Making Mortgage Sense of a New Home Purchase

Finding out just how much home you can both qualify for as well as feel comfortable buying is a preliminary step that gives you the dose of reality you’ll need when looking for a new home. It’s not enough to know you have good credit and make a decent income. There are more factors that will enter into how a mortgage loan works with new construction than you may imagine.

Unlike the garden variety real estate loan scenario-- offering on a used home today that you may go into escrow for tomorrow and move into in 30 days-- purchase loans for new construction are slightly different animals. They are not only designed to lend you money to buy your next palace – they are also orchestrated to assure the builder that you are a good risk in terms of their planning to build a house with your upgrades and architectural options in mind. True, if you somehow didn’t want to or couldn’t go forward with the purchase, the builder could re-sell the house to another buyer under certain conditions. But once it has begun to build the house personalizing it to your tastes, it becomes more difficult for them to find a buyer who might want everything you originally ordered. And once that house has been fully built, the builder has a mortgage payment as well as land-hold costs and remarketing to do before it makes its happy trip to the bank.

Therefore, getting a preliminary pre-approval --and not just a prequalification--is of utmost importance. What is the difference, you may ask?

A prequalification is merely a conversation between a potential buyer and a lender or builder’s salesperson where the basic information is offered by the buyer. For instance, you may tell a lender by phone that you and your wife make X amount of (gross) dollars per year. The lender may ask you for the amount of outstanding revolving monthly debt you have incurred whose payments can continue past ten months’ duration – and perhaps you’ll inform them of a credit card payment, a car loan payment and a department store credit card payment.

However, during a cursory conversation such as this, you may NOT get into the details of (or forget to mention) other debts you may have incurred, such as an outstanding student loan, child support payments, a past bankruptcy, or a rental you own that, although it has been perpetually occupied, has a vacancy factor that must be figured into your debt load.

You may fail to mention that you’ve only been on your current job for a year and switched careers from being a software engineer to an account representative for a cell phone provider. And you may not feel like mentioning that your wife’s plan is to open her own clothing store business in a few months.

The lender may run a preliminary credit check, take at face value what you’ve revealed to him over the phone and issue a prequalification letter to the builder saying that – based on the information they were given and pending verifications of what you’ve represented-- you appear to qualify for a $350,000 home if putting 10% or more down under certain conditions . To a builder, however, this means little.

A pre-approval is more of a sure thing – both for you and for the builder. To get pre-approved, a lender walks you through the entire process as if the only thing missing from the equation is the property address and the final appraisal. This is when you fill out a loan application. This questionnaire asks specifically what debts you owe, how long you are obligated to pay on them, where you work and how long you have been in that line of work, and where the money will be coming from for the down payment on the house to be built. Employment must be verified, seasoned and gifted funds must be confirmed, and a complete credit report is pulled.

Again, the only things missing from a pre-approval that are present for a final approval are the homes’ address, the final price and an appraisal by the lender ensuring the bank’s risk -- as well as a final credit check and review by underwriting at the time the home is finished and everyone expects escrow to close. By the way – you may want to wait until after escrow closes and you have established a mortgage payment history on this house to do anything that can show that new credit was extended, just to be safe. There are variations on this theme – more documentation and paperwork may be required if you are self-employed and less if you are putting down a substantial amount of money, making the loan-to-value ratio much lower and lessening the lender’s risk.

The quality of a pre-approval letter and the terms specified on it can also vary from lender to lender. Builders understand that you may have longstanding relationships with lenders that you’ve worked with in the past. But they also may link some builder-paid incentives -- in the form of credits in escrow – if you use their preferred lender for your mortgage loan. This “play money” can usually be used for what are called “soft costs” to the builder – for things you purchase for the house at retail that the builder gets at wholesale – such as upgrades at the design center, a pool, window blinds, etc. These funds may also be made available to help with your non-recurring closing costs if you opt to use the preferred lender. in today's market, the builder may permit you to lower the price of the home with the incentives, but this is NOT their first choice, since it may affect ongoing appraisals in the neighborhood.

Incentive monies are difficult to pass up when out-of-pocket expenses are a concern, but understand one thing here – no builder can force you to use their preferred lender. A good analogy to this may be the lure of buying a car through a dealer that advertises 0% financing. This incredible deal is available, however, only through the dealer’s own finance company. See the similarity?

At the same time, the builder is under no obligation to offer its incentives if you choose to use your own source of funds.

If the builder’s in-house or preferred lender cannot get your loan approved and some other lender has already proven that they can, however, you may want to press the builder for those incentive monies anyway – you never know what you can get unless you try, after all. A good rule of thumb when you have qualifying issues is to run your loan past two different lenders – the builder’s as well as your own. And see who comes up the winner.

Your loan approval will depend on what are called debt “ratios.” These ratios have to do with the percentage of your gross income to be spent on housing alone (this is called the FRONT ratio). The BACK ratio is one that includes your ongoing monthly debts added to it. Depending on the variety of loan you choose (fixed rate, adjustable rate or varieties on the theme (where it’s fixed for a few years and then can adjust) the ratios can be different.

Lenders also use what they call “compensating factors” when they are attempting to make sense of your credit-worthiness. If you have an outstanding credit score and little debt, your loan officer may be able to ask his or her underwriters to “stretch” the top ratio. These underwriters base their decisions on millions of people like you, calculating how likely you would be default on a loan by assessing the risk. The bottom line is that underwriters are there to minimize risk for the lender they represent.

Whether you use your own lender or opt to use the builder’s however, there are some things to keep in mind about getting approved for financing:

First, leave room in the figure you want to borrow for the extras – the design center upgrades you may choose, the patio you may want the builder to pour, or the floor plan options that will cost you extra money. A $350,000 base price on a builder’s price sheet is only for the basics – like buying a car without many bells or whistles unless they are advertised to be included in the price to begin with. You can find out what is included in the base price of the house by both studying the builder’s brochure and speaking with the on-site salesperson.

But the best way to get a feel for what the house looks like without upgrades and options is to ask the sales person if any nearly-finished houses in the neighborhood exist that you might be able to walk through. Model homes are notorious for displaying hundreds of upgrades available to you through the builder’s design center, but if a builder is smart, they will have examples of just about everything that comes “standard” in their homes somewhere within their model home tours. That is, except for the builder’s included carpeting. The least expensive carpeting probably could not endure the thousands of feet that would trample on it as people toured the models anyway.