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Financing your New Home

Determining the Right Price Range

The first step in the buying process is to determine the price range that is right for you.  You will need to consider how much cash
you are prepared to invest in your home and how much money you will need to borrow.

Your cash on hand will have to cover both the down payment and any closing costs associated with the purchase.  Closing costs
vary significantly based on the terms of any loan you may obtain, but are generally 2% to 4% of the purchase price.  Don’t forget to
budget for moving expenses.

You should also take into consideration how much your property taxes and insurance will cost in addition to a monthly mortgage
payment in determining the right price range.

Pre-qualifying for a Loan

An offer to purchase is given greater consideration by a seller when the offer is accompanied by a pre-qualification or, better yet, a
pre-approval letter from a reputable lender or mortgage broker.  This gives assurance to the seller that you will be able to get the
proposed financing and will not tie up the property needlessly.


Factors to Consider when Shopping for a Lender

Ultimately, when choosing between lenders, home buyers should pick the lender that offers the best combination of highly
competitive rates and excellent service.  Therefore, when evaluating lenders, borrowers should understand the distinction
between mortgage bankers and mortgage brokers.

  • Mortgage bankers lend their own money.  They take applications, gather borrowers’ personal financial information and
    approve loans.  They also prepare loan documents and fund loans independently.  Mortgage bankers are full-service, direct
    lenders and have maximum control over the loan process.  Unfortunately, direct lenders usually have a limited number of
    loan programs, rates and terms, and are subject to the underwriting standards imposed by the lending institutions for
    which they work.

  • Mortgage brokers take applications, gather personal financial information and submit the data to an outside financing
    source that underwrites, approves, funds and services the loan.  Since mortgage brokers can send the loan to many
    different lenders and offer a wide variety of competitive loan programs, they tend to offer both the best opportunity to get your
    loan approved as well as the best available rates and terms.  However, mortgage brokers cannot control the process from
    beginning to end, as direct lenders can.

Some lenders are only mortgage bankers or mortgage brokers.  Not all lenders have the same connections and experience.  It is
a good idea to make sure that your lender is both a direct lender and a mortgage broker and possesses a long history and a
good reputation in the business.



Financing Your Purchase: The Loan Process

Pre-Qualification vs. Pre-Approval

Financing the purchase of a home normally begins with the borrower pre-qualifying for financing.  The pre-qualification process
involves the review of specific financial information including the applicant’s income, assets, debt, source of cash for a down
payment, credit and employment history.  

In a market with many qualified buyers and a limited number of properties, it becomes important that potential buyers become
pre-approved.
 Since pre-approval strengthens their buying position greatly, buyers should not start their home search until
receiving a formal pre-approval
.  A pre-approval involves obtaining a completed loan application and verifying information
borrowers provide about their income, assets, debts, and credit history with supporting documentation such as pay stubs, tax
returns, bank statements and credit reports.  Getting pre-approved with a good mortgage broker is a quick, easy process.

The loan agent submits this information to a preliminary review using an automated underwriting system which evaluates all of
the information and approves the loan.  Upon receiving a pre-approval, the loan agent issues a pre-approval letter to the Realtor.  
That letter is typically submitted to a seller when making a purchase offer.


Steps to Obtaining a Loan

  1. The Loan Application – The process begins with the initial interview where the lender obtains an application and
    evidence of income and assets. Lender also opens escrow with the title company.
  2. Ordering Supporting Documentation – Within 24 hours of application, the lender requests a credit report, an appraisal of
    the property, verifications of employment and funds to close, mortgage or landlord ratings, a preliminary title report and
    any other necessary supporting documentation.
  3. Collection of Documentation – Within one or two weeks, the lender begins to receive the supporting documentation.  The
    lender checks it for accuracy and completeness and requests any additional verifying items needed.
  4. Loan Submission – Once all the necessary documentation is in, the loan package is assembled and submitted to the
    underwriter for approval.
  5. Loan Approval – Within 24 to 72 hours after submission, all parties are notified of the approval and any loan closing
    contingencies are cleared.  Borrower receives an estimate of closing costs from the lender.  The closing process begins.
  6. Loan Documents Drawn – Within one to three days after the loan approval, the loan documents are completed and sent
    to the title company. The borrowers will then sign the final documents and are told how much money they will need to
    close the loan.
  7. Funding – Once all of the loan documents are signed, the lender reviews them.  When the forms are properly executed, a
    check is issued to fund the loan.
  8. Recordation – The title company then must record the legal documents necessary to transfer the property into the buyer’s
    name.  Also, the deed of trust is recorded to show the new loan on the property.  Escrow is now officially closed and you
    own your home.


