Ron Denhaan, Realtor (949) 290-3263. Orange County real estate specialist.
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Financing FAQ

 Real Estate Financing FAQ (Frequently Asked Questions)

Answer: There are five factors that determine your credit scores. They are listed below in order of importance, just as an underwriter would look at your credit report:
  • Payment History: 35% impact. Paying debt on time and in full has a positive impact. Late payments, judgments and charge-offs have a negative impact. Missing a larger payment has a more severe impact than missing a smaller payment. Delinquencies that have occurred in the last two years carry more weight than older items.
  • Outstanding Credit Balances: 35% impact. The ratio between outstanding balance and available credit is what's important here. Ideally balances should stay below 10 % of credit limits and rarely higher than 50%. Credit scores are lowered substantially when balances exceed credit limits.
  • Credit History: 15% impact. The key measure for this factor is the length of time since a particular credit line was established. The longer you've had the credit, the more positive this factor impacts your scores. A seasoned borrower is stronger here.
  • Type of Credit: 10% impact. A mix of auto loans, credit cards and mortgages has a more positive effect than credit cards only. Debts with finance companies and other "high risk" lenders will have a negative effect.
  • Inquiries: 10% impact. This factor is determined by the number of inquiries that have been made for credit by the borrower in the last 6 months. Each hard inquiry can cost from 2 to 50 points on a credit score, but the maximum number of inquiries that will reduce the score is 10. Additional inquiries above 10 will have no further impact on the final score.  

It's important to remember that the computers do not take any personal factors, including income, into consideration when calculating your scores. When your credit report is generated it is simply that day's snapshot of your activities. Once you begin the loan process DO NOT apply for any new credit or increase any debts without consulting your lending professional. Sometimes folks about to buy a new home get excited and buy new cars, new furniture, and the like before their home loan is finalized. This too often changes their credit picture and may alter or eliminate their approval.

We compile a tri-merge credit report which combines the scores provided by all three credit bureaus. Underwriters use the middle score of the three to determine credit worthiness, often to the borrower's advantage.

Do you know your scores? You need to know what your credit scores are and what's in your report before you begin shopping. Some erroneous items may take 2-3 months to get removed.

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Can I use a Zero Down mortgage to buy my next home without having any money to put down?

Answer: Although there really are options for buying homes with no down payment, there are very few options for people with no money for closing costs or reserves (money left in the bank after the loan has closed).  Zero down programs are considered "alternative Financing" and often come with shorter commitments that require you to refinance in 2 -3 years and pre-payment penalties that require you to stay in the loan for 2-3 years. Buyers have access to much better loans if they are able to put 10%, 5%, or even 3% down.

Another consideration is the market you're looking to buy into. If the real estate market is a "seller's market" (high demand and low supply), like we currently have in Seattle, it may be very difficult to buy with 100% financing as homes often sell for more than their appraised value. Investors consider the true value of property to be the selling price or the appraised value, WHICHEVER IS LESS. If the appraised value comes in 5% less than the selling price, the investor will require 5% down for 100% financing.

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What is an interest-only loan and why should I be considering that?

Answer: "Interest-Only" loans are also called "interest first" loans. With these loans, buyers are responsible to pay only the interest on the outstanding balance every month. Typically, loans amortize over a given period (i.e. 30 years) and each payment represents P&I (principal and interest). Interest-Only loans do not require borrowers to pay principal reduction as part of their payment for the first 5, 10 or 15 years (depending on the program). After that time the payment jumps to P&I on the outstanding balance of the remainder of the term, often at significantly higher payments. Will this work for you? It depends: How long are you planning to stay in the property? How long are you going to make the minimum payment? How will you address the higher payment later on? Sometimes these programs are exactly the right solution for the buyer, but often they are used to squeeze someone into more home than they can afford without a plan for how to address the payment increases to come. Before moving forward with this type of loan, be sure you understand all the ramifications.

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I see advertising for mortgages rates starting at less than 3%. Are these loans something I should pursue?

