If you’re thinking about buying a home in the next few years, there are a few things you should know about how different types of debt can affect your credit score. Some savvy financial planning can put you lightyears ahead when you’re applying for a mortgage down the road.
Closing costs can be an expensive part of buying a home. In addition to saving for your down payment, you need to save for closing costs, too. They can vary depending on where you live, but they’re generally between 2 and 5% of the total loan. On a $250,000 loan, that could be between $5,000 and $12,500, so it’s something you definitely need to plan for in addition to your down payment.
It might seem like a great idea to roll closing costs into your loan if it’s an option for you. It all depends on the type of loan you’re getting and what your financial goals are.
Financing your closing costs doesn’t mean that you don’t pay them — you’re just financing them into your loan instead — so you won’t have to bring as much cash to the closing table.
Bringing Less Money to the Closing Table
There are a variety of ways you can reduce how much money you have to bring in for closing. Some options involve rolling closing costs into your loan, but there are some other good choices, too.
Roll Closing Costs into the Loan
Not all purchase loans allow you to roll your closing costs into the loan. If you are able to do so, there are some financial consequences you need to be aware of. Rolling closing costs into a loan means that you’re paying interest on those costs over the life of the loan. That means that you’re paying much more for those costs than you would be if you just paid them upfront.
Also, if you finance your closing costs, it can’t put your total loan over what you’re approved for. So if you’re already at your maximum budget, you may not be able to roll them into the loan.
It’s also important to note that increasing your loan amount lowers your equity in the home, which may affect you down the road if you want to sell or get a home equity loan.
Increase Your Interest Rate in Exchange for a Credit
Some loans will allow you to increase your interest rate while giving you a credit that offsets some or all of your closing costs. However, keep in mind that this means you’ll be paying more on all of the money you borrow for the entire life of the loan (unless you ‘re able to refinance at some point).
If you hear about zero-down loans, they often work this way. The lender covers your closing costs in exchange for a higher interest rate. They’re not usually the fantastic deal they seem to be.
Reduce Your Down Payment
If directly rolling your closing costs into a new mortgage isn’t an option, you may be able to reduce your down payment so that you need less cash, but this means that your loan-to-value ratio will increase (this is the amount of your loan compared to the value of the house). If your LTV is above 80%, you’ll probably have to pay a private mortgage insurance premium each month.
Negotiate a Seller Concession
Another option is to try to negotiate a seller concession, where the seller pays for some of your closing costs, reducing your out-of-pocket expense. But sellers usually won’t do this unless it’s a buyers’ market or they’re desperate. In a competitive market, you’re likely out of luck.
FHA and VA Loans
FHA and VA loans are backed by the federal government, and they have different loan parameters and fees than conventional loans do.
FHA loans require a borrower to pay an upfront mortgage insurance premium, which is usually 1.75% of the loan amount, and it can be rolled into the loan. But you must have a 3.5% down payment, not including closing costs.
Depending on your situation, many other closing costs associated with an FHA loan may be able to be rolled into the loan.
VA loans require a borrower to pay a VA funding fee, and that can be financed. This fee goes directly to the Department of Veterans Affairs to fund the program and pay for any losses due to their loan guarantee. The amount you’ll pay for a funding fee depends on your exact military service and whether or not this is your first VA loan. (Some borrowers are exempt from the funding fee entirely.)
Other closing costs usually have to be paid at closing, but it depends on the exact scenario for your loan. The good news is that the VA loan program limits what closing costs the buyers are allowed to pay, and you can get a VA loan with 0% down.
Refinancing and Home Equity Loans
Closing costs for refinances and home equity loans are generally much lower than they are for new mortgages. Rolling closing costs into the loan might be worth it if you’re not paying too much extra interest. This is especially true with a refinance that gives you a lower monthly payment.
What Should You do?
Having a solid grasp on your financial goals will help you decide if rolling closing costs into your mortgage is a good decision for you. If you need the extra money in your pocket right now, rolling closing costs into the loan may be a good decision. It actually may help you buy a home sooner than you’d be able to otherwise.
If you don’t really need the money right now, you may want to skip the higher monthly costs and just pay the costs upfront to save money in the long run.
If you have any questions about this or would like to go over any specific scenarios together, please don’t hesitate to reach out to our team.
Have you known someone who has bought a multi-family unit and then lived in part of it while renting out the rest? It’s pretty cool to have someone else paying part of your mortgage.
But getting a mortgage on a multi-family unit isn’t the same as getting a mortgage for a single-family home. These loans have different underwriting guidelines.
