Minnesota Attorney General's Office
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Home Buyer's Handbook
Buying a home usually hinges on your ability to get a home loan. You’ll find that a little business savvy can go a long way in getting the best rate for your loan. The purpose of this section is not to offer a boring overview of loans but to give you some great cost saving ideas. Of course, you’ll need to understand the boring stuff first.
The fact is, you can cut your loan costs by comparing interest rates and negotiating lender fees. Lenders charge more than interest for lending you money. They’ll charge fees for their services, too. Many of these fees are negotiable. Understanding them and shopping around for the best prices can knock hundreds or even thousands of dollars off your loan. If you don’t shop around for a lender, you will almost certainly NOT get the best deal you could have gotten.
Minnesota has hundreds of lenders to choose from. Your lender will help you apply for a loan and get it approved through credit checks, property appraisals, inspections and the many other nagging details.
Where Do You Find a Lender?
How do you find the best lender for you? First get to know the basic types. All lenders originate loans and others service them, too. If you’re not sure what they do, simply ask them. Lenders include: banks, savings & loans, credit unions, mortgage companies and public agencies (including cities).
Terms to Know
Mortgage discount points: A "point" equals 1 percent of the amount of your loan. Points are prepaid interest on a loan and you’ll pay them to your lender when you close on a home. A loan with points has a lower interest rate than one without points.
Loan origination fees: These are the fees a lender charges for doing the paperwork involved in getting you a loan. See a full explanation of fees in Appendix E.
Escrow: Lenders often ask homeowners to keep future tax and insurance payments in an escrow account. The lender may administer these payments, asking you to “escrow” money. This means putting money in an escrow account to make sure funds are readily available to pay for your insurance and taxes. (See more about escrow payments on page 37.)
What Type of Loan Is Ideal for You?
There is no “ideal” loan for everyone. Perhaps that’s why there are so many options. Much depends on your financial history, your situation today and your future.
If you have a solid credit history, a good, steady income, and the prospect for reliable income in the future, you should have no trouble qualifying for a loan.
The amount of the loan will depend on the size of your down payment and your income minus fixed expenses. Chances are you’ll choose from one of these types of loans: a conventional loan, a Federal Housing Administration (“FHA”) loan or a Veterans Administration (“VA”) loan (if you’re a U.S. veteran). Any of these loans can be either a fixed rate loan or an adjustable rate mortgage (“ARM”) loan and can range in time from 10 to 30 years.
If you don’t have a large nest egg for a down payment, or you haven’t always paid your bills on time, don’t panic. Talk to several lenders about your financial situation. There are some options for people who have so-so credit records.
Fixed Rate Mortgage vs. Adjustable Rate Mortgage
A fixed rate loan offers an unchanging rate of interest over the life of the loan. So, if the loan starts at 7½ percent, it will always be 7½ percent. An adjustable rate mortgage goes up and down according to an index, often one-, three- or five-year securities of the U.S. Treasury. Many people may be lured into an ARM by a low introductory or "teaser" rate, but these rates can jump significantly in a short period of time. Many homeowners have faced default or foreclosure because they could no longer afford their monthly payment after a rate reset.
Advantages of Fixed Rate Loans
- Certainty is one. You know how much you’ll pay for principal and interest each month throughout the term of the loan. (If you escrow for property taxes and homeowner’s insurance, your monthly payment may vary according to increases in property taxes and insurance. Both tend to rise annually.)
- When interest rates are low, a fixed rate loan can lock you into a good deal.
Disadvantage of Fixed Rate Loans
- If interest rates are high when you take out your loan, they’ll remain high for the term of the loan. (Keep in mind that you can refinance your loan to a lower interest rate if market rates go down, but you may have to pay for an appraisal and closing costs again.)
Advantage of Adjustable Rate Mortgages (ARMs)
- ARMs have starting interest rates one to three points lower than fixed rate mortgages
Disadvantages of ARMs
- If your ARM’s interest rate goes up quickly, you could be paying more than the current fixed mortgage rate within just a few years.
- Most ARMs are not convertible, meaning you won’t be able to switch to a fixed rate mortgage to protect yourself from rising interest rates. You could, of course, refinance, but you’ll have to requalify and pay closing costs.
- ARMs include “exotic” mortgages such as “interest-only” or “negatively amortized” loans where the borrower does not pay down the principal of the loan for a certain period of time or where the amount owed actually grows! Once the borrower is responsible to pay off the principal they may be unable to afford their payment.
