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How First Time Homebuyers Compare Mortgage Costs
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How First Time Homebuyers Compare Mortgage Costs
Many first time homebuyers focus in on the interest rate and the APR when shopping for a loan. While these are indeed very important aspects of the loan, they may not even be the most important for a first time homebuyer. Comparing the Good Faith Estimate provided by the lender can help a first time homebuyer determine if they are really giving you a good deal or if they are trying to taking you to the cleaners. This article is about how a first time homebuyer can use the Good Faith Estimate to compare lenders' costs, but remember there is a huge difference between getting the best costs and getting the best loan.
Within three days after applying for a loan, by law the lender must provide you in person or in the mail a completed Good Faith Estimate. This is a form that represents an estimate of the fees and costs of necessary items to successfully process and close your mortgage loan. These items include origination fees, discount points and other fees. The Good Faith Estimate is normally a legal sized form that is divided into six different categories. These categories are numbered 800, 900, 1000, 1100, 1200, and 1300. It will be accompanied by a Truth in Lending statement that gives you the APR on the loan as well. You should pay some attention to the Annual Percentage Rate, but keep in mind that this is a figure that is easily manipulated and makes some very bad assumptions. APR assumes zero inflation and that the value or buying power of a Dollar today will be exactly equal to the value of a Dollar even 30 years from now. More significantly, the APR calculation assumes that the mortgage will never be paid off early. This is completely unrealistic. Very few first time homebuyers (or other borrowers for that matter) last longer than 5 years without refinancing or selling. So APR is a very poor method of comparing loans. When comparing Good Faith Estimates focus on the section that relates directly to the lender.
Sections 900 through 1300 of the Good Faith estimate are the where third party charges and fees are listed. The lender has only minimal control over these. Sections 900 and 1000 are items required by the lender to be paid in advance or deposited with the lender. This section is where you set up your accounts to pay the taxes, hazard insurance and mortgage insurance and also where you pay your prepaid interest on the mortgage. Although it says 'required by the lender", these charges are specific to the loan program and not the lender. At closing, they will be the same with every lender.
Section 1100 is where the charges from the closing attorney or title company will be. These will be controlled by the closing agent and not the lender. Most of the time, this closing attorney or title company will have been chosen by your real estate agent. You may notice that these fees vary between lenders. This is because the lender is the one that prepares the Good Faith Estimate for you. The lender will estimate these charges based on what these items typically cost. The lender has no control over items in these sections so disregard comparing these when comparing lenders. However, do take note if one loan officer has significantly lower fees in these sections than others do. Some lenders may try to trick you by giving low figures for the third party fees so that their higher lender fees on their Good Faith Estimate will even out. Then when you have to pay extra money at closing, they tell you their numbers are just an estimate, and your agent requested an expensive attorney.
Section 1200 includes all the government related taxes and recording fees. Again, these should be the same regardless of the lender so there is no reason to use these as a comparison. However, if a particular loan officer is significantly wrong on these items, you may want to find out how experienced they really are.
We skipped over section 800 until now because this is the one that includes the items to really compare. These are the charges and fees that relate directly to your particular lender. This is where a first time homebuyer should really focus and review items to make comparisons. This section may include administration fees, application fees, document preparation fees, funding fees, mortgage broker fees, processing fees, underwriting fees, wire transfer fees and any other fees that a lender might be charging. These can be confusing for a first time homebuyer. The key thing you must do here is simply ask why each fee is there and get a reasonable explanation. A competent loan officer will be able to explain these to a first time homebuyer and why each one is there.
Remember, it is vital that you look at the total package and not just focus on the interest rate. Unfortunately, first time homebuyer loans can be complicated and have several moving parts. These can be altered to make one part look more attractive if necessary. A lender can make any part of the loan attractive if they feel that is what is really important to you. For example, one lender may offer a $300,000 loan a half point lower but may have $3,000 in extra fees added in the Good Faith Estimate. Because of the ridiculous assumptions required by law to be used to calculate the APR, this loan may also have a lower annual percentage rate than a loan with lower fees and higher interest rates! So as a first time homebuyer, be sure to spend some time talking over the good faith estimate with your loan officer. Ask questions. Compare the entire package together to see which is really the best deal. In that conversation, take the time to get a feeling for whether your loan officer has your best interest at heart. A good loan officer, who understands the needs of a first time homebuyer, will take the time to put the numbers on that good faith estimate and fit them into the total context of your life.
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How Homebuyer Can Maximize Net Worth
The great inventor and businessman Thomas Edison once said "Opportunity is missed by most people because it is dressed in overalls and looks like work." Because of a unique confluence of factors, there is a great opportunity for first time homebuyers AND sellers right now. Unfortunately, there is a lot of resistance to this opportunity from real estate and mortgage professionals because it requires them to spend too effort on that unpleasant part of the home buying process called negotiation. Going back and forth from one party to the next explaining how the numbers fit is far too much like real work to most of them. They just like to fill out the blanks in the contract and wait for the closing. When the average real estate or mortgage professional is required to think outside the box, they cannot just slap the deal together in a few hours and turn it over to an assistant to finish.
Two seemingly unrelated financial events have come together to produce a win/win opportunity for everyone involved in buying and selling homes. The only catch is that making this opportunity pay off will require just a little bit of extra work. We must think outside the box in order to take advantage of this opportunity.
