REAL ESTATE TOPICS:  FINANCING OPTIONS

Shelter for today’s individual or family comes in a variety of forms: single family residences, townhomes, condominiums, manufactured homes, mobile homes, apartments, and some other less popular types. We have a choice of how we pay for our shelter. Many of us start off by renting. Rental does have a few advantages: no down payment, no maintenance costs, no property taxes, no structural insurance, . . . However, there are some distinct disadvantages: no equity buildup, no income tax credit, limited control over condition of property, no pride of ownership possible, little or no control over rent increases, and some limitation on privacy and quality of life may also be present.

Property ownership is distinctly different - and in most cases, much more desirable. Currently in America home ownership is at an all time high of about 86%. Home ownership is the so-called "American Dream" - but it really is not the stuff of dreams. It is an attainable reality for just about anyone willing to make the commitment. It can be accomplished with no money down and no closing costs. All that is needed is a little effort, a decent credit rating, and an income that will support the monthly payments and expenses of home ownership.

Since most people do not have enough cash to fully pay for a home, financing a mortgage loan is necessary. This fact can be intimidating to some. Hopefully, the following information will help potential home buyers understand what types of financing are available, and reduce the anxiety involved in taking this important step.

CONVENTIONAL / JUMBO

Conventional mortgage financing has evolved over the years from what used to be called Agency loans or "A" loans. To facilitate uniformity and availability of money available for the mortgage market, the Federal National Mortgage Association (FNMA), which is nicknamed Fannie Mae, was created by Congress in 1938. Also, in 1970 Congress acted again and created the Federal Loan Mortgage Corporation (FHLMC), which is nicknamed Freddie Mac. These organizations provide guidelines for standardized terms and conditions on loaned money enabling primary lenders to use so that once a mortgage is given it can then be sold on the secondary market to investors. This helps ensure the best availability of funds at the consumer level.

Under these guidelines, the maximum loan possible is currently $417,000 for single family residences.  For multiple family residences, the limits are as follows:  2 unit - $533,850, 3 unit - $645,300, and 4 unit - $801,950.  Loans greater than these amounts are considered "Jumbo" loans and fall outside the guidelines established by Fannie Mae or Freddie Mac. Generally speaking, interest rates and terms on jumbo loans will be slightly less favorable than with conventional loans.

Interestingly enough, it is estimated that some 55 to 60% of all people will qualify for conventional financing. Conventional mortgage financing offers the lowest interest rates possible and the most flexibility on all other terms and conditions.

Qualifying for conventional financing is very much determined by your credit rating. The credit rating is really a combination of factors. Generally speaking, about 33% of the rating is based on how you pay your bills, another 33% is based on your debt load (or ratio), about 15% is related to how long you have had credit established, and about 10% because of who you obtain credit from, and about 8% on the number of credit inquiries made on your account recently. Virtually all lenders use what is known as a tri-merged credit report. This refers to a credit scoring system or service called FICO (formerly, Fair Isaacs Company) which is now based on information provided by three different sources: Trans Union, Equifax, and TRW. Each of these companies will provide a credit score on you in the range 300 to 900 with 900 being the best. Typically the middle number is the one that is assigned as your rating. It is estimated that the following distribution is generally found among all of us: 5% will score from 500 to 550, 11% from 600 to 650, 29% from 750 to 799, and 11% from 800 to 900.

Many lenders look for a minimum score of about 600. Scores above 800 are always considered excellent. Though every lender may have their own criteria, if you have a credit score of 680 or higher and you have a down payment of 5% or more you will be able to get the best interest rates and terms. If you only put 3% down, your rate will be about 1/4% higher, with 0 down, about 1/2% higher. Conversely, down payments greater than 5% do not result in lower interest rates than those available with 5% down. The lender will also want to know who is making the down payment, and what your cash reserves are.

Lenders are also concerned about their risk in the event of default and subsequent forfeiture. Conventional financing is not guaranteed by any government entity. Therefore if the down payment is less than 20% of the purchase price, most lenders will require Private Mortgage Insurance (PMI). This is insurance that the borrower pays for but does not benefit from. The lender is the one that is the beneficiary of such insurance. When PMI is applied, it can be removed upon reaching a 78% equity position in the property. The cost of PMI will vary but is often about 1% per year of the loan amount. Therefore, on a $100,000 loan, private mortgage insurance will cost about $1,000 per year, or $83 per month. And, unfortunately, this cost is not tax deductible. By the way, your rates for private mortgage insurance can also be affected by your credit score, the amount of down payment, your occupancy status, and other factors.

In addition to your credit score, lenders look at other information too. Your employment and income status and history, your outstanding debt, and any other pertinent information. In general, they look to see that your proposed total mortgage expense to include: the principal, interest, taxes, and insurances (mortgage insurance, homeowner’s or hazard insurance, and flood insurance) as applicable, collectively known as PITI), will not exceed 33 to 45% of your gross annual income. And further, that your total debt (including car loans, other installment loans, alimony payments, etc.) will not exceed 38 to 70% of your gross annual income. These so-called "ratios" are significant qualifying factors.