Federal Housing Administration (FHA) Loans
The U.S. Department of Housing and Urban Development (“HUD”) guarantees loans especially designed for low- to moderate-income home buyers. They are called FHA loans because they are insured by the Federal Housing Administration. These are the most popular loans for first-time home buyers in Minnesota, but they have these specifications:
- Maximum loan amounts vary from county to county. (Check with your local HUD/FHA office for your county’s limit.) Generally, these loans are used for low- to moderate-priced homes.
- You must pay for an FHA appraiser to determine the value of the home.
- You have to pay for mortgage insurance (see page 27).
Advantages of FHA Loans
- You can often make a down payment as low as 3.5 percent.
- You may qualify even if you carry substantial long-term debt. The FHA will allow you to pay 43 percent of your income toward long-term debt. This includes your home payment. (You may not be comfortable with such a large debt load, however.)
- FHA ARMs only move one or two points per year, depending on the product.
Disadvantage of FHA Loans
- You must pay a special fee (called a mortgage insurance premium or MIP) to the FHA in order to receive a loan. The fee is equal to 2¼ percent of the loan amount on a 30-year loan (2 percent on a 15-year loan). Note: First time buyers may be able to have this fee reduced to 1¾ percent, if buyers attend an FHA approved home buying course. You cannot cancel your MIP. Talk to your loan officer for more information.
If you have an FHA Loan, you will not pay the following:
- Real estate commission
- Deed and affidavit
- Underwriting/Document preparation fee
- Water or well certification fee
- Assignment recording fees
- Courier or express mail fees (except to pay off a prior lien)
- Termite inspection/Sewer charge
- Tax services
Veterans Administration (VA)Loans
These loans are available to those who have served in the military. Eligibility is based on length of service. To check on your eligibility, in Minnesota call the Veterans Linkage Line 1-888-546-5838 or (651) 296-2562. Surviving spouses also are eligible for VA loans.
Advantage of VA Loans
- You don’t need a down payment. You can borrow the entire purchase price of a home.
Disadvantages of VA Loans
- You can only finance one property at a time with VA loans. (You are, however, able to take out another VA loan after a previous VA loan has been paid off.)
- You must pay a funding fee similar to mortgage insurance for other loans. If you make no down payment, the fee is 2 percent for veterans or those in active duty, and 2¾ percent for those serving in the National Guard or reservists. The fee is lower if you make a down payment of 5 percent or more. Check with your lender about the funding fee. It may change at any time. You can pay the funding fee as part of your monthly loan payment.
Resources for Low-Income buyers
Home ownership may seem like it’s only for the rich, but it isn’t. Many financial institutions offer mortgage programs especially for people with low incomes.
Unfortunately, studies show that traditional lending practices have sometimes resulted in unfair treatment of low-income borrowers. For example, they may be turned down for loans because credit scrutiny is more strict for them than for middle- or high-income borrowers. Sometimes the scrutiny has less to do with any real credit problems than with where people shop. Stores catering to low-income individuals typically report customers’ late payments to credit bureaus more quickly and regularly than stores that cater to middle- and high-income individuals.
The good news is that help for low-income home buyers is on the upswing. The following resources are now available:
- Minnesota Housing Finance Agency
Offers below-market loans for buyers with low or moderate incomes and for first-time buyers. MHFA has statewide reach. Call (651) 296-7608 or 1-800-657-3769. www.mnhousing.gov
- Home Ownership Center
Refers low-income residents to trained home ownership counselors in nonprofit agencies in Minneapolis and St. Paul. Call (651) 659-9336 or 1-866-462-6466. www.hocmn.org
- Minneapolis Public Housing Authority
Provides information, referrals and assistance to people seeking low-income and Section 8 housing. Minneapolis residents call (612) 342-1400 TTY: (612) 342-1415 www.mphaonline.org
- Minneapolis Community Planning and Economic Development (“CPED”) Department
Information about housing and low-interest mortgages for people in Minneapolis is available by calling: (612) 673- 5095. www.ci.minneapolis.mn.us/ cped
- City of Saint Paul's Information & Complaints Office
Housing information, low interest mortgages, education, counseling and advocacy for people in the St. Paul area. Call (651) 266-8989 TTY: (651) 266-6378 www.stpaul.gov
- St. Paul Public Housing Agency
Provides information, referrals and assistance to people seeking low-income and Section 8 housing. St. Paul residents call (651) 298-5664. www.stpaulpha.org
- USDA Rural Development
375 Jackson Street, Suite 410 St. Paul, MN 55101 Call (651) 602-7800 www.rurdev.usda.gov/mn/
Also contact the city or county where you would like to live. They may offer incentive programs for locating in the area.
