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Financing 101 for Home Buyers

There are 4 major ways to finance your home buying:

• Take a mortgage – the most common way.
• Pay cash – no need to explain that.
• use government loans – such as FHA and VA loans. Requires meeting specific standards.
• use hard money lenders – usually used by investors for a short period of time since the interest is significantly higher.

This article will try and help you, the home buyer, have better understanding of the mortgage taking process.
The process starts with doing some homework; Write down the following numbers:

• Annual household income
• Total debt - credit cards, student loans etc
• Current housing expenses - what's the rent / mortgage payments you currently have.
• Average monthly expenses on credit cards
• Monthly payments on financing – such as student loans and auto financing

Once you have these numbers written down, you are ready to go see a loan officer.
It doesn't matter which loan officer you go to start your financial investigation, the only thing that is important is that he won't be the last you see! The best advice anyone can give you about taking a mortgage is shop around! This is one of the biggest financial transactions you will ever do and every little change in the interest rate means a lot (!) of money over 30 years.
When you meet the loan officer for the first time you will hear a lot of terms you never heard before and it's important you understand every detail and term of the loan in order to be able to compare between the different loans offered to you by the different lenders.
There are many types of loans but the most common are:

• Fixed interest
• ARM – adjustable rate mortgage
• Increasing/decreasing mortgages
• Balloon / interest only mortgage
• Government loans

The Fixed Interest loans are the most commonly chosen mortgage and it means your interest is locked at the beginning of the loan term and stays the same for the duration of the loan. The most common fixed loan duration is 30 years but there are 20, 15 and 10 years options as well.
What does it mean that the interest rate is fixed? It means you have the same monthly payment for the duration of the loan (no increase and no decrease) i.e. if your monthly payment is $1000 today it will be the same 10, 15, 20 years from now.

The ARM loans means your loan's interest rate will change every few years to the market standard at that time. Meaning if your interest rate at the beginning of the loan would be 6% and five years down the road you have a re-calculation point and the market rates are 4% then your monthly payment will decrease; BUT if the market rates are 8% then your monthly payment will increase. ARM loans have re-calculation points every few years for the entire duration of the loan. The re-calculation points are determined at the beginning of the loan (pre-set to 3/5/7 years or any other terms the lenders offer).

Increasing/decreasing loans – a variation of the ARM mortgage where you start paying only the interest for the first few years and adding the principle component after a few years (this is increasing payments) or you start by paying more into the principle in the first few years then you reduce the amount paid towards the principle (decreasing your payments)

The balloon / interest only loans will have you pay just the interest part of the payment for the duration of the loan and you will have to pay the entire principal amount at the end of the loan term. I.e. if you take $100,000 for 30 years on a balloon loan you pay interest payments for 30 years and at the end of the 30 years, you still owe the bank $100,000. This type of loan is usually used by investors that need to keep the holding (carrying) costs low while they fix up a property and prepare it for resale.

Government loans – there are all kinds of government loans, we will not cover them in this article.

So you decided on the type of loan that fits your needs. Good. Now you need to discuss the terms with your lender. Remember, SHOP AROUND and compare prices and terms. Don't hesitate to show the lenders the other offers you got and ask them to beat them.

The loan terms
Aside from the loan duration and total amount borrowed the loan has some more terms to it and they all must be factored into consideration when deciding.

Rate - The most important factor is the loan's rate. Your loan officer will give you two numbers for the rate. The loan's rate percentage and the APR percentage. The APR is the annual percentage rate of the loan. The “real” rate. It is the loan's rate PLUS all kind of charges that the bank applies on the loan divided over the life time of the loan. Naturally, the APR is higher the regular rate, so when you compare loan rates compare them by the APR rates!

Fees – These can be a real deal breaker. The banks have all kind of fees:

• Application Fee – you pay money so the bank will tell you IF they are willing to give you a loan. This fee is waived today by most major banks.
• Closing Fees – the bank has expenses when they issue a loan. The bank is charging you all kind of closing fees. You will hear terms like origination fee, lender's fee, document preparation fee, underwriting fee, commitment fee and the list is lonnnngggg..... Some banks will tell you they will “waive” these fees for you, don't fall for it. This is exactly what they use the APR for. You will pay for it but in a different way and spread over the duration of the loan. This kind of “offer” is very helpful when you don't want to spend a lot of cash when you take the loan. I can tell you that even if a bank is not offering “no closing fees” official, most of them will agree to “waive” it and change the APR rate.

Points – Most banks are willing to sell you a better rate. They use a term called "points". each point will reduce the APR (and thus decreasing the monthly payment) and it will cost you money. The “price” of a point is calculated of the amount of the loan. Ask your loan officer to show you the different points options and you can make a decision if this fits your needs (I.e. if 1 point reduced your monthly payment by $10 and it costs $1000 then it'll take you 100 months to return your investment on buying that point. But if it costs just $200 then 20 months will return your investment) everyone has a different number of months to determine if buying the points is worth your money. A rule of thumb would be if you can return your investment in 4-5 years then it's worth it.

Bare in mind that the money you pay for the points is gone no matter when you close the loan or refinance.

Exit Terms – Every loan has exit terms. It's important to know them and to be OK with them. The best would be no fees for early termination.

Extra Payments – You should ask your loan officer if you can make extra payment into the mortgage and how often. Most of the loans today allow extra payments at any time.

Down Payment – These days the lenders won't let you have 100% financing they require you to put in a down payment towards buying the property. The minimum accepted is usually 5%

PMI / Mortgage Insurance – All lenders will require a PMI on loans that are more then 80% of the property value. This increases the monthly payment. Same as with the closing fees some lenders will offer “No PMI” you will see it in the APR. The basic rule of the PMI is that it's needed when the amount of the loan is greater then 80% of the property value. This also means that after a few years of payments your loan balance goes below the 80% mark and you stop paying the PMI component of the payment.


So you know your loan's terms and you shopped around and you have made a decision to go with lender X. your next step is locking the rate. For that you will have to contact your loan officer and sign a form locking the rate for 30 days (some lenders will lock it for longer) and pay a locking fee. This guarantees that while the bank is going through the underwriting and the preparation of the documents you won't be affected by the market fluctuations. Most lenders have a cause saying that if the rate goes DOWN with in that period in over 0.25% or 0.5% (varies between the lenders), they will adjust the rate down to reflect the change. It's very important to understand from your loan officer that they do that and what is that threshold. It's also very important to follow the rates after you lock and make sure that if there is a need for adjustment, it does occur. Mortgage rates change daily so make sure you stay on top of it.


From this point the lender will guide you through it's own process, ask you for documents and so on. ALL LENDERS will require a “home owners” insurance and all of them will offer you one. Don't take it! It's almost always more expensive then if you shop around and buy it for yourself.


That's it. We hope this article helped you get a good understanding of the process. We always accept comments and questions. Email us at: info@WisdomTX.com

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