Q: We are first-time home buyers. We have signed a contract to buy an older house in a nice neighborhood, and the purchase price is $250,000. We have 45 days in which to obtain financing and have started shopping around with different mortgage lenders. We have two questions.
First, the contract states that we will put down 20 percent and obtain a mortgage loan of 80 percent (i.e., $200,000). However, we have begun to realize there will be significant closing and moving costs, and we would prefer to put down less money.
Are we committed to a down payment of 20 percent, since that is spelled out in the contract? Second, what kind of loans are available, and what's best for us?
A: Your first question is easy. Legally speaking, you are bound by the terms of the sales contract. You must put down 20 percent, or $50,000. However, as a practical matter, I suspect that you and the sellers can sign an addendum to the contract that modifies these terms. As long as the amendment will not create any delay in going to settlement and will not cost the sellers any more than the original sales contract would, such an addendum should cause the sellers no problem and can probably be signed when you go to settlement. I suspect that your lender will want to have this addendum in its files.
Your second question is difficult to answer though, because I do not have any financial information about you. You should discuss these issues with your potential lenders. Ask them to qualify you based on the highest (and the lowest) loan you are seeking. Here are some variations, starting with the most basic:
A "conventional" loan.
This is what's in your contract, where you put down 20 percent and borrow 80 percent. In your case, it will require that you put down $50,000.
Lenders want to be sure that, should you become delinquent on your mortgage payments and the lender has to foreclose on the property, there will be some equity left. The typical benchmark is 20 percent.
Because you indicated that this could create a financial strain for you, you can also consider some alternatives, each of which carries its own set of considerations.
For instance, if you borrow more than 80 percent of the value of the house, you will be required to pay private mortgage insurance premiums for a long time. This PMI protects your lender. It would cover any loss the lender might incur if it forecloses on the house and the price does not cover the mortgage balance. But there is a way around this:
An 80-10-10 loan. With this arrangement, you will be obtaining two loans, one for 80 percent of the purchase price (or $200,000) and a second loan for 10 percent ($25,000). You will have to put only 10 percent down ($25,000) when you go to settlement.
The 80-10-10 loan was designed to help buyers avoid PMI. Because the first mortgage (deed of trust) is only 80 percent, no PMI is required. You should understand, though that you will have to sign a second deed of trust for 10 percent of the value of the house. This second trust will carry a higher interest rate than the first trust has. The second trust also will probably have a shorter due date (perhaps 10 years) than the first trust.
Here are other formulas to consider:
90 percent loan. Here, you will borrow $225,000 and sign only one mortgage document. However, private mortgage insurance will be required.
95 precent loan. Again, private mortgage insurance will be required, but you will have to put down only 5 percent ($12,500).
This is just a small sample of the various loans available. There also are variations on these mortgages. For example:
Fixed 30-year mortgages. With this type of loan, the loan will be amortized over 30 years. Every month you will make the same monthly mortgage payment (although the escrow amount may change each year if taxes and insurance premiums increase).
Fixed 15-year loans. The loan will be amortized over 15 years. This means monthly payments will be much higher, because the loan will be paid in half the time. While some people like the idea of paying off their mortgage early -- and thus saving a lot of interest payments -- I prefer 30-year loans to 15-year mortgages. If you obtain the right to pay off the loan early (in whole or in part) without penalty, a 30-loan mortgage allows you to make payments as if they were based on a 15-year amortization, but it does not require you to make these higher payments should you decide your money can be used for better purposes.
Adjustable-rate mortgages. Called ARMS, these carry various rate-adjustment periods. These adjustments can be made on a yearly basis, or once every three, five, seven or even 10 years. Keep in mind that the shorter the adjustment period, the lower the interest rate.
Balloon notes. Here, the loan may require monthly payments based on a 30-year amortization schedule. However, at the end of a fixed period (e.g., seven or 10 years) the entire balance will become due. This kind of loan is more common for commercial or investment loans, but you should be aware that balloon loans do exist for individuals -- and you should make sure your loan will not suddenly become due after a number of years.
You should contact two or three mortgage lenders and ask the following questions:
* What kinds of loans do you have available?
* What are the rates for each loan?
* Based on our financial situation, can we qualify for any or all of the loans?
* Is there a prepayment penalty if we decide to refinance early, and if so, how much is it?
* Can we pay our real estate taxes and homeowner's insurance premiums directly, or will you require that we have an escrow account? This means the lender will collect, on a monthly basis, one-twelfth of the real estate tax and one-twelfth of the annual insurance premium. When the tax and the insurance come due, the lender will make these payments on your behalf. However, when a lender requires these escrow arrangements, it means the monthly mortgage payment will be higher. This is referred to a PITI (payments of principal, interest, taxes and insurance).
You are entitled to receive two documents from your lender when you apply for a mortgage. One is known as the "good faith estimate," which will give you a ballpark figure on how much you will have to pay when you go to settlement. The other document is known as the Truth in Lending disclosure, which will tell you the annual percentage rate of your loan. The APR is (or should be) the true rate of return that the lender will get on the loan you are obtaining.
Shopping for a mortgage loan is time-consuming, tedious and often confusing. However, it is your money at stake and you don't want to make a major mistake that will haunt you for years.
Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address.