Lori Erickson

Loan considerations for a first time buyer

Lending guidelines are changing on a daily basis for every type of loan: conventional, FHA, VA & commercial. Nevertheless, there are still very attractive first-time home buyer options available. If you are or will be a first-time buyer, it is critical to speak with a loan officer before looking at homes. It is a crushing feeling to view a home, picture making it your own and then find out that you cannot qualify to purchase it. A loan officer will pull credit, analyze debt-to-income ratios, review assets and income and determine what you can afford.

Presuming a pre-qualification occurs, the loan officer will then be able to provide an array of loan options. Presently, FHA loans are the predominant loan for first-time home buyers as they offer flexibility with down payment, income and assets. In 2009, FHA loans will require a 3.5% down payment; however, such funds can be a gift from friend or family member. Additionally, pending on where the home is purchased, many cities still offer down payment monies to assist borrowers with little or nothing down. There is even a program that permits someone to purchase a home for as little as $100. Please keep in mind that when a borrower does not make a down payment, their interest rate will likely be higher, since it the loan will have greater perceived risk.

Conventional loans are very comparable to FHA loans in loan terms and fees. They can be more restrictive with down payment options, debt ratios and alternative forms of credit. But, they require less paperwork than FHA loans, which typically means a smoother underwriting process. Furthermore, they do not require an up-front mortgage insurance premium like FHA loans ---- although, their monthly premiums are higher than FHA. FHA, conventional and VA loans are in the low 6% range on 30 year fixed mortgages with no prepayment penalties. These rates, coupled with lower prices make it an opportune time to purchase real estate.

Overall, there are pros and cons to each option. As a first-time buyer start thinking through such factors as: what payment you would be comfortable in making, how much money you can put down, establishing a contingency plan for a job loss, how much you would like saved for unexpected expenses and if you were relocated or forced to sell how would handle the situation?

How can you improve your FICO score?

To improve one's credit score, it's critical to understand the factors influencing a credit score. The factors that contribute to a FICO score and the weighted percentages for each are as follows:

• 35% - timeliness of payments
• 30% - the ratio of used debt to allowable debt for consumer credit
• 15% - length of credit history (the more credit history and showing proof of consistent timely payment, the better the score)
• 10% - types of credit used
• 10% - recent credit inquiries and recent new credit

The greatest driver behind a score is making timely payments on all accounts. Scores will be adversely affected for any payment that is 30 days late or more. Being late on a mortgage payment will not only crush one's score, but will also make qualifying for a new home loan extremely challenging. Collections and past due accounts are obviously bad; however, paying off old collections can actually hurt FICOs in the short term. Many collections report from years past. If that collection is paid off, the account activity date is brought current, which could initially drive down the score.

A common misconception is that having one's credit pulled is the worst thing you can do to your scores. While it's wise to keep credit pulls to a minimum, keeping the proportion of monthly debt to allowable debt at low ratios is far more critical in improving one's score. For example, if a borrower has a credit card with a maximum limit of $15,000 and they owe $14,000, the proportion is almost 100% and the borrower is close to being maxed out. Getting the ratio below 50% would help and below 35% would be optimal. For revolving debt, I recommend borrowers contacting their credit card companies every six months to request increased maximum limits. It is vital not to use this new allowable debt, rather, use it as a means to always keep the proportions in check. Additionally, many borrowers will spread out their credit debt over a few cards to keep the ratios below 35% on all of the cards. Or, if liquid funds are available, it could make sense to pay down the debt.

Another method of improving FICOs is to establish credit history over prolonged periods of time. By doing so, the scoring formula treats longer credit history as a means of proving that a borrower can be extended credit, but do not put themselves into a compromising situation. Many borrowers will keep inactive credit cards open, instead of closing them, in order to increase credit history. Most lenders like to see at least four lines of credit on a report (called tradelines) that are open with at least two years of history. Of these tradelines, it's ideal to have balance between the types of accounts: mortgages, installment loans, revolving debt. Too much revolving debt, such as credit cards, can adversely impact scores as it can make the borrower to appear to be over-extending themselves.

How does your FICO score impact your interest rate on your loan?

Low credit scores are deemed greater risk for lenders since the likelihood for defaulting on the loan increases. As such, lower FICO scores translate into higher interest rates. Mortgage lenders will group credit scores in a range, usually in 20 or 40 point increments, with interest rates progressively getting better for each higher interval. For example, a borrower with a middle credit score between 660 - 680 will have a higher interest rate (presuming all other variables being equal) compared to one with a 680 - 700 score. Typically, when a borrower has a 750+ credit, they will be able to secure the best possible rate, assuming their income, assets, collateral and down payment are acceptable.

