 Personal Finance PowerPoint Presentation Financing basics for first-time home buyers. Get ready to get financially fit by practicing personal finance. Most financial decisions can be broken out into those short-term decisions and the long-term decisions. The short-term decisions being the ones that we're going to train our guts so we can trust our gut. We're going to be using trial and error tinkering type of process in order to hone down our habits so we can depend on our habits to help us out with those day-to-day decision processes with less formal thought or time put into them. The long-term decisions, on the other hand, we have to follow the adage of measure twice, cut once. We've got to go through a more formal process. We can't use the tinkering or the trial and error method as easily. And of course, the home purchasing process falls into that long-term category. Five categories we might list our purchasing process under. Number one, determine the home ownership need. Number two, find and evaluate a property to purchase. Number three, price the property. Number four, obtain financing. Number five, close the purchase transaction. We're moving now to the financing basics for first-time home buyers. Most of this information can be found at Investopedia, which you can find online. Take a look at the references and resources and continue your research from there. It's by Robert Stammers, updated January 22, 2022. Obtaining a mortgage is a crucial step in purchasing your first home, and there are several factors for choosing the most appropriate one. So clearly, when making a home purchase, we can't usually do it with just cash and need to have some form of financing. So while the myriad of financing options available for most first-time home buyers can seem overwhelming, taking the time to research the basics of property financing can save you a significant amount of time and money. So clearly, we want to look into the financing option. When we're thinking about the home purchasing process, we obviously want to look at the cost of the home itself. We want to be able to think about whether we can afford the financing or afford the loan and the payments. And we also want to map that out longer term to think about the consequences for the financing going out into the future. We could usually kind of start from a baseline of the financing for a standard kind of financing option where we're thinking 30-year fixed financing, which will be more standard from institution to institution. And if we're looking for a more exotic type of loans, possibly adjustable rate loans, different amount of years covered, we want to go from there noting that that will add a significant amount of complexity into our research generally. Understanding the market where the property is located and whether it offers incentives to lenders may mean added financial perks for you. And by taking a close look at your finances, you can ensure that you are getting the mortgage that best suits your needs. So clearly, you want to look at your own finances. When you're doing that, as you're looking at your finances, that you want to note that the bank is not the person that's doing the budgeting for you. The bank is the one hopefully giving you a loan. What you would like to do is be approved for as much financing as you can and then you do your own research to determine how much you can actually afford. It would be nice if you could finance more than you can afford, meaning the credit line would be available to you, the amount of purchasing power, the amount of a loan available to you. And then you pick the lower amount that you need, right? So those two things have to be distinct. We kind of tie them together in our mind sometimes because we depend on the bank's heuristics, their calculations, their tools to determine how much they think that we'll be able to pay back. But those tools are based on their needs to see if we can pay them back and possibly based on regulations and whatnot, whether they can sell the loan on the secondary market and so on, not based on our actual finances per se, our actual spending habits, our actual lifestyle. So this article outlines some of the important details first-time homebuyers need to make their big purchase. So first-time homebuyer requirements. To be approved for a mortgage, you'll need to meet several requirements depending on the type of loan for which you are applying. To be approved specifically as a first-time homebuyer, you'll need to meet the definition of a first-time homebuyer, which is broader than you may think. A first-time homebuyer is someone who has not owned a principal residence for three years, a single person who has only owned with a spouse, an individual who has only owned a residence, not permanently affixed to a foundation, or an individual who has only owned a property that was not in compliance with building codes. So that's a little bit broader than you might have originally thought in terms of what might qualify for a first-time homebuyer. You'll generally need to have proof of income for a minimum of two years sufficient to pay the mortgage, a down payment of at least 3.5%, and a credit score of at least 620. So these numbers may, of course, change over time as the landscape changes over time including the economic landscape as well as the government regulations and the bank regulations that are going to mirror most likely the economic landscape and the government regulations. But clearly, when they look at your income level, they're usually going to go a couple years back. They might want to get verification. They're going to want to verify it some way. They're probably going to want your tax returns and possibly payment stubs in order to help to verify those things, noting that some income levels are going to make a lender feel more secure than others when you're talking about W-2 income, like a standard kind of job that you've been at for a long period of time. A lender might feel more comfortable that that's stable going forward as opposed to, unfortunately, sole proprietors, entrepreneurs often have more difficulty to prove their Schedule C kind of income. So that can be a bit of a hurdle to go over if your income level is not perceived to be as stable. The down payment, at least 3.5%. Again, that could change over time. And then you might want to think like the 20% is like the classic 30-year loan, 20% down kind of thing, but usually you're going to have to have some kind of down payment