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Understanding
the Financing Process
When Buying Martha's Vineyard Real Estate
We already know that the home buying process
on Martha's Vineyard is a complicated process; and shopping
for the right home is the fun part. It is the financing and
closing the sale that is the most mysterious and stressful
for the buyer. Therefore, I want to address the process and
unravel some of the mystery.
PRE-QUALIFICATION:
A mistake that most inexperienced buyers make is they fail
to find out exactly how much home they can afford. This affects
almost every aspect of buying a new home - including how the
Offer To Purchase is constructed. Martha's Vineyard real estate
agents are equally guilty because they start showing a buyer
property without knowing if the buyer can afford the home
they are looking at. It is generally recommended that the
first thing a buyer needs to do is pre-qualify themselves
so they know exactly how much they can afford to spend for
their dream home and how much cash they will need for a down
payment. Pre-qualification acts as a dry run for the loan
application process. The mortgage lender will use details
you provide about your credit, income, assets and debts to
arrive at an estimate of how much of a mortgage you can afford.
The whole process may take only minutes and there is usually
no charge to the buyer. The pre-qualification is non-binding
to the lender because the information you provide has
not been verified. However, it serves as a good indication
to the lender of your general creditworthiness.
This also simplifies the pre-approval process which is the
next step. In many cases, the buyer will be surprised because
they have under-estimated their buying power. Pre-qualification
is an easy process and can be done either on-line or with
the assistance of a lending agent. Items considered when pre-qualifying
for a mortgage loan are employment history, credit history
and FICO (credit rating) score,
and monthly income and expenses.
PRE-APPROVAL vs. PRE-QUALIFICATION:
You may be wondering what the difference is between pre-approval
and pre-qualification. Pre-approval takes pre-qualification
one-step further. The lender will actually contact your employer,
your bank and others to verify your income, assets, debts
and credit history, and then issue you a letter stating that
your mortgage is approved for a certain amount within a certain
timeframe. You may be charged a small fee to cover the cost
of your credit reports and your application. This fee is often
refunded at the time of closing. I always ask my clients to
get pre-approved when they’re getting serious about
making a purchase, because in today’s market a pre-qual
letter carries very little weight with savy sellers. SplitRock
Real Estate can assist you in getting pre-qualified or pre-approved.
LOAN APPLICATION:
The first step in applying for a loan is to understand the
mortgage programs that you may qualify for, its advantages
and disadvantages, so make a list of any questions you may
have (i.e. Why choose a Fixed Rate Mortgage over an Adjustable
Rate Mortgage?) Depending upon the economic climate at the
time you are applying for a loan, you may want to lock-in
the interest rate or float the loan's interest rate. Locking-in
the rate means that the lender usually commits to the mortgage
interest rate and terms (points and fees) at the time the
loan application is submitted. Buyers who opt to "float the
loan" believe interest rates and terms may become more favorable
between the time (weeks or months) of the application and
the closing. This means that the buyer can lock-in the interest
rate anytime between the loan application date and closing.
As you can imagine, this is a gamble because you take the
risk that interest rates may rise instead of drop. In addition,
the terms may not be the same, thereby increasing the mortgage
payment. The next thing you want to think about is if you
want to pay additional points to lower your interest rate.
Each point is one (1%) percent of the mortgage loan payable
in cash at closing.
Read our article "Locking
in the Rate" here.
The following list itemizes most of the documentation you
will need for your loan application:
- Check to pay for the application fee.
- Property Information:
- Completed Offer To Purchase or Purchase and Sales
Agreement contract signed by the buyer(s) and seller(s).
- Copy of the legal description and the LINK data
sheet for the property.
- If you are selling your current home, a copy of
the listing contract.
- If you have sold your current home, a copy of the
settlement statement (HUD-1)
- Income & Assets:
- Pay stubs for the last 30 days.
- Names and addresses of each employer for the past
2 years.
- W-2s for the past 24 months
- Statements for each bank, mutual fund, and/or investment
account for the last three months.
- The estimated value of all personal property.
- If you have made any large deposits to your accounts:
- Explanation and source for the deposit(s).
- If the large deposit was a gift:
- Signed gift letter (lender can supply).
- Copy of the gift check.
- Copy of the deposit receipt.
- If you own more than 25% of a business:
- Corporate or Partnership tax returns.
- If self-employed: Tax returns for the last 3 years
(with schedules),
Year-to-Date Profit and Loss Statement prepared by an
accountant.
- If you own rental property: Tax returns for the last
2 years and any current lease agreements.
