HOMEOWNERS, FLOOD & EARTHQUAKE INSURANCE

What is it?

Homeowners insurance pays for losses and damage to your property if something unexpected happens, like a fire or burglary.  Note that if you are buying into a multi-unit building, your condominium association’s fees usually include master insurance for the common areas of the building, but you need your own insurance for your specific unit.  Lenders require proof of homeowner’s insurance as a condition of your loan and often require you to obtain enough coverage to the replacement cost of rebuilding the home from a carrier that has an A.M. Best rating of B or higher. 

In addition to homeowner’s insurance, in some locations it might make sense to purchase flood coverage which is not covered by homeowner’s insurance. Learn more about flood insurance by clicking here. Finally, depending on what part of the country you live in, you may want to consider earthquake insurance, as again, earthquake disasters are not covered in a standard homeowner’s insurance policy. Many lenders provide you the option to pay for the insurance as part of your monthly payment.

Important Considerations on Picking your Policy

• Bundle Discounts – This is your opportunity to save money by potentially bundling your auto and other insurances into one carrier (as most carriers offer bundle discounts).

• Reputation – Consider the reputation of the insurance carrier in how they cover their customers when something happens.

Tip: Compare the cost and coverage amounts by changing around the deductible to find the right plan for you. 

The Insurance Process

1. Once you have a quote in hand, show your loan officer the quote and make sure it meets the lender’s requirements for insurance coverage.
2. Your insurance company will then provide you a “binder” (this is simply a document detailing the insurance coverage) to give to your lender showing proof of coverage even though the policy has not been locked in (“bound”) yet.
3. You do not need to ”bind” (lock in) your insurance until the closing day of your loan. Keep your insurance company posted on the status of your loan and give them a few days heads up before the closing. Note that your insurance company should never bind the policy more than a day before the closing date.

CONVENTIONAL LOANS

PROS

•  More streamlined in approval given the government is not involved.
•  Because the loan is the most common and is faster to close, you are likely to be a more competitive buyer.

CONS

•  Higher credit score requirements than government backed loans.
•  Higher down payments generally required over government backed loan types.

TYPICAL HOME INSPECTION SCOPE

A home inspection will vary in scope depending on the type of inspector (engineer, architect, licensed or unlicensed inspector) you hire.  However most inspections will include the following:

∙ Structural elements such as construction of walls, ceilings, floors, roof and foundation.  Key questions should be answered such as does the foundation seem secure?  Does the roof leak?  Has there been a fire in the attic?

∙ Exterior evaluation including wall coverings, landscaping, grading, elevation, drainage, driveways, fences, sidewalks, fascia, trim, doors, windows, lights and exterior receptacles. 

∙ Roofs and attics inspected for framing, ventilation, type of roof construction, flashing and gutters.  However, note that many inspectors don’t guarantee the roof condition. 

∙ Plumbing including drainage, waste and vent pipes condition.  Toilets, showers, sinks, faucets and traps are inspected but not sewers.

∙ Water heaters, furnaces, air conditioning, duct work, chimneys, fireplaces and sprinklers (though not all inspectors will check sprinklers).

∙ Electrical systems including the main panel, circuit breakers, types of wiring, grounding, exhaust fans, ceiling fans and light fixtures.

∙ Appliances sometimes are included, including the dishwasher, oven, garbage disposal and washer / dryers.  Whether appliances are included or not, smoke detectors are almost always included.

∙ Garage walls, ceiling, firewall, door opener, lights, windows and roof.  

WHAT IS TYPICALLY NOT COVERED?

Asbestos, radon, methane, radiation, formaldehyde, wood-destroying organisms, mold, mildew and fungi, rodents and lead.

ADDITIONAL INSPECTION SERVICES (OPTIONAL)

1. Lead paint inspection – the federal government banned the use of lead based paints in 1978 but homes built after that year may still have lead-based paint.
2. Termite inspection
3. Mold inspection
4. Water / Septic System / Well Quality inspection
5. Environmental inspection – Buyer’s rarely get this but if you believe there are environmental hazards in your area, its not a bad idea to get this done.

DOWN PAYMENT

The down payment requirement depends on the type of mortgage and credit score ranging from 0% to 20%. Down payment, less than 20% may require private mortgage insurance (PMI). PMI may require a premium of 0.5% to 2.25% of the loan amount per year.