FHA, VA and a few conventional loans are assumable. This means a buyer can take over the seller’s loan and make the payments that were negotiated by the seller years ago. You might not have to go through the qualification process to assume some conventional loans. But the FHA and VA may make you meet their qualification standards.
Aside from the possibility of easy qualification, the advantages of assuming a loan are all but dried up in a time of low interest rates. Assumable mortgages may carry higher interest rates than those currently available, although they will generally have lower closing costs.
Will You Need Mortgage Insurance?
Mortgage lenders require you to purchase insurance that protects them in case you default on your loan. Even though the insurance isn’t for your benefit, you must pay for it unless you make a down payment of 20 percent or more on a conventional loan. The insurance you need depends on your type of loan.
Private Mortgage Insurance
If you have a conventional loan and make less than a 20 percent down payment, you must buy private mortgage insurance (“PMI”). This is usually paid monthly. The servicer of the loan must notify you annually, beginning 24 months after your loan was completed, to tell you under what conditions you will be released from PMI. You cannot cancel PMI during the first two years of the loan and you cannot have a history of late payments. Contact your mortgage lender for details. You may be released when you gain 20 percent equity in your home.
But there is a big difference in how equity is calculated under federal and state law. Because federally chartered lenders do not have to abide by state law, you must first determine whether your lender is state or federally chartered. Under the federal law, your home’s value is based on the original value of your home when you bought it. Market appreciation is not considered. Because the first years of a mortgage payment are mostly interest, a homeowner would have to wait years, often a decade or more, before reaching the required 20 percent in equity as determined by federal law.
Fortunately, Minnesota has one of the best laws in the country for early cancellation of PMI. Under Minnesota law, the value of your home is based on what it would be worth if you sold it today. This amount includes appreciation in home value. For instance, if you bought your home for $100,000 with 5 percent down, and your house is now worth $130,000, you probably are eligible to cancel PMI under Minnesota law. Remember you cannot cancel PMI during the first two years of the loan and you cannot have a history of late payments. Contact your mortgage lender for details.
Mortgage Insurance Premium
FHA loans include a mortgage insurance premium (“MIP”) of 2¼ percent of the total loan amount for a 30-year loan. The premium is 2 percent on a 15-year FHA loan. You can pay the insurance when you close on your home or pay it as part of your monthly payments. You’ll also have to pay an annual fee of ½ percent of the loan amount in monthly installments. The lower the down payment, the longer you will have to pay this fee. You cannot cancel your MIP under Minnesota’s private mortgage insurance cancellation law.
How Can You Get the Lowest Loan Rate Possible?
You don’t have to be a genius to get good interest rates and reasonable fees for your loan. You must shop around. Some solid research will do the trick. Here are four steps to take in comparing loan interest rates and fees.
Step 1: Get a Good Faith Estimate
Lenders charge all kinds of fees, called closing costs, for loans. The long list may overwhelm you at first. Hang on to your hat — and your wallet. You may not have to pay all these fees. Many are negotiable (if not with the lender, then with the title company or closer). We’ll discuss some of the fees here. For specific definitions of all the fees, see Appendix E. Ask your lender for the HUD booklet, Buying Your Home: Settlement Costs and Helpful Information, which explains the fees further.
Within three days of applying for a loan, your lender must give you a disclosure form called a good faith estimate. Expect closing costs to run 2- 4 percent of the total amount of your loan. A good faith estimate will list the fees you will be asked to pay to close on a house. Remember that many fees are negotiable and that you should inquire about such fees. Some are interest and points, some are passed on to a third party (such as a title company or an appraiser), and others may be well-padded to ensure a profit for the lender. See Appendix F for an example of a good faith estimate. Remember, however, the interest rate you are being quoted is just that - a quote- it could change the next day. See page 30 for information on how to lock-in an interest rate.
Step 2: Compare Fees
Use the worksheet on pages 31-32 to compare closing costs. When you walk into a lender’s office with this worksheet, the loan officer will take you seriously! When negotiating your mortgage, understand the following fees:
Lender/broker fees. These fees, such as a document preparation fee or processing fee are paid to the lender/broker and are generally negotiable. Make sure to ask questions about such fees before you agree to pay them as part of your closing costs. It doesn’t matter what the lender calls the fees - they are just fees. You may want to add all of these fees together and negotiate by using that one number.
