Mortgage and Financing

How much home can you afford?

Many real estate investors who are purchasing a home for the first time have no idea exactly how to figure out how much house is enough, and how much is too much. There are some key points to take into consideration when purchasing a home. The first time investor will need to examine their budgets, their finances and the potential real estate assets closely in order to be able to make an informed investment decision.

People make careers out of writing books to tell us how to budget our money, how to manage our finances and how to get the most bang for our buck. There is one major problem with all of them however. They do not include any "real-world" variables. Not everybody is a whiz with finances, able to live off very little money and spend only what is necessary while dutifully saving the rest.

Then there are the minor inconveniences, which are so frequent in the real world and so seemingly unimportant to the authors of those books. The car breaks down, the kids braces need to be replaced; the other child has broken the neighbor's bay window playing baseball in the yard. All of these factors force the investor and potential homeowner to face the very real fact that they have to spend a lot of money just to survive.

When we are renting our homes, we do not freely associate many costs with home ownership. If the garbage disposal breaks at two in the morning, all we have to do is call the property owner or the maintenance person and they fix it. When the real estate investor or homeowner has a problem, the costs multiply rapidly. Throw that in on top of the normal costs of life itself, and it should be easy to see that the potential homeowner needs to look beyond what they pay for rent as a basis to decide how much home they can or cannot afford.

Factors that Determine Loan Approval

What is your FICO?

A FICO score is a credit score developed by Fair Isaac & Company to help lenders determine the risk involved in lending money to any person applying for a loan. It is widely accepted by lenders as one of the most important components helping determine eligibility as well as specific amounts, rates and terms that can be offered. FICO scores range from 300-850. The higher your score, the less risk involved in lending to you. There are approximately 30 factors that influence your credit rating. Some of these factors, such as your payment history, weigh more heavily on eligibility than others. Every factor’s importance varies by person and can change individually as your credit history lengthens. Also keep in mind your score can change daily as new credit is established or paid down/off. All factors can be grouped into 5 main categories:

·Payment History – Do you make your payments on time? Since this determines (on average) 35% of your score, it is certainly in your best interest to make any and all payments on time! Your payment history includes credit cards, car payments, mortgages, student loans and other loan types. Other public records on file, such as a bankruptcy, will be calculated in this group as well. If you have been late on payments bits of additional info, such as how recently these payments were made and how much time elapsed between the due date and pay date, will also factor into your score.

·Outstanding Debt – Most people over the age of 18 have debt. The question is how much? All outstanding balances for credit cards, car loans, mortgages, etc. will determine (on average) about 30% of your score. How many of these accounts have balances? For example, if you can possible pay down significantly or pay off credit card debt, you’ll be in much better shape during loan approval. Eliminating some avenues of credit can demonstrate your willingness and ability to responsibly pay back new loans.

·Credit History – How long have you been establishing your credit? Specifically, how long have your current accounts been opened and how long as it been since you used each of them? This usually determines approximately 15% of your score. If no credit history exists, you should begin by establishing credit accounts and be sure to keep them spotless. The less history that exists, the less the loan amount you’ll likely be able to obtain.

·Pursuit of New Credit – Each time you apply for credit, there is an inquiry into your current credit score. How many inquiries into your credit score are there and how recent were they made? If you recently applied for a VISA card, Nordstrom account and car loan, you may want to hold off applying for a home loan for a few months. Each inquiry may slightly reduce your FICO score and may portray you as someone overindulging in credit. This usually accounts for approximately 10% of your total score.

·Types of Credit in Use – How many types of accounts are reported for ATM cards, car loans, credit cards, travel accounts, or any other type of account where payments are being made? This will usually determine approximately 10% of your final score as well.

Once your bank is aware of your FICO score they may or may not choose to share this information with you. Assuming they do share your score with you, it is important to remember the higher the score, the more likely you are to obtain a loan. Also, a higher score directly translates to lower interest rates. Over time with home loans, lower interest rates can play a significant role in the total amount you end of SAVING! See two examples of home loans below and the amount of money you can potentially save while boasting a great FICO score.

As you can see, over a long period of time you would save much money if you have a good credit rating upon loan application. For this particular loan, you have the potential to save $56,520 over 30 years. That’s money that could potentially be invested into your retirement, used for vacations, a new car or two, etc. etc. It pays to keep your credit score as high as you are able. For larger loans, the savings potential climbs substantially!