FHA LOANS

PROS

•  Lowest credit score requirements of the various loan types
•  Least restrictive in terms of who qualifies of the government backed programs (since VA and USDA loans have certain criteria attached to them)
•  Outside of VA and USDA loans, FHA loans allow you to place the least down payment
•  More forgiving to qualify if you’ve had a bankruptcy or foreclosure in the past

CONS

•  Given the lower credit score requirements (and therefore greater risk for the lender), these loans will carry higher interest rates.
•  You will have to pay for mortgage insurance which will increase the size of your monthly payments.
•  You are dealing with two entities to ultimately get a loan approval : HUD & your lender. 

IMPORTANT DETAIL

•  Those with less than a 500 score are not eligible for FHA loans. 
•  Given that the government is doing a favor (doesn’t happen often!), there are limits to the loan amount because they don’t want you going out to buy a mansion.
•  Loan limits vary by state and you will want to check here for your state limits.
•  Appraisal must be done by an FHA approved appraiser 
•  Two years of employment at same company (sometimes same industry is fine)
•  Property must be primary residence (no rental properties)
•  18 years or older

FREE ANNUAL CREDIT REPORT

A 2013 Federal Trade Commission study found that 5% of credit reports contain errors that can erroneously ding your score.  It’s always a good idea to check your detailed credit report to ensure your profile is accurate, particularly before applying for a mortgage loan. You are entitled to one free report annually; the official site where you can get your credit report containing data from all three bureaus is annualcreditreport.com 

CREDIT SCORES

The three main credit bureaus – Equifax, Experian and TransUnion – create your credit reports, which VantageScore and FICO use to come up with a score. All of your various debts from credit cards, home loans, car loans, student loans, etc. are used to compute this score. Often the credit bureaus have slightly different data from one another, so your score may vary for each bureau. FICO is currently the only tool that is approved for use to evaluate credit risk for government-sponsored loans, while most scores offered for free online are from VantageScore.  Fortunately both FICO and VantageScore are very similar in approach and produce a score in the range of each other.  FICO discloses exactly what goes into your credit score and while VantageScore doesn’t, it is widely known to be similar to FICO.  Note that the old VantageScore went up to 900 (which is why you may see some credit score scales up to 900), but they recently updated it to be on the same scale as FICO. If you want more detail on comparing credit score you can visit a good page on Nerd Wallet by clicking here.

TYPES OF CREDIT (10% OF SCORE)

HOW IT IS CALCULATED

Those with variety of debt (credit cards, mortgage, student loan, etc.) score highly.  The scoring companies believe those with a lot of different types of debt are safer borrowers (which doesn’t make sense to us!).  

HOW TO OPTIMIZE THIS SCORE

•  Bear in mind this is the least important factor of the 5 scores.  Over time this factor will likely work itself out for you as most folks will have a mix of debt between their mortgage, car payments, credit cards, personal loans, and other types of installment loans as they progress in their lives. 
•  There is no stated rule of how many accounts you should have in total but there is some evidence to show those with 10 or more accounts score well in this area.  
•  Obviously don’t open accounts you really don’t need just to maximize this score.  If you do go out and get another type of credit, while this part of your credit score will increase, your “New Credit Opened” portion of your credit score will decrease.  
•  Our recommendation is to not open new accounts unless you need them, especially when about to apply for a mortgage.

LENGTH OF CREDIT HISTORY (15% OF SCORE)

HOW IT IS CALCULATED

Those with longer standing accounts score highly.  The longer your accounts have been around the safer you are deemed as a borrower.  Note that they will take an average length of all your accounts to determine this score.  The scoring companies do not disclose what constitutes a great score, but it is generally understood if your average length per account is greater than 10 years, then you will score very strongly in this category. 

HOW TO OPTIMIZE THIS SCORE

•  There is a misconception that closing unused accounts is a good thing; unfortunately this is not true, especially if they are older accounts in good standing as taking these accounts out will lower your average account length.  It’s worth keeping that unused account open, especially if it doesn’t carry an annual fee.  
•  Obviously with new accounts it takes years of having good credit to get a good score in this area so we encourage you to build credit early on and be patient on this one.  
•  Another interesting way to optimize this score is to become an authorized user on a good friend’s or relative’s card account; once you are authorized, their account shows up on your credit report and you are basically inheriting the good credit history of their account.  This is particularly helpful for those that are younger and don’t have a long credit history.

