We have all done it, and for those of us that haven’t, we surely will at some point. It isn’t a bad thing by any means, but it can be if not handled the right way. This is a real estate blog, so you may have already guessed what this act is!
At a certain stage in life, almost everyone buys a house. Everyone seems to be getting the same information and the same advice for life. We all seem to get the imprints of going to school, finding a good job and living the American dream of buying a house and having a family. It is what you see on the television and what our instincts seem to tell us to do, so we obey most of the time.
Living the dream is different for everyone, but it more than likely includes buying a house for personal ownership. Buying a house is the single most expensive purchase of one’s life and can easily be a cause for getting into financial trouble. For those reasons, I am writing about the mortgage process and attempting to clarify some of the components that go into purchasing a house. After all, it can be complicated, but it doesn’t need to be. And with such a big decision, jumping into such a process shouldn’t be taken for granted.
Before we get into the weeds, we do need to clarify a few terms.
There are plenty more terms, but knowing what these are is a good start for understanding the financing or real estate.
Getting approved for a mortgage starts with an application with a lender to buy a property. There are many lenders available and they will each have advantages and disadvantages over the other due to several factors.
These lenders need information on the property and the borrower because the loan application will need to have underwriting done. The application needs the basics: property information like age, loan balance and taxes, borrow information like age, employment, financials and education, and finally supporting documentation like reports (appraisals), contracts, credit and verification of income and employment. Once all this is provided, the underwriting process can begin.
Underwriting is done by the lender to assess the risk associated with lending to said borrower for said property. If the numbers are good and the loan fits within certain criteria, the lender will provide a loan commitment and pledge funds to the purchase.
The two components of a mortgage loan (borrower and property) will have to qualify for lending.
The borrower has to be able to show income stability, cash qualifications, financial strength and credit worthiness. Borrowers might have to show stronger or weaker financial fitness depending on the loan to be given. Take a VA loan as an example; they will lend with zero money down because they are backed by assurances that other lenders don’t have, meaning there is more security in the VA mortgage. Different loans will have different requirements.
The mortgage has to be qualified too. There are “ability-to-repay” requirements that must be met for the property to be mortgaged. This is where lenders can analyze the risks associated with the loans available. Lenders are essentially protecting their assets and themselves in the event that the borrower fails to repay. Part of this protection is in the valuation of the home to ensure that the price isn’t going to be a detriment to the loan.
Let’s talk numbers for buying a house. We should all be aware that there are certain numbers that lenders use to qualify a mortgage for a borrower. One of these numbers is the income ratio, or the ratio of monthly housing expenses to monthly gross income. Housing costs include PITI in addition to utilities. Depending on the lender, the ratio will need to be 31% or lower in order for the loan to be approved. A monthly housing expense of $1300 divided by a gross income of $4500 is a 29% ratio, which would be too high for some lenders, but not all.\
The debt ratio takes this formula further and analyzes housing expenses in addition to monthly debt payments (car loan, revolving debt, etc). The same formula applies where all expenses are divided by monthly gross income in order to get the debt ratio. Since many Americans are overloaded with debt, let’s use a monthly debt load of $1200 that is separate from housing expenses. That would be $1200 plus $1300 ($2500) divided by $4500 and would give us a debt-to-income ratio of 55%! That could be a detriment to a loan, but some people are in far worse shape that 55%!
Other factors go into analyzing the risk a borrower is making, to include credit and income stability. Frequent job changes aren’t necessarily a bad thing if the jobs accepted were better than the prior ones. Basically, lenders want to see an ability to repay debts and minimize risk. Cash and net worth (assets) will come into play as well.
Ah, that dreaded stack of paperwork at closing (it really makes you appreciate closing with cash)!
First of all, closing happens at a title company in Florida. Funds are provided to the title company and they are used to secure the transaction. Disclosures are presented (if they haven’t been already) for the buyer and seller so that everyone knows their rights and all pertinent information. Paperwork should have been provided for review by this point and shown more accurate numbers, like the loan estimate, monthly payments, interest rates, etc.