to be putting down because that shows the commitment for you as the home buyer to the lender and it also basically lowers the distance between the value of the home and the loan. In the event that there's a foreclosure to safeguard the lender to be able to foreclose on the home and sell it for more than the loan amount and a good credit score, which obviously is impactful for give trust to the lender. However, as a first-time home buyer, there are programs that can allow you to buy a home with a low income, zero down and credit scores as low as 500. So clearly you can go into those programs, which are going to be a bit of a deviation from like the standard. So you would think that of course the standard loans would be going through the financial institution where both people are kind of on a market conditions for the most part or at least as close to it as possible with the bank and you dealing together. Obviously these other programs that are going to alter it more favorable terms like having nothing down, it's going to be a lot more risky to the financial institution. Therefore you would expect government intervention in some way for those kind of conditions to be met. You want to have an idea of what those are and how those work. So conventional loans are mortgages that are not insured or guaranteed by the federal government. So clearly if the federal government is guaranteeing the loan, that's going to have a significant impact on it because that removing of risk, that is what the bank does. It mitigates risk. So it wants to give you the loan because it wants to make the interest but it needs to mitigate its risk. It does that by charge. It has the interest rate that's reasonable and it makes sure that you can make the payments and it usually requires a down payment so that it can foreclose on the home if it needs to in the event that you don't pay the loan. So they are typically fixed rate mortgages. They are some of the most difficult types of mortgages to qualify for because of their stricter requirements. A bigger down payment, higher credit score, lower debt-to-income DTI ratios and the potential for a private mortgage insurance PMI requirement. So if the loan isn't backed up by the government, then of course the bank needs to mitigate its risk by doing these other kinds of things. What's the bank going to do to mitigate its risk? They're going to say that they want a bigger down payment. That's why you've got the classic 20% down on a higher credit score. They want to make sure that you've got a good history of paying back the lower debt-to-income ratios and a potential for private mortgage insurance. So they might want added assurance if it's not by the government, by basically insurance to assure the payment of the loan. However, if you are qualifying for a conventional mortgage, they are usually less costly than loans that are guaranteed by the federal government. Conventional loans are defined as either conforming loans or non-conforming loans. Conforming loans comply with guidelines such as the loan limits set forth by government-sponsored entities, GSEs, Fannie Mae, and Freddie Mac. So those are quasi, like the government basically, entities which have a significant impact in the housing market. So these lenders and various others often buy and package these loans then sell them as securities on the secondary market. So basically you've got these backed securities that are backed by basically these loans. Could be sold on the secondary market and the Fannie Mae and Freddie Mac are big factors in that. And that whole process, of course, skews a lot of the dynamics in terms of the investment dynamics and so on in the housing market. However, loans that are sold on the secondary market must meet specific guidelines to be classified as conforming loans. And obviously there's been a lot of scrutiny on this since 2008 crash when there was a housing bubble that was perceived to be part of the problem. Some of these regulations and some of this bundling kind of stuff and the whole secondary market kind of thing happening during that time. So I do think, you know, but the market will still have these bubble ups and downs due to the bubbles and whatnot and have these same kind of secondary market items in there but hopefully it's, you know, more transparent would be the idea. The maximum conforming loan limit for a conventional mortgage in 2022 is $647,200 although it can be more for designated high cost areas a loan made above this amount is called a jumbo loan. A jumbo which usually carries a slightly higher interest rate. Now, obviously if you're in high cost of living areas like you might think, well, man, that's a high, that's fairly high loan for a normal kind of individual, normal first time home buyer, for example. But because that's just the loan amount, that's not even like the cost of the home amount. But if you're in a higher income area like possibly California or New York, for example, then, you know, the higher rates are clearly going to have more jumbo loans often times. So these loans carry more risk since they involve more money making them less attractive to the secondary market. For non-conforming loans, the lending institution, now the fact that they're less conducive to the secondary market, then, of course, makes them less desirable to some degree, right? Because the bank can't offload those loans. You know, you've got the higher risk that's going to be involved in it and so on. For non-conforming loans, the lending institution that is underwriting the loan, usually a portfolio lender, sets its own guidelines due to regulations non-conforming loans cannot be sold on the secondary market. So Federal Housing Administration, the FHA loans, the Federal Housing Administration FHA part of the U.S. Department of Housing and Urban Development, HUD, in other words, H-U-D, various mortgage loan programs for Americans. The FHA loan has lower down payment requirements and is lesser to qualify for than a conventional loan. FHA loans are excellent for first-time home buyers because in addition to lower upfront loan costs and less stringent credit requirements, you can make a down payment as low as 3.5%. So that's a huge difference in terms of the down payment, which again under normal circumstances you would think the bank would be highly skeptical of that unless they had some other kind of guarantee, right? And that's the idea. So all that's happening here is you've got this shifting going on with regards to