NEW CREDIT OPENED (10% OF SCORE)

HOW IT IS CALCULATED

Those who have not applied for new debt in the past 6-12 months score highly.  The scoring companies are trying to determine the risk related to how often you go out to borrow.  The more accounts you open recently (or try to open), particularly within the last 6 to 12 months, the riskier you are deemed to borrowers and your score will be penalized.   However it is a catch 22 as without opening new accounts you will never have a good line of credit to obtain a strong credit history down the road! Important to note that in addition to opening new accounts, “hard inquires”, which are when you give a lender permission to access your credit history to determine if you are creditworthy, hurts your score slightly for each inquiry. 

HOW TO OPTIMIZE THIS SCORE

•  If you need to open a new account, we recommend not opening the new account in the same period of when you are applying for a major loan (like a mortgage!).  Any new credit you take is going to lower your score so it’s better to open your accounts when you don’t really need a great score. 
•  If you need to have hard inquiries and you keep the total number to under 2 every six months, it will minimally affect your score.  
•  The big takeaway: Do not open any new credit lines while you are in the mortgage process and minimize hard inquires into your credit history.

AMOUNT YOU OWE (30% OF SCORE)

HOW IT IS CALCULATED

Those who have the least percentage borrowed of their total credit line score highly.  The scoring companies are trying to determine your default risk with this category.  Having less debt makes you a safer borrower.  At the end of each of your monthly statements they are going to measure how much you borrow as a percentage of your credit line, a measure mostly relevant on your credit card accounts.  The lower you borrow, the higher your credit score will be.  There are various thresholds published on what this number should be under, but a monthly balance under 1% of your total credit limit will score the highest for this category.  

HOW TO OPTIMIZE THIS SCORE

•  If you have the financial flexibility, pay down your credit cards in full BEFORE your monthly statement ends.  Remember that they measure your utilization based on the numbers from your monthly statement.  So set a reminder to do this a few days before your statement closes out each month.  This way your utilization ratio on your monthly statement will be 0%, which will lead to a perfect score in this category!   Do this for a couple of months while you are searching for your home and then you can go back to your lender when you found your place with a more competitive credit score.  You will be surprised how much your score will improve (not uncommon to see a 20 to 30 point increase).  
•  If you don’t have the financial flexibility to do this, try to keep the ratio under 6%, or worst cast under 30% (two commonly published figures where the score becomes more negatively affected once you cross them).
•  Finally another way to reducing your utilization ratio is asking for a credit line of increase.  HOWEVER, we do not recommend you do this if you plan to buy in the near term as your provider will likely put a hard inquiry into your credit to determine if you are worthy of an increase, thereby potentially decreasing your credit score in the near term.

PAYMENT HISTORY (35% OF SCORE)

HOW IT IS CALCULATED

Those who have not missed a payment score highly.  Payments late by 30 days or more hurt your score, and the later you pay, the greater the damage. 

HOW TO OPTIMIZE THIS SCORE

•  Obviously pay off any outstanding debt that is overdue immediately and keep your credit free of any missed payments for a few months.  Even if your score has been negatively impacted already, it has the potential to go up a bit once you do this.  For some folks the extra points matter in qualifying for some types of mortgages.  
•  If you’ve had an accidental late payment only once, there is a chance the company will remove it from your credit report if you call them and ask.  Not guaranteed to work but worth a simple call.  This obviously will not work if you have a history of late payments. 
•  Longer-term, any account that has a derogatory mark will eventually fall off your credit history in 7-10 years, so at least a mistake in the past won’t follow you around forever.

INTEREST ONLY LOANS

These loans do not pay any Principal at all for a period of time (typically 5, 7 or 10 years).  Following that period, monthly payments go up significantly because the principal payments then come into play (and given you didn’t pay any principal for the interest only term, you are going to need to catch up for the remaining term of the loan).  Interest rates are also adjusted after the initial term to the current rate.  Unlike an ARM, there is usually no interest rate cap when the fixed period is over.

