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Read one of our many articles on home purchasing to educate yourself on the process.
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I had a conversation with a lovely couple, Jeff and Jess, who were in their late 20’s recently. They are preparing to purchase their first home, and like many first time homebuyers they had some excellent questions, and a few misconceptions. The first question was, “Do we need to have 20% to put down on a house?” That amount is generally a pretty big reach for most people and for this couple it would mean putting off purchasing for a couple years.
Having 20% ready to put down on a home is not necessary. The 20% down myth started because people didn’t want to pay PMI (Private Mortgage Insurance), but the industry said they needed to. The government backed FHA loan requires only 3.5% down, and there are certain conventional loans that allow for a 3% down payment. With an FHA loan, there is mortgage insurance required that will continue for the life of the loan unless you refinance. The upside of an FHA loan is that it is easier to qualify for in that your credit score may be lower than for a conventional loan. The interest rate may be as much as .25% lower as well.
With a conventional loan, if you put less than 20% down, you will need to purchase PMI, but you can stop paying it as soon as you have 20% equity in your home. You will reach that point as you make payments and your loan balance goes down, and as your home appreciates (increases in value), your equity also increases. If you qualify for a VA loan, you do not have to put any money down when you purchase.
If you aim for a 5% down payment, the mortgage insurance is not overwhelming, and it gets you into a home, which means that you are building your housing wealth. Homes generally appreciate at about 4.5% a year historically, so the amount you are “earning” by buying earlier outweighs the amount you will pay in PMI in the years it takes to hit the 20% equity mark. Of course, you must have enough income that your debt to income ratio is not too high in order to get a mortgage.
Jess had a question about credit scores. “How are they determined and if there are two borrowers, what score is used?” There are three bureaus, Experian, Equifax and TransUnion. Each one of them uses its own algorithm, which is how it is possible to get three different scores from the same information. When your credit is pulled for a mortgage loan, a tri-merge report is required drawing on all three bureaus. If you are a single borrower, the middle score (mid-score) is used to determine the interest rates you are eligible for. If there are two borrowers, the lower mid-score is the one that is used.
Credit history, rates and approvals are determined by credit scores in 20-point increments. A 740 score is needed for the best pricing on a conventional loan. The lower the credit score, the higher the interest rate for which you will qualify, so maintaining good credit pays off. If your credit is bruised, there are ways to improve it. Give us a call for help.
Jeff wondered, “How do you get approved for a mortgage, and what’s a pre-approval?” You will need your most recent 30-days of paystubs, and your W2’s for the past two years. If you have worked at the same place for 2 years then bonuses can count toward income. If you are self-employed or on commission, the last two years of federal tax returns may be needed. At Silver Leaf Mortgage we have loans for self-employed borrowers that other lenders are unable to offer.
To discover your usable income for two borrowers, take both gross monthly incomes (income before taxes) and multiply by 45%. That is the usual maximum your total debt can be, however, there are a few programs that will allow as much as a 50% debt to income ratio (DTI). Subtract the debts on your credit report and what remains is the amount you can use for housing expenses. Ideally, the target is 25% to 30% of your gross income for housing, PITI (Principle, Interest, Taxes and Insurance) and PMI. The Principle repays the loan; Interest repays the lender; Property taxes and Homeowners Insurance (HOI)). Keep in mind that you may have Homeowners Association dues (HOA) as well. At this stage you are just estimating what your taxes, HOI and HOA might be on your new home.
You will need two months of bank statements to document where your down payment money will be coming from. Once you start the loan process, leave the money there. You will have to document deposits of $500 or more during the loan process, so keep a paper trail showing where the money came from. Also, be sure not to open any new credit or make any large purchases before closing on your home.
A pre-qualification is a basic discussion of how much income and how many assets you have, how much you owe, and how much you can qualify for. Better than that is a pre-approval letter that we can provide based on a more thorough examination of the details of your qualifications. We will have your details underwritten and provide a letter to you and your Realtor which gives more strength to your offer when you find the home you want. This is more important if there are issues of any kind with your credit or income. It is advisable to speak with your Loan Officer (LO) perhaps 30 to 60 days before talking to your Realtor.
You should tell your LO what you feel comfortable with as a payment and then your LO can tell you what you may qualify for. You will drive the discussion based on what you feel comfortable with. Keep in mind that there are different taxes in different counties so you may be able to get a more expensive house in a county where taxes are lower.
Rather than wait while you save up a large down payment, the sooner you get into the house the sooner you start building wealth because the house will gain value no matter how much or little you put down. If you wait 3 years to put down 20%, and the home you might have bought will have appreciated by 4.5% a year which is a great deal more than the around $125 per month in mortgage insurance that you will have saved.
An excellent question Jeff and Jess asked was, “When do you start talking to a Realtor?” When you are starting to get serious, you may want to find an excellent Realtor who will have your best interest at heart. If you can identify the three or four things that are “must haves” in a home, the four or five that you would like to have, and the handful of things that are “deal breakers” you will be more able to recognize the right house when you find it!
Your Realtor is paid through the transaction. They don’t send you a bill. They will sometimes have a buyer agency agreement meaning that they have a higher level of responsibility to look out for your best interest. Be sure the agreement states that he Realtor only gets paid when the purchase closes.
Have your eyes open to the general condition of the house you are considering. Some homes may be updated, but you may get a better deal if the house is not updated. It might be something that you would like to do. You will pay top dollar for top condition. You have to maintain your new house, so ask the seller to provide at least three months of utility bills and possibly an overview of the utility bills in summer as well as winter. When thinking about your expenses as a new homeowner, don’t forget to include some money for maintenance. There will not be a landlord to call when something breaks
The next question was, “What happens after you put an offer on a house?” The Realtor puts together an offer and should show you what price comparable homes have been listed and sold at so you know if the house you are interested in is listed at the right price or over-priced. In some locations homes are put on the market at a higher price with the expectation that the offer will be lower, but some places are lower priced because there will be a bidding war that will push the ultimate price higher. Find out how long average houses stay on the market. That way you know better how to negotiate. A good Realtor will be able to advise you.
Next Jeff and Jess asked, “How does the inspection work?” A home inspection is paid for by the prospective buyer and costs around $200 – $500. The inspector goes through the property with a fine-toothed comb and gives you a report with everything found. This should be done as soon as the ink is dry on your initial contract because you need to know if there are any s3erious issues with the property that are not readily apparent. If there are issues, you may negotiate with the seller as to how to deal with them. For example, if a new roof is needed either the seller puts on a new roof, or discounts the selling price so that you can pay for it.
“How much are closing costs, and who pays them?” Jess wanted to know. Closing costs vary from place to place, but rule of thumb is around 2% of the price of the house. Included in the closing costs are the cost of the appraisal, title work, lender fees, HOI that must be prepaid and property axes that are prepaid. The reason that several months of HOI and taxes are collected as “prepaids” at closing is that the lender will be paying this items for you so you must establish an escrow account from which they take the money at the appropriate time.
Closing costs could be less than 2% or up to 3% if the taxes on your new home are high.
You really need to know that you can trust your Loan Officer. There are many who are not going to really look after you and be honest. Our mission at Silver Leaf Mortgage is to “love and serve our clients well.” Contact us with your questions and we will take good care of you. We want to do everything we can to help you own the house of your dreams!