the risk, which we've got to be careful of because clearly if you have a situation where the bank no longer has the risk, this was part of the issue, if the bank shifts the risk from the bank to somewhere else, the bank has incentives then to give out loans that are not likely to be paid back, right? They're likely to fail or go into default and that causes, of course, problems. So the FHA loans cannot exceed the statutory limits described above. However, all FHA borrowers must pay a mortgage insurance premium so rolled into their mortgage payments. So you have that mortgage insurance premium involved. Mortgage insurance is an insurance policy that protects a mortgage lender or title holder if the borrower defaults on payments passes away or is otherwise unable to meet the contractual obligations of the mortgage. U.S. Department of Veterans Affairs, the VA loans. The U.S. Department of Veterans Affairs, the VA guarantees VA loans. The VA does not make loans itself but guarantees mortgages made by qualified lenders. So you've got another kind of government involvement here. The VA clearly, it's more defined for a specific purpose in that case for the VA's, of course. So this guarantee allows veterans to attain home loans with favorable terms, usually without a down payment. So again, huge, huge impact. So in most cases, VA loans are easier to qualify for than conventional loans. Lenders generally limit the maximum VA loan to conventional mortgage loan limits. Before applying for a loan, you'll need to request your eligibility from the VA. If you are accepted, the VA will issue a certificate of eligibility that you can use to apply for a loan. In addition to these federal loan types and programs, state and local governments and agencies sponsor assistance programs to increased investment or home ownership in certain areas. Equity and income requirements. Home mortgage loan pricing is determined by the lender in two ways and both methods are based on the creditworthiness of the borrower. So clearly your creditworthiness is going to be a major component in terms of the types of loans that might be out there. So obviously better credit, better than the bank's going to be feeling more assured and the bank will give typically better terms in that case. Or worse credit than the bank's not going to be feeling as good and the terms are going to be reflective of that. In addition to checking your FICO, your FICO score from the three major credit bureaus, lenders will calculate the loan to value, the LTV ratio and the debt service coverage ratio, the DSCR, to determine the amount that they're willing to loan to you plus the interest rate. LTV is the amount of actual or implied equity that's available in the collateral being borrowed against. So for home purchases, LTV is determined by dividing the loan amount by the purchase price of the home. Lenders assume that the more money you are putting up in the form of a down payment, the less likely you are to default on the loan. So the logic of course being, like if you didn't have all this other, like any other kind of guarantee kind of thing, if it's just a deal between you and the bank, they're lending you money, they're making interest and you're getting a loan for the purchasing power of it, then the bank's going to be earning the interest on it. They're going to want to balance the risk versus the reward. They're going to lower the risk to them by seeing if you have a better credit. Your better credit lowers the risk to them and they want to have a significant down payment. And the down payment once again does two things. It locks in the buyer to being invested in the home. It's less likely you're going to walk away from the home. And if the home goes down in value, which hopefully is not likely but certainly possible, then it would have to go down fairly significantly to cover like a 20% down payment, right? So that means that if the home went down in value, then if you didn't put any money down or you only put a little money down, it's possible the loan would be higher than the home value, which would lead people possibly more likely to walk away from the home because they're no longer feeling financially invested in it like they were before. And if there was a default, then the bank wouldn't be able to sell the home in order to cover the costs of the home sale as well as the loan outstanding. So they want that down payment can be quite significant, right? So the higher the down payment, the more secure, the more good feeling that the bank is going to be, more security risk lowering effect. So the higher the LTV, the greater the risk of default. So lenders will charge more. For this reason, you should include any type of qualifying income that you can when negotiating with a mortgage lender. Sometimes an extra part-time job or other income generating business can make the difference between qualifying or not qualifying for a loan or in receiving the best possible rate. So remember, the loan officers is going to be defining their loan on the bank heuristics oftentimes, which require them to base it on kind of your gross income and then use like their percentage calculations to try to figure out how much you can basically afford. So they might be critical of the type of income you have, possibly W-2 income being more secure than possibly another kind of income like business income. But you also want to make sure that you're trying to give them the highest amount of income that you can that qualifies, that's legal to give them so that you can qualify for the highest loan possible, not because you necessarily want to take the highest loan possible. You want to have the capacity to be able to take as the highest loan possible and then do your own research to determine how much you can afford and what kind of house you want and then do your own budgeting to see how much you can afford. Again, you're not relying on the bank to determine how much house you should purchase or do your personal budgeting. You're trying to give the bank the information and get it in such a way so that you have the capacity to get as much lending as you want in the event that you need the lending and that means that you want to give them the highest income levels, numbers you can. Like if it's the W-2 income, you want to give them the gross income if that's what they're asking for, not the net income. For example, in any case, a mortgage calculator can show you the impact of different rates on your monthly payment.