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That's one of the questions I've been asked, and it deserves an answer. Know that there is some flexibility to the answer, as there are embedded trade offs. You don't need as much of an income, or as high of a credit score, if you have a down payment. A sufficiently high credit score can also mean that you can afford a more expensive property, as higher credit scores get better interest rates, and therefore, lower payments for the same property. On the flip side, if you have monthly bills that consume a large amount of your income, you cannot afford to pay as much for a property. The same applies if you cannot prove sufficient income via the traditional means of w-2s or income tax forms, as the alternative loan forms do not give rates as good. Finally, most of this only applies if you want or need a loan. If you intend to pay with cash, you can buy anything legal that you desire with your cash, and the hurdles become much smaller.
The first thing any buyers need if they want a loan for the property is a source of income. If you want a loan, you've got to have money coming in from somewhere to make the payments. Preferably, it's a documentable, regular source of income, such as paychecks or income from a business on which you report taxable income. I suppose I should mention that tax cheats have difficulty getting good quality home loans, because I have dealt with a few people I suspect of that. Don't worry, I'm not an IRS employee and I won't turn you in. But all lenders must report loan transactions, and every real estate transaction is a matter of public record. If you make a major purchase or take out a major loan, the IRS can take an interest in you. Just sayin'.
You income, together with whatever amount you have for a down payment, gives you a budget for a property. If your credit score is not horrible, a down payment is optional, but you will need at least a couple thousand for a good faith deposit, and probably another thousand at least for appraisal, inspections, and miscellaneous stuff. The once-upon-a-time rule of thumb about a 2% earnest money deposit has long gone by the wayside, but a good deposit is often evidence that you are serious about your ability to consummate the deal, and might get you a lower price in negotiations. I will argue against my listing clients accepting any offer, no matter how good, without a deposit, and most sane real estate agents agree with me.
Regarding the down payment, it may be optional, but at least a certain amount is a good option if you have it. In order to make a difference on the terms of your loan, the required down payment generally goes in increments of 5%. 5% will get you better terms than you would get for no deposit, 10% will get you better terms than 5%, 15% better than 10%.
If you want to take advantage of a governmental first time buyer assistance program, either the Mortgage Credit Certificate or a locally based buyer assistance program, you need to be very careful about staying within what you can prove you can afford via tax forms. Stated Income, or documenting your income via bank statements, is not an option on any of those programs. Using creative financing options, such as negative amortization loans, with such programs is similarly forbidden. First time assistance programs are not designed to encourage irresponsibly buying a more expensive property than you can afford; they are designed to help you stretch what you can afford a little further. Know what you can afford in terms of sales price, because agents and loan officers can too easily manipulate payment quotations. Rules of thumb (2.5 times income, four times income, whatever) are worthless. This article will help you compute what you can afford, once you know the approximate rates for current thirty year fixed rate loans.
You will need to be able to document a two year history of housing payments. Since you have never bought before, this means rent. No fun to have had to enrich someone else for a couple of years, but there are valid reasons why lenders require a history of regular housing payments on time. If you can document that you've been paying regular rent to your parents, grandparents, or what have you, that can count, although lenders will usually ask for copies of the canceled checks rather than accepting their word for it.
You will also need a history of credit payments. Mortgage lenders want to see evidence that you have the habit of paying your debts on time regularly. The usual criteria is three total lines of credit, one open for at least 24 months, the other two for at least six months. These can be revolving lines of credit such as credit cards, or installment debt such as car payments. Note that they do not necessarily have to still be open, but whatever balances and monthly payments you still have will be counted against your debt to income ratio.
Also, you generally need at least two open lines of credit in order to have credit scores reported by the major credit bureaus. Ideal is two long term credit cards with very small balances. You will need an appropriate credit score for what you are trying to do. What score is sufficient will depend upon the exact characteristics of your transaction. For 100% financing under full documentation, a credit score of 580 is generally sufficient. Better scores will lower your rate, and therefore your payments, but the best thing that can be said about a 580 credit score is that it isn't putrid.
The last things I will mention that will stand you in good stead are also optional: An educated layperson's knowledge of the process (I would like to think being a regular reader here will help with that), a investigative attitude, and the willingness to shop effectively for services, both loan and real estate.