Third-party fees. These fees, such as title insurance are paid to a third-party outside the lender or broker. Often, these fees are negotiable. Be sure to ask questions about the affiliation of third-parties and the possibility of reducing such fees. You should shop around to various title companies and request quotes.
Government taxes. This includes taxes payable to the city, county and state. These fees are not negotiable, but it is important to have your lender or broker explain such costs to you. Be sure to ask questions. For purposes of comparing good faith estimates by different lenders, you generally do not need to consider differences in estimated government fees because these charges should be the same regardless of who you select - the government charges them, not the lender.
Step 3: Find the Annual Percentage Rate (“APR”)
The annual percentage rate (“APR”) is an interest rate that reflects the total of all the fees a lender charges you to make a loan, including your ongoing interest rate, points paid up front and fees for processing the loan. With all these variables, it can be hard to tell exactly what you’re paying for a loan. While your loan may have a stated rate, for example, of 8 percent, by the time you take all the other fees into account, you may be paying the equivalent of a considerably higher rate. That’s what APR measures. By asking lenders for the APR on the loans you’re considering, you can compare them far more easily.
Step 4: Get a Lock-In Agreement
You applied for your loan in September and you’re not going to close on the home until November. How can you guarantee that the low interest rates your lender quoted will be available in November? The answer: Get a Lock-In Agreement. This contract states the interest rate and points you agreed to when you applied for the loan. But the agreement comes with this warning: Once you’ve signed it, the lender will expect you to accept the loan at the stated rate, if it’s approved, even if you find a better deal somewhere else.
Signing Lock-In Agreements can guarantee you current rates until the agreement expires. But if rates are going down, you might want to wait to lock in your interest rate, or float. On many lock-in forms you can check one of two boxes. You can either agree to float your interest rate or lock it in at the current rate. Which should you do?
- If interest rates are going down, consider “floating” with the interest rates. You can lock in when you think rates are as low as they’ll go before your closing.
- If you think interest rates will go up, lock in as soon as possible.
To ensure that you get the rate you want, sign your Lock-In Agreement and mail or fax it to your loan officer as soon as interest rates are where you want them. Simply phoning in a lock-in request isn’t safe. You must sign the agreement to make it valid.
What If the Agreement Expires?
Lock-In Agreements typically expire after 60 days. If you are applying for a loan during a busy time, your paperwork may be delayed. You could risk losing the attractive interest rate you were locked in to.
Minnesota law says that lenders cannot offer you a Lock-In Agreement unless they believe, in good faith, that they can close on the loan during the lock-in period. Ask lenders how many days they think it will take to close on your loan. If a lender won’t put this information in writing, then make your own written record of what the lender tells you.
Contact your loan officer periodically to check the progress of your loan application and to see if any more information is needed. Keep a written record of these contacts for your files. You may be able to pay an extra fee to extend your agreement to 90 or 120 days. This may be worthwhile if there are unavoidable delays in closing on your home.
The Property Appraisal
To approve your loan, your lender will require you to pay for a property appraisal. This estimates the value of the home. A lender requires a buyer to have a home appraised to make sure its value supports the loan amount. The value may not be the same as the price you agreed upon with the seller. Ask your lender for a copy of the appraisal. By law, you have a right to obtain one.
What If the Appraisal Is Less Than The Price You Offered?
Your lender will lend you only enough money to cover a home’s value (minus the amount you’ll be paying for a down payment and up-front costs). What if the appraisal is lower than the amount you offered to pay for the home? You either can ask the seller to drop the price or have the home reappraised in the hope of getting a higher appraisal. A different appraiser may think the home is worth more. Buyers commonly add a contingency to the purchase agreement permitting the buyer to cancel the agreement if the home’s appraised value is lower than the price offered. FHA and VA financing addenda have pre-printed contingencies for this purpose; the standard Minnesota Association of REALTORS® conventional financing addendum does not.
Understanding Your Loan Payment
Once you buy a house, you’ll pay your mortgage payment each month either to your lender or the company that services your loan. Your check then is divided up to pay for your loan (principal and interest), taxes and insurance. You might be surprised to know how much of your loan is interest.