Loan Programs

Below is a brief explanation of some of the most commonly used loan programs:

  • Fixed Rate Loan – A fixed rate loan has an interest rate that remains constant throughout the life of the loan, usually 15 or
    30 years.
  • Adjustable Rate Mortgage (ARM) – An ARM is a loan having an interest rate that can change, either upward or downward, at
    specified periods during the life of the loan.  The change in the interest rate is usually tied to a published financial index
    over which the lender has no control.
  • Midterm ARMs – These loans are generally 30-year loans, with the interest rate fixed for the first 3, 5, 7 or 10 years, after
    which they become adjustable rate loan for the remainder of the thirty-year term.

More on ARMs:

Lenders usually charge lower initial interest rates for ARMs than for fixed rate loans because the borrower is sharing the risk if
interest rates go up.  ARMs, therefore, are less expensive in the beginning than fixed rate loans.  This may mean that a borrower
can qualify for a larger loan if they select an ARM.  Borrowers run the risk of payments becoming burdensome, however, if rates
rise substantially.

Indices:  Index ARM’s

Interest rate changes are tied to changes in an index rate.  An index usually moves with the general trend of the economy.  The
most commonly used indices include:

  • Six Month Certificate of Deposit (Six Month CD) – This index is a weekly average of interest rates paid on banks’ Six Month
    CDs.  This index is generally considered to react quickly to changes in the market.
  • One year Treasury (One Year T-Bill) – This is the weekly average yield on the U.S.  Treasury Securities adjusted to a
    constant maturity of one year. This index generally reacts quickly to market changes.
  • 11th District Cost of Funds Index (COFI) – The average cost of deposits and borrowings for Saving & Loans in the Federal
    Home Loan Bank’s 11th District, which consists of California, Arizona and Nevada.  This index is slow moving due to the
    size of the deposits (approximately $3.5 Billion) and generally lags behind market fluctuations.
  • London InterBank Offered Rate (LIBOR) – The LIBOR is an average of the daily lending rates from several major English
    banks, used as a common international interest rate index.  Like the CD, it tends to react quickly to changes in the market.
  • Prime Rate – The Prime is the lowest commercial rate charged by banks on short-term loans to their most credit-worthy
    customers.  Mortgage rates and consumer loan rates are generally close to the prime rate, but exceptions occur.

Margin

To establish the actual ARM rate that is used to calculate payments, percentage points are added to the index value.  These
percentage points are called the margin.  The lender establishes the margin at the inception of the loan and it remains constant
for the term of the loan.  To calculate the interest rate at the time of adjustment, add the index to the margin (Rate = Index +
Margin).

Periodic & Lifetime Caps

The note supporting an adjustable rate loan contains a schedule that states the frequency of the adjustment.  A typical example
would be a one-year ARM based on the One Year Treasury Index.  This loan would have a low start rate.  After the 12th month, it
would adjust, and would continue to adjust annually for the term of the loan.  ARMs are usually named for the frequency of the
rate and payment adjustments.  A loan that adjusts annually with the rate based on the One Year Treasury is called a One Year T-
Bill ARM.

To make ARMs an attractive alternative to fixed rates, lenders build in caps or limits so that the adjustment cannot be too severe.  
For example, on the 1 Year T-Bill ARM, there is usually a 2.00% annual cap.  This means that the rate for year two is a fully
indexed rate, i.e., the index plus margin.  For example, if a loan starts at 5.00% and has a 2.00% annual cap, the maximum rate
for the second year would be 7.00% and the maximum for the third year would be 9.00% regardless of what index + margin your
loan may actually equal.

In addition to these periodic caps, ARMs will also contain a lifetime cap or ceiling.  That is the maximum rate for the life of the
loan, regardless of what the market dictates.  This amount can be considered the worst case interest rate and will usually exceed
current fixed interest rates.

Payment Caps and Deferred Interest (Negative Amortization)

In addition to periodic caps, there are payment caps.  This is a fine, but important distinction.  These loans will not have a built in
periodic cap, usually just a lifetime cap.   What they offer is a payment cap.  This is the maximum that the payment can increase
in any given period.  Lenders still calculate the rate based on Index + Margin, but they offer a minimum payment that may be less
than one generated by a fully indexed rate.  The difference in the payment is called deferred interest.

Lenders will review the loan to determine if the minimum payments have covered the fully indexed payment.  This difference is
then added to the loan balance, hence the term negative amortization.  A borrower may avoid negative amortization by making the
fully indexed payment.  Cost of Funds (COFI) loans are usually structured this way.

11th District Cost of Funds ARMs and Monthly Treasury Index (COFI/MTA)

Called the “dinosaur” of the adjustable market, the COFI is the slowest moving adjustable index offered.  The MTA is also a slow
moving index and used by some lenders instead of the COFI.  Typically used for purchases, these programs will provide the
most stable adjustable payments over any other adjustable loan index while providing monthly payment options.  These options
include:

  • Principal and interest payments over 30 years
  • Principal and interest payments over 15 years
  • Interest only payments
  • Minimum or deferred interest payment

The Components of a Mortgage Payment

Your monthly housing expense is made up of several components:  Principal, Interest, Taxes, and Insurance, commonly
referred to as
PITI.  A mortgage payment generally includes amounts for principal (P) and interest (I).