What is a Multi-Family Property?
First, let’s define what a multi-family home is. It’s multiple living units (as few as two) with separate entrances and exclusive living areas. Duplexes, triplexes, and fourplexes all fit this definition. (Properties with five or more units are considered commercial real estate, but properties with four or fewer are considered residential when it comes to financing.)
What is Your Goal?
If you’re buying an entire unit as an investment property, you don’t have nearly as many options as you do if the unit is partially occupied by the owner.
If it’s strictly an investment, you don’t have access to government-guaranteed loans like FHA and VA loans, which can make it easier for you to buy a multi-family property.
Additionally, you’ll need a higher down payment and will pay higher interest rates. For the remainder of this article, I’ll be talking about multi-unit loans where the owner is occupying one unit.
It depends on the loan program, but you’ll usually have to put more down for a multi-unit mortgage that you’d have to for a single-family home, which can require as little as 3% down.
Typical down payments for multi-unit conventional loans are:
Duplex, 15% of the purchase price
Triplex, 20% of the purchase price
Fourplex, 25% of the purchase price
If you qualify for an FHA or VA loan, you’re in luck with the down payment. FHA loans require just 3.5% down, while VA loans allow for 100% financing.
A side note: Freddie Mac’s Home Possible program does allow you to finance 1- to 4-unit properties with just 5% down, but it does have income limits.
Depending on the loan program, a parent or relative may be able to kickstart your investment by providing a percentage of the down payment funds.
Maximum Loan Limits
Another plus to getting a multi-family property is that you can get a more expensive property without heading into jumbo loan territory (which comes with higher interest rates). More units equals a higher lending limit.
Income—and Can You Use Rental Income to Qualify?
Obviously, you’ll need a higher income to qualify for a bigger loan. That begs the question: can your new rental income be used to help you qualify.
As usual, it depends. Guidelines vary, but typically you’ll need to have some sort of landlord experience under your belt. This shows us that you can consistently collect rent and find good tenants.
Even so, you can usually use only 75% of rental income as qualifying income (to account for maintenance and vacancies), and you’ll usually need to have signed leases in hand.
Interested in Purchasing a Multi-Family Unit?
Are you interested in purchasing a multi-family unit? It can be a smart investment strategy that will pay off for years to come. If you have any questions about what a mortgage might look like for you, give me a call! I’m here to help.
Thinking about buying a home? Congratulations!
Buying a home is an exciting time in a person’s life, but if you aren’t prepared, setbacks may dampen your mood. Spending time preparing now can save you time and headaches after you’ve turned your application into the bank.
Here are 10 steps that will make the mortgage application process go more smoothly for you.
Check Your Credit Score
First, you need to check your credit score. This number will be your first introduction to any potential lender, and they’ll use it to glean a picture your overall financial health.
A bad credit score doesn’t necessarily mean you can’t get a mortgage, but it means that the terms of the loan probably won’t be as good as they would be if you had good credit. Bad credit scores mark potential borrowers as higher risk, and the borrowers could be forced to pay higher interest rates and larger down payments to compensate for that extra risk.
Don’t despair if your credit score isn’t where you want it to be. There are steps you can take to improve your credit score now, before you ever apply.
Avoid New Loans and Lines of Credit
A mortgage is a big loan, and lenders will probably want it to be one of the only ones you’ve applied for recently. Old loans won’t usually disqualify you, as long as you’re making your payments on time. A recent loan or new credit card, on the other hand, could look bad to potential lenders.
That’s in part because loan applications and hard inquiries on your credit can negatively impact your credit score. Those little dents aren’t usually a problem over time, because your score improves as you pay off those loans and as the hard inquiry on your credit falls off, but make sure you give yourself time to rehabilitate that score before applying for a mortgage.
Pay Off as Much Existing Debt as You Can
If you currently have lots of debt to your name, lenders won’t be eager to help you add debt to your financial profile. Even if you’re not drowning in debt, try to pay off as much of it as you can. Minimize your credit card bills and pump some money into any long-term loan debt you’re working on erasing. It shows lenders that you’re serious about paying off loans and that you can be trusted to stick to payment plans over a long period of time.
You’ll want to save money for down payments and closing costs, but using any extra cash to pay down debt will help spruce up your financial profile at a crucial point. This will also help improve your credit score, though there can be a delay between the debt payment and the credit score improvement.
