Achieving loan approval

Even if you have perfect or near-perfect credit, you may encounter financing problems with some properties. And, of course, not all real estate buyers have a perfect credit history, tons of available cash, and no debt. Because of the soft real estate market in the late 2000s and the jump in foreclosures since that time, lenders tightened credit standards to avoid making loans to people likely to default. If you’re one of those borrowers who end up jumping through more hoops than others to get a loan, don’t give up hope. Few borrowers are perfect from a lender’s perspective, and many problems are fixable.

To head off some potential rejections before you apply for a loan, disclose to your lender anything that may cause a problem. For example, if you already know that your credit report indicates some late payments from when you were out of the country for several weeks five years ago, write a letter that explains this situation.

Debating fixed-rate versus adjustable-rate mortgages

Two major types of mortgages exist: those with a fixed interest rate and those with an adjustable rate. Your choice depends on your financial situation, how much risk you’re willing to accept, and the type of property you want to purchase. For example, obtaining a fixed-rate loan on a property that lenders perceive as a riskier investment is more difficult than getting an adjustable-rate mortgage for the same property.

Deciding between fixed and adjustable mortgages

You can’t predict the future course of interest rates. Even the professional financial market soothsayers and investors can’t predict where rates are heading. If you could foretell interest rate movements, you could make a fortune investing in bonds and interest-rate futures and options. So cast aside your crystal ball and ask yourself the following two vital questions to decide whether a fixed or adjustable mortgage will work best for you.

Finding your best fixed-rate mortgage

You may think that comparing one fixed-rate loan to another is simple because the interest rate on a fixed-rate loan is the rate you pay every month over the entire life of the loan. And as with your golf score and the number of times that your boss catches you showing up late for work, a lower number (or interest rate) is better, right?

Unfortunately, banks generally charge an up-front interest fee, known as points, in addition to the ongoing interest over the life of the loan. Points are actually percentages: One point is equal to 1 percent of the loan amount. So when a lender tells you a quoted loan has 1.5 points, you pay 1.5 percent of the amount you borrow as points. On a $100,000 loan, for example, 1.5 points cost you $1,500. The interest rate on a fixed-rate loan must always be quoted with the points on the loan, if the loan has points.

You may want to take a higher interest rate on your mortgage if you don’t have enough cash to pay for a lot of points, which you pay up-front when you close the loan. On the other hand, if you’re willing and able to pay more points, you can lower your interest rate. You may want to pay more points because the interest rate on your loan determines your payments over a long period of time — 15 to 30 years.

Suppose one lender quotes you a rate of 5.75 percent on a 30-year fixed-rate loan and charges one point (1 percent). Another lender, which quotes 6 percent for 30 years, doesn’t charge any points. Which is better? The answer depends on how long you plan to keep the loan.

The 5.75 percent loan is 0.25 percent less than the 6 percent loan. However, it takes you about four years to earn back the savings to cover the cost of that point because you have to pay 1 percent (one point) up-front on the 5.75 percent loan. So if you expect to keep the loan more than four years, go with the 5.75 percent option. If you plan to keep the loan less than four years, go with the 6 percent option.

To make it easier to perform an apples-to-apples comparison of mortgages from different lenders, get interest rate quotes at the same point level. For example, ask each lender for the interest rate on a loan for which you pay one point. And remember that if a loan has no points, it’s sure to have a higher interest rate. I’m not saying that no-point loans are better or worse than comparable loans from other lenders. Just don’t get sucked into a loan because of a no-points sales pitch. Lenders who spend big bucks on advertising these types of loans rarely have the best mortgage terms.

All things being equal, no-point loans make more sense for refinances because points aren’t immediately tax-deductible as they are on purchases. (You can deduct the points that you pay on a refinance only over the life of the mortgage.) On a mortgage for a property that you’re purchasing, a no-point loan may help if you’re cash poor at closing.

Consider a no-point loan if you can’t afford more out-of-pocket expenditures now or if you think you’ll keep the loan only a few years. Shop around and compare different lenders’ no-point loans.

Landing an appropriate adjustable-rate mortgage

Selecting an ARM has a lot in common with selecting a home to buy. You need to make trade-offs and compromises. In the following sections, I explain the numerous features and options — caps, indexes, margins, and adjustment periods — that you find with ARMs. (These aren’t issues with fixed-rate loans.)

