Tag Archives: lending

Appraisals – Part II

Appraisal Report

After a few rounds of counter offers and negotiations, buyer and seller agree on a price and the home goes into escrow. Time to celebrate? No, not just yet unfortunately. Within the escrow process, there are several hurdles to overcome, one of which is the appraisal. As we mentioned in last week’s post, appraisals are a critical component of the lending process. A low appraisal can derail the agreement reached by the buyer and seller.

Low appraisals can arise in a declining housing market due to the lack of recent comparable homes sales, making it difficult for appraisers to determine the current market value of a property. When home sales slow, good comps “age” fast. Comps of homes that sold over six months earlier generally become obsolete data and aren’t factored in the valuation. Add foreclosures and short sales to the equation and appraisal values can vary greatly depending on the appraiser’s methodology. But, low appraisals can also occur when the market is rising rapidly as appraisers may have a hard time adjusting their valuations to account for escalating market value.

The reality is that appraisals are conducted by independent 3rd parties hired by the buyer’s lender. Legislation requires lenders to use an intermediary entity who then in turn selects the appraiser, ensuring that the lender and the appraiser have no conflict of interests. The regulatory intent is to have the appraisal be as impartial as possible. So it’s not at all possible for the buyer or the seller to choose who performs the appraisal. However, if you have a knowledgeable and seasoned real estate agent representing you, he or she can be instrumental to the process. Here’s how:

  • Your real estate agent would never want his/her client to overpay for a house so chances are, during the negotiations process, he/she will be facilitating the negotiations towards fair market value, already mitigating the chances of a low appraisal report.
  • Your real estate agent presumably is an area specialist so he/she should be well-studied in the specific neighborhood of the home so that he/she might drawn upon nuanced knowledge of schools, community and other neighborhood desirability details that can be shared with the appraiser.
  • All reputable real estate agents will attend the appraisal at the home and provide a package of most relevant comps to the appraiser.
  • In addition, the agent could have knowledge of off-market home sales in the area that can impact the appraisal or conversely have knowledge of recent foreclosures and short sales that should be exempt from the valuation.

Good agents are keen to the fact that appraisers tend to draw their comps straight from the MLS but that data collected may not represent the clearest picture of market activity and value.

And should the appraisal return a lower value than the negotiated sales price despite the diligent efforts of your agent, here are the buyer’s options:

  • Negotiate a new price – sellers may entertain a lower sales price as a low appraisal is a blemish on their home should they have to put the house back on the market, or there could be other circumstances at play like the purchase of the next home contingent of the close of the current home that might increase seller flexibility.
  • Put more money down – if feasible, buyers can always bridge the difference between the loanable amount with cash.
  • Hire a new lender – a new lending entity will restart the process potentially with a new appraiser.
  • Cancel contract – contracts are typically written with an appraisal contingency to protect the buyers from having to follow through on the heels of a low appraisal.

Under any of the circumstances above, the thing to avoid while navigating the pitfalls of a low appraisal is letting the appraisal contingency period expire or else the buyer is locked into the transaction.  Again, your real estate agent should be well aware of the contingency period and would never allow the period to expire.  A seller benefits from a mutual resolution so typically they will grant an extension while the buyer vets all options.

Whether you are the buyer or the seller in a low appraisal situation, your seasoned real estate agent should be guiding you through the entire process and see you through its resolution.

Appraisals Explained

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Appraisals are a critical component of the lending process.  In any home sale/purchase transaction that requires financing, the lender will mandate an appraisal on the property.  So what exactly is an appraisal?

Often confused, a home appraisal is a separate analytical report from the home inspection.  An inspection identifies potential physical issues with the house to prevent costly repairs down the road.  An appraisal is a third party expert opinion on the current value of a piece of property.  Lenders rely on the appraisal report to ensure that they are not over-loaning on a property.  In the event a borrower defaults on the mortgage and the property goes into foreclosure, the lender recoups the money it lent by selling the home.  If the bank loaned above the value of the property, then the lender is unlikely to recoup their investment.

An appraiser is an independent and objective third party who does not have any financial stake in the transaction apart from his fee for performing the appraisal. Appraisers are state-licensed and work in regions and neighborhoods they are familiar with so they have an expert knowledge of any environmental or other concerns that may affect the value of a property.  Typically, the homebuyer pays for the property appraisal when applying for a home loan and the cost varies greatly depending on the size of the home and the experience of the appraiser.