- If you are retired: The Pension Award Letter.
- If you receive Social Security: The Social Security
Award Letter.
- If you are counting child support as income: Copy of
the divorce settlement,
Copy of 12 months of cancelled child support checks.
- Debts:
- Names, addresses, account numbers, balances and
monthly payments on all current loans.
- Explanation of credit report anomalies, including:
Late payments, credit inquiries in the last 90 days,
charge-offs, collections, judgments and/or liens.
- Bankruptcy filed within the last 7 years (bring
a copy of your bankruptcy papers).
- VA Loans: Copy of DD Form 214, Report of Separation
from Service.
- Miscellaneous:
- Photo ID and proof of Social Security Number.
- Residence addresses for the past 2 years.
- If applicable, a copy of your divorce decree.
- If you are not a citizen, a copy of the front and
back of your green card.
WHAT DO I HAVE TO DO TO MAINTAIN MY LOAN APPROVAL?
Just because you have been approved for a loan doesn't mean
that your financing is secure. The mortgage lender will most
likely make a second credit check just prior to closing because
the mortgage loan is only conditionally approved. The lender
reserves the right to re-verify credit, income, assets and
employment at any time prior to closing and may cancel the
loan if there are any adverse changes to your qualification
status. Red flags can disqualify you for the approved mortgage
program. A red flag is any inquiry made regarding your credit
worthiness. If you decide to purchase a big ticket item -
like that Porsche roadster or sailboat you have wanted - prior
to closing, you are at risking a red flag showing up on your
credit report. Another thing you do not want to do is move
your money around --- leave your bank and investment accounts
alone until after the closing. Do not close accounts or change
banks. A large withdrawal or deposit to any accounts will
trigger a red flag. If a red flag is triggered, you may be
asked to produce a paper trail tracking large withdrawals
and/or deposits. Although your employment status also affects
your credit worthiness, a change of jobs for salaried employees
to one of equal or higher pay will not trigger a red flag.
However, commissioned sales people should not change jobs
prior to closing on their mortgage loan. Mortgage lenders
typically average your commissions over the last two years
to determine income. Changing employers eliminates the two-year
commission history and places uncertainty on your income status.
The bottom line is not to make any changes without first talking
with your mortgage lender.
PRE-PAYMENT PENALTY:
Okay, you have your loan and you closed on your Martha's Vineyard
property on time with no problems so you are one happy camper.
You have been enjoying your home on Martha's Vineyard for
a few years but lower interest rates have you thinking about
refinancing your loan. However, you failed to read the part
in your loan agreement that addressed a pre-payment penalty.
What can you do --- nothing! If it was in the agreement when
you accepted the loan, you have to pay. But, what is a pre-payment
penalty and why is it part of some lending agreements? I explained
earlier the how and why of paying points as part of the loan
package. However, consumers today are demanding cheap loans,
meaning that they do not want to pay any points. Lenders are
acquiescing to the market demand for cheap loans by offering
to pay a mortgage broker a "yield spread premium". This presents
a good argument for not using a mortgage broker and dealing
directly with a bank. Do you really want to know what a "yield
spread premium" is?
Read our article on "Yield
Spread Premium" here.
Anyway, the reason for including a pre-payment penalty clause
is because the lender is trying to protect themselves from
making a cheap loan, usually an Adjustable Rate Mortgage (ARM)
that the borrower intends to pay off or refinanced in a few
months. Massachusetts allows a lender to charge a pre-payment
penalty but it must be clearly spelled out in the loan document.
Most pre-payment penalties do not exceed three years, so a
loan with a three-year-pre-payment clause may be constructed
with the following terms:
" Penalty of three percent of the outstanding loan balance
if paid off in the first year; " Penalty of two percent of
the loan balance if paid off in the second year; " Penalty
of one percent of the loan amount if paid off in the third
year.
As you can see, the penalty lessens the longer the loan is
held. Most lenders will allow up to 20-percent in additional
pay downs of the balance of the loan principal per year without
a penalty. Furthermore, many pre-payment penalties apply only
to a pay off because of a refinance and will not affect the
homeowner if he or she decides to sell the property within
the pre-payment penalty period. As I think you can see, pre-payment
penalties exist as a deterrent to what the financial market
calls "refinance churning".
In summary, it is important first to decide upon the mortgage
product that best suits your needs. Ask the lender if the
loan includes a pre-payment penalty for early payoff. After
the details of the pre-payment penalty are explained, you
can decide if the terms are agreeable to you.
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