Keep Credit Card Accounts Open
This one may seem counterintuitive at first. While you do want to pay off credit card debt, you don’t want to close credit card accounts altogether. When you close a credit card account, you lose that line of credit from your financial profile, and your credit score will usually sink.
The best way to use a credit card is to have as large of a line of credit as possible, use only a fraction of it, and pay off the debt quickly.
Pay Your Bills on Time
As you focus on reducing your existing debt, don’t let any extra debt pile up. Keeping up with your bills won’t help your credit score, but falling behind will hurt it. Showing lenders you can keep the lights on and the water running is an important step in getting them to trust that you can pay to keep a roof over your head, too.
Save Up Cash
Mortgages come with closing costs and down payments, so you’ll want to save up some cash. In the months before applying for a mortgage, try to bulk up your checking and savings accounts.
While you want to plenty of cash on hand, you want to avoid large deposits before applying for a mortgage. Lenders usually impose restrictions on cash gifts. Those restrictions may include providing an explanatory letter about where the large deposit came from and why. If a potential lender doesn’t know where an unexplained deposit comes from, they might decide to reject the application.
Keep Your Employment Steady
If finding a new job and buying a home are both on your to-do list, pick the home first. Lenders usually prefer applicants to demonstrate their ability to hold down jobs. There’s some leniency when it comes to getting a new position in the same career field, but in general, lenders will expect you to hold down the same job for a couple of years.
You should also try to avoid taking a leave of absence, even if you plan to return to the same job. A maternity absence usually shouldn’t disqualify borrowers from securing a mortgage, but other types of absences may.
Plan Your Budget
Before applying for a mortgage, take a hard look at your budget and figure out how your mortgage will fit into that. Many lenders want borrowers to spend no more than 28 percent of their paycheck on their mortgage. Borrowers might not want to, either.
Your debt-to-income ratio, or the amount of your income that goes toward paying off debt, should max out around 42 percent. If you can shoot for a lower ratio, that’s even better. Whatever your preferred debt level, the more your mortgage eats into that, the less you’ll have to put toward car payments, student loans, etc.
Gather Together the Documents You’ll Need
Mortgage applicants are required to provide quite a few supplemental documents. Among them, you can expect to turn over two years’ worth of tax returns, a month’s worth of pay stubs, and documents related to your rental history.
These documents back up your promise to repay the bank for the loan. It’s proof that you actually have the income and financial history that you claim.
Avoid Any Big Purchases
Once you’ve done everything else on this list, you’re ready to apply for a mortgage! Just make sure to hold off on any other major purchases, at least until after you’ve closed on your loan. Trust me that buying a brand-new car right before closing is not a good idea.
Applying for a mortgage isn’t easy, but it’s manageable. Once you’re done, you’ve taken a major step toward homeownership. If you have any questions about the application process, don’t hesitate to reach out or leave a comment below!
If you’ve got extra cash, you might consider investing that money in a rental property. Rentals can help diversify your investment portfolio and build financial stability. If you haven’t purchased a rental before, there are a few things you need to know about the down payment.
How Much You Can Expect to Put Down
Put simply, you can expect to pay more upfront for a rental property when compared to a standard home mortgage. Most rental property loans require a down payment of at least 15 percent. That’s the bare minimum, and that’s only for people with the best credit. The truth is, most people can expect a minimum down payment of more like 20—25 percent down.
You can also expect to pay more than you would for a typical home’s closing costs. Interest rates for a rental property loan will most likely be higher as well, since there’s more risk associated with a rental property investment.
How to Reduce Your Minimum Down Payment
If you want to minimize your down payment, consider a rental property with fewer units. The minimum down payment for a single-unit rental property mortgage can be as little as 15 percent. If you’re buying multiple rental units, that down payment minimum will rise as high as 25 percent.
Living in one of the property’s units will drastically expand your loan options, including options for lower down payments. You can find FHA loans that require as little as 3.5 percent down if you plan to live in the property. Living in the property may also help you qualify for down payment assistance.
Keep in Mind…
For many lenders, gifts won’t qualify as part of your down payment. That means your parents can’t help you put money down for your rental property purchase.
If you need a way to scrape up a little extra cash to meet the down payment requirements, home equity loans can count toward your down payment. If you’ve built up enough equity in the home you currently live in, you can borrow against that amount to help fund your down payment and closing costs.
This is a very basic overview of rental property down payments, but the down payment is just the beginning. If you have any questions about rental property down payments or what comes next, leave them in a comment below. And remember, I’m always here if you have any questions or are ready to get started.
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