That’s finally changing. Now, thanks to rising home prices, less-stringent down-payment requirements and new rules that limit lenders’ liability when loans that meet certain criteria go bad, borrowers should encounter fewer obstacles getting a mortgage. No one wants to go back to the days of too-easy credit. But a little loosening will provide a shot in the arm for the sluggish housing market as it opens the door to buyers who have been shut out of the market and provides more options for all borrowers.
It’s still true that whether you’re buying your first home or trading up, the stronger your qualifications, the lower the interest rate you’ll be able to lock in. Borrowers with a credit score of 740 or more and a down payment (or equity, in a refinance) of at least 25% will get the best rates. You don’t have to meet those benchmarks, but if you don’t, you could see—in the worst case—as much as 3.25 percentage points tacked on to your rate.
The down-payment hurdle
First-time home buyers usually find that accumulating a down payment is their toughest challenge. The same goes for many current homeowners who lost most of their equity in the housing bust. A popular misconception is that you must put down at least 20%. Usually, you’ll need much less. For a loan of $417,000 or less that is backed by Fannie Mae or Freddie Mac (called a conforming loan), you’ll need just 5% for a fixed-rate mortgage or 10% for an adjustable-rate loan. For “high balance,” or “conforming jumbo,” loans of up to $625,500 in high-cost markets, you must ante up at least 10% and meet slightly higher credit-score requirements.
Non-conforming jumbo loans of more than $625,500 are more widely available than before, with lenders offering them at rates comparable to conforming loans, says Guy Cecala, publisher of Inside Mortgage Finance. Because lenders keep these mortgages on their own books rather than sell them to Fannie Mae or Freddie Mac, the loans require higher credit scores than for conforming mortgages and at least a 10% to 15% down payment, says Ramez Fahmy, a branch manager with Caliber Home Loans, in Bethesda, Md.
After home prices tumbled, your only option for a low-down-payment loan was an FHA mortgage, which requires just 3.5% down (and a minimum credit score of 580). But borrowers must pay for FHA mortgage insurance—an up-front premium of 1.75% of the loan amount and an annual premium of 0.85% of the loan. (Read more on Kiplinger.com: 5 things home improvement reality shows don't tell you)
Fannie Mae and Freddie Mac recently resurrected loan programs that allow just 3% down on a fixed-rate mortgage. For Fannie Mae’s program, at least one borrower must be a first-time home buyer. Fannie’s program launched in December 2014, and Freddie’s will be available to borrowers whose loans settle on or after March 23, 2015. Big banks aren’t rushing to offer the program, while smaller, nonbank mortgage lenders seem eager to sign on, says Cecala. Borrowers who qualify will save money on interest and mortgage insurance compared with FHA loans.If you do put down less than 20%, you must pay for private mortgage insurance (PMI), which protects the lender if you default. The more you put down and the higher your credit score, the less coverage you’ll need and the lower the cost of PMI. The annual cost for a 5%-down loan runs from 0.54% to 1.52% of the loan balance, according to a recent report by Wallet Hub, a financial information site. When your equity reaches 20%, you can ask the lender to cancel the PMI; at 22%, the lender must automatically cancel it.
You can reduce the down payment and avoid PMI with a so-called piggyback loan—an 80% first mortgage, a 15% second mortgage and 5% down. This kind of loan is especially useful if you haven’t yet sold your previous home but you have enough cash to put 5% down and you can afford to pay the mortgage on both homes temporarily. You can pay off the second mortgage (and pay down your new loan) when your previous home sells.
You won’t need a down payment (or mortgage insurance) if you’re a vet who qualifies for a Veterans Affairs home loan, but you will have to pay an up-front “funding fee” of up to 3.3% of the loan amount. Rural Development Guaranteed Loans from the U.S. Department of Agriculture also allow qualified, low-income borrowers in selected areas to buy with nothing down, although they will pay an up-front guarantee fee (rolled into the loan amount) and an annual fee.
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The ARM alternative
Over the past several years, most borrowers gladly locked in low fixed rates. But you can trim your rate further with an adjustable-rate mortgage. If you do, choose a hybrid ARM, which features an initial fixed-rate period followed by adjustments after set periods of time. Match the fixed-rate period to the time you expect to own your home and you won’t have to worry about the rate adjustments. You’ll find hybrid ARMs with fixed-rate periods of three, five, seven and 10 years. In early January, the average rate on a 5/1 ARM was 3.1% and the rate on a 10/1 ARM was 3.5%, compared with the 30-year fixed rate of 3.9%, according to HSH.com, which tracks rates. Some versions adjust every five years or even every 15 years.
Today’s ARMs have built-in safeguards that protect borrowers against features that fueled the mortgage meltdown—such as exploding rates at the first adjustment and minimum-payment options that allowed the loan principal to grow. Lenders must inform you up front what your new payment will be after the first adjustment if your rate rises to the loan’s cap (which should be no more than two percentage points). If the ARM has a fixed rate for five or fewer years, lenders must qualify you for the loan based on the payment amount that would result if the interest rate rose to the cap on the first adjustment.