PROS

•  Monthly payments are low during the interest only term, allowing you to afford a larger home

CONS

•  Significant increase in monthly payment after the interest only period; borrower should plan ahead to be able to handle these payments; even if you plan to sell the property, you never know what the market might be like at that point so always best to be prepared.
•  No interest rate cap after the fixed period is over
•  You are not building any equity in your home during the interest only portion of the loan
•  Not available for conventional or government-sponsored loans

GOOD FOR

Those who want to afford a bigger home and know that they will not be there for a long period of time

ADJUSTABLE RATE MORTGAGE (ARM) LOANS

These loans lock in the interest for a period of time but then the rate changes after that fixed period to the current interest rate at that time. Most common are 10/1, 7/1, 5/1 and 3/1 loans.  The first number indicates the number of years the rate is guaranteed to be fixed and the second number indicates how often the rate can change after that fixed period.  For example, a 7/1 ARM means you have the rate locked for 7 years and every one year after that it will adjust up or down based on what interest rates are at that point.  There is usually a fixed cap that protects you in terms of how much the bank can raise the rate each year. 

PROS

•  Because the rate is only fixed for a period of time, you will get a significantly cheaper rate (roughly 1% cheaper on average to a fixed rate mortgage). 
•  If you plan to live at a property for only a few years, these are great options knowing you will end your mortgage before the rate lock period is over. 

CONS

•  If you end up staying at your property for longer than the fixed rate portion of the loan and interest rates rise, expect to pay a higher rate. 
•  Not available for USDA loans.

GOOD FOR

Those who do not plan to be at their home for a long period of time

FIXED RATE LOANS

These loans have a fixed interest rate for the duration of the loan, allowing you to have the same monthly payment throughout. The most common length is 30 years, though they are available for different lengths of time such as 15 years, depending on how quickly you want to pay off your loan. 

PROS

•  Great way to lock in a rate during low interest periods
•  If you are planning to hold / live in the home for a long time, this is a great option knowing your rate is fixed for the life of the mortgage

CONS

•  Since the bank is taking the risk of locking in the rate for the full loan term, these tend to be more expensive than adjustable rate mortgages
•  Most banks will require you to have private mortgage insurance if you put down less than 20%

GOOD FOR

Those who plan to be at a home for a long time and do not want to take the risk of future interest rate changes

USDA/RHS LOANS

PROS

•  Unless you are a qualified military member for a VA loan, this is the only other option that allows the general public to buy a home with no money down
•  More competitive interest rate (up to 40 basis points, or 0.40% less than conventional loans)

CONS

•  If you live in a major city or large town, chances are your area doesn’t qualify 
•  There is a 1% upfront fee of the loan amount plus a small monthly fee
•  Must be primary home for one family and not a multi-unit home; can not use for a second home purchase.
•  You are dealing with two entities to ultimately get a loan approval: USDA & your lender

VA LOANS

PROS

•  Typically easier to qualify than a conventional loan
•  Typically competitive interest rate is offered for these types of loans
•  Ability to buy a home with no down payment

CONS

•  You are dealing with two entities to ultimately get a loan approval : the VA & your lender. 

IMPORTANT DETAIL

•  If you qualify, you must obtain a Certificate of Eligibility (COE) from the VA. Click here to start the process of getting your COE.

CONVENTIONAL JUMBO LOANS

PROS

•  More streamlined in approval given the government is not involved.
•  Given loan’s common place and speed of closing, you are likely to be a more competitive buyer.

CONS

•  Higher credit requirements than a Conforming loan given the larger size of the loan.
•  Higher down payments generally required over government backed loan types.

POINTS VS. CREDITS 

POINTS

Points, also known as discount points, are an upfront fee you pay in order to lower your interest rate. The fee is expressed as a number of “Points”.  1 point equals a fee of 1% of your mortgage loan, 2 points equals a fee of 2% of your mortgage loan, and so on. A loan with one point should always have a lower interest rate than one with no points (assuming you are comparing the same loan type from the same lender).  It is important to note that a loan with one point from one lender may or may not have a lower interest rate than the same loan with zero points from a different lender; this is because various lenders have different pricing structures, which is why is always recommended you shop around and receive multiple quotes from various lenders. 

CREDITS

Lender credits work in the same way as point, but opposite.  You pay a higher interest rate in exchange for the lender giving you a credit to offset your upfront closing costs and theoretically allowing you to afford a larger mortgage.  Lender credits may appear on lenders worksheets as negative points. Just like with points, the exact increase in interest rate depends on your lender and the type of mortgage.  Again, we recommend you shop around to see which lender will be more competitive.

