Home Buying 101

Step Two: Loan Pre-approval

Step Two of the home buying process is obtaining your Loan Pre-approval letter. There are three similar sounding but very different levels of being approved for a loan: Pre-qualification, pre-approval, and commitment.

Pre-qualification - The lender has talked to the prospective lendee and run his or her credit.

Pre-approval - The lender has run the prospective lendee’s credit and reviewed his or her qualification documents.

Commitment - The loan underwriter has approved the loan.

You should have a loan pre-approval in hand or at least in the works before touring homes, because pre-qualification is not a steadfast certainty on which you can rely. In a perfect world, buyers would have a loan commitment from a lender before touring houses, but that is a rarity. Think of it this way: Pre-qualification is like having tentative plans to have dinner with someone. Pre-approval means that you have determined a date, time, and place. Commitment means that you’re at the restaurant. You’re excited about all of those levels, but they are not equal.

Loan types - There are several ways to finance the purchase of a home: Cash, conventional loan, VA loan, FHA loan, and USDA loan.

Cash - Chances are that if you’re in the position to buy a house outright without taking out a loan, you don’t need me to explain it to you. But just for information’s sake: Paying cash eliminates interest payments on a loan, and also removes closing costs that are associated with obtaining a loan, such as origination fees, appraisal fees, or other assessment fees charged by lenders. In fact, in contrast to all other loan types, with cash payments the home appraisal is optional. Cash payments can make your offer more appealing to sellers since it speeds up the purchase process, and removes the risk of a sale falling through due to a lender denying the loan. Therefore, if you’re in a bidding war situation you are equipped with more bargaining power if you have the dough to back it up. If you have the dough, make sure that you maintain plenty of liquidity in case the house needs repairs, or if you need to sell sooner than anticipated. There are also tax implications for a cash payment, since mortgage interest payments are tax deductible. Make sure you carefully weigh the return on your investment, and compare it to other investments that you could make with your capital. If you choose to purchase your home with a cash payment, you can expect to settle within two weeks.

Conventional loan – A conventional loan is a mortgage that is not guaranteed or insured by any government agency, including the Federal Housing Administration (FHA), the Farmers Home Administration (FmHA) and the Department of Veterans Affairs (VA). It is typically fixed in its terms and rate. The most common loan type for home purchases, a conventional loan presents the least risk to lenders because the buyer is putting more of his or her own money down. Since the credit requirements are more stringent, the buyer profile for a conventional loan is stronger. If you purchase your home with a conventional loan you can expect to settle within 30 days.

VA Loan – A VA loan is a mortgage loan guaranteed by the U.S. Department of Veterans Affairs (VA), designed to offer long-term financing to eligible American veterans or their surviving spouses. VA loans are provided by private lenders, but since the VA guarantees a portion of the loan, it enables the lender to provide more favorable terms for lendees. To qualify for a VA loan you need military eligibility proven by a certificate from the Department of Defense, which can nowadays be obtained online. There are credit qualifications and a minimum credit score that a buyer needs to meet to qualify for a VA loan, and VA loans are only applicable for the purchase of a primary residence. Some VA loan benefits are stronger than those that come with conventional or FHA loans, such as 100% financing without private mortgage insurance (PMI). There are also certain closing fees that a VA buyer does not need to pay, such as the cost of a pest inspection, as well as the loan origination fee. There is, however, a funding fee of which to be aware, which can be paid upfront at closing or financed into the loan. Even though this loan type is structured by the Federal Government, you should always contact a local lender for your loan. Real estate is a local business, so rules and regulations vary based on your location. If you obtain a VA loan you can expect to settle within 45 days.

FHA Loan - An FHA loan is a mortgage insured by the Federal Housing Administration. Borrowers with FHA loans pay for private mortgage insurance (PMI), which protects the lender from a loss if the borrower defaults on the loan. FHA loans are attractive to buyers because they allow lower credit scores, are less stringent on credit qualifications (meaning that you can get away with some judgments), and they only require a 3.5% down payment. The PMI can be paid two different ways: A monthly fee that is added to your loan balance, or a lump sum upfront payment at settlement.  The downside of adding to your loan balance is that you have to pay interest on it. There is a subset of FHA loans called a 203k, which is a renovation loan where the lender gives you money for the purchase of the house, and additional money to make necessary repairs. With an FHA loan a buyer profile is not as strong as it is with a conventional loan, so keep that in mind since the sellers will be able to see what type of loan is being pursued. If you obtain an FHA loan you can expect to settle within 40 days.

USDA Loan – In Maryland there is also the option of a USDA loan, which is a mortgage backed by the U.S. Department of Agriculture as part of its USDA Rural Development Guaranteed Housing Loan program. Launched in the 1990’s, USDA loans are available to home buyers with below-average credit, and offer 100% financing with reduced mortgage insurance premiums, and below-market mortgage rates. In order to be eligible for a USDA loan, household income must meet certain guidelines, and the residence has to be located in an eligible rural area as defined by the USDA.

For all loan types, the lender will require a home appraisal, which is not to be mistaken for a home inspection. Appraisal is about fair market value, to make sure that the lender and buyer are not paying more than the home is worth. If you need guidance in finding a lender and/or determining which loan type is best for you, your realtor can and should advise you. Don’t know where to start? Give us a call.

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