For mortgage lenders and originators, it is often easy to forget how overwhelming and mysterious the homebuying process is for borrowers. Particular aspects of this process that professionals take for granted may catch potential borrowers off guard.
There are many examples of the pitfalls of the home-purchase process. A closing might fall through because the buyer decided to buy a motorcycle between signing the purchase contract and sitting down at the closing table. The buyer may have experienced an interruption in income, such as a job loss. Although the buyer may have thought they were in the clear because they had been approved for their loan, they didn’t realize that a change in debt or a decrease in income could put their pending mortgage in danger.
To improve the share of applications that make it to the finish line, originators should help borrowers understand that the mortgage process is more than just a downpayment and a monthly bill. By helping to explain how the costs of purchasing a home can change based on the various circumstances of the borrower or property, originators can share their expertise and ensure that prospective borrowers become satisfied homeowners.
This is critical because borrowers need to know what is coming. They need to be sure they have enough money to take on the responsibilities of homeownership. Even if their debt-to-income ratio and credit scores look great on paper, there are many other costs to consider that can make the trip to closing easy or a stumble in the dark.
To improve the share of applications that make it to the finish line, originators should help borrowers understand that the mortgage process is more than just a downpayment and a monthly bill.
Common misperceptions
Originators have truly seen it all. Having guided borrowers through the homebuying process many times before, they have seen unexpected costs arise time and again, and they can use their vast knowledge to help inform borrowers of what a mortgage truly requires. Let’s dig into some of the most common misperceptions about home-purchase expenses.
Although “prequalified” and “preapproved” sound the same to many borrowers, mortgage professionals know there is a huge difference between the two. Home shoppers can get a prequalification letter by simply plugging their income and debt obligations into an online form. Although this can provide a good estimate of what a borrower could afford, the financial institution has not vetted any of the supporting documents.
On the other hand, preapproval is a much more thorough process in which the lender has vetted a borrower’s financial situation and approved a loan up to a certain amount, barring any major changes. At that point, the true unknowns are the property appraisal and the acceptability of the property, if the buyers make a selection in a condominium project or planned unit development. Today’s sellers typically prefer buyers with a preapproval letter since it indicates a vetted ability to purchase a home.
Saving up for a downpayment is a major accomplishment for many prospective homeowners, especially first-time homebuyers. With the median U.S. home value nearing $250,000, borrowers often need to have saved about $10,000 to make a standard 3.5% to 5% downpayment.
Purchase costs don’t end with the downpayment. Borrowers also will typically need to set aside an additional 1% to 2% of the borrowed amount for closing costs, in addition to paying for the appraisal. Many lenders also want to see at least two months of mortgage payments in reserve.
Unexpected expenses
In an ideal world, there would be a clear title on a new home. But many properties will have potential collection accounts, judgments or liens to be settled. Additional property-related expenses can add to the preclosing costs of a loan. A few of the more common property-related expenses include the home inspection, oil-tank search, radon testing and the structural report.
After the inspection of the home, the buyer and seller may need to negotiate who handles repairs that cause a house to be out of code. Commonly, there also are adjustments made for any items the seller might have prepaid, such as taxes, assessments or utilities. For example, although its price is not mentioned upfront, the buyer might be responsible for repaying the cost of the heating fuel the seller recently bought for the house.
Although it is illegal for lenders to intentionally underestimate closing costs on the loan estimate, there are costs that can change between the initial disclosure and the closing table. This is one of the most confusing aspects of mortgage costs to many borrowers, so originators should be able to explain which costs can change along with which ones cannot. Interest rates that are not locked in may change at any time. Even if a rate is locked, changes to information on the application or the expiration of the lock period can result in a change in rate.
With closing costs, there are two categories of fees that can potentially change. Certain costs are not controlled by the lender and can increase by any amount at any time. These include prepaid interest, property insurance premiums or initial escrow-account deposits. Lenders also have no control over optional third-party services, or those that the borrower chooses that are not on a lender’s written list of approved providers. These are noted as services the consumer can shop for.
Other closing costs, when subtotaled, can increase by no more than 10% from what was listed on the loan estimate. These include recording fees and required services provided by approved vendors who are not officially affiliated with the lender. The remaining costs cannot change unless there is a material change to the mortgage application. These changes include selecting a new loan product, an unexpectedly high or low appraisal, credit changes due to new debt or the inability to document income.
Taxes and fees
Lenders often share what is called PITI — principal, interest, taxes and insurance — with borrowers when determining the monthly payment. Taxes, however, can become more complicated than simply estimating the annual property taxes.
Depending on where the buyer is moving to or from, there may be taxes for moving to a new county or leaving the state. These are usually dependent on location, so it is important to be informed about the taxes in the area of the purchased property. For instance, if a borrower seeks to leave a high-tax state such as New Jersey, they may be obligated to pay an “exit tax” (technically an advance payment on income tax from the sales proceeds) when they purchase a home in another state.
Borrowers also are sometimes surprised that their mortgage payment can change even with a fixed-rate loan. This is because local governments typically reassess property-tax values each year, which can raise (or occasionally lower) the monthly payment.
Something else to consider, when selling a home and buying a new one, is a capital-gains tax. If a house is sold and a profit is made, money that is not used on a new property and exceeds certain allowances may face significant capital-gains taxes.
Borrowers who are looking to buy either a condominium or a home within a homeowners association (HOA) should be aware that some HOAs require their annual dues to be included in the mortgage’s escrow. These fees can potentially add several hundred dollars to the homeowners’ monthly responsibilities. Additionally, there are expenses such as trash removal, snow removal or road maintenance that may be overlooked. These surprise fees may be minimal but could cause a purchase to fall through.
For originators, these costs are a daily fact of life. Buyers often do not know the unique circumstances that impact the fees and taxes they will be responsible for. Originators need to make sure borrowers are aware of these to avoid bumps in the road. Originators and lenders also need to share programs and tools that help the borrower understand and plan for the cost of a mortgage.
Being transparent with what the borrower is up against should not be a scare tactic — rather, you should be a guide to help the borrower in the homebuying process.
Valuable tools
Originators can take advantage of many tools to help them better inform buyers and communicate effectively about any hidden or unexpected costs. The Consumer Financial Protection Bureau (CFPB) provides a home preparedness guide to help potential buyers shop and explore their options.
The CFPB also provides closing-disclosure and loan-estimate explainers that lenders can use for borrower questions they might not immediately have answers for. These also serve as strong third-party resources to help borrowers feel confident that they have all the right information.
The CFPB’s home loan toolkit also serves as a great resource for potential homebuyers. This package of worksheets and tools helps buyers to review their credit, set a budget and save money in preparation for their purchase. Referring borrowers to this resource six months in advance of their expected purchase will ensure they have ample time to educate themselves and put plans in place to prepare for their purchase.
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Communication is one of the best tools an originator can utilize. Being transparent with what the borrower is up against should not be a scare tactic — rather, you should be a guide to help the borrower in the homebuying process so they are confident in pursuing a life-altering purchase.
As the homebuying expert, it is your job to share your knowledge with buyers and ensure they are sufficiently educated about the true cost of the impending purchase. There are so many factors not listed on the price tag, but with the right communication, borrowers can feel confident in knowing what to prepare for and how to handle any additional costs. ●
