Credit scores, down payments, mortgage rates — oh my.
As confusing as the financial terms involving real estate can be (fixed-rate and adjustable-rate mortgages, what?), you’ll need to understand them to get closer to buying a home.
In the second of a series from the Houston Chronicle, Houston How To dives into what you need to know about the financial aspects of the biggest purchase of your life.
Understanding credit scores
Credit score tracking is all the rage for personal finance-savvy consumers. With websites like Credit Karma, you can monitor your current score and keep an eye on irregularities in your line of credit.
But those aren’t the numbers used to gauge your credit-worthiness for a loan. Instead, banks rely on what’s known as the FICO score, an amalgamation of information about your ability to pay back credit cards, student loans, car debt and other forms of debt on time.
Here’s why you need a good credit score to buy a home: Credit scores impact the interest rate of your mortgage and could factor into whether you receive a conventional home loan (meaning that they are available/guaranteed through private financial institutions, or one of two government-backed entities, Fannie Mae or Freddie Mac).
You can visit annualcreditreport.com and get a report from one of the three major credit bureaus, Experian, TransUnion and Equifax. This check will not hurt your score, but it will give you an idea of how trustworthy you look to lenders.
If you think your credit is in good enough shape to begin working with a lender, you can ask the financial institution to check your credit. All hard credit checks from mortgage lenders within a 45-day-window are treated like one inquiry. That’ll allow you to compare two to three lenders to see who will offer a more competitive mortgage rate. FICO advises taking advantage of this by shopping around for rates within a 30-day-window.
“The idea that they’re going to suffer creditwise each time we inquire is not accurate,” said Omar Enriquez, manager of affordable housing at Amegy Bank.
FICO has updated its scoring method, and new scores will be out in the summer of 2020. But while those new numbers might be a shock, they won’t have much impact on home loans because mortgage lenders prefer to use older FICO scoring models to determine a borrower’s eligibility, NPR reported.
Putting down the down payment
Down payments are fairly straightforward: it’s the amount you pay out initially when agreeing to buy a home, and the more you put down, the less you have to borrow from a mortgage lender to continue gaining equity in a home.
The minimum down payment to get a mortgage is 3.5 percent of the home’s cost, although unless you put down 20 or more percent on a conventional loan (more on that later) or get a mortgage backed by a federal agency, you’ll be subject to paying for mortgage insurance, according to the Consumer Financial Protection Bureau.
But if the down payment is just out of reach, there are some grants and assistance programs in Houston to put you in a place to purchase a home, even on a low-to-moderate income. The City of Houston offers a down payment assistance program for residents affected by Hurricane Harvey. NeighborhoodLIFT, a national down payment assistance program, provides $15,000 for most eligible homebuyers and $17,500 for teachers, law enforcement officers, paramedics, veterans or service members and firefighters.
If you’re branching out from the city of Houston, Harris County offers help for buying in unincorporated parts of the county (outside of the cities of Houston, Baytown and Pasadena). And the Texas Department of Housing and Community Affairs offers two down payment and closing cost assistance programs worth up to five percent of your mortgage loan.
Picking the right mortgage plan
Chances are if you’re a first-time homebuyer you don’t have the capital to buy a home outright. You’ll likely need a mortgage, or home loan, to pay for the house you choose.
The interest rate in a fixed-rate mortgage stays the same throughout the life of the loan, while it changes every few years in an adjustable-rate mortgage. While the former’s rates might be higher than the latter’s at the beginning, they’re not subject to the whims of indices that determine interest rates.
An adjustable-rate mortgage may be a better choice for homebuyers who think they may move or sell the house within a few years. Monthly payments may also shrink if interest rates drop. The inverse, of course, applies — if interest rates jump, your payment might suddenly be higher than you can afford.
There are caps to protect buyers in those cases. An initial adjustment cap bars interest rates from jumping more than a certain percentage the first time the rate changes. A subsequent adjustment cap keeps interest rates from jumping more than a certain percentage — commonly around two percentage points — than the previous rate. And a lifetime adjustment cap protects the interest rate from jumping above a certain percentage for the duration of the mortgage, according to the Consumer Financial Protection Bureau.
A fixed-rate mortgage is a better choice for people who like knowing exactly how much the payment will be, and who plan to stay put for a long time. Just note that those mortgages won’t benefit if interest rates drop.
Lenders are looking for a few things when considering homebuyer applications.
“In a nutshell, it’s a review of the applicant’s profile from a debt versus disposable income standpoint,” Enriquez said. “It’s also the evaluation of the collateral being purchased, the actual agreed upon price of contract and whether that collateral in fact has that value.”
The debt-to-income (DTI) ratio is particularly key for lenders. Debt consists of how much you currently owe such as student loans, car payments and credit card payments, compared to your gross monthly income (before taxes are taken out).
Fannie Mae, a federally backed company that purchases and guarantees mortgages for borrowers, allows a debt-to-income ratio of up to 45 percent, although it may be as high as 50 percent for people with phenomenal credit scores and incomes.
The DTI score might be a wake-up call for you, too.
“When people are preparing for the process, a great exercise is to sit down and write down what your survival number is,” said Jennifer Hughes Hernandez, a loan officer at Legacy Mutual.
A “survival number” is the bare minimum it would take to survive to pay for rent, bills, groceries, gas and necessary medical expenses. Then, substitute the amount for rent with the costs of a mortgage payment, home insurance and other fees a homebuyer will pay per month. Use that number to determine if it’s worth it to take on the costs of home ownership.
One of the fees and costs to consider is the amount to be paid in property taxes. The amount varies from county to county, and if you intend to make your first-time property purchase your primary home, you may qualify for certain exemptions. Harris County, for instance, offers exemptions for school and county taxes, along with additional ones set by cities, special districts and others.
Not every cost estimate will provide an idea of how much a homeowner will owe in taxes. To get an idea of how much you can owe, look up the address of the property on the Harris County Tax Assessor-Collector’s website. While the previous homeowner may qualify for certain tax exemptions, and the value of the home may change, it’s a good way to get an idea of what it will be worth.
Then there’s the question of whether to pick a local or online lender. Local lenders know the costs associated with living where you plan to buy. If you prefer to make your large financial decisions face to face with someone, then you should use a local lender.
“When picking your lender, you should be getting referrals for who that lender is, not going by way of the online route and cheapest rates you absolutely can find,” said Eric Fontanot, president of Patten Title Company.
Online lenders might provide more affordable rates — these financial institutions are willing to engage in bidding wars to offer you a loan. Getting current data and pre-qualification takes mere minutes over the internet, said Glenn Brunker, a mortgage executive at Ally Home, the mortgage arm of Ally Bank.
“Our customer goes from pre-qualified all the way to accepting disclosures in a 15-minute time window. With most retail lenders, it takes three to five business days,” Brunker said.
That might be ideal for buyers who want the process done as painless and quickly as possible.
Once you’ve familiarized yourself with the necessary financial information for getting a home loan, you’re ready to start looking seriously for a house.
In part one of “Open House,” the Houston Chronicle’s series on first-time homebuying, learn from Houston How To about the real estate agents, mortgage lenders and escrow officers who will help you on your property buying journey.
In part three of “Open House,” the Houston Chronicle’s series on first-time homebuying, Houston How To gets into the good stuff: what to look for once you’re finally ready to check out homes.
In part four of “Open House,” the Houston Chronicle’s series on first-time homebuying, Houston How To looks at closing and escrow, the most important part of the purchase.