Now that you’ve checked your credit reports and FICO scores from the three nationwide credit bureaus, it’s time to consider the best ways to finance your house or condo purchase. Let’s discuss specific home-purchase finance methods whether or not you have good credit.
1. GET PRE-APPROVED IN WRITING FOR A HOME LOAN. Unless your FICO score is below 600, if you have adequate income you can probably get a home mortgage. FHA and VA home loans are usually the easiest to obtain with the most liberal qualification rules.
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Traditionally, mortgage lenders wouldn’t approve home loans if the monthly housing payment exceeds 28 percent to 33 percent of monthly household income. But in recent years, lenders have greatly liberalized their standards. I’ve seen home loans approved recently that take up to 40 percent, and even 50 percent, of monthly household income if the borrower(s) has a high FICO score, stable income, and little or no other debt.
Today, there is a lender for almost every potential home buyer. “A-paper” is the term mortgage lenders use for their best borrowers, typically those with FICO scores above 680 or 700. “B-paper” and even C-paper and D-paper means the borrower has “credit challenges” and the lender’s risk is higher so the interest rate will be above competitive market interest rates.
To learn what home mortgage you can obtain, it’s best to get pre-approved in writing by one lender before you start shopping for a home. Most lenders do not charge for mortgage pre-approvals. If there is a charge, such as $200, make sure it will be credited against loan fees when you actually take out the mortgage. After you are pre-approved with one lender, you can still keep shopping among other lenders to see if you can improve on the first lender’s pre-approval mortgage terms.
However, please don’t confuse “pre-approval” with “pre-qualification,” which means only the lender thinks you can qualify based on the information you provide. PRE-QUALIFICATION IS WORTHLESS! But a written mortgage pre-approval letter or certificate comes from an actual lender, such as a bank or mortgage banker, after you fill out a written loan application which is then verified before the actual lender issues a pre-approval up to a specified maximum mortgage amount. Although mortgage brokers can arrange your mortgage pre-approval, since they are not actual lenders loaning their own funds, they cannot issue written pre-approvals. Here are the types of lenders to consider for your pre-approval:
A – Mortgage brokers are “middlepersons” between borrowers and lenders. Ask how long the mortgage broker has been in business. If it is not at least five years, I suggest you keep shopping for a more experienced mortgage broker. There are many great mortgage brokers who can arrange “impossible loans” for difficult situations.
But I’ve encountered too many mortgage brokers who are “bait and switch” con-men (and women) who will promise almost anything to get written loan applications from prospective borrowers who can then be “shopped” by the mortgage broker among many lenders. Until a mortgage broker has a written loan application, he or she has nothing to shop among actual mortgage lenders.
However, I’ve had very good experiences with other mortgage brokers who are honest and reputable. The big advantage offered by mortgage brokers is they have contacts with dozens, sometimes hundreds, of out-of-area lenders so they can match you with the best lender for your situation. Especially if you are “credit challenged,” a mortgage broker might be your best bet to obtain a lender’s pre-approval letter. Wherever you obtain a written pre-approval, be sure it contains a specific expiration date, usually 60 to 30 days. Also, ask about interest-rate lock-ins in a rising interest-rate market.
As with any lender, be sure to obtain in writing a list of loan fees you will be asked to pay when the mortgage broker arranges a home loan for you. Please be aware mortgage brokers (and some other lenders too) earn their fees from three possible sources: (1) a loan fee, such as one or two points (each “point” equals 1 percent of the amount borrowed), paid by the borrower (or sometimes the home seller, if the seller agrees to do so as a sales incentive); (2) a “yield spread premium,” which the actual lender pays to the mortgage broker (or to a mortgage banker) for producing a slightly higher than market interest rate mortgage (such as a home loan at 6.25 percent when the “going rate” is 6 percent); and (3) add-on junk or garbage fees, which are 100 percent lender’s profit and are not for specific services (names of these negotiable fees include origination fee, processing fee, documentation fee, warehousing fee, underwriting fee, and (when the lender runs out of names) miscellaneous fee).
Please don’t confuse these negotiable junk or garbage fees with fees to third parties for actual services rendered, such as appraisal fee, title insurance fee, FedEx courier fee, credit report fee, and escrow or attorney fees. A trick some lenders play is they charge 100 percent pure profit markups on third-party fees, such as charging $450 for an appraisal that only costs the lender $350. Wells Fargo Mortgage recently lost a big U.S. Court of Appeals case regarding its illegal markups on third-party fees. At this moment, based on the U.S. Court of Appeal decisions in different parts of the nation, such markups are legal in some states and illegal in other states.
A special advantage of some mortgage brokers is they often have contacts with wealthy individual lenders who loan mortgage money without checking the borrower’s credit or income. But these interest rates and loan fees are not cheap! If you only need mortgage money for a short time, such as one to five years, these “hard money” mortgage brokers who don’t ask many questions can be worthwhile. You will usually find these “hard money loan” specialists advertising in the weekend newspaper classified ads under “real estate loans” or in the phone book yellow pages.
B – Banks, credit unions, and savings banks are direct lenders of their own funds. The advantage of working with these lenders is they are loaning their own funds so there is no middleperson. But their loan officers are usually on a salary plus bonus or commission so they are really salespeople. However, a disadvantage is these lenders only offer their own loan programs and they might not have a loan plan for your situation, especially if you have credit problems.
Today, these lenders have about 40 percent of the home mortgage market, way down from prior years. Although they originate the home loans, these lenders often immediately sell these mortgages in the secondary mortgage market to Fannie Mae or Freddie Mac so they can obtain more funds to loan to other borrowers.
