With home buying comes a series of decisions, including where to buy, what kind of house, whether to obtain a loan and what are its terms, and so on. One issue that is often overlooked until the end of the transaction is, “Why do I need title insurance?”
Every buyer and seller in a real estate transaction sees charges for a title insurance policy, but few know what the purpose of the policy is, other than something gets insured. Title policies insure that things are what they are supposed to be: in a purchase the title policy is insuring that you are the rightful owner, that no one can come along later and claim ownership of your property. For lenders the title policy insures that their lien has a certain priority on title and that the only liens against title are documented and disclosed. Title insurance covers any title issues that occur up to the date deeds are recorded when the policy is in effect, it does not cover any issues that occur after the transaction.
Title insurance is not cheap, and claims are rare. But when title insurance companies do pay claims, they are usually very hefty, think tens or hundreds of thousands of dollars. Because of this most of the revenue title insurance companies collect do not go to paying claims, in fact the industry average is that only about 5% of premium revenue goes to claims compared with approximately 70% for auto insurance. Title insurance companies spend the bulk of their premium revenue on loss prevention (research).
Claims might be paid if the owner of your current home purchased the property eight years ago from a seller who had a lien against the property that was recorded improperly in the county records and that lender stepped forward to collect on your home and possibly force the sale. Forgeries on deeds, unpaid liens, easements improperly recorded or illegal confiscations of title on the property are problems; bank foreclosures and short-sales can complicate things, as can divorce settlements with a recalcitrant spouse, estate issues, easements, or a private party second from a prior seller.
Title policy premiums pay for all the work done by the title company prior to closing so they can insure the buyer/person refinancing obtains clear title. And if the owner discovers later that they do not have clear title, it is the title insurance company’s obligation to pay to correct any claims that may arise.
Our agents are sometimes asked, “Why are mortgage rates different?” It is important for borrowers to remember that mortgage rates and interest rates in general, are determined by different factors, so an understanding of how mortgage rates are determined will help to better understand how banks and mortgage lenders set interest rates.
Every loan scenario is different, with different amounts, different borrower credit scores, different types of housing etc. – dozens of variables - and each loan must be priced accordingly. The predominant factor in determining interest rates and prices, however, is the risk of default risk, which is called “risk-based pricing.” The higher the risk, the higher the rate.
Banks and lenders start with a base interest rate and then either raise it or lower it based on the loan criteria. These include loan amount, documentation (full, limited, or stated), credit scores, occupancy, loan purpose (purchase or refinance, and if there is cash out), Debt-to-Income Ratio, property type, loan-to-value, and so on. In recent years, for example, loans made on non-owner occupied properties, or loans to borrowers with low credit scores have defaulted at a higher rate than other types of loans, and thus the rates are higher. And loans that do not fall under the maximum mortgage loan sizes set by Freddie and Fannie are usually pegged at a higher rate, since those loans are not easily bought and sold in the secondary markets.
Our borrowers often come to us with an ad from a newspaper, TV, or radio. Any rates that we hear about in the media are usually a best-case scenario: owner-occupied single family home, a perfect credit score, a huge down payment, and a conforming loan amount. Few of our borrowers are perfect, and as a result, they’ll see different mortgage rates. And “different” often means higher depending on the factors listed above.
In underwriting a home loan, generally the income from a borrower who is an employee (that is paid regularly and who receives a W-2 at the end of each year), is whatever monthly income the employee is making at the time of the loan – including recent raises. Borrowers who are self-employed, however, often feel as though they are being discriminated against when it comes to qualifying for a mortgage. And rightfully so: income used to qualify for a mortgage for a self-employed borrower must be averaged over a 12 – 24 month period.
For sole proprietors, the income that is used to qualify the borrower must come from the bottom line on Schedule C of the federal tax returns. It is called “Net Profit” and is divided by 12 to come up with the monthly qualifying income. The net profit is what is left after the taxpayer deducts all of his expenses from his or her gross income. The more deductions the taxpayer claims, the lower the net profit and the lower the income tax liability; however, it also reduces the purchasing power of the borrower. Underwriters will often say, “A borrower can’t have one set of books for a loan and another set for taxes.”
