How do I buy a house? (Part one)


I’ve been thinking about what to write for a while and I realized something: If I was a little smarter I would have started my first blog with a post like the one I’m now writing which answers the question many people have (and might be afraid to ask) which is, “How do I buy a house?”

There is a lot to cover and a lot to know, so I’m going to break this up into two parts and write one post this week and one next week.  The post this week will explain how you know you are ready to qualify for a  mortgage, while the post next week will be a step by step guide to the mechanics of how the process of buying a home works.

In order to qualify for a mortgage, a lender is looking for four things- and like all good preachers or teachers or speakers know- those 4 things all have to be in the form of either alliteration or rhyme; here that takes the form of alliteration with the “4 C’s” from easiest to most confusing:

Cash

Credit

Collateral

Capacity

I like to describe getting a mortgage as being similar to picking out a chair- the strongest and stablest and best chair will have 4 legs, that are all in good shape and the same length and able to hold weight. If all 4 legs are doing their job and doing it well then there is nothing to worry about with the chair and it would be considered good.  Now, as we’ve all experienced you can sit on a chair with one leg less sturdy than the other three legs and that chair should likely support our weight and not collapse.  This isn’t an ideal chair, of course, our sitting experience might not be as comfortable as we’d like it to be, but the chair can still be functional and work to serve our purpose.  Similarly weakness in one of these “4 C’s” doesn’t need stop a buyer from getting a loan, but it will stop them from getting a really good deal on a loan, and it will mean that all the rest of the legs of the chair need to be really strong in order to support the mortgage and get qualified.

Cash

So, the first leg of the chair is easiest to conceptualize and that is “Cash”.   The first question one reading might now might ask is “how much cash do I need?”

That answer, like much of this process, varies.  We have loans available for Veterans through the VA and the USDA rural homestead programs which allow a buyer to purchase a loan with no down payment.  We have loans available through affordable home programs that come with 3% down payment, FHA loans with 3.5% down payments and conventional programs beginning at 5% down.  Most of these loans (all except the VA loans), however, come with private mortgage insurance (PMI), which is essentially a charge for having put down less than 20% for a down payment.  The best down payment, that qualifies for a mortgage that comes without PMI, is a conventional loan with 20% down.

No sales transaction comes without closing costs, and those have to be paid somehow and someway.  If you are getting the closing costs from me- it will come in the form of a higher interest rate than you might have otherwise qualified for.  If you are getting the closing costs from the seller it means that you could have likely bought the house for a smaller amount of money than you ultimately paid.  Both of these can be very good ideas for any buyer, as often times not having to fork out $5,000-$7,000 in cash today and choosing instead to pay $15-$50 a month more in your mortgage payment tomorrow can be a real win, but, it is something to be considered.

Finally, we don’t often need or require money in the bank for reserves to qualify for most mortgages, but in the real world that is a very nice thing to have, and sometimes a strong cash position can help someone qualify for a loan they otherwise might not have qualified for.

Credit

Again, this is something that almost everyone is aware of in today’s society. Anyone who interacts with debt in any way, shape or form (and even some who don’t with collections for medical debt or the like) has a credit score.  The higher the score the better the deal, as that means you have a good and long track record of paying back your debts, and you are not currently overextended financially.

So- what do you need for a credit score to buy a house?  Like everything else in this analysis the answer is- “it depends”.  I’ve gotten loans for people with credit scores from 503-832 before, so all kinds are welcome to apply.  As I’m sure you can imagine, the higher your credit score is the better the deal you qualify for will likely be.  Some Benchmarks:

500- able to qualify for a loan. Non qualifying products.  High interest rates. High down payments. Risky loans. We only put people in here when they have an exit strategy for how to get out of the loan, but sometimes it makes sense.

580- generally the point in time where you can qualify for a government loan on normal terms and market-ish rates.  We do plenty of 580 credit score people on FHA or VA type loans.  These rates are typically 0.5%-1.0% percent higher than other rates with government loans, but they aren’t far off market and typically qualify

620- This is the stage where government loans start to get a lot easier to qualify for and our DU typically runs most of these people through qualification without much of a problem.