For a small fee, many lenders can supply you with an amortization chart, showing the principal and interest payments on a loan over its term. For example, if you have a 30-year $80,000 mortgage at 7½ percent, even after paying on the loan for 21 years, more than half of each monthly payment would still be going toward interest! By the time the loan is fully paid off, you will pay $123,210 in interest! If you were able to make higher monthly payments, you could pay less in interest by choosing a 15-year loan instead. With the shorter loan, more than half of each monthly payment would be going toward principal after only seven years, and you would pay only $55,944 in total interest over the life of the loan.
As this example shows, you can save a lot of money by paying off a loan in a shorter span of time.
What Is “Equity” in a Home?
Equity is the value of your ownership interest in the home, or the amount of the home’s value that you own, free and clear of any mortgage or lien. Until you pay off the loan, the lender has a lien on your home. The more principal you pay, the more equity you have in your home.
Who’s Servicing Your Loan Now?
At some point after you take out a loan, you may find that the address where you send your payment has changed. The company that gave you the loan no longer “services” it. Like a stock or a bond, your loan has value and your lender can sell it. In fact, your loan might be bought and sold to several lenders throughout its term. Each lender must service the loan according to the agreement you made with your original lender. Like with any business, however, some services are better than others.
By law, your original lender must tell you at the time of the loan application whether your loan might be serviced by another lender, and the percentage of loans your lender has assigned, sold or transferred over the past three years. If your lender tends to assign or transfer its loans, ask about what companies it tends to transfer its loans to, and do some research into that lender and its reputation for customer service. Your lender also must disclose the lender’s capacity to service loans.
You will be asked to sign a statement saying that you’ve read and understand this disclosure. Please see pages 38-39 for an explanation of your legal rights.
BEWARE OF ABUSIVE AND PREDATORY LENDING
Buying a home can be a very exciting time but remember that buying or refinancing a home may be one of the most important and complex financial decisions you will ever make. Misinformed consumers are the best targets for predatory lenders so it is important that you understand the process of securing a financial loan. Offers coming from abusive lenders and brokers may seem like good deals initially, but beware of financial pitfalls that may cause you financial hardship in the future.
Predatory and abusive lending can take many forms. Be cautious and be wary of offers with:
- High Interest Rates And Fees
Don’t be afraid to ask the lender or broker questions about something you don’t understand in your loan document. Don’t let someone pressure you to sign. Take time to review your loan thoroughly as it may contain high closing costs and hidden fees. You may find loan origination fees, underwriting fees, broker fees, as well as closing costs. It is important to know that these fees are negotiable and you should ask the lender or broker to explain the basis for the fee.
- Small Monthly Payments With A Large Balloon Payment At The End Of The Loan Period.
Make sure you review and understand the full payment arrangement on your loan before you sign. Sometimes lenders will stretch out the payments so that your initial loan payments are small enough to afford. However, stretching out the payments on your loan may result in large unaffordable payments later on which can force you into obtaining another high interest loan to make final payment or selling your home. It is important to know what your payments will be over the life of the loan.
- Inflated Appraisals
Remember that appraisals are only estimates of the property’s worth. For instance, suppose you get a $200,000 loan based on an inflated appraisal. You will be held responsible to pay the $200,000 back in full even if your home only sells for $160,000. Whether you are a first-time home buyer or looking to refinance, be careful of appraisals that overstate the value of your property.
- High Loan-To-Value.
Be extremely cautious of lenders or brokers who encourage you to borrow more than 80 percent of your home’s value. A high loan-to-value- ratio puts both your home and your financial record at great risk.
- Adjustable Rate Mortgages (“ARM”).
As opposed to a fixed rate loan, the interest rate on ARMs fluctuates according to the market. Watch out for ARMs with tempting low introductory rates. Just because you can afford mortgage payments at the present interest rate doesn’t mean that you will be able to do so if the interest rate rises.
LOOK OUT FOR PREPAYMENT PENALTIES
These are fees designed to penalize consumers from paying off some or all of their loan early. Facing prepayment penalties, consumers may stay locked in high interest rate loans because it would be too expensive to pay the penalty.
Under Minnesota law, the terms of the penalty must be fully disclosed to the borrower at the time of application. The penalty can only be up to two percent of the unpaid principal or 60 days interest on the unpaid principal, whichever is less. A penalty cannot be imposed beyond 42 months of the loan, or upon the payoff of the loan as a result of the sale of the property. Minnesota law on pre-payment penalties does not apply to all loans made in this state. Some loans may be subject to stiffer penalties as stipulated in the loan agreement.