The first building block of opportunity is the fact that several wonderful new conventional community lending mortgage products for first time homebuyers and others have recently come into the market. These programs allow first time homebuyers and other borrowers to get a mortgage and buy a home: with no money down; less stringent credit guidelines (in other words, some credit problems); greater flexibility in income qualifying guidelines; interest only terms and longer amortizations (35/40 year loans); lower mortgage insurance coverage; and the kicker that really makes the difference - seller contributions to closing costs and prepaid items that can be up to 6 percent of the sales price!
The second factor creating this opportunity is that the country is in the midst of a rare buyer's market in real estate. Sellers have had to lower the prices on their homes to get rid of them, resulting in falling home values in many areas. Mortgage rates have dropped, but buyers still remember a couple of years ago when those rates were insanely low. They all want a million dollar house with a $1500 payment. And even though rates have dropped, they are not THAT good.
Today's typical "inside the box" real estate contract has the the first time homebuyer using a standard 30 year fixed rate fully amortized mortgage to finance their purchase. The seller ends up dropping their asking price by 3 to 5 percent, and paying 3 percent or even less in closing costs for the buyer. For example, on home offered for sale at $310,000 lately, today's first time homebuyer is agreeing to pay $300,000 for the home with the seller contributing 3% of the sales price towards the buyers closing costs. Even financing 100% of the sales price, this typical transaction still forces the buyer to bring $7000 or $8000 to close on the home. At a rate of 6.5%, the principal and interest payment would be approximately $1896.20. Throw in tax and insurance escrow payments of about $337.50 (in Georgia - many states are higher), and the mortgage insurance payment of $240 and you have a total payment of about $2473.70. Now add the more stringent credit and debt ratio limits (ratio of total payments to income) for this type of 100% financing and you have a perfect recipe for dramatically reducing the total market of buyers who can qualify for this property!
I started my journey in the real estate/mortgage business at a time when mortgage rates had just dropped to about 14%, so a payment like that for 100% financing on a $300,000 home still doesn't shock me all that much. But the average first time homebuyer today - who has lived through some of the lowest interest rates in history, and who was an infant when rates were high doesn't believe the houses they can buy for $300,000 are worth making that extra payment.
Now let's all step outside the box. What if, instead of dropping the price on the house all the way down to $300,000, the sellers agreed to accept the same net bottom line BUT they do it by agreeing to pay all the buyer's closing costs and all their prepaid expenses (such as hazard insurance, prepaid interest and setting up escrow accounts) and they put the rest toward discount points to buy down the borrowers interest rate!
Here is how that might work. The sellers accept a sales price of say $312,600 and pay 5% of the price towards closing costs, discount points and prepaid expenses. Sure they could go with the full listed price and contribute a little more, but lowering the accepted sales price helps satisfy the basic human need in the buyers to negotiate the price down at least a little bit.
Next, instead of applying for that standard 100% loan to value conventional loan (known in the business as a Fannie Mae FLEX100), the borrowers apply for a 40 year loan with a 10 year interest only payment period! This is one of the newest programs being offered under the FNMA MyCommunity loan program, which is wonderful for first time homebuyers. In the present market, the extra seller contributions in this transaction would most likely be able to buy down the interest rate on that mortgage down to 6.25%.
Now we have our first time homebuyer purchasing the house without having to bring any money at all to the closing AND they have an interest payment of $1628.13. This is $268.07 less than their payment would have been at the lower price. It gets even better. Add on the tax and insurance escrow payments of about $351.68. Then add on the mortgage insurance of $153.70. (MyCommunity loans require less mortgage insurance coverage than regular conventional loans.) Now our buyer has a total payment of $2133.51. This is approximately $340 per month less than the payment on the original lower sales price!
I know what you're thinking right now though. This is an interest only loan. Surely the buyer would be better off in five years if they had the fully amortized loan and their loan balance was going down. However, remember that extra money the buyer would have had to bring to closing on the 30 year conventional option? When you count the money the borrower had to bring to closing, and even figure in the effect of paying down the principal with the 30 year option, as well as the higher sales price on the 40 year loan, at the end of 5 years the 40 year loan will still have cost the buyer $6,096 LESS than the 30 year loan. This happens if our borrower does nothing beyond just making the payments and blowing the closing money on a vacation. In real life, by five years most buyers will be selling the home in order to trade up.
However, let's say the intelligent and frugal first time homebuyers in our case take that $7,000.00 in closing money they did not have to use and put it into an investment account at 6%. Then they take the $340.00 they are saving on the payment every month and drop it into the same investment account. Even when we account for the appreciation of the home (which will be almost the same regardless of the loan program), at the end of 10 years our buyers will have increased their net worth by approximately $27,116.00 MORE than they would have by making the exact same payment for 10 years on the 30 year loan program.
I must warn you that there are some limitations. These numbers will not fit every scenario exactly. The MyCommunity loan has income restrictions. However, in my experience the limits in most metropolitan areas are sufficient to qualify for homes in this price range. Interest rates may change. The numbers I have used are for example purposes only. There are other similar programs available for creative mortgage and real estate professionals to use when the building blocks of the transaction are different. When all the parties involved in a real estate transaction work just a little harder at analyzing the numbers and negotiating, sellers have a larger potential market for their home and buyers can use smart mortgage planning to vastly increase their net worth.
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