KEY ATTRIBUTES OF A GOOD AGENT

KNOWLEDGE / EXPERIENCE

• Choose an agent that has experience in your preferred neighborhood 
• Also make sure that agent has a history of houses in your price range and type
• Ask what kind of experience they have in buying homes; similarly, gauge how competent your broker is in local laws, taxes, loan process etc.; ask plenty of questions and hear their answers!
• Check your state’s licensing agency (often times called The Department of Real Estate) to see if there are any disciplinary actions on the agent’s record

PERSONAL ATTRIBUTES

• Does not rush you!  Unfortunately the incentive system is not aligned in your best interest as a broker only gets paid when you buy (therefore they would rather you pick a place quickly).  Ask the broker on average how many listings do they show on average before a transaction occurs.
• Really tries to understand what you are looking for – You can tell this based on the quality of the listing the broker is showing you.  It’s ok if they show you a couple of bad places, but is he or she adjusting what they show you to match the feedback you provide him or her
• Strong online reviews (though use this only as one data point as it’s not that hard these days to have your friends write a ton of fake reviews for you)
• Strong references – Remember to not be afraid to ask the agent for references!

Tip: If applicable, be careful with the pressure you may feel to work with a family member or friend who is a real estate agent; remember that this may be the most important purchase of your life so it is important to find the agent that is most experienced for what you are looking for.

RATE LOCK QUESTIONS 

1. When in the process will you lock the rate?  What flexibility do I have on the timing of this?
2. How long is the rate lock period for?  What is pricing to extend the rate lock period?
3. When is the latest I can decide whether to purchase the additional rate-lock?
4. What happens if the loan is delayed due to lender’s fault?  

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EXTENDED RATE LOCKS

Some common scenarios when buyers consider purchasing an extended rate lock feature in exchange for an upfront fee (essentially it is like insurance) include:

1. Buying new construction (when you don’t know exactly when the home will be finished)
2. When you anticipate the seller or sellers’ attorney will be slow 
3. If you believe you are not organized to comply with the financial information request of your lender on a timely basis

APPRAISAL

A home appraisal is an unbiased report on the worth of a house in the fair market, performed by a trained and licensed appraiser.  Lenders want to verify that the house is worth more than you’re borrowing since the house will serve as collateral for the loan — i.e. they can sell the house if you stop making payments.  The appraiser must be chosen by your lender to provide a level of independence from the buyer and seller.  Most purchase contracts contain a provision (a “contingency”) that if the home does not appraise for the amount you offered to pay, you are not obligated to complete the transaction (click here to go back to the important contract negotiating features).

After visiting the home and evaluating recent sales in the area, an appraiser creates a report with the appraised market value and comparable properties. You’re entitled to receive a copy of that report.  If the appraisal identifies major repairs that are needed, the lender may require that the repairs be made prior to closing as a condition of getting the loan or the lender may ask you to put enough money in a special account to pay for the repair immediately after closing.  

Tip: If you receive a low appraisal, discuss options with your agent. As a buyer, it is natural for you to want the seller to reduce the price, but there might be other options such as obtaining another appraisal or providing a bigger down payment on your purchase.

IMPORTANT CONSIDERATIONS WHEN PICKING YOUR INSURANCE BROKER

• Access – All insurance brokers get the same EXACT same pricing to sell you insurance from the major carriers, however not all brokers are created equal as many brokers (particularly the smaller firms) don’t have access to all the carriers.  Note that there is no price advantage by going directly to the insurance carrier so therefore we recommend using a brokerage firm that has access to the full market.  Click here (1) for a quote from JW Terrill, one of the largest insurance brokerage firms in the country.

• Single Broker System – Unlike receiving quotes form multiple mortgage lenders, in the insurance world you can really only work with one broker because once a broker requests quotes from insurance carriers, they automatically block out in the system any additional insurance brokers that may try to represent you with that carrier.  This system is designed by insurance carriers to avoid potentially paying two brokers for the same business.

• Honesty – Insurance brokers get an annual percentage of the policy premium you purchase; therefore it is in their incentive to sell you more insurance than you may need.  Find a broker who is in it for the long-run and values your relationship to sell you just what you need.