Answer: Do not be fooled by what is too often deceptive advertising. These loans have interest rates much higher than 3%. What they have is payment rates that start as low as 1% or higher (hence the deceptive "if you're paying less than 3% we can save you money"). These advertisements (often Spammed) represent Neg-Am loans or Options arms.
Neg-Am loans are adjustable-rate mortgages that have payment rates less than the interest that is due. Instead of reducing the debt a little with each payment (amortized loan), the debt actually grows with each payment (negative-amortized loan). Obviously, these loans should only be used in situation where the payment must be at the very minimum for a short period of time and there is plenty of equity in the home to start. Does that mean nobody should consider this type of loan? Heavens, no. From time to time we have had clients where this was the perfect solution for a short-term situation. For example, a client who was having a home built in another state wanted to reduce the payments on his current home as low as possible to defray the cost of his big move. His move was scheduled in less than 24 months. This was a perfect solution.
These types of loans should never be considered for "first time homebuyers" that intend to stay put. The period of neg-am is typically limited to 3-5 years, and no-one should have to experience the payment shock at the end of this period.

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What is an "Option Arm" and should I be looking for one?

Answer : "Options Arms" are called this because each month borrowers are offered several options when making their mortgage payment: 1) Minimum payment, 2) Interest-Only payment, 3) 30-year amortized payment, and 4) 15-year amortized payment. We're going to focus the answer on the minimum payment because that is where most people get confused.   Minimum payments start out at payment rates as low as 1%, so a minimum payment on a $500,000 loan might be $1,608.20. However, the loan itself is an adjustable-rate mortgage at a much higher rate, say 5.85% so the interest due could be $2,437.50. the difference of $829.30 is called " interest" or "negative amortization". In other words, the borrower is now $829.30 deeper in debt.   Although the payment may start as low as 1%, every year the payment increases by 7.5%. The $1,608.20 first year payment goes to $1,728.82 the 2nd year, $1,845.48 the 3rd year, and so on. Most programs go 5 years before recasting into a fully amortized loan based on the current rate and the balance due.
If the borrower makes the minimum payment every month and interest rates climb, the amount of "deferred interest" could reach the limits of the program (typically 110% of the original balance) and force recasting before the 5
-year time limit. This can come as quite a shock to folks who did not understand the program and thought they had found the cheapest mortgage payment ever. For instance, the example we used earlier would produce a recast payment of $5,792.73 if the rate on the arm were to reach its maximum rate of 12.0% at 110% of the original loan amount just at the 5-year limit. Many analysts are concerned that uniformed borrowers will be forced to walk away from their homes and debts should rates rise quickly and they continue to make minimum payments.

Does that mean you have to be a fool to get an "Options Arm"? Quite the contrary. As long as you understand what it is, how it works, and what its limitations are, these types of loans can be very beneficial. For example, a client of ours has a wife who wanted to return to school. Although the equity position in their house was very strong, their mortgage payment would be much harder to make for the two years she was in school and not earning. We took out some cash to pay off some of their debts, and reduced their monthly mortgage payment  and other payments by more than half her salary. After she returns to work, they have the option of converting to a 30-year fixed rate or refinance the mortgage. Also, I should point out that although the program I described on the left is typical of "Options Arms" programs, there is one investor that   in this type of loan and offers some very attractive improvement, including: more stable indexes, 125% recast limit, and 10 years of graduated minimum payments instead of 5. If you are working with a mortgage broker who steers you toward an "Options Arm", ask him or her to explain "recasting". If you sense any hesitation, run away. There are far too many inexperienced loan officers selling these programs as the "latest & greatest" solution without really understanding the loans. And if the loan officer doesn't understand it, how likely do you think the borrower will understand it?

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  What is a Home Equity Line of Credit or HELOC?

