Publication Date: Wednesday, March 12, 2003

Getting a home loan
Navigating the waters of first-time home buying

by Sue Dremann

Buying a home for the first time can be daunting, fraught with twists and turns. Prospective Bay Area home buyers also have to contend with sticker shock, regardless of how many news reports they've read about the exponential growth in local home prices.

But there is good news. "There are currently two exciting things happening for first-time home buyers: The market is currently experiencing the lowest rates in 40 years, and prices are coming down - it's a double-bonus," said Berna Davis, an agent with Coldwell Banker in Menlo Park.

Realtor Berna Davis offered this home on Seventh Avenue in Menlo Park as a good example for first-time buyers. It was on the market in early March for $549,000.

On a printout of starter homes, Davis found list prices in Menlo Park ranging from a low of $365,000 to a high of $599,000 for a two-bedroom, one-bath, single-story residence. A four-bedroom, two-bath home on Madera Avenue is even available for $525,000. Prospective home buyers who thought that they could only purchase a condominium in that price range are now finding that nice homes can be purchased, Davis said.

"A real concern in this area is the high cost of housing," said Jeff Crang, principal broker at Bayside Funding Corporation and C and G Real Estate in Palo Alto, where starter homes cost more that $600,000.

The hardest part to getting started is getting together the down payment, which on average amounts to 20 percent of the price of the home, he said. That starter home in Palo Alto could require as much as $120,000 for the down payment.
And that's just the beginning of the financial picture. Other factors, such as inspections, appraisal fees, taxes, flood certification fees, and items that the lender requires be paid in advance, such as a 30-day estimate of interest, mortgage insurance and hazard insurance premiums - closing costs -- are costs that buyers often neglect to factor into the price of the home. "Even a bargain is still a lot of money," Davis said.

Coldwell Banker real estate agent Berna Davis acknowledges that even a bargain in this area can be a lot of money for first-time buyers.

Getting a clear picture of the total costs, and preparing for the lending process can go a long way in making one's dream come true. Crang suggests asking a lender or broker for a copy of a "Good Faith Estimate of Borrower's Settlement Costs," which lists the kinds of fees that one can expect to incur as closing costs. Then ask the broker or lender to explain it, he said.

Other advice: Get a credit check done a few months before applying for the home loan through Equifax and the other credit bureaus. Make sure that there aren't errors on the credit report. Having a high score - what's known as a FICO score - of 680 and above, one can secure a loan with 5 percent down, Crang said.

Don't make a lot of inquiries to apply for credit cards in the months before applying for the home loan. Lenders also want to see a good credit history, and a minimum of five trade lines. Two credit cards may not be enough. They will also want to see activity on those credit lines within the last 12 months. Have a good track record for two to three years, he added.

Lenders will also look at the debt-to-income ratios: Divide into the gross income the amount of debt, including the home-loan amount. The debt should not exceed 40 to 42 percent, said Crang.

That percentage varies depending on who one consults with. In general, lenders allow the total monthly housing costs to go as high as but not higher than 30 percent of the gross monthly income. Not more than 36 percent of the gross monthly income can be tied up in monthly house payments and payments on outstanding long-term debt, according to Fidelity National Title Company's buyer's home guide.

Plan also to have two to three months' worth of cash reserves - what is known as PITI - the principle, interest, taxes and insurance, Crang said.

If a buyer comes in with less than 20 percent down, lenders require private mortgage insurance, also known as PMI. The PMI costs can be considerable, depending on whether they are fixed or adjustable.

One way around the PMI requirement can be to obtain secondary financing. "If you have 5 to 10 percent down, you can get a first loan for 80 percent of the home cost, and a second loan for 10 to 15 percent of the down payment to make up the balance needed to reach 20 percent. It's all fully tax-deductible," Crang said.

There are a number of ways to get the down payment for a home. "We're in an era where a lot of first-time buyers are getting gifts or loans from parents. It's very common. Parents who want their children and grandkids nearby are doing everything to keep them near," Davis said.

Regarding cash gifts, lenders like to see money "seasoned." It should be in the borrower's possession in an account for at least 60 days, or have a paper trail showing where it came from, Crang said.

Other sources of down payments can include money in a 401(k) or IRA. Some plans will allow for borrowing against the plan. Although some lenders will count the use of that money against a borrower, the more progressive ones don't, he said.

There are many kinds of mortgages. With a fixed-rate loan, "what you see is what you get," Crang said. Equal payments are made at a fixed rate for 30, 20 or 15 years. Amortization, common term in financing parlance, is the repayment of a loan in equal installments of principal and interest, rather than interest-only payments.

Hybrid loans are generally amortized over 30 years. The payment rate is fixed for three or five years. After that, it becomes an adjustable mortgage. Take a good look at how often a lender can change the interest rate or payment, he said. Prepayment penalties are in the fine print, and everyone should understand them. They can cost thousands of dollars, he said.

Beware the Option ARM adjustable rate mortgage. Some have possible negative amortization. Caps, or limits on how much an interest rate or monthly payment can change either at each adjustment or over the life of the mortgage, can be set too low. The monthly payments can fail to cover the interest cost. The interest that isn't covered is added to the unpaid principal balance. Even after several payments, borrowers could owe more than they did at the beginning of the loan.

Savvy borrowers can sometimes utilize ARMs to defer the teaser amounts (initial lower payments during the fixed portion of the loan). "These are great loans for those who can manage it. One program, the interest-only loan, is very popular with people at all ends," Crang said. For a fixed period of time, perhaps for five years, borrowers pay only the interest on a 30-year loan. Over the next 25 years, the borrower plays catch-up, he said. Some have a balloon payment for the entire principle, he added.

One way to increase one's buying power is to get an energy-efficient mortgage, or EEM, said Steve Curtis, owner of Affordable Home Energy in Mountain View. EEMs allow the borrower to add several thousand dollars onto the value of the loan by getting a loan to make home improvements, such as adding double-paned windows, upgrading a furnace, plumbing or adding insulation. Packages range from $5,600-$6,500, and up to $10,000.

The one hitch is that EEMs are only accessible through FHA and VA federal loans. Those loans, which usually are limited to a maximum of $300,000, are usually too low to purchase a home in the Bay Area.

There are pockets where homes are inexpensive enough to be covered by a federal loan, he said. "A pilot program is currently in place with a loan program through Fannie Mae and Freddie Mac." Once you qualify for the loan, getting the EEM is "a slam-dunk," he added.

"There's always a way to put things together," said Crang.

Sue Dremann can be reached at sdremann@paweekly.com.