Terms of the loan may require, or borrowers may choose to pay, a pro-rated portion of annual taxes (T) and homeowner’s
insurance (I) monthly along with principal and interest.

  • Principal is the amount of money loaned, excluding interest, and also the remaining balance of a loan, excluding interest.  
    Interest is calculated based on the principal.
  • Interest is the charge, in dollars, for the use, or loan, of the money.
  • Taxes -- The county assessor determines the property tax based on the value of your home.  Two tax installments are due
    each year.
  • Hazard Insurance is a contract between homeowner and insurance company in which the insurance company pays for
    loss from certain hazards, including fire.  You obtain homeowner’s insurance from your own insurance agent.  The
    standard policy pays replacement costs, minus depreciation based on actual cash value.
  • Private Mortgage Insurance (PMI) -- Lenders want to make loans to homebuyers even if down payments are minimal.  
    However, loans with small down payments involve substantially more risk for the lender.  To offset this risk, lenders typically
    require the additional protection of PMI to cover potential losses in case the loan goes into foreclosure.  Without an 80/10/10
    or 80/15/5 program, loans with down payments less than 20% usually require PMI.

Paying Points

Points represent interest paid at the time of the loan closing to reduce the interest rate.  One point equals one percent of the loan
amount.  For example, one point on a $300,000 loan equals $3,000 added to closing costs.  A one-point loan will almost always
have a lower interest rate than a zero-point loan from the same lender.  Therefore, paying points is a trade off between paying a
fixed amount of money at closing in order to receive a lower interest rate and lower monthly payments.

Generally speaking, you should only pay points if you plan to keep the loan for at least four to five years.  Because points are
prepaid interest, the loan should be kept long enough to recoup these costs through lower monthly mortgage payments.
If you are considering moving again within a four-year period, or if the general interest rate market is declining, you should
consider a no-point loan.  If the plan is to keep the property for an extended period of time and the interest rate market is
increasing, paying points is appropriate.  Nonetheless, because each case is different, it is recommended that borrowers seek
the assistance of a financial advisor or mortgage planner before making a decision.

The tax treatment of points depends on what the loan is being used for.  Points are normally 100% tax deductible in the year a
home is purchased.  This is true even if the seller is paying for the buyer’s points.

In a refinance transaction, points must be amortized over the life of the loan. For example, on a 30-year loan, each year you can
deduct 1/30th of the points.  If a property is subsequently refinanced or sold and the loan paid off, the remaining unamortized
points can be deducted in the year of the subsequent refinance or sale.


Closing Costs: Who Pays What?

Closing costs are the various charges made by the lender, the title company, real estate agents, and other service providers
necessary to complete a transaction.  Although who pays for the various closing costs is negotiable between the buyer and
seller, the following sets forth the customary division in San Francisco County.

The Buyer customarily pays:

•        Title insurance premium for lender and buyer
•        Escrow fee
•        Notary fees
•        Contractor’s and pest inspection fees
•        All new loan charges (points, appraisal, document processing fees, etc.)
•        Interest on new loan from date of funding to 30 days prior to the 1st payment date
•        Beneficiary fee for assumption of existing loan
•        Home warranty (if specified in contract)
•        Homeowner’s insurance for 1st year
•        Earthquake insurance (optional)
•        Private mortgage insurance (typically 2 months) if required by lender
•        Private mortgage insurance impound account (1 year) if required by lender
•        Property tax impound account if required by lender
•        Move-in fee (for some condominiums)
•        Miscellaneous charges

The Seller customarily pays:

•        Real Estate commission
•        Document preparation for deed
•        Documentary transfer tax (amount is dependent upon sales price)
•        Payoff of all loans in seller’s name
•        Interest accrued on loans being paid off, reconveyance fees and re-payment penalties
•        Home warranty (if specified in contract)
•        Any judgment or tax liens against seller
•        Reconveyance fees
•        Property tax proration
•        Unpaid homeowner’s dues (for condominiums)
•        Bonds or assessments
•        Delinquent taxes
•        Move-out fees (for some condominiums)
•        Notary fees and recordation fees
•        Third party Natural Hazard Disclosure Statement
•        Pre-sale pest inspection fee
•        Underground storage tank report
•        Miscellaneous charges
Honesty. Service. Results.
Great Homes SF
John Beeney, Realtor
Cell:     415-310-0225
Office:  415-701-2618
JBeeney@paragon-re.com

DRE #01487478