One of the things people keep asking about is first time buyer programs. They exist, but lenders are not the first place to ask. Why? Because many, if not most lenders, actually charge a quarter of a point or so for first time buyers, in addition to their regular rates. They do this because so many of them fall out, and they want some money for their trouble. Also, interfacing with local first time buyer programs is a bit of a hassle, and it often takes much longer to close the loan, if it does close. Yes, you need to tell them if you are using a first time buyer program, but if you start at the lender you may get hit with the charge for your loan, and then find out at the last minute that that particular lender does not participate on the first time buyer program for that city.
The place to ask about first time buyer programs is the government of the city that you intend to buy in, usually the housing department, but sometimes the planning department. If you intend to buy outside of city limits, call the county housing department. Yes, you do need to know ahead of time where you're intending to buy. I know how many people hate to plan, hate to "limit themselves" and hate to do preparatory work, especially multiple sets with multiple cities if they're not certain where they will buy, but it's necessary if you're going to achieve a positive result.
Most first time buyer programs are funded with money that the municipality gets from the federal government. You'd think they would be similar, that funding would be consistent, and that participating lender lists would be mostly compatible. You could not be more wrong.
Once each city gets the money, they are still subject to federal oversight, but that is broad and there's a lot of latitude. One of the things that all of them have in common is that they charge a fee for a lender to participate every year. Unless that lender gets a lot of business through that program, it's not cost effective to automatically renew every year. I only routinely pay the fees for the much broader Mortgage Credit Certificate program every year - I wait until someone wants a given city's program before I pay the fees associated with that program. So the list of approved lenders is going to concentrate heavily on major direct lenders with offices in that city. This has the effect of limiting the competition, although brokers who are willing to sign up still have all of the advantages of brokers, because for the vast majority of these programs, it only matters that the originating office participate, not that the funding office does. Once I'm signed up with most programs, it does not matter what funding lender I use because originating office is what's important, not the actual funders of the loan.
Now, each and every first time buyer program will be different. Any similarities between any two programs are basically coincidence. Income limits, qualifying properties, amount of funding, how long it lasts into the fiscal year (or quarter), how much money they get from the federal government relative to the population and cost of living, and most importantly, whether they have any funds at the time you want them and qualify.
Even the form that the first time buyer program takes is wildly variable. Most common is a second (or third) mortgage with nominal payments and a nominal rate. For instance, one east county city requires a 3% interest only payment. Also very popular is a "silent" second (or third) mortgage with no payments, but it needs to be paid back in full if you sell, and in many cases, if you refinance. Some first time buyer programs work off of a "shared equity" basis, with no payments and no interest charged, but they own a fixed share of the property and are entitled to payment in full at sale, and in many cases, of the base loan amount plus appreciation if you refinance. This lessens the financial benefits of home ownership, because normally the appreciation belongs entirely to the homeowner. Nonetheless, without the program, you wouldn't have had any of the benefits of ownership, economic or otherwise. Still other cities have programs geared towards maintaining a pool of limited income housing in that area, and the price you sell for when you sell will be restricted, negating most of the financial benefits of ownership. Some programs are even tiered based upon income, and those making a lower amount will get more favorable terms that those who still qualify, but make more than people in the first group, and there may be more funding available for the lower tiers. It all depends upon the locality where you buy, and if you apply and qualify for a first time buyer program in City A but end up buying outside of that City limits, you are out of luck. For this reason, you need to work with a buyer's agent who knows the programs and their boundaries and is careful about them. Just because it has the appropriate ZIP Code or telephone prefix does not necessarily mean anything, and I find properties with the wrong ZIP Code in MLS quite often. For instance, properties that are actually in northern Pacific Beach here in San Diego will quite often have the more upscale La Jolla Zip in MLS. Before making an offer, you can always call to make certain the property is within the boundaries covered by the program, of course. You want to double check, because you will pay a fee, usually several hundred dollars, when you apply to the first time buyer program, and I don't know of any that refunds the money if you don't qualify, if you are outside the area, or if you just don't get the funds because they are out of money right then.