There are two basic methods of appraisal used for residential properties. First, there is the sales comparison approach whereby the market value of the subject property is determined via “comparable” analysis.  The appraiser typically visits the home in question and obtains specific home information and statistics and then compares the data with “comps,” properties of similar kind in the same geographical area that have recently sold.  The second method is the cost approach, which evaluates value by determining how much money it would require to replace the property if it were to be destroyed.  This approach is more commonly used in evaluating new construction.

The appraiser gathers information for the appraisal report from a number of sources, but the process always begins with a physical inspection of the property inside and out.  Additionally, the appraiser may look at county courthouse records and recent sales reports from the multiple listing service. The appraisal report typically includes:

  • An explanation of how the appraiser determined the value of the property.
  • The size and condition of the house and other permanent fixtures, along with description of any improvements that have been made and the materials used.
  • Statements regarding serious structural problems, such as water damage and cracked foundations.
  • Notes about the surrounding area, i.e. proximity to schools, new or established development, lot size, relevant aspects affecting desirability and resale, and so on.
  • An evaluation of recent market trends of the area that may affect the value.
  • A comparative market analysis that supports the appraisal including maps, photographs and sketches.

Next week we will discuss how to prepare for an appraisal and what happens if the appraiser returns a value lower than your contract price.

Boosting Your Credit

 

Credit report on a digital tablet

Several blog posts ago, we covered what you ought to do in anticipation of an imminent home purchase.  One of the “must do’s” was to check your credit as your credit score is a critical factor a lender considers in their underwriting process that goes into determining the details of your loan package.

For that reason, it’s incredibly relevant for you to check your credit report and score with the three credit bureaus: Experian, TransUnion and Equifax. Each bureau will yield different credit scores so it’s pertinent to cover all three.  Upon receipt of your reports and scores, carefully review them and see if there are ways to improve your credit profile as often times the reports will include incorrect information and errors.

Boost Your Credit Score

Here are a couple of actionable steps to take that can boost your score over time:

1)   Pay your bills on time and in full when possible.

2)   Don’t open new lines of credit.

3)   Try to reduce your credit card debt to 25% or less of your credit line on each card.

4)   Don’t close your credit card accounts because then you’ll be using more of your overall credit limit.

5)   If you have an old credit card that you haven’t used in awhile, use it and then pay the bill in full to show that you can responsibly handle credit.

6)   Bring your over-the-limit and past-due accounts up-to-date.

7)   If you have any collections or judgments against you, pay them off as quickly as possible.

A reputable lender can suggest specific actions on how to deal with errors in reporting so it’s smart to develop a relationship with a lender early in the home buying process.  Additionally, lenders can tell you what minimum credit score is required for a particular loan program.

While lenders look at many factors when evaluating you for a mortgage loan, including your debt-to-income ratio, your income and assets, how much your down payment will be and your job history, your credit score is a vital determinant toward a favorable loan package.  Therefore improving your credit profile is clearly in your best interest during the months before beginning a serious home search.

The Pre-Buying Don’ts

Credit history form on a digital tablet

 

In our last blog installment, we discussed some pre-buying do’s.  Equally important to your home buying preparatory work are several pre-buying don’ts:

1)   Don’t Go Credit-Crazy

As previously mentioned in the “do’s” post, it’s smart to monitor your credit in the months leading up to a home purchase.  With every new line of credit opening, your credit score gets dinged.  So if a creditor solicits you for another amazing credit card with major perks, don’t bite during this crucial time.  Avoid any financial transactions that require inquiry into your credit health.

2)   Don’t Get Behind on Bills

Having a late payment hit your credit report before closing can impact your ability to get the loan you need.  Payment history comprise about a third of your credit health.  Many banks require 12 consecutive months of on-time payments to qualify for a loan in the first place.  A 30-day late blemish could cause lenders to rethink your loan application all together.

3)   Don’t Switch Jobs

Any change in employment is a significant risk from a lender’s perspective.  Lenders desire clients with stable, reliable income and generally will ask you to provide a picture of income stability during the underwriting process, as stability equates to the less likelihood of default in the their eyes.  During this crucial time of financial scrutiny, don’t switch jobs, don’t go entrepreneurial and become self-employed, and certainly don’t quit your job.

4)   Don’t Buy Anything Major

Don’t buy a car or truck or any other form of transportation that you have to finance.  Buying one increases your debt-to-income ratio and that’s something loan officers don’t want to see.  Additionally, don’t buy furniture or major appliances before buying your new house.  Like financing a car, charging big-ticket items negatively impacts your financial standing.  Keep yourself in good graces with your lending institution by minimizing your large expenditures.

The process of purchasing a home can be long and complicated.  From the moment you decide to become a homeowner until you close on your dream house, you want to provide a clean bill of credit so that your home gets financed favorably. Even if you have good credit at the beginning of the journey, there are ways to blemish your qualifications and make lenders think twice.  Being fiscally absentminded or slightly irresponsible with your credit health could cost you down the line.