HELOC stand for Home Equity Line of Credit. It is like having a gold or platinum credit card that is tied to your home. Most HELOCs are 2nd mortgages used to help buyers without enough funds for down payment to keep their mortgage below 80%LTV (see question on having less than a 20% down payment). For example, if you were buying a home for $300k and were planning to put $15,000 down (5%), the balance of $285,000 is 95% of the value of the home. You could opt for PMI, or you could do a combo loan with a 1st mortgage of $240,00 (80%LTV) and 2nd mortgage of $45,000 (15%LTV). HELOC's offer advantages and one big disadvantage. Let's start with the positive side.  
Unlike fixed rate 2nd mortgages, HELOCs have a maximum draw amount that can be used again and again. In the earlier example you could opt for a HELOC 2nd mortgage. You would draw the full amount at closing. Your minimum payment every month would be the interest due on the outstanding balance. No principal payment is required during the "draw period" (often 10-15 years). This payment would obviously be less than a P&I payment on fixed rate mortgage with a 15-20-year payoff. Also, should you follow the advice of your mortgage consultant, you could pay principal reduction every month once you become comfortable with your new house payments. Let's say you reduce the debt on the HELOC to $30,000 over a five year period. You would have the remaining $20,000 available to you for home repair or to reduce your consumer debts without having to apply for it.
So what's the downside? HELOCs are adjustable-rate mortgages usually tied to the prime rate. Therefore,  the federal reserve (Alan Greenspan) raises the discount rate, the prime rate changes. Depending on what period in our history you study, that could be a good thing, or a very bad thing. In 2003 the prime rate changed once, from 4.25 to 4.00 where it stayed the rest of the year. In 2001 it changed 11 times and ranged from 4.75 to 9.00. In 1980 it changed 38 times and ranged from 11.25 to 20.00. From 2004 to mid-2005 when mortgage rates stayed relatively flat, the prime moved from 4.00 to 6.75.

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  If I don't have 20% to put down, does that mean I will have to pay PMI?

Answer: Not necessarily. This question causes lots of confusion because the rules have changed over the years. Many of us go to our folks or trusted older family member for advice when we first start looking into buying a home. Unfortunately, often the advice is correct but out of date. Today there are several alternatives.   First of all, it helps to understand the historical reasons for 20% down. Banks track how much it costs to foreclose on real estate. Each year this averages 18-22% of the value of the home. These costs include legal fees, repairs (evicted owners rarely leave with everything in good shape), listing commissions, selling commissions, title fees, escrow fees, taxes (local, county & state), and the like. Therefore, whenever mortgages exceed 80% of the value if the home, the investor is at risk. Today there are several ways to address that risk:   1) PMI - Private Mortgage Insurance. Mortgage insurance is a contract that insures the lender against loss caused by a mortgagor's default on a mortgage. Mortgage insurance issued by a private company is called "PMI". Mortgage insurance can also be issued by a government agency like the FHA and is called PMI.  2) LPMI - Lender-Paid Mortgage Insurance. With these programs investors charge a higher rate to "sel- insure" against the risk. The advantage for borrowers is that the interest is tax deductible, where PMI or MI isn't.   3) Combo Loans - For these programs, borrowers have a 1st mortgage that is 80% or less of the value and a 2nd mortgage to close the gap between their down payment and the balance remaining. For example, 5% down combo loans are referred to as 80/15/5 and 10% down combo loans are 80/10/10. The advantage for borrowers is that they can write off the interest on both loans. They can also work to pay the 2nd off faster, leaving them in a comfortable equity position.   4) Alternative Lending - These are typically loans with a shorter to a fixed rate, often 2-5 years. After that time, they become Adjustable-Rate Mortgages, often with higher margins that force borrowers to refinance out of them quickly. Investors manage to the risk and require pre-payment penalties to prevent borrowers from refinancing too quickly.
Which solution is best? It depends. If the borrower doesn't have much money and weak, but not horrible credit, an FHA solution can serve them well. FHA requires MI on mortgages that exceed 80%.  FNMA offers combo loans up to 95% LTV. They require the borrower have strong, clean credit and enough money in reserves after closing to cover 3-6 months of payments.   Alternative Lending and PMI are often better solutions than waiting until the potential home buyer saves more for their down payment.

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What advantages are offered by Mortgage Bankers and Mortgage Brokers?