NON-CONFORMING

For those who may not be able to qualify (due to a poor credit rating) for Conventional, FHA, or VA financing, there is still another option. Non-conforming loans, sometimes called "B" Credit, or SubPrime, or Hard Money loans can provide an option. An option to renting, that is. Non-conforming loans will have higher interest rates and require higher down payments. Certainly not the most desirable way to go, but it is a viable option for some people. And, it can be a necessary and beneficial step in reestablishing a better credit profile with the hope of re-qualifying for conventional financing in the future.

FHA (Federal Housing Administration)

In Pima County, Arizona (as of March 5, 2008) the maximum loan amount for FHA guaranteed financing is $316,250 for a single family residence.  For multiple family residences, the limits are as follows:  2 unit - $404,850, 3 unit - $489,350, and 4 unit - $608,150.  The required down payment and closing costs are typically about 3% of those amounts.  Therefore, the maximum sale price of a single family residence under FHA would be approximately $326,000.

FHA loans are potentially available to anyone. FHA loans are not just for first time home buyers, but this can be a very good program for them - for a number of reasons. Especially if the buyer’s income and credit score do not qualify them for favorable rates under conventional financing. And, it may be possible to find creative ways to deal with down payment and closing costs such that the buyer may actually be able to get into the property with 0 money down and 0 closing costs. There are other benefits possible with FHA loans too.

One such benefit is that FHA loans are assumable (subject to qualification of the future buyer). This can make future sale of the property easier. Another great advantage over conventional financing is that "streamline" refinancing is permitted. That is, if interest rates drop in the future, lenders may waive or minimize the refinancing and closing costs and rewrite the loan at the lower rate.

VA (Veterans Administration)

VA loans are mortgage loans that are partially guaranteed against loss by the Veterans Administration. VA loans have also been known as GI loans. Active duty, reserve duty, and discharged veterans of military service are eligible for VA financing. The VA sets no maximum amount for the loan, although there is a maximum guarantee. That maximum is currently $359,650. Unlike with the FHA program, if no financial institution will make a loan to an eligible veteran, the VA will make the loan itself. The initial loan must be made to a qualified veteran or the dependent of a qualified veteran, usually a surviving spouse. As with all other forms of home financing, there are advantages and disadvantages.

VA loans are not solely dependent on FICO credit scoring, but the vet must be financially capable (ratios) of handling the loan payments. There is no requirement for any down payment. Financing is available for single family residences, duplexes, triplexes, and 4 unit homes - provided the property is owner occupied by the veteran. Private mortgage insurance is not required, however there is a "funding fee" of 2% to 3% which is added to the loan balance. An exception is provided for those vets who are 10% or more disabled. In such cases the funding fee is waived. Another important advantage is that all VA loans are assumable. This fact can be a great benefit at the time the property is resold. If another veteran assumes the loan, the full benefit is restored. However, if the loan is assumed by a non-veteran, the selling vet’s future qualification is limited to less than the full amount. Otherwise, the VA benefit may be used forever - again and again. Also, VA loans can benefit from "streamline refinancing" without re-qualifying, no appraisal, and without closing costs. Though most types of mortgages nowadays do not penalize for prepayment, the VA loan also has that benefit.

On the down side, there can be some disadvantages or inconveniences associated with VA financing. The appraisal process can be less than desirable. Government assigned appraisers must be used by the lender. They have been known to be difficult to work with and may take 3 to 4 weeks to get the job done. Regular appraisers can perform in a matter of days. Title and vesting in the property purchased is limited to the veteran, the veteran and their spouse, or veteran and veteran. VA financing is not available for use on 2nd homes or on investment rental property.

Another factor that really benefits the vet is that the VA requires the seller to pay any and all lender "garbage fees" and the escrow fee. Some sellers may refuse to do so. But, with a little negotiation on selling price and some creative language on the closing statements this issue can be addressed to everyone’s benefit.

And of course, there are a few extra hoops to jump through with any government program. The veteran must obtain a Certificate of Eligibility from the Department of Veterans Affairs. It takes the VA benefit request Form 26-1880, and either a copy of the Statement of Service (for active duty personnel) or the DD 214 (for discharged personnel). Mailed applications should take about 10 days turnaround time. Personal visits to the VA office in Phoenix result in on demand issuance. When the VA benefit has already been used previously, a copy of the closing statement on the sale of that property is also required.

Still have questions and need more information? Call the VA, toll free, at 1-888-487-1970 or visit their website at www.va.gov.

DISCLAIMER

John P. Hale is owner and Designated Broker of Touchstone Residential Realty, Inc., 2485 West Tom Watson Drive, Tucson, Arizona 85745.  He has been a residential real estate agent in the greater Tucson Metropolitan area since 2000.  In addition to being licensed as a Broker rather than a salesperson, John holds the following designations awarded by the National Association of REALTORS^®:  ABR – Accredited Buyer Representative, ASR – Accredited Seller Representative, CRS – Certified Residential Specialist, and GRI – Graduate Realtor Institute.  And, John is among the very few that have been named, MRE – Master of Real Estate by the Arizona Association of Real Estate.

Please note that this article was written by him to reflect the author’s opinion of good practice at the time of its’ writing for the general benefit of those considering sale or purchase of residential real estate, it is not intended as definitive legal advice and you should not act upon it as such without seeking independent legal counsel.  Frequent changes in the law and standards of practice may cause this information to become outdated and no longer applicable or even incorrect.