Assessing your future interest rate

The first thing you need to ask a mortgage lender or broker about an adjustable rate is the exact formula it uses for determining the future interest rate on your particular loan. You need to know how a lender figures your interest rate changes over the life of your loan. All adjustables are based on the following general formula, which specifies how the interest rate is set on your loan in the future:

The index determines the base level of interest rates that the mortgage contract specifies in order to calculate the specific interest rate for your loan. Indexes are generally (but not always) widely quoted in the financial press.

For example, suppose that the current index value for a given loan is equal to the 6-month Treasury bill index, which is, say, 2 percent. The margin is the amount added to the index to determine the interest rate that you pay on your mortgage. Most loans have margins of around 2.5 percent. Thus, the rate of a mortgage driven by the following formula

is set at . This figure is known as the fully indexed rate. If the advertised start rate for this loan is just 3 percent, you know that if the index (6-month Treasuries) stays at the same level, your loan will increase to 4.5 percent.

Compare the fully indexed rate to the current rate for fixed-rate loans. During particular time periods, you may be surprised to discover that the fixed-rate loan is at about the same interest rate or even a tad lower. This insight may cause you to reconsider your choice of an adjustable-rate loan, which can, of course, rise to an even higher rate in the future.

Understanding other mortgage fees

In addition to points and the ongoing interest rate, lenders tack on all sorts of other up-front charges when processing your loan. Get an itemization of these other fees and charges in writing from all lenders that you’re seriously considering. (I explain how to find the best lenders for your needs in the next section.) You need to know the total of all lender fees so you can accurately compare different lenders’ loans and determine how much closing on your loan will cost you. These other mortgage fees can pile up in a hurry. Here are the common ones you may see:

• Application and processing fees: Most lenders charge a few hundred dollars to work with you to complete your paperwork and funnel it through their loan evaluation process. If your loan is rejected, or if it’s approved and you decide not to take it, the lender needs to cover its costs. Some lenders return this fee to you upon closing with their loan.
• Credit report charge: Most lenders charge you for the cost of obtaining your credit report, which tells the lender whether you’ve repaid other loans on time. Credit report fees typically run about $75.
• Appraisal fee: The property for which you borrow money needs to be valued. If you default on your mortgage, a lender doesn’t want to get stuck with a property that’s worth less than you owe. The cost for an appraisal typically ranges from several hundred dollars for most residential properties to as much as $1,000 or more for larger investment properties.

Some lenders offer loans without points or other lender charges. However, remember that if they don’t charge points or other fees, they charge a higher interest rate on your loan to make up the difference. Such loans may make sense for you when you lack the cash to close a loan or when you plan to keep the loan for just a few years.

To minimize your chances of throwing money away applying for a loan that you may not qualify for, ask the lender whether he sees any reason your loan request may be denied. (Also consider getting pre-approved.) Be sure to disclose any problems on your credit report or any problems with the property that you’re aware of. Lenders may not take the time to ask about these sorts of things in their haste to get you to complete their loan applications.

Finding the best lenders

You can easily save thousands of dollars in interest charges and other fees if you shop around for a mortgage deal. It doesn’t matter whether you do so on your own or hire someone to help you, but you definitely should shop because a lot of money is at stake!

Refinancing for a better deal

When you buy a property, you take out a mortgage based on your circumstances and available loan options at that time. But things change. Maybe interest rates have dropped, or you have access to better loan options now than when you first purchased. Or perhaps you want to tap into some of your real estate equity for other investments.

If interest rates drop and you’re able to refinance, you can lock in interest rate savings. But getting a lower interest rate than the one you got when you took out your original mortgage isn’t reason enough to refinance your mortgage. When you refinance a mortgage, you have to spend money and time to save money. So you need to crunch a few numbers to determine whether refinancing makes financial sense for you.

Calculate how many months it will take you to recoup the costs of refinancing, such as appraisal costs, loan fees and points, title insurance, and so on. You also have to consider tax issues. For example, if the refinance costs you $2,000 to complete and reduces your monthly payment by $100, it may appear that you can recoup the cost of the refinance in 20 months. However, because you lose some tax write-offs if you reduce your mortgage interest rate and payment, you can’t simply look at the reduced amount of your monthly payment.

For a better estimate without spending hours crunching numbers, take your tax rate as specified in Chapter 4 (for example, 28 percent) and reduce your monthly payment savings on the refinance by this amount. That means, continuing with the preceding example, that if your monthly payment drops by $100, you’re actually saving only around $72 a month after you factor in the lost tax benefits. So it takes about 28 months ($2,000 divided by $72), not 20 months, to recoup the refinance costs.