• Customer service – Because insurance brokers receive an annual percentage of the premium after you purchase a policy, their sale is technically done and they have the incentive to focus on looking for new business rather than helping their clients when they have to file a claim.  The best agents understand that in order to keep their clients (and the broker’s annual recurring commission) that they need to be there when something happens or to be responsive to answering your questions.

TYPICAL DOCUMENTATION NEEDED

The below is a list of items you can expect to provide to your lender. If you are in doubt whether your lender is going to need a particular piece of documentation, gather it anyway as they likely will ask for it further down the process.  Remember, the more organized you are, the quicker your loan process will be completed. 

– Pay stub for the last 30 days
– W-2 forms, last two years
– Signed federal tax return, last two years
– Documentation of any other sources of income
– Bank statements, two most recent
– Documentation of the source of your down payment: investment or savings account statements showing at least two months’ history of ownership. If some of the funds were a gift, get a signed statement from the giver stating that the funds were a gift.
– Documentation of name change, if recent
– Proof of your identity (typically a drivers’ license or non-driver ID)
– Social security number
– Certificate of housing counseling or home buyer education, if you have one

Note: Veterans and military members should obtain a Certificate of Eligibility from the VA

MORTGAGE INSURANCE

Mortgage Insurance, or PMI which stands for Private Mortgage Insurance, is a layer of protection lenders require for themselves when you are putting down a smaller down payment (typically less than 20%) as they deem your loan riskier.  If the lender requires PMI for your loan, a monthly PMI fee will be added to your mortgage.  The PMI amount is typically in the 0.3% to 0.5% of the loan amount but you should check with your lender for exact pricing.  Your lender may also give you the option of paying the PMI as one lump payment instead of a monthly fee.

Tip: If your lender requires you to get PMI, keep close track of your loan and call the lender once your loan balance reaches 80% of the home’s original value to ask if they can drop the PMI charge going forward.

FINAL WALK THROUGH

Before you sign any papers, do a final walk-through of the property even if it is vacant. Don’t be tempted to blow off the final walk-through since it is an opportunity to make certain that the property is in the condition you agreed to buy, agreed-upon repairs, if any, were made, and nothing has gone wrong with the home since you last looked at it. If you find a serious issue, address it now before you close. Try to avoid financial arrangements that could change your closing disclosure or your loan documents might need to be redrawn, causing your closing to be delayed.

The below is a list of some important items to check during the final walk through:

• Turn on and off every light fixture
• Run water and check for leaks under sinks (along with checking for leaks from other appliances)
• Test all appliances
• Check garage door openers
• Open and close all doors
• Flush toilets
• Inspect ceilings, wall and floors
• Run garbage disposal and exhaust fans
• Test heating and air conditioning
• Open and close windows
• Make sure all debris is removed from the home

POTENTIAL COST INCREASES

Costs that can increase by any amount

These costs are not controlled by the lender, and therefore have the right to increase by any amount.  They are:

1) Prepaid interest, property insurance premiums, or initial escrow account deposits

2) Fees for services required by the lender that you purchased separately (which was not on the lender’s list of providers)

3) Fees for third-party services that the lender does not require

Costs that cannot increase at all 

Baring a major change in circumstances, these costs can not change:

1) Fees paid to the lender, mortgage broker, or an affiliate of either the lender or mortgage broker for a required service

2) Fees for required service that the lender did not allow you to shop separately for, when the provider is not affiliated with the lender or mortgage broker

3) Transfer taxes

Costs that can increase by up to 10 percent

If there is no change in circumstances, then the total of these costs cannot increase by more than 10 percent:

1) Recording fees

2) Fees for required services when you have chosen a third-party service provider on the lender’s written list of providers (note if the provider is an affiliate of the lender, the cost cannot change at all)

IMPORTANT STEPS TO COMPLETE PRIOR TO CLOSING

Once the closing date is set, we recommend the following done at least a week before closing:

1. Contact your lender or closing agent (title company, escrow officer, or attorney) to find out who will conduct your closing and where it will be.
2. Ask the person who will conduct your closing (closing agent or title company) what you need to bring and what amount to have ready in certified checks (yes you will need to get bank certified checks for the closing).
3. Request a copy of your closing documents in advance and carefully review for errors (e.g., personal information, terms) and make sure you have a clear und