640- This is where, essentially, every lender in the world is willing to lend to you, regardless of program type.  Typically your rates on FHA, VA and USDA programs start getting really good here- but conventional financing basically still isn’t super impressed

680- This is where you basically start maxing out what your best rate will be in an FHA, VA or USDA program.  Anything over this score is likely overkill and will get you 1/8 of a point better- maybe- on a really good day.

700- Conventional lenders start punishing you less for your credit score here

740- The place where conventional lenders stop paying attention to score.  A 740 score and an 800 score or going to be underwritten and priced the same.

So, in summary anywhere above 500 we have a loan program for someone out there looking, if all their other stars are in alignment, while the other benchmarks are provided for where the deals start getting better.

Collateral

I will certainly talk the least about this- it’s pretty simple really.  Basically, the collateral is the house that we are loaning you money for. The lender wants to make sure it’s worth what you are paying for.  The way we do this is by ordering an appraisal and having an appraiser tell us how much that house is worth in a fair market value. If the house appraises for at or above the price you paid, and is insurable and livable then the deal is going to be ok. If it comes in lower than what you agreed to pay then 1 of 3 things are going to happen:  1) The seller will agree to sell to you for less than the original contract, 2) you will write a check for the difference between the appraised value and the price of the contract, or 3) The deal will die.  This is collateral 101 and there are some nuances in different types of deals we could explore, but we will do that in a later blog post some other time. It’s situation dependent and more technical and nuanced than most first time home buyers would want to know.

Capacity

This one, is by far, the most difficult one to explain and I will definitely tackle this much more in depth toward the end of February (I know, right- I promised you a two-parter this week and next week, and then you get to eagerly anticipate a full throated breakdown on debt to income later in February, dear reader?  What can I say- February is the month of love and I’m just trying to share as much of it as I can with you right now!)

The simplest way to think of capacity is this “If I bought this house- do I have the ability to pay back the Principal, Interest, Taxes, Insurance, Mortgage Insurance, and home owners association, as well as all the rest of my debts, based upon how much money I have coming into my household).  That equation, is your debt to income ratio (DTI) and differs based upon the program you are trying to apply for.  I’ve had people with DTI’s below 20, and this week, I just had a veteran qualify with a DTI of 63 (it’s not irresponsible- I promise- it makes sense in his particular scenario) to break the record, but most typical programs you want to see a DTI in the 40’s at the tops, though FHA goes up to 56% pretty regularly and the VA can go even higher at times.
So, you calculate your DTI by adding up all your monthly debt obligations as the numerator (this is stuff like cars, student loans, credit cards, personal loans etc) and dividing that by your monthly income as the denominator (for those who aren’t working with their little ones on long division right now that means little number on the top, big number on the bottom)  and getting your number- which should be greater than 0 and less than 1.

Conclusion

OF course, conclusion too starts with a C (what- you thought I was going to title this section summary) and the conclusion is this:  if you have 3-5% to put down, on a new home, with credit over 620 or 640 and a good job and manageable debt you are going to pretty easily qualify for a home and be ready to get a really good deal in the marketplace right now.  If you have a 700+ credit score with 20% to put down you will get the best possible deal in the market place. If you have some of these factors that are good, and some that aren’t quite as good, you can get a loan but the terms won’t be amazingly awesome. If you have 2 or more of these legs out of whack we need to do some strengthening and improving so you can buy a house later.

I LOVE to help first time home buyers (or first time in a long time) buy a home.  I get loans for people, I like to teach, and I like to help.  Working with first time home buyers leads to an intersection of those three things I love about my job. As such, I’m always available for a free consultation, that comes with a full analysis of your credit, a full analysis of all the moving parts in your financial life (as it pertains to qualifying for a mortgage) and either the amount of house you qualify for now, the terms of the deal, or a written summary and plan (and time frame) for how we can get you ready to buy a house in the future.  Call me at 832-557-1095 anytime on my cell or email me at gabekmg@gmail.com  I’d love to hear from you.  Also, I sure would appreciate it if you told your friends I’d like to help them too.

Thanks
Gabe