Consider refinancing when you can recover the costs of the refinance within a few years or less and you don’t plan to move in that time frame. If it takes longer to recoup the refinance costs, refinancing may still make sense if you anticipate keeping the property and mortgage that long. If you estimate that breaking even will take more than five to seven years, refinancing is probably too risky to justify the costs and hassles.

Refinancing a piece of real estate that you own to pull out cash for some other purpose can make good financial sense because under most circumstances, mortgage interest is tax-deductible. Perhaps you want to purchase another piece of real estate, start or purchase a business, or get rid of an auto loan or some high-cost credit card debt. The interest on consumer debt isn’t tax-deductible and is usually at a much higher interest rate than what mortgage loans charge you.

Be careful that you don’t borrow more than you need to accomplish your financial goals. For example, just because you can borrow more against the equity in your real estate doesn’t mean you should do so to buy an expensive new car or take your dream vacation.

Recognizing agent conflicts of interest

All real estate agents (good, mediocre, and awful) are subject to a conflict of interest because of the way they’re compensated: on commission. I respect real estate agents for calling themselves what they are. They don’t hide behind an obscure job title, such as “shelter consultant.” (Many financial “planners,” “advisors,” or “consultants,” for example, actually work on commission and sell investments and life insurance and therefore are really stockbrokers and insurance brokers, not planners or advisors.)

Real estate agents aren’t in the business of providing objective financial counsel. Just as car dealers make their living selling cars, real estate agents make their living selling real estate. Never forget this fact as a buyer.

The pursuit of a larger commission may encourage an agent to get you to do things that aren’t in your best interest, such as the following:

• Buy, and buy sooner rather than later: If you don’t buy, your agent doesn’t get paid for all the hours she spends working with you. The worst agents fib and use tricks to motivate you to buy. They may say, for example, that other offers are coming in on a property that interests you, or they may show you a bunch of dumps and then one good listing that has much of what you’re looking for to motivate you to buy the nicer property.
• Spend more than you should: Because real estate agents get a percentage of the sales price of a property, they have a built-in incentive to encourage you to spend more on a property than what fits comfortably with your other financial objectives and goals. An agent doesn’t have to consider or care about your other financial needs.
• Purchase their company’s listings: Agents also have a built-in incentive (higher commission) to sell their own listings. So don’t be surprised when an agent pushes you in the direction of one of her own company’s properties.
• Buy in their territory: Real estate agents typically work a specific territory. As a result, they usually can’t objectively tell you the pros and cons of the surrounding region.
• Use people who scratch their backs: Some agents refer you to mortgage brokers, lenders, inspectors, and title insurance companies that have referred customers to them. Some agents also solicit and receive referral fees (or bribes) from mortgage lenders, inspectors, and contractors to whom they refer business.

Selecting a good agent

A mediocre, incompetent, or greedy agent can be a real danger to your finances. Whether you’re hiring an agent to work with you as a buyer or as a seller, you want someone who’s competent and with whom you can get along. Working with an agent costs a good deal of money, so make sure you get your money’s worth out of him.

Interview several agents and check references. Ask agents for the names and phone numbers of at least three clients with whom they’ve worked in the past six months in the geographical area in which you’re looking. By narrowing the period during which they worked with these references, you maximize the chances of speaking with clients other than the agent’s all-time-favorite clients.

As you speak with an agent’s references, ask about these traits in any agent that you’re considering working with, whether as a buyer or as a seller:

• Full-time employment: Some agents work in real estate as a second or even third job. Information in this field changes constantly, so keeping track of it is challenging on a full-time basis. It’s hard to imagine a good agent being able to stay on top of the market on a part-time basis while working full time elsewhere.
• Experience: Hiring someone with experience doesn’t necessarily mean looking for an agent who’s sold real estate for decades. Many of the best agents come into the field from other occupations, such as business and teaching. Agents can acquire some sales, marketing, negotiation, and communication skills in other fields. However, keep in mind that some experience in real estate or a related field does count.
• Honesty and integrity: You need to trust your agent with a lot of information. If the agent doesn’t level with you about what a neighborhood or particular property is really like, you suffer the consequences.
• Interpersonal skills: An agent must get along not only with you but also with a whole host of other people who are involved in a typical real estate deal: other agents, property sellers, inspectors, mortgage lenders, and so on. An agent needs to know how to put your interests first without upsetting others.
• Negotiation skills: Putting a real estate deal together involves negotiation. Is your agent going to exhaust all avenues to get you the best deal possible? Most people don’t like the sometimes aggravating process of negotiation, so they hire someone else to do it for them. Be sure to ask the agent’s former client references how the agent negotiated for them.
• High quality standards: Sloppy work can lead to big legal or logistical problems down the road. If an agent neglects to recommend an inspection, for example, you may get stuck with undiscovered problems after the deal is done and paid for.

