Financing Requirements for Home Purchases
Buying a home for you and your family, to many, is still the American dream. The realization of owning a home for most new home buyers, means stability and a sense of safety for a future family or one that may already exist.
The process however can seem a little overwhelming to some but have no fear, there are steps everyone must take in order to purchase a home. In most cases, taking these steps early in the game will allow you to be better prepared when you’re ready to start searching for a home.
There are many people involved in the transactions of just one home purchase. With thousands of home buyers actively seeking across the Nation, taking the step to buy a home will put you in the cross roads of many in a very lucrative industry. From the appraisers, to loan officers, real estate agencies, property inspection firms or individuals and underwriters just to name a few.
In this article we are going to focus on those you will engage with in the financing side of the industry. This includes:
- Loan Officers
- Mortgage Lenders
We are also going to focus on the important parts of a home loan and what are the standard requirements to those parts. The top 2 most important include:
- Loan to Value (LTV)
- Premium Mortgage Insurance (PMI)
- Debt to Income Ratio (DTI)
- Yield Spread Premium (YSP)
What is a Loan Officer?
A loan officer is an independent lending associate through a loan brokerage firm. In most cases, a loan office can shop for the best loans available to borrowers with great credit. In other cases, they can shop for a hard to find loan that can finance even borrowers with a credit score of 620 or even 580 “if they still do that now a days”. Of course, these are not prime lenders, so you may get a much higher rate of interest for your loan.
The Pros & Cons
- The pros: of a loan officer is that they can search many available lending institutions on your behalf. If you do not have good credit, a loan officer may be a good option for you to go with.
- The cons: of a loan officer, they incur larger closing fees in most cases. This is due to their commission and in other cases, your interest rate could be higher because of something called the Yield spread premium which we will go more in depth on this topic a little later in this article.
What is a Mortgage Lender?
A mortgage lender is usually involved directly with the lending institution. You could call them the direct finance lenders. There are direct finance lenders for many industries, from small business financing to financing a mortgage for your home through a direct finance lender. As opposed to a finance broker which is more comparable to your usual home loan officer.
The Pros & Cons
- The pros: A mortgage lender is direct access to the lending institution. For those that are prime borrowers (borrowers with 720 fico and above with good credit history), your loan can come at a very low cost in terms of interest rates, even down to 3.5%.
- The cons: A mortgage lender has lack of available options. In many cases, direct lending institutions like Wells Fargo Home Loans and Bank of America Mortgage Lending, you are only able to fit into their limited programs. This can make it very difficult for borrowers with a lower than perfect credit score and a spotty credit history.
What is an underwriter?
In all cases, whether you are getting a home loan, a small business loan or commercial financing for real estate property, your applications and requirements will go through an underwriter that will analyze your ratios, make sure that all required documents are provided and make sure that the validity of those documents you are providing as a borrower are legitimate and current in date.
The underwriter will work with your loan officer or mortgage lender and their processors to facility the funding process and make sure the order of operations is running smoothly. Another term you can use for an underwriter is quality control. They have QC overview prior to funding in order to meet the investors criteria’s for financing a home loan.
What is a Processor?
A processor is pretty much what it sounds like. The individual inside of the brokerage firm or direct lending institution that works with your underwriter to facilitate the funding process. Some would say that a processor is the first line of quality control. It is not wise to waste an underwriters time if the loan won’t fund.
The processor puts a package together on behalf of the borrower and their loan officer or mortgage lender. This package will be delivered to the underwriter, the processor makes sure that the documents required by the lending institution are completed, available and ready for submission. They are in constant communication with the underwriter and in some cases may even contact the borrower to collect documents when necessary.
What is Loan to Value (LTV)?
Loan to Value is the difference between the value of your home compared to the total loan amount being borrowed for that home. To a lending institution, an LTV ratio is a lending risk assessment and it is used to assess the risk of a loan for a property. The bigger the LTV, the larger the risk the investor or lending institutions in taking on.
Loan to Value = Mortgage Amount / Appraised Value of the Property
2nd mortgage options exist to help balance this risk. Instead of one lending institution providing 100% of a home loan, a second lender can come into play and provide the 20% for a 2nd mortgage. This however is not recommended even if the option is available. Maybe a 10% second mortgage with 10% down by the borrower is a wiser option.
What are the pitfalls of a high LTV?
- You can incur a much higher interest rate cost in both your first and second mortgage for having a high LTV value.
- Premium mortgage insurance will be required in loan amounts of 80% and above.
- Your second mortgage will be at a higher interest rate if you do not go with a full single mortgage option.
What is Premium Mortgage Insurance?
Premium mortgage insurance protects the lender in the case of a default in payments of the property and foreclosure. Most lending institutions will require premium mortgage insurance for all loans with a high LTV ratio. Having a second mortgage is one way of bypassing this requirement however, as previously mentioned, a second mortgage will come at a high rate of interest.
With this in mind, you will have to decide whether the overall cost of the mortgage with the PMI is greater than or less than the overall cost of the 1st mortgage of 80% LTV and the 2nd mortgage of 10% to 20% LTV depending on the down payment. Keep this in mind when making this very important decision. If you can put down 20% on your new home, you will come out on top in the long run.
You will pay less interest to lenders and you can pay off your home quicker and even faster with a 15 year loan.
What is a Debt to Income Ratio (DTI)?
A debt to income ratio is the difference between the overall debts a borrower currently has and is making payments into compared to the overall income that an individual borrower currently produces. The debt to income ratio is used by lending institutions across the world to assess if an individual or business can manage and maintain consistent payments for the loan being requested.
In most cases, lending institutions want you to stay at a 38% DTI or below. This means that only 38% of your income is being used to pay off current debts such as car payments, credit cards, etc. Most lenders would prefer a 32% to 38% however, you can find some lenders that like to take bigger risk and will allow your DTI to increase up to 43% and a very rare few that used to allow up to 46% DTI. They may or may no longer exist. Those are rare finds without it being a hard money loan.
As a borrower, you want to take into account all of your current debts, and make a plans with your family that show exactly what other external expenses are presented in your life. This will allow you to calculate properly for your own personal DTI prior to choosing a loan amount that may be too high for your family to sustain.
What is Yield Spread Premium?
This is actually not a direct part of the loan acquiring process, but we felt it is such an important factor in your interest rate and your closing cost that you should know more about this.
A Yield Spread Premium (YSP) is a payment made to the loan officer or mortgage lender for selling you – the borrower and home buyer – a higher interest rate for your loan. Think of the Yield Spread Premium as a commission to the loan officer or lender that is for getting you your home loan, keep in mind that a yield spread premium slightly increases your interest rate. It could range between .25 to 1% depending on the YSP.
Some use it in order to help an investor save up-front cost while the loan officer makes his money in the back end. If the investor is turning the property over after purchase, then this is a good option. It is an agreement between the two parties that allows the investor to benefit while the lender is still able to get paid for his or her work.
For a homeowner looking at their retirement home, this is not the best option to go with. Make sure that you ask your loan officer or mortgage lender what the yield spread premium is and find out if you are ok with the fee. Some lenders will look to a standard 2% or more loan origination fee and in order to not charge you all of that up front in your estimated closing cost, they break it up into two. One loan origination fee in the estimated hud and another in the yield spread premium.
We hope that this article has been very helpful and useful to you. If you have more questions, please feel free to engage with us, leave a comment and follow us on social sites at Kashmiri Realty & Property Management.