At CAV_OK, our goal is to help you feel confident about your financial decisions. In this monthly column, we will answer frequently asked financial questions. This edition's content is educational for everyone; however, it's probably most beneficial for young adults and first time home buyers.
Buying a home is considered a crucial part of the American Dream, white picket fences and all. While the size and shape of these houses may differ, for all intents and purposes, owning a house is a uniform ideal entrenched by decades of marketing and societal expectation. Despite being an integral part of having “made it” there exists a great deal of confusion as to how to go about the home buying process. Due to the clear majority people having to utilize a mortgage, this article will place emphasis on that aspect of the home buying process.
The home buying process can be divided into six basic steps: Pre-approval, house shopping, mortgage application, loan processing, underwriting, and closing. These can be further subdivided into essential steps that we will breakdown as we go along. To illustrate this process, we will consider the experience of a purely fictional family, the Holmes with the purely fictional Lestrade Lending Institution, and other assorted corporate entities.
The Holmes, Sherlock, Mycroft, and Eurydice are a clever bunch. Having spent some time in the UK they were not at all pleased with the cost of living in London. After much consideration, customary for their family, they have decided to replace their flat in London with a proper house across the pond in Virginia. After going through the naturalization process, they became fully fledged citizens of the United States of America.
Being shrewder than some they elected to get preapproval out of the waybefore they went house shopping. Talking to a loan officer named Grant, at the Lestrade Lending Institution, Sherlock was instructed to verify his income, employment, assets and debts. He promptly went and acquired his previous year’s W-2 and his 2 most recent payroll stubs from Scotland Yard to verify income. He also found his bank statements, retirement and brokerage account statements. Once he met up with the loan officer he realized he had been distracted by a case and forgotten his debt obligations such as his school loans, auto loans and credit card statements. After being chided by Mycroft and then acquiring said debt statements they were pre-approved for a loan of $400,000.
House shopping for the Holmes was simple enough. Mycroft’s contacts found a reputable, licensed real estate agent that helped them look for houses in their price range. They were able to find the most UpToDate prices and housing inventory through their agent’s access to the Multiple Listing Service (MLS). They found a bungalow with all the requisite amenities and space for their various hobbies. The Holmes then made sure to carefully structure their offer on contingencies that would protect their earnest money deposit. Their offer was contingent upon the appraisal value being close to the loan amount, the house passing its home inspection, and final loan approval.
The trio was then ready to finalize their mortgage application. They went back to Lestrade Lending Institution to be formally evaluated through their underwriting process. Sherlock learned from his previous encounter and made sure to bring not only his paystubs, w-2s, bank statements but also debt statements regarding his student, and auto loans as well as credit card statements. Upon arrival, the loan officer also requested proof of homeowners’ insurance, the property’s address and the type of mortgagethey were requesting. Having received the pertinent information, Grant the loan officer informed the Holmes that the ball was in his court so to speak. He told them that by law they should receive their loan estimate within 3 days of application and that it would describe the terms and predict the costs. The Holmes left, satisfied that their part in this portion of the process was finished.
Grant then went to work opening the Holmes file. He proceeded to order a credit report, verify their employment and bank deposits, order a property inspection, order a property appraisal and order a title search. He then went about the process of underwriting, evaluating the documentation he had received from the Holmes, cross checking the eligibility requirements, reviewing credit history and assessing the collateral. Meanwhile, at the Holmes residence, Mycroft’s contacts had found an excellent home inspector, Mr. Anderson, and the property inspection was underway. As is customary, Mr. Anderson assessed the roof, foundation, electrical system, heating and cooling, and plumbing. It was the latter portion of the inspection that the inspector found a troubling matter. Due to a particularly sudden torrent of rain, the sump pump had been overwhelmed and had resulted in a partially submerged basement. Accordingly, the inspection report made note of this. The Holmes were troubled by this new development but were reminded of the contingencies they had cleverly built into their offer. Using their contingent offer as leverage they were able to convince the seller to replace the sump pump with a superior offering, more suited to sudden deluges as well as fix the basement.
The next step was the home appraisal. The good people at the Lestrade Lending Institution had found an impartial appraiser from an appraising management company that specialized in residential housing. Molly Hooper, a superb licensed professional, opted to use a comparison appraisal approachas the neighborhood the Holmes’ prospective home was in was well developed and had undergone a spate of recent home sales. Sherlock, being a rather inquisitive chap, queried why she didn’t use a cost appraisal approach. She countered that the cost appraisal approach was mostly used for new housing and in neighborhoods where there was a great deal of recent developments. The Holmes home was situated in a very well-established neighborhood and new construction had been rare in recent years. Soon the home appraisal was finished, and Ms. Hooper gave Sherlock the final appraisal. Both the Lestrade Lending Institution and the Holmes found the appraisal within the expected, acceptable range per the contingent offer.
Later, within the 3-day timeframe Greg had informed them of, the Holmes had received their loan estimate. The loan estimate described the terms of the mortgage as well as predicted the costs of the mortgage such as closing costs, the interest rate, the monthly payments, and late charges. Grant, being nothing if not diligent, had finished the underwriting process within 7 business days. He called the Holmes to his office and approved their mortgage with the condition that the Sherlock reveal the source of a large sum of money recently deposited. Sherlock obliged and revealed the nature of a lucrative assignment from a mysterious benefactor. Having satisfied the underwriting condition, it was time to lock the interest rate and have title insurance ordered before the closing meeting.
The Holmes were eager to enter the final stretch of the home buying process. The loan documents were drawn up and sent to an attorney’s office. Grant noted that Lestrade Lending Institution was required to give the Holmes their Closing Disclosure 3 days prior to the closing meeting. Grant further mentioned that this 3-day review period would be reset if any significant changes occurred. As it happened, Lestrade Lending Institution decided to add a prepayment penalty of 3% which reset the 3-day review period. During this review period, the Holmes made sure to have a final walkthrough of the property. Eurydice was eager to enter her new home. She made sure that Sherlock brought his two forms of identification and proof of insurance to the closing meeting at the escrow office. She also had fully funded the escrow account for the necessary settlement fees and prepaid expenses. Once at the meeting Sherlock had to sign the promissory note, mortgage note, deed of trust, the deed, as well as an affidavit. Having done this, as well as pay the requisite attorney fees and escrow fees, the Holmes were given the keys to their new home.
Stay tuned for next month's column where we will answer more of your frequently asked financial questions.