Dial ‘M’ for Mortgage

By Rick Koze

Building a new home has many facets that require coordination with the customer. The home-building process is not an easy one, but using an experienced builder will help allay your fears, especially when it comes to applying for a mortgage.

I’ve worked with thousands of customers during the home-buying process since taking over the helm at Kay Builders, and one thing I’ve noticed is that many people start the building process in the wrong order. That is, they start looking at homes before determining how much they can afford to spend. And that’s definitely putting the cart before the horse.

Additionally, new-home buyers tend to choose too many options, which the builder often requires to be paid for up front. This sometimes leaves the buyer short of the cash required for closing costs (see additional information below), which can cause the deal to fall apart at the end.

While builders have  little input into the financing, we certainly have a vested interest in customers securing financing they can manage on a monthly basis. Searching for the right mortgage is as intense as picking out carpets, cabinets and floor plans.

Without a solid mortgage in place, the entire building process can come to a screeching halt.

Having spent the first part of my professional career in the financial industry, I understand the ins and outs of securing a mortgage, which can be tricky in today’s environment. However, contrary to what you may have heard, it is still relatively easy to qualify for a mortgage. Just be aware — the process will take longer, and there are a few more forms to fill out; however, this new process will protect you as much as the lender.

The Basics

There are a few basic terms you want to understand before you begin shopping for a mortgage:

Lender – A person or company that makes loans for real estate purchases; sometimes referred to as a loan officer.

Credit Score – A number representing the credit-worthiness of a person. It represents the likelihood that that person will pay the debt. The minimum that buyers should have is 630.

Mortgage – A lien on the property that secures the promise to repay a loan. The mortgage gives the lender the right to collect payment on the loan.

Down Payment – The amount of money that the buyer must have in a bank account to close on the loan and therefore to buy the home.

Closing Costs – These are items such as transfer tax, real estate commissions (if any) and money to fund the escrow for insurance and property taxes. Do not underestimate these figures, as they can be upwards of $10,000 or more.

Escrow – A separate account into which the lender puts a portion of each monthly mortgage payment. An escrow account provides the funds needed for such expenses as property taxes, homeowners’ insurance and mortgage insurance.

Monthly Payment  – The amount of money you pay the mortgage lender every month. The interest paid on the loan and property taxes held in escrow are deductible for income tax purposes.  These deductions give a homeowner more buying power than someone who is renting.

(For a complete list of terms, check out kaybuilders.com/new_buyer_help.cfm.)

How your Mortgage is Constructed

Most loans are for 30 years, although 15-year loans are available, also. During the life of the loan, you’ll pay far more in interest than you will in principal — sometimes two or three times more. Because of the way loans are structured, in the first years you’ll be paying mostly interest in your monthly payments. In the final years, you’ll be paying mostly principal.

Separate from the mortgage structure is the down payment, which is the portion of a home’s purchase price that is paid in cash. This amount varies based on the loan type. It is determined by taking the difference of the sale price and the actual mortgage loan amount. Mortgage insurance is required when a down payment of less than 20 percent is made.

So what can buyers do when they don’t have the 20 percent to put down?

Nearly one-third of our customers now look to VA or FHA loans, which will accept a down payment in the 1-5 percent range. Another option is for the buyers to talk to their parents — or a relative — about gifting. It gives loved ones the opportunity to provide support for a sound investment — and see the results of their generosity.

Again, with these options, it’s important that buyers go mortgage shopping first — and then talk to a builder.

One word of caution here: Because of the recent events in the mortgage industry, the days of down payment money falling under the 20 percent level are gone. Lenders are stricter about the amount of down payment money they will require, and you must be able to prove that you can make those monthly payments. Again, that’s why I recommend buyers go mortgage shopping first.

Your monthly mortgage payment is made up of more than just the money owed the lender. Most mortgages have four parts:

Principal – The repayment of the amount you actually borrowed.

Interest – Payment to the lender for the money you’ve borrowed.

Homeowners’ Insurance – A monthly amount to insure the property against loss from fire, smoke, theft, and other hazards. This insurance is required by most lenders.

Property Taxes – The annual city/county taxes assessed on your property.

Types of Mortgages

There are many types of mortgages, and a wide variety of mortgage lenders. Use the real estate section of your newspaper or search the Internet for lenders, varieties of mortgages and current rates. At press time, rates were favorable and should remain that way through 2010. The more you know about lenders and rates before you start, the better.

Most people use a fixed-rate mortgage. In a fixed rate mortgage, your interest rate stays the same for the term of the mortgage, which normally is 30 years. The advantage of a fixed-rate mortgage is that you always know exactly how much your mortgage payment will be, and you can plan for it.

Another kind of mortgage is an adjustable rate mortgage (ARM). This is also referred to as an adjustable mortgage loan (AML) or variable-rate mortgage (VRM). With this kind of mortgage, your interest rate and monthly payments usually start lower than a fixed rate mortgage. But your rate and payment can change either up or down, as often as once or twice a year. The adjustment is tied to a financial index, such as the U.S. Treasury Securities index. The advantage of an ARM is that you may be able to afford a more expensive home because your initial interest rate will be lower.

There are several government mortgage programs that might interest you, too. Most people have heard of Federal Housing Administration (FHA) mortgages. The FHA doesn’t actually make loans. Instead, it insures loans so that if buyers default for some reason, the lenders will still get their money. This encourages lenders to give mortgages to people who might not otherwise qualify for a loan.

Closing Costs

The final part of the mortgage equation thatfrom my experiencetends to leave home buyers a little “short” is the closing costs, or the fees for final property transfer not included in the price of the property. Typical closing costs include charges for the mortgage loan such as origination fees, discount points, appraisal fee, survey, title insurance, legal fees, real estate professional fees, prepayment of taxes and insurance, and real estate transfer taxes. A common estimate of a buyer’s closing costs is two to four percent of the purchase price of the home. And you must pay those costs at closing to complete the mortgage process.

To avoid coming up short at closing time, buyers should review their list of home options. There are probably items on that list that can be changed or even omitted entirely. For instance, take a look at the appliance package for the kitchen. While top-of-the-line appliances will look magnificent, picking a mid-level group instead will definitely help buyers seal the deal.

Rick Koze is president of Kay Builders, Inc., a family business based in Allentown. A Lehigh Valley native and Emmaus High School graduate, Koze holds a bachelor’s degree in economics from Yale University. He has more than 15 years experience working for Fortune 500 companies.

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