How Financing Affects Your Offer
Most buyers do not have enough cash to buy a house, so they need to obtain a home loan, aka a mortgage. Since you will probably make your purchase contingent upon obtaining a mortgage, the seller has the right to be informed of your financing plans in order to evaluate them. This is one of the reasons why financing details are included in your offer. When your agent submits your offer to the seller, she will want to attach a mortgage preapproval letter. You may obtain a preapproval letter from any lender you wish to work with, but your agent should have recommendations for reputable lenders who can assist you. It is very important to work with a good lender. You should understand the terms of the loan clearly, and your lender should be experienced enough to know exactly what types of loan are available. Your real estate agent and your lender will be in frequent touch during the escrow period. You can use our Mortgage Calculator to estimate your monthly housing payment. If your loan broker gives you an estimate, be absolutely sure that s/he is including the cost of property taxes and hazard insurance! Property taxes in Los Angeles County are around 1.25% of the purchase price. They can be paid in two annual installments, or can be added to your monthly mortgage payment.
Down Payment and Financing
As part of your offer, you will need to disclose the size of your down payment. Once again, this allows the seller to evaluate your likelihood of obtaining a home loan. It is easier to obtain a mortgage when you make a larger down payment. The standard down payment is 20%, but when prices are as high as they are in Los Angeles County, this is unrealistic for many people. If you only have 5% down, you will obtain two mortgages: the first for 80% of the value of the house, and the second for 15%. Your 5% + the first mortgage of 80% + the second mortgage of 15% = 100% of the purchase price of the house.
The second mortgage basically supplements your down payment: You only have 5%, so you obtain a mortgage for another 15%. Simply put, the second lender is providing the remaining funds needed to cover 20% of the purchase amount, since the first mortgage provider will not make a loan for more than 80%. For anyone who has less than 20% available in cash, the typical mortgage scenario is that they have two loans. Note that the second mortgage, the smaller of the two, is almost always at a higher interest rate than the first.
In today’s tighter lending market, most lenders want buyers to have at least 10% down. There are exceptions, however, so you should talk to your loan broker about the best options. FHA loans, for example, can be obtained with only 3.5% down, but they carry more conservative restrictions. For example, you can not obtain an FHA loan on a home that is in need of extensive repairs. For that reason, FHA loans are often not feasible for the purchase of foreclosures, since so many foreclosed homes have been damaged in some way. Your real estate agent should call each foreclosure that you are interested in, to find out if the seller will accept FHA financing.
You also need to understand the difference between ‘conforming’ and ‘non-conforming’ loans. Currently, the ‘conforming’ loan amount is $417,000. ‘Conforming’ loans conform to Fannie Mae guidelines. All you need to know as a buyer is that conforming loans carry more attractive, i.e. lower, interest rates than non-conforming, or ‘jumbo’ loans. But a new category of loan has been introduced in order to stimulate the real estate market in pricier areas like Southern California. This category lies between ‘conforming’ loans and ‘jumbo loans,’ and is called ‘high-balance conforming’. The cap for this in Los Angeles County is currently $729,500. This ‘high-balance conforming’ category offers interest rates that are a little higher than for loans up to $417,000, but are lower than for jumbo loans. Talk to your loan broker about the differences in conforming and non-conforming rates. This may make a difference in what you are comfortable paying for a home!
Interest Rates
Another reason your agent will include financing details in your offers is to protect you. If interest rates suddenly rise, as sometimes happens, you may be looking at a mortgage payment much higher than you anticipated. By specifying a maximum acceptable interest rate in the offer, you are protecting yourself from having to proceed with the home purchase if rates go up too dramatically. At the same time, the seller will want to know that there is some flexibility in the financing terms you are willing to accept. If interest rates are currently at eight percent, and if you indicate in your offer that this is the highest rate that you will accept, you could cancel the contract without penalty if interest rates rose above that point. The seller would suffer, having lost valuable marketing time, and perhaps having to revise plans that were based on successfully closing the transaction.
Your lender should “lock” your interest rate early in the loan approval process, and as soon as they find what they believe will be the best rate available to you. That way, even if rates rise, you will obtain the rate that was locked for you. Note that rates can not always be locked for more than 30 days, and you should make sure your escrow closes before the lock is set to expire. Your realtor and lender should coordinate this.
Closing Costs and Financing Incentives
There may be times when, as part of your offer, you request the seller to pay all or a portion of your closing costs, or provide some other financial incentive. One common request is asking the seller to provide funds to temporarily buy down your interest rate for the first year or two. Such incentives can be especially effective if a buyer is tight on money or pushing their qualifying ratios to the limit.
Whenever you ask for incentives, you will probably find the seller less willing to negotiate on price. After all, what you are really asking is that the seller give you money to help you buy their house.
Seller Financing
Another occasional request is to have the seller “carry back” a second mortgage to help facilitate your purchase of their home. In cases when the seller does not need all the proceeds from their sale in order to purchase their next home, this is an option. The seller essentially gives you a second mortgage, on top of the first mortgage you are receiving from a regular lender. The advantage to you, the buyer, is that by combining your down payment and the second mortgage from the seller, you may be able to avoid paying mortgage insurance and save yourself some money.
If such a carry-back is part of your offer, you should include the terms you wish to pay on the second mortgage. Keep in mind that the lender who is loaning you the first mortgage, aka the first trust deed, needs to know this information so he can underwrite your loan properly. That lender will have certain minimum requirements. The minimum term of the second mortgage can be five years, for example. The minimum payment can be “interest only.” Longer mortgage terms and payments that also include principle are also acceptable.
With lenders tightening their guidelines, however, seller financing is becoming less and less common.
Cash Offers
If you are one of those rare individuals making a cash offer to buy a home, it makes sense to provide some documentation with your offer that shows you have the funds available. An account statement showing a sufficient balance is enough, even if you do not plan to use the funds from that exact account. If you have to liquidate stocks or some other asset, your offer should indicate a timetable on when you will show proof that you have converted the assets into cash.
How FHA and VA Loans Affect Your Offer
Extra Costs to the Seller
If you are obtaining a VA or FHA loan in order to finance your purchase, you must include that information in your offer. This is because government loans place additional financial and performance obligations on the seller.
Non-Allowable Fees
First, VA and FHA loans prohibit buyers from paying certain types of fees that are often charged by lenders, escrow companies, settlement agents, and title companies. These are called “non-allowable” fees. They still get charged, but as the buyer, you are “not allowed” to pay them. The result is that the seller ends up paying them.
Most of these “non-allowable” fees are charged by lenders. You or your real estate agent should ask your lender ahead of time how much the lender’s non-allowable fees will be. Experienced agents should also have an idea of what non-allowable fees will be charged by the escrow or settlement agent and the title insurance company.
Since these are fees the seller would not pay for a buyer with conventional financing, the information must be included in your offer. You should also realize that since the seller will be paying these additional fees, they may be a little less flexible on the price.
FHA and VA Appraisals
Home appraisals on FHA and VA loans are a little more detailed (and more expensive) than on conventional loans. The appraisers are required to perform certain minimum inspections as well as evaluate the market value of the property. Although these inspections are not as detailed as a professional home inspection and should not be considered a substitute, sometimes repairs are required.
These repairs are also additional costs the seller would not be obligated to pay for someone obtaining conventional financing, so your offer should include a maximum figure that the seller should pay for these repairs. Otherwise, the seller is signing the equivalent of a blank check, and their agent will advise them not to do so!
Whatever amount you specify in your offer will affect the seller’s willingness to negotiate on the price of the house. If you stipulate that the seller should provide $500 for any repairs, the seller may be $500 less flexible on the price.