For qualifying, underwriters use the middle credit score pulled from the three bureaus versus an average of the three. For instance, a borrower with scores of 702, 717 and 749 would have a 717 FICO compared to an average score of 722. If there is more than one borrower on the loan, the lender will use the lowest middle score of all borrowers versus the middle score of the primary wage earner, like many lenders used to do. Often times, a husband and wife will have drastically different scores. When that occurs, it is best to qualify off of only the person with the good credit. However, if a spouse or partner is left off of the loan (they can still go on title though), none of their income or assets can be used to help qualify. Therefore, the sole qualifying person must have ample liquid assets, as well as gross monthly income to stay below the lender's allowable debt-to-income ratio.

Take a look at the first page, for AUN (Aurora North). Note these positive market trends this year:
- number of active listings steadily declining
- average list price pretty stable (finally!)
- U/C up dramatically
- Number of sales / month up (partially seasonality)
- DOM dropping
- Stability in average sold prices and sold price as % of list
- Sold price as % original price UP a lot - banks are getting better at pricing
- Number of expired listings down

Every indicator is improving this year in AUN. You will see the same trends in DSW (southwest Denver County), but not as marked an improvement as AUN.

By contrast look at DSE (southeast Denver County).
- listings are up (they should be - seasonality)
- Note the average list price ($758,000) is a lot higher than the average sold price ($418,000). Lots of expensive listings brining up the average ask price, but apparently they are not selling
- DOM (Days on Market) declining as it normally would due to seasonality
- Average price declining rather rapidly. Probably a mix issue - smaller, cheaper homes are probably selling better.

Since these homes in DSE are pricier, it has more of an effect on the "average" sales price on metro Denver. Oddly, we could see improvement led by the cheapo neighborhoods, with the lux neighborhoods falling behind for a while. It will be interesting to watch.

(C) Copyright 2008 Your Castle Real Estate

Investor often ask me what types of real estate investments are available on the market. Here's what we tell them.

This is the first of several postings on the topic.

Please offer comments - positive or negative!

Assignments. If you don't have much equity to work with, and/or if your credit power is limited, assignments can be a way to get started in real estate investing. You will need to have a strong "sales" personality to succeed at it, though.

Rental Condo or Rental Home. Purchase of a residential property to be rented out to tenants, usually on a 6-12 month lease term. This is how most new landlords get started. You can hire out all of the property management functions, but in many cases you will do many of them on your own. There are smaller down payment requirements than for larger rental buildings. The purchase process and financing process is very similar to what you experienced buying the home you live in now. It's a great way for beginners to get started.

Small (2-4 units) Apartment Building. Purchase of duplex, triplex or quadplex to be rented to tenants, usually for 6-12 month terms. Usually what the rental home / condo landlords graduate to. In most markets they cost a little more than a rental home, but are much more likely to cash flow on the average month. Less cash flow risk; if one unit is empty you have other tenants that still help you with the mortgage payment so it doesn't all come out of your pocket. Many owners will start to delegate some of the property management tasks to an on-site assistant (typically the most responsible tenant), such as yard maintenance and showing empty units. The financing process is only slightly more involved than a residential loan. Relatively small down payment requirements make it affordable. The purchase process is also very similar to purchasing a home. It's a good way for beginners to get started.

Large (5+ unit) Apartment Building. Still targeting tenants for 6-12 months at a time, buildings with more than five units are considered "commercial" property. The loans are more difficult to qualify for, and usually a larger down payment is needed. Uncommon for the new investor; this is usually what landlords with several years of experience "trade up" to. Cash flows on larger buildings are more stable than for smaller buildings, and the economies of scale make it practical (and desirable) to hire a property manager to take over most the work for you. This takes reduces the hassle factor of the landlord process.

Lease Options. Again you are seeking a tenant for a property, but usually for a slightly longer term (12-18 months) and frequently (though not always) with the goal that the tenant purchase the property from you at the end of the lease. If you purchase the property, then it's an easier process; if you find a highly motivated seller to let you re-lease the property to another tenant, it can be a lot of work to set up. However, the re-lease method doesn't require any cash out of pocket and does not rely on your credit score, so it is appealing to many investors. Great for beginners with the right skills and attitude.

Fix and Flips. Purchasing a home that needs work. The scope can range from the basic "paint and carpet" to extensive overhauls to scraping a decrepit property and completely starting over. Usually does not involve tenants, and the objective is to get in and out of the property as quickly as possible. Great for beginners with the right skill sets or the willingness to learn.

Conversion of Apartments into Condos. A synthesis of the fix and flip and rental operations - purchasing an apartment building in a neighborhood dominated by owner occupants, then converting the building from apartment building to condominium. Often requires renovation of the units to meet the expectations of owner-occupant buyers in that area. Complex and time consuming, but has wonderful tax advantages compares to fix and flips and often has superior returns to all other asset classes. Ideally suited for the sophisticated investor with extensive experience.

Scrapes, Pops and New Construction. Purchasing a small home in an expensive neighborhood that may or may not need work. The home is bulldozed and a new home or duplex is put on the lot. Alternatively, the existing home is renovated and more square footage is added on. A pop-top is adding a second story to an existing home to add more square footage (commonly, a master bedroom suite).

(c) Copyright 2008 Your Castle Real Estate

Contact me at lonwelsh@yourcastle.org for more info.