After I spoke with Clarisse O’Brian about the first-time homebuyer’s Loan package, I started talking to people who were also connected with the housing market: other lenders, realtors, loan counselors and buyers. The theme song for all of them was the same: first-time homebuyers aren’t savvy enough to avoid the pitfalls and don’t always take the warnings seriously. With a cooling market, and Freddie Mac just announcing that they are longer buying subprime loans, with housing prices at some of the highest points they’ve ever reached and middle-class incomes at a plateau, the costs of getting a first-timer’s package are rising.
The theory behind the loan packages is great. Theory, however, sometimes is staring at the world through some seriously rose tinted glasses. Recent studies by Knight Ridder and similar organizations have found widespread dissatisfaction with the first-time homebuyer’s loan package, and there have continued to be a growing number of people who overdo what they have and can afford. To help you avoid some of these pitfalls, we’ll travel the process and point out, in no particular order, the key elements that the experts think leads to failure.
Essentially, the first-time homebuyer’s loan is a package of several smaller loans and, often, a grant or two. On a conventional mortgage, you’ll have to put down between 5 and 15% of the total price of the house as a down payment, which could run to a $30K investment in a $200,000 house before you even walk in the door. First-time homebuyers, as a rule, are young and still in the lower ranks of work; a $30K payment may be the equivalent of most of a year’s take-home salary to them. Even with FHA underwriting, most mortgages will require a fair amount of up-front cost, which means that long-time renters without significant savings are generally unable to foot the bill. Beyond the down payment, however, you can run into all sorts of additional costs: title fees, taxes, and insurance are only a few of the pricetags that get attached to the selling cost of the home.
The first-time homebuyer’s loan package does away with a great deal of that up-front cost. Essentially, the loan package starts with a conventional fixed-rate mortgage for about 90% of the selling price. A second mortgage (recorded as a second lien against your property) then makes up the difference, meaning that you have little to no down payment to make. The loan may also cover a portion of your closing costs, or a grant may come into play to help there. Finally, the interest rate on the loan is paid down somewhat (one or more “points” are paid) if current rates are high.
To qualify, you will generally have to undergo some form of loan counseling, which will give you some idea of your current assets and liabilities, as well as your current borrowing ability. DO NOT TOSS THIS ASIDE! You will need this later on, when you start talking to a lender and a realtor.
We’ll call this part the “pre-buying” pitfalls, since up until this time no money has actually changed hands or been signed for.
Pre Buying Pitfall #1: DO NOT PURCHASE A HOME AT THE EXTREME UPPER END OF YOUR BUYING POWER!
I can’t even begin to estimate the number of people who get themselves into this trap. The lender will plop down a form that outlines how much you can borrow and gives a “maximum home price” somewhere on it. This is the lender’s estimate (sometimes called the “good faith” estimate) of your borrowing power. It’s a legal contract, by the way; the lender is agreeing to lend you up to this amount. However, the lender may not be functioning at a realistic point. In at least one case that I recently dealt with, the lender presumed that the family could use as much as 50% of the take-home pay for the house payment (a safer, and more realistic, guideline is 30%)
The sad thing here is that many young families will do away with other necessities so that they can make the outrageous payments. Buyers I spoke with listed decisions such as having one or more utilities shut off, not going to doctors and not making payments on other loans, such as student debt. In many cases, the families ended up breaking apart due to the financial pressures, and foreclosures still occurred, even with the sacrifices.
To avoid this pitfall, says debt counselor Denise Roberts, do your own math. Most families can handle a monthly house payment of 30 to 35% of the household’s take-home pay, although she cautions that couples who want children will need to factor in the cost of one of the parents not working or of daycare for the little one(s). Once you have that number, ask the lender what amount of mortgage that payment will support. Add 5% to that point and DO NOT exceed this number.
Pre-Buying Pitfall #2: GET A GOOD REALTOR!
A lot of people are suckered into this trap by sellers (or others) who don’t want to have to pay the realtor’s commission. Big error. Your realtor is your confidante, professional muse and person of all good things when it comes to the world of buying a house. Veteran homebuyers may be able to dispense with the realtor’s services; newcomers cannot afford to do so. Besides the minor point that many first-time homebuyers’ loan packages require you to work with a realtor, common sense tells you to get an expert when you’re laying the equivalent of three years’ salary on the table. Your realtor is that expert.
Another side note, get a realtor who doesn’t already represent the seller. Your costs are not going to change if you do, and you can be assured that the realtor is working for you, not your seller/adversary. While some realtors will try to push you into buying at a price above what you want or feel you can handle, good ones realize that pushing too hard leads to no sale, and no commission.
Finding a good realtor is actually easer than you think, says Century 21 realtor Jeremy Crawford. Start by asking friends, family and neighbors. Within a few hours, you’ll have a laundry list of realtors to avoid, and hopefully the names of one or two who are recommended.
Pre Buying Pitfall #3: READ THE FINE PRINT!
A first-time homebuyer’s loan package is a package deal, usually comprised of a conventional mortgage, a second (deferred) mortgage and on e or more grants. Your monthly payments will be based on the primary mortgage, as the second mortgage does not require payment until the first mortgage is retired. The grants act more like forgivable loans than true grants; they disappear a little at a time over the course of several years. Make sure you know what is financing your home!
As an example (and a rather painful one) of this pitfall, I purchased a home some eight years ago in New Mexico under a first-time homebuyer’s loan package. I didn’t read all of the fine print, but rather relied on my lender’s assurances that my house was being financed by a conventional mortgage and two grants. Both of the grants would not have to be repaid if I lived in the house for five years.
When I went to sell the house five years after buying it, blithely assuming that what I had been told years ago was true, I found out that one of those “grants” was in fact the second mortgage I’ve mentioned several times. It cut my gain on the house from slightly more than $11,000 to less than $2K.
And lastly, Pre-Buying Pitfall #4: DO NOT SIGN ANYTHING AT THIS POINT WITHOUT A THOROUGH EXPLANATION!
A recent MSNBC article revealed that some unscrupulous lenders were forcing borrowers to sign agreements that they would use that lender’s bank for financing. The same article also said that some realtors were doing the same thing, in essence forcing the buyer to pay for their services whether they were used or not! Prequalification does not require any contracts to be signed, and your realtor does not need the form that designates him or her as your agent until closing. Asking for your signature, especially if they cannot explain why it is required now rather than later in the process, is a sure sign that you do not want to be associated with these clowns. Find a new group to business with.