 

Getting Ready to Buy? A Few Do’s.

Family with real estate agent

You’ve been flirting with the market for months, touring open houses on the weekend and logging in late night hours on Redfin or Zillow.  You’ve pinpointed the ideal neighborhood that suits you best and have toured the schools in the district.  You are ready to take the plunge and buy.  What next?  A few do’s:

1)   Get a Realtor

A seasoned real estate agent can provide you with valuable insights on homes and neighborhoods during the search portion of your house hunt.  And even with the proliferation of online real estate search engines, when the time comes to write an offer, you will need an experienced real estate professional on your side to navigate the negotiations, escrow and closing process with you.  Over the years, the laws for home buying have become increasingly complex and the process is filled with many moving parts.  Ask your trusted friends for quality agent referrals and find yourself a good teammate.

2)   Get Preapproved for a Loan

Consulting a mortgage lender will help you get a clear picture of your purchasing power so make this step at the top of your list of to do’s.   Understanding what you can afford from a lending perspective helps define your house search so you don’t waste time looking at homes you cannot afford.  Plus, often the market moves fast on well-priced homes, so having a pre-approval letter in hand lines you up at the front of starting block.

3)   Make A Checklist of “Must Haves” in a House

No two houses are the same and no house is ever 100% perfect, but having a checklist for your ideal home is useful so you are efficient in your house hunt.  A house can always be redecorated to perfection but it’s a bigger headache if your new house is missing that home office you had hoped to have.

4)   Check Your Credit

Your credit score helps lending institutions determine the rate and terms they can offer you on the loan.  If your credit is high, meaning that your credit history indicates that you are fiscally responsible, lenders will see you as a low-risk investment and offer you a lower rate on your loan with good conditions.  If your score is low, lenders will think you are a riskier investment and charge you with higher interest rates to take on the perceived risk.  Get your credit scores from Equifax, Experian and TransUnion, the three major credit agencies, so you can see how you stack up in terms of investment risk and see if you have time to improve your credit health.

Stay tuned next week for a list of pre-buying don’ts.

Changes to Lending Laws. Good or Bad for You?

Mortgage application

Last week, changes to current lending laws took effect.  These reforms seek to prevent the housing crisis of the late 2000s from happening again.  As we all vividly recall, millions of homes across the country during that time went into foreclosure because homeowners found themselves with loans they simply could not afford.

So, what are these changes and how do they affect you?

First, there’s the Ability-To-Repay Rule aimed at tightening the bank’s underwriting process.  Borrowers without a lot of debt won’t be affected by this new rule, but those who have a debt-to-income ratio above 43% will find it harder to qualify for a loan.  Self-employed borrowers will have to show more proof of income.  This rule attempts to hold banks more accountable by increasing the due diligence work required to qualify their clients.  While there are opposing opinions on whether this Ability-to-Repay Rule truly benefits the homeowning public, it does mean that borrowers from this point forward will likely have to jump through a few more hoops to secure a loan.  It potentially could mean that there are less qualified buyers in the market place as well.

Under this rule, you may start hearing the term “QM” which stands for Qualified Mortgage.  A QM loan meets the new guidelines.  So as a borrower, go and get yourself “QM-ed!”

The other changes to lending laws are likely to be less impactful.  For instance, there’s now a cap on loan origination fees.  Fees are to be limited to just 3% of the loan amount, which is great because borrowers won’t be paying an arm and leg for their loans.  But, this potentially could mean that lenders may not be interested in offering smaller loans.

Also, mortgage servicers are required to provide borrowers with a far more detailed statement on a monthly basis.  Statements must clearly show interest rate, loan balance and escrow balance.  Again, this is a consumer friendly rule trying to provide more transparency for the borrower.

A few things have not changed.  $625,500 is still the borrowing threshold at which it becomes a jumbo loan.  In a luxury market like Newport Beach, most buyers are seeking jumbo loans with a 20% down payment minimum.  Also, guarantee fees were scheduled to rise, but newly appointed FHFA head Mel Watt delayed the hike until further evaluation.  So for the time being, the guarantee fees remain unchanged.

Mostly, these changes imply more paperwork for the lender. While the intent of these changes is to avoid another foreclosure crisis, how these changes ultimately trickle down to the borrower and their impact on the greater housing market has yet to be fully determined.  What we surmise is this: it will be a little harder to qualify for a loan, more paperwork will be involved in the process, unconventional loans will be less available, and quite possibly, the market will have less ready and able buyers.