Ty Laffoon
Shop smart
About six months before you want to buy a home, pull your credit score, review your credit report and dispute any errors in it. You can also use the time to pay down debt, beef up savings and gather documents. “The last thing you want is to find your dream home and not qualify for a large-enough mortgage,” says Bob Walters, chief economist for Quicken Loans. To get an idea of what you can afford, user.
Before you tour homes, get preapproved for a mortgage by a local lender that sellers and their agents will recognize (your agent can recommend one). A preapproval letter printed on the lender’s letterhead and submitted with your purchase offer assures sellers that your finances are up to snuff and you can close the deal. If there are multiple offers, that may help lift yours above the others.
As soon as you have a ratified purchase contract (if not before), track down the best rate. Try different types of lenders, including the one that preapproved your mortgage, your bank and your credit union (check membership qualifications if you don’t already belong to one). Or contact a mortgage broker, who represents multiple lenders . You may get the best rate from a nonbank mortgage lender, whether it’s a brick-and-mortar operation or an online lender such as a Prime Mortgage Loans.. If one lender turns you down—say, because you have a ding on your credit history, a small down payment or you’re buying a fixer-upper—another one may welcome your business. (Read more on Kiplinger.com: 10 cheapest cities you'll want to live in)
To compare apples to apples, ask lenders for their “par rate,” with no fees or points (a point is prepaid interest that “buys down” the interest rate by about one-eighth to one-fourth of a percentage point), plus an estimate of closing costs. Or tell the lender the amount you have budgeted for closing costs and ask what the corresponding rate will be, says Walters. Lenders can estimate the interest rate for which you’ll qualify only until you have a contract for a home and you file a loan application. After that, they’ll issue a formal good-faith estimate.
The national average cost to close on a $200,000 mortgage in 2014 was $2,539, including the cost of an appraisal, according to Bankrate.com. Costs have risen for the past two years as lenders ramp up to meet new regulations. (Visit Bankrate.com to see what average closing costs are in your state.)
Which is better—a lower rate or lower closing costs? It depends on how long you plan to keep the loan. If you expect to be transferred to another city by your employer within, say, five years, then a no-cost loan with a higher interest rate is a great loan, says Josh Moffitt, president of Silverton Mortgage, in Atlanta, because you may not have time to offset higher up-front closing costs with lower mortgage payments.
Try to get a sense of whether a lender will provide the handholding you need, especially if you’re a first-time buyer. Ask the lenders on your short list whether they can close within the time demanded by your purchase contract. “Is chasing that eighth of a percentage point worth it when you go to a lender no one has heard of and 30 days later you’re paying fees to delay the closing date, or you lose the house because you can’t close on time?” asks Walters. Some lenders, including Discover Home Loans, advertise a “closing guarantee.” If they fail to close on time, they’ll pay you from $500 to $1,000.
You may not have to deal with paper until you close on the loan, which most states require to be done in person. However, the process can be as personal as you want it to be. “We have loan officers who will go to a person’s home and take an application over dinner,” says Moffitt.
Vetting the deal
Before a lender can approve your loan, it must document the amount and source of your down payment, closing costs, income, assets and more. At the very least, a lender will request two pay stubs, two months of bank statements and two years of W-2 forms.
The list will be longer if you have income that doesn’t show up on a W-2—say, from self-employment or alimony—or income that’s inconsistent, such as commissions or bonuses. In that case, a lender may ask you for several months of bank- and investment-account statements to verify your assets, two years of tax-return transcripts from the IRS, or a year-to-date profit-and-loss statement and balance sheet prepared and signed by your accountant.
As a lender scrutinizes your file, it may ask for more documentation, especially to explain any gaps in employment or inconsistent income. For gift money, you may need to provide documentation for the source of the funds for the gift—perhaps a copy of the gifter’s bank statement. (Loan programs may have different rules about the percentage of your own money versus gift money allowed.) To do your part to get to closing on time, don’t do anything that would change your credit profile, such as taking on new debt or paying a bill late.
The lender will hire a real estate appraiser to determine whether the purchase price on which you and the seller have agreed is supported by recent sales of comparable homes in the area. If the appraised value is less than the sum of your loan amount and down payment, someone—you or the seller—must make up the difference with more money.
You or your lender can rebut a valuation that comes in lower than the purchase price—say, if it appears that a relevant comparable sale has been overlooked. After the housing bust, deals often fell through because the appraised value fell short of the purchase price, but recent appraisals ordered by Quicken Loans have come in higher, on average, than homeowners thought they would.
You could still save on a refi
If you have equity in your home and haven’t bothered to refinance at today’s low rates, it’s not too late to save. You don’t necessarily have to reduce your rate a lot. The question is whether you will stay in your home long enough to recoup the closing costs with savings on your monthly payments
To refinance an existing mortgage with a conforming loan backed by Fannie Mae or Freddie Mac (and roll your closing costs into the loan), you’ll need a minimum of 5% equity for a fixed rate and 10% equity for an ARM. With a maximum debt-to-income ratio of 36%, lenders may require a minimum credit score of 660 if you have less than 25% equity.
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