Real Estate Financing Guide
- Start a green file that contains all of your important financial documents, including all financial statements for bank accounts, investments, credit cards, auto loans, recent pay stubs, and either two years of W-2 forms from your employer or the most recent two years’ tax returns if you are self-employed. Include proof of other income sources, such as alimony, trusts, or rental income, a copy of your driver’s license, and if you’re not a U.S. citizen, a copy of your green card or visa.
- Check your credit rating to help determine your credit rating. Credit scores range between 400 and 800, with 620-plus considered “good” and 680-plus considered “premium,” which may help you get a lower interest rate. Below are links and phone numbers for the three major credit reporting agencies, if you choose to do this yourself. Or, you may contact a lender who can pull the reports for you and provide guidance on improving your score, if needed. We will be happy to recommend experienced lenders to assist you.
- Set aside adequate reserves to use toward your down payment, inspections, and closing costs, such as the appraisal, escrow, title insurance, and miscellaneous fees.
- Pay down any existing debt with high interest rates, such as credit cards.
- Avoid major changes such as career moves, moving your money among accounts, or buying any big-ticket items, especially opening any new credit accounts. Debt payments can significantly lower your potential loan amount. If any major changes like these are critical, meet with a lender and ask how to best proceed.
Once your financial picture and documentation are in order, it’s time to choose the right mortgage broker or lender and loan. Below are important points to consider in choosing your mortgage broker or lender, and some of the many types of loans available.
- Interview several mortgage brokers or lenders to evaluate their response time and ability to explain things clearly, including the competitiveness of interest rates, costs, and fees; the availability of loan programs to suit your situation; and access to a local loan approval committee that understands the kind of property you are buying.
- Today there are so many types of loans on the market that it is beyond the scope of this page to list or explain them all. Your broker or direct lender is the best person to help you select a loan program to suit your needs. Below are the three most popular loan types we see in practice.
- A fixed loan assures your monthly payments will stay the same over the life of the loan, which is typically between 15 and 30 years. Fixed rate loans may be best if you intend to hold the property for a long period of time, say over 7 years.
- An ARM (adjustable rate mortgage) may be suitable if you plan to sell or refinance your home within the next few years. The starting interest rate is typically lower than a fixed rate loan, saving you money initially.
- An intermediate ARM, also called a hybrid loan, can offer fixed interest rates for the first three, five, seven, or 10 years after which the interest rate adjusts with the market every six months or year thereafter.
Below is a summary of upfront costs and financial terms that contribute to financing a real estate investment.
- An application and processing fee is typically a few hundred dollars and is charged to cover the lender’s work to evaluate your ability to repay the loan. Some lenders will credit this back to you upon closing.
- The APR, or annual percentage rate, is the sum total of all your borrowing costs expressed as a percentage interest rate charged on the loan balance.
- The interest rates on variable loans readjust periodically based on changes in an index. Typical indexes include the Federal Funds Rate, Treasury Bill.
- When mortgage companies are competing by offering lower interest rates, they may charge you a one-time, pre-paid interest payment calculated as a percentage of the loan. Called “points,” this may range from 0.25% to 2% of the loan balance and is usually paid up front. Points are tax-deductible; consult with your tax advisor.
- Appraisal costs vary depending on the property, type of appraisal, and region in which it is conducted. Lenders hire experienced, independent appraisers to evaluate the property’s purchase price, condition, and size compared to similar recent neighborhood sales to ensure the purchase price is not too high and underscore their confidence in recovering their investment in the event a borrower defaults.
- Expect to see various charges incurred in the processing of your loan which might include notary, courier, and county recording fees.
A pre-qualification letter is an opinion from a lender of the maximum amount of real estate for which you may qualify for financing and is based on less information than is required for getting pre-approved. In a competitive seller’s market, a pre-approval letter carries more weight than a pre-qualification letter, because you know exactly how much real estate you can afford, it reduces the amount of time it takes your lender to fund your loan, and your offer is better positioned than someone less prepared.
To attain pre-approval, be prepared to provide comprehensive documentation to your lender, which they may independently verify. This documentation should be gathered in your green file and include recent pay stubs and two years’ tax filings to show your employment status and income, the past three months’ bank statements to show cash on hand and monthly debt payments, and any other statements showing your total assets and debts.
Lenders have analysts called underwriters who crunch your numbers and verify your documentation to confirm your ability to repay the loan. Once you are in contract on a property, there may also be a loan approval committee that meets to review the underwriters’ conclusions regarding your creditworthiness and evaluate the property on which they are lending. This is called the underwriting process, and questions are bound to arise. Check in with your broker periodically and always return your mortgage broker’s calls promptly to keep the process moving forward smoothly.