Agents who pitch themselves as buyers’ brokers claim they work for your interests. However, agents who represent you as a buyer’s broker still get paid only when you buy. And agents still get paid a commission that’s a percentage of the purchase price. So they still have an incentive to sell you a piece of real estate that’s more expensive because their commission increases.

Some agents market themselves as top producers, meaning that they sell a relatively larger volume of real estate. This title doesn’t matter much to you, the buyer. In fact, you may use this information as a potential red flag for an agent who focuses on completing as many deals as possible. Such an agent may not be able to give you the time and help you need to get the house you want.

When you buy a home, you need an agent who is patient and allows you the necessary time to educate yourself and who helps you make the decision that’s best for you. The last thing you need is an agent who tries to push you into making a deal.

You also need an agent who’s knowledgeable about the local market and community. If you want to buy a home in an area where you don’t currently live, an informed agent can have a big impact on your decision.

Finding an agent with financing knowledge is a plus for buyers, especially first-time buyers or those with credit problems. Such an agent may be able to refer you to lenders that can handle your type of situation, which can save you a lot of legwork.

Negotiating basics

When you work with an agent, she usually carries the burden of the negotiation process. But even if you delegate that responsibility to your agent, you still should have a strategy in mind. Otherwise, you may overpay for real estate. Here’s what you should do:

• Find out about the property and the owner before you make your offer. How long has the property been on the market? What are its flaws? Why is the owner selling? The more you understand about the property you want to buy and the seller’s motivations, the better your ability to draft an offer that meets everyone’s needs. Some listing agents love to talk and will tell you the life history of the seller. Either you or your agent may be able to get a listing agent to reveal helpful information about the seller.

• Bring facts to the bargaining table; get comparable sales data to support your price. Too often, homebuyers and their agents pick a number out of the air when they make an offer. If you were the seller, would you be persuaded to lower your asking price? Pointing to recent and comparable home sales to justify your offer price strengthens your case.

  Price is only one of several negotiable items. Sometimes sellers fixate on selling their homes for a certain amount. Perhaps they want to get at least what they paid for it several years ago. You may get a seller to pay for certain repairs or improvements or to offer you an attractive loan without all the extra fees that a bank charges. Also, be aware that the time for closing on the purchase is a bargaining point. Some sellers may need cash fast and may concede other terms if you can close quickly. Likewise, the real estate agent’s commission is negotiable.

• Try to leave your emotions out of any property purchase. Being objective rather than emotional regarding a purchase is easier said than done, and it’s hardest to do when buying a home in which you’ll live. So do your best not to fall in love with a property. Keep searching for other properties even when you make an offer because you may be negotiating with an unmotivated seller.

Inspecting the property

Unless you’ve built homes and other properties and performed contracting work yourself, you probably have no idea what you’re getting yourself into when it comes to furnaces and termites.

Spend the money and take the time to hire inspectors and other experts to evaluate the major systems and potential problem areas of the home. Because you can’t be certain of the seller’s commitment, I recommend you do the inspections after you’ve successfully negotiated and signed a sales contract. Even though you won’t have the feedback from the inspections to help with this round of negotiating, you can always go back to the seller with the new information. Make your purchase offer contingent on a satisfactory inspection.

Hire people to help you inspect the following features of the property:

• Overall condition of the property (for example, look for peeling paint, level floors, appliances that work properly, and so on)
• Electrical, heating and air conditioning, and plumbing systems
• Foundation
• Roof
• Pest control and dry rot
• Seismic/slide/flood risk

Inspection fees often pay for themselves. If you uncover problems you weren’t aware of when you negotiated the original purchase price, the inspection reports give you the information you need so you can go back and ask the property seller to fix the problems or reduce the property’s purchase price.

Never accept a seller’s inspection report as your only source of information. When a seller hires an inspector, he may hire someone who isn’t as diligent and critical of the property. Review the seller’s inspection reports if available, but also get your own evaluation. And beware of inspectors who are popular with real estate agents. They may be popular because they don’t bother to document all the property’s problems.

As with other professionals whose services you retain, interview a few different inspection companies. Ask which systems they inspect and how detailed of a report they can prepare for you. Consider asking the company that you’re thinking of hiring for customer references. Ask for names and phone numbers of three people who used the company’s services within the past six months. Also request from each inspection company a sample of one of its reports.

