Written by Benny L. Kass
Question: We are first time home buyers. We have signed a contract to purchase an older home in a nice neighborhood, and the purchase price is $400,000. We have 45 days in which to obtain financing, and have started shopping around with different mortgage lenders. We have two questions. First, the contract states that we will put down 20 percent and obtain a mortgage loan of 80 percent (i.e. $320,000). However, we have begun to realize that there will be significant closing and moving costs, and we would prefer to put down less money. Are we committed to a 20 percent down payment, since that is spelled out in the contract? Second, what kind of loans are available and what’s best for us?
Answer: Your first question is easy. Technically (or legally) speaking, you are bound by the terms of the sales contract. You must put down 20 percent — or $80,000. However, as a practical matter, I suspect that you and your sellers can sign an addendum to the contract which modifies these terms. So long as the amendment (1) will not create any delay in the time you have to go to settlement and (2) will not cause the seller’s to spend any more money than was originally called for in the sales contract, this addendum should cause the sellers no problem and indeed it can probably be signed when you actually go to settlement. I suspect that your lender will want to have this addendum in its files.
Your second question is quite difficult to answer, since I do not have any financial information about you. You should discuss these issues with your potential lenders. Ask them to qualify you based on the highest (and the lowest) loan which you are seeking. For example, a “conventional” loan is where you put down 20 percent and borrow 80 percent. In your case, this will require that you put down $80,000. Since you have indicated that this will create a financial strain for you, you can also consider the following options:
- an 80-10-10 loan. Here, you will be obtaining two loans. One in the amount of 80 percent (i.e. $320,000) and a second loan in the amount of $40,000. Under this arrangement, you will only have to put $40,000 down when you go to settlement. The 80-10-10 loan was designed to help homeowners avoid the necessity of paying private mortgage insurance (PMI). Lenders want to be sure that should you become delinquent on your mortgage payments, and the lender has to foreclose on the property, that there will be some equity left in the property. The typical benchmark is 20 percent. If you borrow more than 80 percent of the value of the house (called “loan to value ratio”) you will be required to pay private mortgage premiums for a long period of time. This PMI is insurance coverage for your lender, which will cover any loss which it incurs should the house be foreclosed upon and the foreclosing price does not cover the entire mortgage balance.
- However, since the lender in an 80-10-10 loan is only making a first mortgage (deed of trust) in the amount of 80 percent, no PMI is required. You should understand that you will have to sign a second deed of trust in the amount of 10 percent of the value of the house. This second trust will carry a higher mortgage interest rate than you will get for the first trust. Additionally, the second trust will probably have a shorter due date (perhaps 10 years) than your first trust.
- a 90 percent loan. Here, you will borrow $360,000, and sign only one mortgage document. You will still need $40,000 cash at settlement. And private mortgage insurance will be required.
- a 95 percent loan. Again, private mortgage insurance will be required, but you will only have to put down five percent (i.e.$20,000).
This is but a small sample of the various loan which are available. There are also variations on these various mortgages. For example:
1. Fixed thirty year. Here, the loan will be amortized over 30 years. Each and every month, you will make the same monthly mortgage payment (although if the lender escrows for taxes and insurance, the amount may change on a yearly basis depending on whether taxes and insurance premiums are increased).
2. Fixed fifteen year. Here, the loan will be amortized over 15 years. This means that although the interest rate will be lower than for a 30 year loan, your monthly payments will be much higher, since you will be paying off the loan in half the time. While some people like the idea of paying off their mortgage early — and thus saving a lot of interest payments — I am personally opposed to a 15 year loan. If you have the right to pay off the loan (in whole or in part) without penalty, a thirty loan gives you the right to make payments as if they are based on a 15-year amortization, but you are not obligated to make these higher payments should you decide that your money can be used for other — and better — purposes.
3. Finally, there are a number of adjustable rate mortgages — called “ARMS” — which carry different rate adjustment periods. These adjustments can be made on a yearly basis, or once every three-five-seven or even ten years. Keep in mind, that the smaller the adjustment period, the lower the interest rate will be.
4. Balloon notes. Here, your loan may require that you pay monthly mortgage payments based on a 30-year amortization. However, at the end of a fixed period (for example 7 or 10 years) the entire balance then outstanding will become due and payable. This kind of loan is typically more common for commercial or investment loans, but you should be aware that balloon loans do exist — and you should make sure that your loan will not suddenly become due (i.e. balloon) after a number of years.
You should contact two or three mortgage lenders and ask the following questions:
- what kinds of loans do you have available?
- what are the rates for each loan?
- based on our financial situation, can we qualify for any or all of the various loans?
- is there a pre-payment penalty if we decide to refinance early, and if so, how much is the penalty?
- can we pay our real estate taxes and homeowner’s insurance premiums directly, or will you require that we escrow. This means that the mortgage lender will collect, on a monthly basis, one-twelfth of the real estate tax and one-twelfth of the annual insurance premium. When the tax and the insurance comes due, the lender will make these payments on your behalf. However, when a lender requires these escrows, this means that your monthly mortgage payment will be higher. This is referred to a PITI (payments of Principal, Interest, Taxes and Insurance).
You are entitled to get information giving you an estimate of what you will have to pay when you go to settlement. You are also entitled to get full disclosures of the mortgage interest rate for your loan. For more information, go to the Consumer Financial Protection Bureau (CFPB) website and search “Know Before You Owe”.
Shopping for a mortgage loan is time-consuming, tedious and often confusing. However, it is your money at stake and you don’t want to make a drastic mistake which will haunt you for years to come.