Please note that one other feature all first time buyer programs have in common is that they require owner occupancy of a single occupancy dwelling. These are not intended to help investors grow their real estate empire. These programs are intended for people who would not otherwise be able to afford the property and intend to live in it. In some cases, moving out triggers a requirement for immediate repayment in full (and just when it got more expensive to refinance because it's now investment property, too!). In others, so long as you live in it for a given number of years, you can keep it going providing you don't break other rules. Every program has it's own little twists on the owner occupancy requirement. None of them permit you to buy residences suitable for more than one family, either. Duplexes and apartment buildings are disallowed from every program I've worked with.
First time buyer programs are not grants. I've dealt with them all over southern California, and I don't know of any that are outright grants. In many cases, that would be more cost effective, not only to the buyer but to the city as well, than the hoops that have to get jumped through. So I suspect that outright grants are prohibited by the enabling federal legislation, although I've never read the regulations.
Some first time buyer programs do have mechanisms for forgiveness of the loans after a certain period of time. The requirements and length of time vary. I've seen those that have the forgiveness feature be as short as five years and as long as fifteen.
Prospects for subordination if you refinance are also variable depending upon where you buy. Some require payment in full if you refinance at all, while others will allow themselves to be subordinated to new First Trust Deeds providing certain requirements are met. Chief among these are usually requirements that essentially prohibit cash out refinancing unless you pay off the first time buyer program.
One final caveat to these programs is that most of them will not pre-approve you. In other words, they won't look at your application before you've got a fully negotiated purchase contract. I know of only one program that will pre-approve applicants, and none that will commit funds before you have a fully negotiated purchase contract. If they run out of money in the meantime, that's just too bad. - you're out the application fee. For this reason, you need to stay on top of not only the program requirements and boundaries, but also the funding status as well. If they don't have any money when you actually have a contract to buy, you are wasting the time and money to apply.
Now I don't mean to say these programs are not worthwhile. They can and do make the difference between being able to afford the property and being forced to continue to ride the rent escalator. I should also note that they are basically a band-aid to treat the gaping economic wound caused by artificial restrictions to the housing supply. But if the conditions are right for the band-aid to help you, there is no reason why you shouldn't take advantage of it.
While I have been reading the site for about a year, I have tended to gloss over or completely ignore the posts regarding real estate and purchasing a home. That is, until about two weeks ago when I had a conversation with my parents and decided that I want to stop being a renter and instead purchase my first home this spring. I have tried to wade through your numerous posts on Home Buying and Real Estate but am having trouble finding a nice, organized timeline of posts to read. Could you perhaps help me by providing a suggested reading list of your posts for a soon-to-be first time home buyer, in the order that you think I should read them?
Thanks for your time. I appreciate all of the work you put into the site.
The organization on the site is not intended to be in any kind of order. Still, I'll go over a few of the most important ones that everyone needs to know.
Should I Buy a Home? series
Then read my basic series on loans: The Mortgage Loan Disclosure Statement, parts I and II, Truth in Lending, and HUD 1, and why you should ignore APR.
The California Mortgage Loan Disclosure Statement (MLDS) Part I, The California Mortgage Loan Disclosure Statement (MLDS) Part II, Truth In Lending, HUD 1, Why You Should Ignore APR
Now you're ready for the advice on shopping a loan, and dealing with agents. In no particular order:
Payment, Interest Rate and Up Front Costs: Choosing a loan Intelligently
Mortgage and Real Estate Red Flags
Levels of Mortgage Documentation, or, Why You Should Demand to Do More Paperwork
Questions You Should Ask Prospective Loan Providers
Available Real Estate Loan Types
Fixed rate, Balloon, ARM and Hybrid Loans
One Loan Versus Two Loans
The Best Idea About Applying for a Mortgage
Loan Rate Sheets: An example, and the games lenders play
Mortgage Loan Rate Locks
Loan Quote Guarantees
On dealing With Real Estate Agents:
Then then while the whole thing is in process, come back and read as much as you have time for.
I'm exploring book publication, organized in more or less the chronological order you need to know everything.
(If anyone has access to a good literary agent, I'm interested!)
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