In this situation, over 30 years, you have the potential to save a whopping $186,840!!! It pays to be dependable! With the money you could save on this loan the possibilities are endless.

Now, a great FICO score will not be the only determining factor in loan approval. There are additional factors that figure into the approval process as well. Some examples include:

    * Income – Your current income will also be a significant determining factor in loan approval. Pay stubs for the previous two months as well as W-2 forms for the previous year will be requested to help determine your ability to repay the loan amount.

    * Employment History – Your employment history can tell a lender much about your stability. If you’re constantly switching jobs it could raise a red flag. However, as their may be other factors influencing your employment length (such as a spouse in the military), lenders may choose to ignore this factor.

    * Down Payment – Do you have a down payment? How much? Being able to provide a down payment can be extremely useful in the loan approval process. It means the amount borrowed will be less than the total cost to purchase the home. In some cases, depending on the amount of the down payment, your monthly payments can significantly drop.

The important thing to remember is that no matter what your FICO score, employment history or income levels are there are things you can do to help improve your chances of obtaining loan approval. Get referrals to local credit counselors or financial advisors to help optimize your resources fully.

Getting Pre-Approved

Most of us have spent a great deal of time imagining our dream home; the yard full of roses encased by a white picket fence, the elegant staircase climbing around and around, the large kitchen with marble countertops, the master bath with it’s Jacuzzi tub surrounded by candles, and the waterfall pouring gracefully into the marvelous clear blue pool.

After a couple hundred hours searching far and wide for this perfect treasure, you find it! It’s everything you hoped and dreamed of for so long. After scrounging up the courage to make an offer you head to the bank to obtain your loan.

After the bank processes your application, they call. Your loan application has been denied.

Your dream just turned into a *nightmare*! How could this have happened? What could you have done to prevent this from wrecking havoc in your life? If ONLY you had gotten pre-approval from a bank before beginning the search for your dream home.

Getting pre-approval from a bank or other financial institution is imperative before beginning the search for a home. It is important to understand the price range you’re able to afford and specific aspects of your financial situation that may determine your eligibility. When you make an offer on any property a pre-approval or pre-qualification letter also gives you more opportunity to negotiate the price with the seller.

Below are explanations of two different types of “pre” letters that can be obtained from a bank or other financial institution:

·Pre-Qualification letters are given as informal and tentative approvals for buyers. The financial institution issuing the letter would have taken information regarding the buyers’ financial situation in order to determine eligibility; however, they would have NOT verified the accuracy of the information. Since the financial institution would not perform a credit check of the buyer at this point they are in a position to withdraw their approval if additional financial (or other significant) factors are later uncovered. There is no charge to obtain Pre-qual letters.

·Pre-Approval letters are formal agreements and offer buyers’ a guarantee of loan approval for a specific amount. The financial institution issuing such a letter may or may not charge for this service. They will verify credit history, employment status, assets and liabilities to help determine the amount of credit they are able to offer. If you are a serious buyer, this is the suggested “pre” letter to obtain. Keep in mind that even with a pre-approval letter, your bank may deny the loan on the specific house you wish to purchase. As one example, banks will deny the loan for a specific property if the appraisal is significantly less than the sale price.

1031 Exchange

WHY?  When the owner of investment real property sells the property, they are often required to pay capital gains taxes.  Section 1031 of the Internal Revenue Codes of 1986 allows a taxpayer to sell the real property and have the proceeds used too purchase new investment real property, thereby deferring the taxes on the sale.

WHO? A taxpayer may not just sell the property and use the money to purchase replacement property.  There are very strict requirements in order to be qualified for Deferred Exchange treatment.

To qualify, the taxpayer must enter into an exchange agreement with a third party (Qualified Intermediaty). The Qualified Intermediary must hold the funds from the sale and both parties must comply with the requirements of the regulations.

The regulations allow the taxpayer and Qualified Intermediary to place the funds into an escrow account.  The Qualified Intermediary will prepare most of the documentation that is required and must conduct all business in compliance with the regulations.

HOW?  The Qualified Intermediary prepares and Exchange Agreement  and an assignment document.  All parties sign the required documentation and deliver to the escrow agent handling the sale.

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