When the lender keeps the mortgage, it is called a “portfolio loan.” Portfolio lenders are often more flexible than lenders who sell all their mortgages. By the way, these originating lenders frequently keep the highly profitable loan servicing (which pays 1/4 percent annual interest to the loan servicer) so the borrower often doesn’t know the loan has been sold. These lenders can issue pre-approvals direct to borrowers, or through mortgage brokers.
C – Mortgage bankers loan their own funds but quickly sell the new loans in the secondary mortgage market. Major mortgage lenders such as Countrywide, Home Side Lending, and Wells Fargo Mortgage are mortgage bankers who originate home loans with their own funds and then quickly sell them into the secondary mortgage market. Because these lenders prefer to keep the loan servicing to earn that 1/4 percent servicing fee, borrowers usually never learn who really owns their home mortgage. Mortgage banks can issue pre-approvals direct to borrowers, or through mortgage brokers.
2. HOME-SELLER CARRY-BACK MORTGAGE. Armed with a pre-approval letter or certificate from an actual lender (not from a mortgage broker, although the mortgage broker can arrange such a pre-approval), you’re ready to shop for your next house or condo. The mortgage pre-approval gives the home shopper a feeling of confidence, although you might not need that pre-approval to buy the home you select.
In the right circumstances, you will be better off buying a home whose seller will carry back the mortgage financing for you. With seller financing, there is no loan application, no credit check (some sellers and their realty agents wisely suggest a credit check so be sure to disclose any credit problems up front!), no long wait for mortgage approval by unreasonable lenders, no appraisal, no extra loan costs, and the buyer (that’s you!) gets to specify the mortgage terms you want (such as 6 percent interest, 30-year mortgage term, etc.) in your purchase offer for the home. If the home seller doesn’t like the seller carry-back mortgage terms you offered, the seller can counteroffer with acceptable terms which you can then either accept or decline.
Having bought many homes with seller carry-back financing, I’ve learned the best candidates for seller financing are homes that (a) have been listed for sale at least 60 days, (b) are vacant, (c) are free and clear, and/or (d) are being sold by retirees who don’t need immediate all-cash, but want increased retirement income with safety, such as a mortgage secured by their former residence. Personally, when I get old and feeble, this is the way I plan to sell my home in about 30 years!
3. TAKE OVER AN EXISTING MORTGAGE. Closely related to seller financing, taking over an existing mortgage already secured by the home usually avoids the hassles of getting a new home mortgage. There are two primary methods:
A – Purchase the home “subject to” its existing mortgage. This method works especially well with a highly motivated seller who doesn’t have much equity in the home. “Take over payments” is often advertised by the motivated seller (or the motivated real estate agent!). If the home is in the foreclosure process, that is an especially good time to use this technique to quickly cure the default. For more details, please read my special report, “Pros and Cons of Earning Big Profits from Foreclosures and Bargain Distress Properties.”
As the buyer, this method has virtually no risk for you. However, as explained earlier, there is a risk for the seller because, if the buyer defaults, that default shows up on the seller’s credit report but not on the buyer’s credit report. Like seller financing, no credit check is usually required.
However, most existing mortgages contain “due on sale” clauses, That means when the property title transfers, with limited exceptions such as for transfers to spouses, family heirs who live in the home, and into trusts, the lender could call the loan due in full. The way most lenders learn of the title transfer to a new owner is when the name on the fire or homeowner’s insurance policy is changed. To avoid calling the lender’s attention to the title transfer, you might want to take over the old fire or homeowner’s insurance policy and add your name to the existing policy as an additional insured.
Only once can I recall having a lender try to enforce the “due on sale” clause when I purchased “subject to” the existing mortgage. Most lenders will then allow the existing mortgage to be assumed by the buyer, in return for an assumption fee of 1 percent or 2 percent of the loan balance. Or, after taking title to the property, the new owner can refinance the home with another lender to pay off the old lender who tried to enforce the due on sale clause.
B – Formally assume the existing mortgage. The other method of taking over an existing mortgage is to assume its legal obligation. Home sellers should insist on being released by the lender from further liability after the buyer assumes the existing mortgage. But that’s the home seller’s problem, not yours. My experience has been most lenders will allow assumption of an existing mortgage by buyers with good credit upon the payment of a 1 percent or 2 percent assumption fee.
Unless your seller insists you formally assume the existing mortgage, I prefer to take title “subject to” the existing mortgage. I’ve found after holding the title, I’m in a “power position” with the lender. Before purchase, if you ask the existing lender to assume the mortgage, the lender will usually try to extract lots of fees from the buyer. Most mortgage lenders prefer to write a new mortgage for the new owner instead of allowing an assumption. But after the buyer holds title, the lender doesn’t have so much power. Of course, always make the monthly mortgage payments on time!
4. BUY A HOME WITH A LEASE OPTION WHILE CLEANING UP YOUR CREDIT. If you have really bad credit, you just plan to keep the home for a short time (such as while you renovate it before selling at a quick profit – called “flipping”), or you don’t want to deal with mortgage lenders until you clean up your credit and improve your FICO score, consider a lease with option to purchase.
Although I am not “credit challenged,” the lease-option is still my favorite method to buy and sell homes. It requires very little up-front cash, yet it gives the buyer-tenant control of the property and benefits from the probable future market value appreciation. Leasing is almost always far cheaper than holding title.
Lease-options won’t work on every home, but as interest rates gradually rise and home mortgages become less easily available, lease-options usually become more acceptable to sellers. Details, especially how to find and create lease-options, are in my special report, “How to Profitably Use a Lease-Option to Buy or Sell Your Home or Investment Property.”
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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