and title insurance.
Enjoy your new home!
What type of mortgage is best for your lifestyle?
Buying for the long haul
Loan: 30-year fixed rate.
Why: Financial peace of mind can be worth the higher interest rate that comes with an interest rate that won't change for three decades.
Job with good but inconsistent income
Loan: Option adjustable rate mortgage (ARM).
Why: These loans, considered among the riskiest offered in recent years, originally were designed for people with incomes that vary a lot from month to month. Each month you have a choice of payments: the full amount needed to pay off principal and interest as scheduled, an amount that covers only the interest owed that month, or an even smaller amount that doesn't even cover interest owed.
In a month in which your earnings are lean, you might choose to make one of the lower payments, even though that actually adds to the amount of debt you must eventually pay back. In a month of strong earnings, you could choose to make the full payment. Over time, however, your required payments could rise significantly if you have frequently chosen to make only the smaller payments.
Refinancing (15-20 years before retiring)
Loan: 15- or 20-year fixed or ARM.
Why: You can retire the loan before you retire from your job. A fixed rate generally has a higher interest rate than an adjustable but will give you more certainty in budgeting. However, if ARMs are significantly cheaper and your income can handle possible payment increases, you could save with the adjustable rate.
Recent graduate with strong earnings potential
Loan: One-year ARM.
Why: Stretch your dollars with low interest rates during the years when your income is at its leanest. Your rate can go up (or down) each year, but interest-rate caps will limit that change to a predictable amount, and your rising income should be able to handle it. Watch out for loans that don't cap the interest rate but instead cap your payment. They could cause your indebtedness to grow even as you make monthly payments. ARMs also come in varieties that adjust -- up or down -- every six months or even more frequently.
Self-employed
Loan: No- or low-documentation loan.
Why: Though you'll pay a higher interest rate, not having to produce paycheck stubs or employer references, which you would be expected to supply when applying for a traditional loan, can be a huge help to those with variable incomes.
Planning to live in home 4 or 5 years
Loan: A 5/25 hybrid loan.
Why: If you won't keep the loan longer than five years, why pay extra to lock in an interest rate for a longer period? If you do end up staying longer, you can either refinance or live with an interest rate that adjusts every year.
Job relocation for a short run
Loan: Interest-only mortgage.
Why: While these loans can be risky for novice borrowers or those stretching to afford a home, they can be a smart tool for financially sophisticated borrowers who already have assets built up. Monthly payments are low because you're not repaying principal, so you can afford a larger loan. If you eventually sell the home for less than you paid, however, you could have to take money out of savings to pay back the full amount owed on your mortgage.
Active duty military or veteran
Loan: VA loan.
Why: The Department of Veterans Affairs offers loan guarantees that allow qualified military personnel and veterans to take out mortgages for as much as $417,000 with zero down payment. In Alaska, Hawaii, Guam and the U.S. Virgin Islands, that loan amount goes up to $625,000.