The day before you close on the purchase, take a brief walk-through of the property to make sure everything is still in the condition it was before and that all the fixtures, appliances, curtains, and other items the contract lists are still there. Sometimes, sellers ignore or don’t recall these things, and consequently, they don’t leave what they agreed to leave in the sales contract.

Shopping for title insurance and escrow services

Mortgage lenders require title insurance to protect against someone else claiming legal title to your property. For example, when a husband and wife split up, the one who remains in the home may decide to sell and take off with the money. If the title lists both spouses as owners, the spouse who sells the property (possibly by forging the other’s signature) has no legal right to do so. The other spouse can come back and reclaim rights to the home even after it has been sold. In this event, both you and the lender can get stuck holding the bag. (If you’re in the enviable position of paying cash for a property, buying title insurance is still wise to protect your investment, even though a mortgage lender won’t prod you to do so.)

Title insurance and escrow charges vary from company to company. (Escrow charges pay for neutral third-party services to ensure that the instructions of the purchase contract or refinance are fulfilled and that everyone gets paid.) Don’t simply use the company that your real estate agent or mortgage lender suggests — shop around. When you call around for title insurance and escrow fee quotes, make sure you understand all the fees. Many companies tack on all sorts of charges for things such as courier fees and express mail. If you find a company with lower prices and want to use it, consider asking for an itemization in writing so you don’t receive any unpleasant surprises.

An insurance company’s ability to pay claims is always important. Most state insurance departments monitor and regulate title insurance companies. Title insurers rarely fail, and most state departments of insurance do a good job of shutting down financially unstable ones. Check with your state’s department if you’re concerned. You can also ask the title insurer for copies of its ratings from insurance-rating agencies.

Negotiating real estate agents’ contracts

Most people use an agent to sell real estate. As I discuss in “Selecting a good agent” earlier in this chapter, selling and buying a home demand agents with different strengths. When you sell a property, you want an agent who can get the job done efficiently and for the highest possible sales price.

As a seller, seek agents who have marketing and sales expertise and who are willing to put in the time and money necessary to sell your house. Don’t be impressed by an agent just because she works for a large company. What matters more is what the agent can do to market your property.

When you list a property for sale, the contract that you sign with the listing agent includes specification of the commission that you pay the agent if she succeeds in selling your property. In most areas of the country, agents usually ask for a 6 percent commission for single-family homes. In an area with relatively low-priced housing, agents may ask for 7 percent. For small multifamily properties and commercial properties, commissions often hover around the 3 to 5 percent range.

Regardless of the commission an agent says is “typical,” “standard,” or “what my manager requires,” always remember you can negotiate commissions. Because the commission is a percentage, you have a much greater ability to get a lower commission on a higher-priced property. If an agent makes 6 percent selling both a $200,000 and a $100,000 property, the agent makes twice as much on the $200,000 property. Yet selling the higher-priced property doesn’t usually take twice as much work.

If you live in an area with generally higher-priced properties, you may be able to negotiate a 5 percent commission. For really expensive properties, a 4 percent commission is reasonable. You may find, however, that your ability to negotiate a lower commission is greatest when an offer is on the table. Because of the cooperation of agents who work together through the multiple listing service (MLS), if you list your real estate for sale at a lower commission than most other properties, some agents won’t show it to prospective buyers. For this reason, you’re better off having your listing agent cut his take instead of cutting the commission you pay to a real estate agent who brings a buyer for your property.

In terms of the length of the listing agreement, 3 months is reasonable. If you give an agent too long to list your property (6 to 12 months), the agent may simply toss your listing into the multiple listing database and not expend much effort to get your property sold. Practically speaking, you can fire your agent whenever you want, regardless of the length of the listing agreement, but a shorter listing may motivate your agent more. A shorter listing period also allows you to more easily part company with your agent if he doesn’t do a good job and to move on to someone who will.

Selling without an agent

The temptation to sell real estate without an agent is usually to save the commission that an agent deducts from your property’s sale price. If you have the time, energy, and marketing experience, you can sell sans agent and possibly save some money.

The major problem with attempting to sell real estate on your own is that you can’t list it in the MLS, which, in most areas, only real estate agents can access. If you’re not listed in the MLS, many potential buyers never know that your home is for sale. Agents who work with buyers don’t generally look for or show properties that are for sale by owner or listed with discount brokers.

Besides saving you time, a good agent can help ensure you’re not sued for failing to disclose known defects of your property. If you decide to sell on your own, contact a local real estate legal advisor who can review the contracts. Take the time to educate yourself about the many facets of selling property for top dollar. Read the latest edition of House Selling For Dummies, which I co-authored with Ray Brown (published by Wiley).