Obtaining financing when buying your first home can be intimidating. As one of the largest financial decisions many of us face, it is also the one we experience the least frequent. Lack of experience, coupled with high stakes, creates a process ripe for consequential mistakes.
“We will probably be ready for a place in about a year, but I’d love to meet with you now so I can learn how to best prepare.”
Those were the exact words I said to Eric upon meeting him. Two months later, my wife and I closed on our first property in San Diego.
The mortgage lender we worked with, Eric Union, was terrific and kind enough to revisit many of the questions I asked him during our process. We want to arm you with the appropriate information prior to your big decision. Below are Eric’s responses to a number of my questions:
Knowing what to Buy
What I have learned over the years is that the answer to this question is unique to every client I work with. The two main areas I focus on when it comes to what is suitable, appropriate and prudent are:
1) Financial Profile
2) Peace of Mind
Housing is a Dual Asset Purchase
House- This will likely be one of the best performing assets on your balance sheet – San Diego houses historically have doubled in value every 15 years, may provide rental income, leverage & tax write-offs.
Home- This is your safe haven to come home to after a long day, where you raise a family, build memories, and provides a roof over your head.
Financial Profile Considerations
Income and Employment History – How solid and sustainable are they, is the skill set driving the income well developed, and is the income fixed or variable?
Assets – How much money is saved versus consumed, are there adequate emergency cash reserves or adequate liquidity.
Credit and Debit History – How many lines, how much strategic and non-strategic debt, are credit scores above 800 with all three credit bureaus, how leaned up is the spend, how much discretionary cash flow is left over each month, etc.
Specific to San Diego
Buying a home in San Diego historically has been an excellent long-term financial decision.
San Diego has a housing supply problem that is not easily solved, the population is growing through birthrate, not net migration, and the economy is diversified with many progressive industries. With 3% – 5% down payment programs available, most people don’t realize they can buy.
Debt and Student Loans
Strategic Debt: controls an asset that can appreciate in value over time and you can write off the interest.
Non-Strategic Debt: is the opposite of strategic, goes down in value and non-deductible.
Student loans: you are the asset that appreciates and if you earn a lot of money you phase out of being able to deduct the interest. These loans are treated more favorably with underwriting. There are several ways the payments can be low relative to the principal balances owed.
Your home’s interest rate is impacted if your debt to income ratio exceeds various thresholds depending on the loan program (Conventional, Jumbo, FHA, VA, Non-QM, etc.)
Key Credit Scores
The base level for credit scores is 620 but there are programs that allow for lower scores. No judgement here, but buying a home is likely not suitable until scores are higher and finances are stronger.
There are significant improvements in rate when scores exceed 680, 700, 720, 740, 780 & 800. Underwriting flexibility improves with higher scores.
Budgeting Other Items
Your maintenance and repairs cost will depend on the type of property you buy and the inspection report you will get during the escrow.
First time buyers typically buy a condo or town home which has an HOA fee which covers the structure and grounds, leaving only the inside of the structure to maintain.
Closing costs are typically about $4,000 – $6,000 for buying in the $250,000 – $1,000,000 range.
Pre-Paid expenses (mortgage interest, taxes, insurance, inspections) ~$2,000 – $5,000 but then you skip a month’s mortgage payment.
Impound Account (required if <10% down payment) ~$2,000 – $5,000. There are several ways to meet these cash needs – Seller Credit, Lender Credit, 401k loan, IRA distribution (Exclusions available for first time buyers), Gift, etc.
Different Mortgage Types
Conventional mortgages– These are the most common, they have traditional terms and guidelines that are sold to a government agency (Fannie Mae or Freddie Mac), who “securitizes” or “packages” the loans into a security (Mortgage Backed Security) that can be sold to investors.
FHA mortgages– are insured by the Federal Housing Administration, they have much more flexible qualifying guidelines (weaker credit history, higher debt ratios, lower down payment (3.5% vs 5% on loans above $484,350), more income sources) but typically cost more.
VA mortgages– are a wonderful benefit for those who serve our country! No down payment needed (up to $690,000) and only 25% of amount above $690,000, No MI, flexible but unique underwriting guidelines.
Shopping for the Best Interest Rate
Having the right mortgage plan and strategy builds peace of mind and significant wealth over a 20-30 year period.
Saving .125% to .25% in rate on the wrong strategy can have big opportunity costs. In addition, lower rate means you will likely not be able to talk to the same person twice, underwriting may take 45-60 days and savvy Listing Agents may not recommend your offer to the Seller if there are other offers with a local reputable lender.
Buying investment property in addition to your primary residence is a great way to build wealth.
When you think about buying a $400,000 property in San Diego when you’re 30, it will likely double to $800,000 at age 45. It will then redouble to $1,600,000 when you are 60.
Points are additional cost you pay up front in order to have a smaller interest rate.
The higher the rate the lower the cost and vice versa. One point equals 1% of the loan amount. It usually takes 4-9 years to break even when paying points (buying down the rate).
In the higher interest rate cycle that we are in it is usually more advantageous not to pay points.
Top Takeaways from Eric:
- Know what you can afford
- Effects of debt and loans on your purchase
- Consider the additional costs
- Have the right mortgage plan and strategy
Now that Eric has clarified much of the daunting terminology associated with the lending process when buying your first home, you might be asking well how much can I afford? I recently came across this helpful spreadsheet that can assist you in your calculations. And of course, if you’d prefer to work with a professional, we’d love to talk!