Answer: Each offer many advantages, but let's first put these in perspective. In the past when you applied for a mortgage, it was assumed you would go to the local bank or savings and loan where you keep your savings and checking accounts. Today, there is a wide range of choices. You also can apply with a mortgage broker, mortgage banker, credit union, professional or trade associations that you belong to, the financial services firm that manages your mutual fund investment account, state and regional housing agencies, a private home financing company or even the seller.

Let's begin by understanding some terms. Mortgage Bankers provide the funds at the closing table. Although they may (and usually do) sell the loan to an investor for servicing, they underwrite and fund the loans themselves. This control offers flexibility that can avoid delays at closing. Although some Mortgage Bankers represent only one bank (usually their namesake), many today are approved to fund loans for several of the larger banks. Often the best rates are made available to the Mortgage Bankers or "correspondent" lenders.

Mortgage Brokers don't bring their own funds to the closing table and they don't underwrite their loans. They establish relationships with a pool of lenders that approve their loans and provide funds for closing. The advantage Brokers offer is they can shop many (sometimes hundreds) of lenders to find the best program or rate available. Often the more creative programs are only offered only on a Broker basis.

We at Rainier Mortgage & PRIVATE LENDING SERVICES are part of the new breed of hybrid lenders: we offer our clients both Mortgage Banking and Mortgage Broker services. As Mortgage Bankers we offer competitive rates, confidential one-to-one personal service with fast approvals in-house underwriting, and local funding. As Mortgage Brokers we have access to thousands of specialized mortgage programs for that unique property or solution.

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Should I consider using my credit union for my home loan?

Answer: You certainly can, if they have the right solution for you. Credit Unions will usually have a very limited number of mortgage offerings. It's a bit like shopping for a dining room table at your local Costco warehouse. If they have the exact table you want, the price will likely be very attractive. If, however, you need it in another size or color, you're better off at a place that offers real selection. The strength in credit unions is their flexibility for loans like emergency loans, auto loans, RV loans, and the like. For these loans they use their own funds. When they offer mortgages, it is usually brokered to very limited list of banks - sometime only one. If they have the exact loan you need, they will probably price it well. However, they probably don't have someone experienced with the more creative or aggressive offerings that can explain your options. Although they might be worth considering, they should always be shopped.

Should I look to a major bank for financing my next home?

Answer: Major Banks offer a certain security, some of it is illusion created by their image, some of it very valid. Let's explore these.
Banks spend a fortune to create and market an image. I worked for a year with the stagecoach bank. I was very pleased and impressed with their commitment to teaching ethics to their employees. They offered a fairly broad spectrum of products, but it's fair to say that clients either fit into their programs or they didn't. Some of the competitor banks made very tight decisions about what kinds of loans they wanted to do and what kind they left to their competitors. Several of our current customers work for Major Banks but prefer our services because of the options we offer.
On any given day one Major Bank's rates are higher or lower than the other banks for any given product. For example, if there has been a flood of 30-year fixed loans the rates may inch up on those and rates for 3/1 ARMS drop in order to encourage a more well-rounded portfolio. As Mortgage Brokers and Mortgage Bankers we use an online "loan finder" service that compares the rates from Major Banks at any given moment. The bank with the best rate for each product is always changing.
Some Major Banks focus more of their business on brokered loans and have a limited number of retail mortgage loan officers. Their pricing is usually better through the broker channel because they want to protect that business. Other Major Banks focus more on their retail lending but know they don't have to compete that well in the marketplace because their loyal clients will choose to use them regardless.
There are two strategies for you to consider if you are going to use a Major Bank. The first is to trust that they are offering you a competitive rate and the best solution without questioning them too much. After all, they are your bank and you trust them with the rest of your money. The second approach is to shop them to the other Major Banks. That's really the only way you can know if you have the best solution.
We recommend that you find a loan officer who can look at Major Banks, smaller banks, and any other lending institutions that have products to match your needs. Provide your personal data once, to one loan officer that you trust. Have them research the many alternatives and provide you options to consider. Demand that they tell you what options are available, which ones they recommend, and why. You've got more to do than run from bank to bank to figure out who has the best solution for your needs.

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Ron Denhaan, Realtor    


DRE# 01728866

Ron Denhaan, Realtor, Coto de Caza, CA specialist


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