Since many lenders want to average the self-employed borrower’s income over the last two years of federal tax returns, any increase in profits realized by the borrower from one year to the next is diluted when the sum of two years of net profits must be divided by 24. To top it off, when a self-employed borrower’s income drops significantly from one year to the next, it is the income on the most recent tax returns that is used to qualify the borrower and an explanation as to why their income is dropping is required.
Cash that sits in a business account of a self-employed borrower will generally not be accepted as cash that can be used to cover the down payment or closing costs for a home purchase. Generally borrowers who own 25 percent or more of a partnership, LLC, or corporation must also provide the partnership returns and/or corporate returns for two years – like a self-employed borrower.
There are, however, some programs that are better for self-employed borrowers, and that can be explained by a trained loan officer. Check with your lender!
Sometimes loan officers are asked the simple questions, “Why should I buy a house? Is it a good investment?” Here in the United States the enthusiasm for buying a home remains remarkably strong. Recent surveys found that almost two-thirds of Americans think that buying a home is the best long-term investment a person can make.
But is buying a house really a good investment? There are plenty of non-monetary benefits to owning a home, but is buying a home a good financial call? As always, it depends on your individual situation, but generally the data suggest that compared to the stock market, buying a home has produced similar or better returns with less risk—especially over longer horizons.
If you compare the increases in the prices of homes and stocks by looking at the S&P 500, stocks seem much more attractive. Since 1975, the S&P 500 has increased more than twentyfold while over the same period, the Zillow Home Value Index, which tracks the value of the median house in the United States, has only increased in price fivefold. Once dividends and rents are included, however, and after accounting for taxes over the period from 1975 to present, the annual return of the S&P 500 is about 10% versus housing’s nearly 12%!
As a homeowner you don’t just benefit from the increase in the price of your home, you also could receive rent, or living in it “for free” after the loan is paid off. There are tax benefits in the form of deductions, versus actually paying taxes on stock dividends or bond income.
And the difference between 10% and 12% might sound small, but over a long period of time it can compound to quite a big difference. Over 40 years an annual return of 11.6% means that a dollar would grow to almost $80 but at 10.4% that same dollar would grow to just over $52. A difference of only 1.2% each year compounds into a difference of more than 50 percent over 40 years.
Any lender knows that credit, collateral, and character are of the utmost importance in the lending decision. Unfortunately for many people of sterling character, in this day of automation and decision making, credit and collateral have more focus on them, and have become purely a numbers game. In fact one of the biggest issues facing homebuyers today is problems with their credit scores. Available loan products and interest rates will vary significantly with a person's credit score, and loan officers spend a fair amount of time working with borrowers to make sure that their credit score are as high as it can be.
Borrowers are told to make their mortgage payment on time and in no event later than the 30th day of the month. Even one 30 day late mortgage in a year can drop a credit score by 40-50 points and make one ineligible for certain mortgage products. Borrowers should not allow their credit card balances to go above 50% of their maximum credit limits, ideally (for credit score purposes) keeping the balances at 25% of the credit limits.
All minor medical bills should be paid once the insurance company has finalized the person’s share of the bill. Disputed charges are often less than $200, but a Collection Account on a credit report can reduce a credit score by 20-100 points.
A borrower, whether it is a purchase or a refinance, should not take out new debt during the mortgage process without speaking with their lender. This includes car loans, credit cards, etc., and also includes co-signing a loan for a friend or relative. (Co-signing, from a legal perspective, is the same as signing.) Nor should they have too many institutions run their credit report as each credit pull will reduce a credit score by about 5 points.
Many people are involved in the home loan process and lending decision, and it is in everyone’s best interest to keep credit scores as high as possible.
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