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The Home Financing Process

The Home Financing Process

“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.

Getting financing for your 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.

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.

How much is too much house?

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 and 2) Peace of Mind.  Buying a primary residence is a “Dual Asset” purchase. It’s a House, which 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. It’s your Home, 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 include your income & employment history – how solid and sustainable are they, how well developed is the skill set driving the income, is income fixed or variable. Assets – how much money is saved versus consumed, are there adequate emergency cash reserves, adequate liquidity. Credit & Debt history and current structure – how many tradelines, 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. 

Peace of Mind considerations entail risk tolerances for each borrower, married couples bring in different financial filters on finances based on their upbringing, parental influences and personal interest. Financial stress is a leading cause of divorce and family breakdown, it is important to work with professionals who have high levels of experience and expertise when determining how much is too much house. 

Buying a home in San Diego historically has been an excellent long-term financial decision. The sooner people can buy a home the more wealth they will build provided they keep it on their balance sheet for the long haul or trade up, or ideally do both. San Diego has a housing supply problem that is not easily solved, our population is growing through birthrate, not net migration, and our economy is diversified with many progressive industries.  With 3% – 5% down payment programs available most people don’t realize they can buy. There is a wise saying, “When is the best time to plant a tree? 20 years ago. When’s the next best? Today.”

I know debt to income ratio is a key factor in determining an interest rate, is all debt created equal? Specifically, how will my student loans impact my home’s interest rate?

I teach clients to think of their debt in two main categories, Strategic and Non-Strategic. 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, goes down in value and non-deductible. There are important habits, structure and strategies to deploy when it comes to credit card use that impact Debt to Income ratio and to build credit scores.

Student loans are a “tweener,” 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 and 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.)

Are there any key credit scores? For example, being above a certain number when rates become more favorable, or being below a number that rates become significantly higher.

Absolutely. Since 2009, there are over 30 different Loan Level Price Adjustments that factor into the rate a borrower receives; it is not uncommon for there to be as much as a 1% difference in rate due to these LLPAs.  Credit scores are a top 5 needle mover and we can create strategy to positively move the needle over a short period of time.  The base level for credit scores is 620 but there are programs that allow 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 and underwriting flexibility improves with higher scores.

There is a little more to it than just being able to pay the mortgage, insurance and taxes. What other items should we budget for and what should we expect of closing costs?

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 townhome which has an HOA fee which covers the structure and grounds, leaving only the inside of the structure to maintain and you get a home warranty policy paid for by the Seller covering all appliances and systems for a year. A good Buyers Agent will properly advise you on ongoing costs for each property, as will the home inspector in their report.

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 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.

Should I still move forward if I need to take on PMI? Will PMI eventually go away?

In most cases yes, Mortgage Insurance should not be a deterrent, and with most programs it will eventually go away. Proactive management of this by your mortgage advisor can make a big difference.  There are many different ways to structure your financing; work with a seasoned professional who can put together a plan that integrates well into your long and short term goals and proactively manage it on an ongoing basis.

What is the difference between the mortgage types – conventional, FHA, VA?

Conventional mortgages 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.

With each of these main types, you can get a loan up to $690,000 on a condo/townhome/single family residence, you can also go higher for 2-4 unit properties – Duplex $883,300, Triplex $1,067,750, Fourplex $1,326,950.

With the aforementioned Loan Level Price Adjustments (LLPAs) being standardized, how important is it to shop around for the best interest rate, if at all?

Shopping around for a rate is difficult because MBS are traded all day every day just like a share of Apple stock, with pricing changing constantly. Whatever “Rate” is advertised on the internet or billboard etc is stale so it is not uncommon for people to find that the advertised rate is very different from the actual rate. Rates can move as much as .5% in a couple of hours. Keep in mind, with 30 LLPAs it is impossible for a lender to advertise what your actual rate will be.  Most lenders will be within .125% to .25% in rate once the dust settles – LLPAs are determined, property is found, inspections and financing contingencies are cleared and escrow closes.  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.  Underwriting guidelines and loan programs are a little different for a rental property and being a Landlord has a learning curve. But, when you think about buying say a $400,000 property in San Diego when you’re 30 it may likely double to $800,000 at age 45 then redouble to $1,600,000 when you are 60.  Just think if you can buy and hold 3 of these and have them free and clear for retirement, it’s not as hard to do as you might think if you work with professionals.

What are points?

Points are additional cost you can pay up front in order to have a lower interest rate. Think of it like a seesaw, on one side is your rate, on the other is your closing cost (points). 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.  A good lender will prepare a Total Cost Analysis comparing multiple financing strategies over the short, medium and long term to help you make the most informed decision possible.

Thank you Eric! 

Now that Eric has clarified much of the daunting terminology associated with the lending process, 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!

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