Closing is the process of transferring title and recording the transfer. During this process, the promissory note is signed (basically an I.O.U. to the lender) and recorded. Since we are primarily doing business in Florida, we will talk about closing in terms of Florida. So paperwork is signed, the loan is authorized and the buyer walks away with title to the property and a lien that will be repaid over the term of the loan.
There is nothing scary about this process, I promise! Clauses are present and used in a way that seems excessive, but they are there for protections of the buyer, seller and lender. We won’t go into non-traditional closing like cash closings and deed restrictions just to keep things simple.
Florida is a lien-theory state. What that means is that legal title (ownership) is transferred to the buyer and the buyer provides a promissory note to the lender promising to pay. Since the lender isn’t in control of title and has taken risk by lending capital, a lien is placed on the property to secure the investment of the lender. Once paid off, the lender removes the lien and the title is free of encumbrances (basically money owed to someone else that is secured by the property [collateral]).
Don’t think that a lien is something that needs to be avoided. Having a lien on a mortgage can be a very good thing!
Many people love real estate because of liens and leveraging other people’s money. Let’s use our next home purchase as an example (we are in the process of closing on our next house presently). I am a veteran so we are using a VA loan to purchase a condo. With the VA, there isn’t a down payment requirement, so we don’t need to come to the table with any money up front.
That being said, when lenders see that there is no money from the buyer at closing, that means that the lender is taking 100% of the risk on the loan. Because they are taking so much risk, the lender will require a VA funding fee (points up front) in order to recoup future losses. This is nominal (1%), but it must be paid in order to get the loan. With some negotiation, that fee can be tied into the mortgage so that you literally bring nothing to closing. All funds are provided by other people. Our first house purchase to owner occupy was this way, albeit with the exception that we did have to write a check in order to close. That is my favorite check because we closed with $7 down!
$7 and we were homeowners!
Our first house purchase was daunting for me because it was completely new for me. I didn’t know anything about anything to do with real estate and went through the motions trusting that everything was good. My wife had known contract law for years prior to that, so I trusted that if there was something awry that she would be able to spot it.
Title companies do a great job of explaining it as the process happens, so even if you do have a question, you shouldn’t have to ask because they are explaining it as they go through the motions. Clauses are big in this aspect because the names aren’t necessarily intuitive and can need further explanation beyond the legal speak in the paperwork.
We, of course, are not a title company or lender. We aren’t even real estate sales associates/Realtors (yet). This isn’t something that we have to know being investors primarily, but it is something that clients and customers of ours need to know, so that dictates that we have to become proficient in such practices. Knowing this and presenting it to you is important because it will show you what options you may or may not have available as a seller or buyer.
Take a foreclosure as an example. Let’s say that it is weeks away from being foreclosed on. The problem with mortgages is that they take time and can’t close as fast as investors, so even if the home is unable to be financed, the buyer to be found has to be able to close very quickly in order to stop foreclosure. Not many conventional buyers (mortgaged purchases) have the cash on hand to close quick, especially with a house that costs upwards of $50,000 or greater.
And that is the limitation of mortgages… Mortgages are great for listed properties, but properties that can’t be financed require the hand of investors to return them to the market. As investors, we specialize in that area of real estate and provide the solutions that mortgages and conventional lenders can’t. We offer cash and can close quickly because some homeowners need exactly that!
Sonny Side Property Solutions is here to help everyone with their real estate needs. Our offers have to make sense, first and foremost, to the owner. They are priority number one because they have the problem that needs solved. And investors are good problem solvers! While we may not be licensed agents (yet), we do adhere to the same laws and do what we can to inform the consumer of the options available and the legalities of certain actions.
Feel free to reach out to us for anything, whether it is a general question, to inquire about selling a property, to inquire about buying a property or anything else. We are here to serve the community and provide real estate solutions for any situation and have a national network of investors on our team that we use for many situations.
We can be reached by phone at (850) 710-0710 or by email at firstname.lastname@example.org.