Buyers need to get “pre-approved” for an actual loan for several reasons: (1) to know what purchase price they qualify for; (2) to make sure they are comfortable with the potential payment; and (3) to make sure their offers are taken seriously. Sellers will not entertain offers without a formal Pre-Approval Letter attached to it. Formal pre-approvals can also make offers more enticing by offering a “fast close.” We can close as fast as 14 days at JVM Lending, and sellers often prefer a “fast close,” or short escrow period, over a “slow close,” even if the slower close is associated with a higher price.
How to Get Pre-Approved
It is easy and free. We email or send borrowers a list of documents that we need, as well as some questions we need answered for the loan application. The documents consist primarily of tax returns, W2s, pay-stubs, and bank statements. We do all the work for our borrowers and make sure all potential issues are addressed up front. We then tailor “Pre-Approval Letters” for every offer (see “Make Offers” below).
No Unexplained Deposits
We include this section towards the beginning of this guide to emphasize its importance. All “large deposits” showing up on bank statements must be explained and/or “paper-trailed.” Deposits as small as $500 that are from “mattress money,” untraceable foreign bank accounts, or cash payments of any kind can render an entire bank account invalid and unusable for qualifying purposes. Borrowers need to keep a paper-trail of every large deposit, and if they need to make large deposits that are difficult to paper-trail, we encourage them to contact us first.
Find a Real Estate Agent
We strongly recommend the assistance of an experienced Real Estate Agent. Experienced Real Estate Agents have access to the Multiple Listing Service (MLS) and can better assess all the properties available in a buyer’s price range. Real Estate Agents know the local market much better in most cases, and can help buyers avoid purchases that are not in their best interest. Appropriate offer-prices can be difficult to assess, and a Real Estate Agent’s guidance is crucial in a competitive market. Without a Real Estate Agent’s expert guidance, buyers might pay too much or offer too little and not get the house they want. Real Estate Agents also make sure buyers’ rights are adequately protected and that they get all of the necessary “Inspections” (see below) done properly. And finally, Real Estate Agents help buyers effectively negotiate for “Seller Credits” (see below) for closing costs and repairs, among other things. Please let us know if you need a Real Estate Agent referral; we know experienced Real Estate Agents in most major markets throughout California.
When buyers find a house they like, their Realtor will write an offer on their behalf and submit it to the Listing Agent (the Realtor who “listed” the house for the seller). Buyers’ offers will not be taken seriously, however, unless they are accompanied with a formal “Pre-Approval Letter,” as we mentioned above. Buyers’ Realtors usually tell us what the offering price is and we then send a formal Pre-Approval Letter tailored to the exact offering price. We recommend that buyers do not use a single Pre-Approval Letter that indicates the maximum purchase price a buyer qualifies for because it may indicate a willingness to pay a higher price to the seller. Often a seller, through his agent, will counter a buyer’s offer with a higher price or different terms. Buyers and sellers can go through several iterations of this before finally agreeing on the price and terms.
Once a buyer’s offer is accepted, his Realtor and JVM will take care of almost everything. His Realtor will open “Escrow” (see below) and arrange for necessary “Inspections” (see below). JVM will order the Appraisal (see below) and submit the buyer’s complete loan package to underwriting. Buyers will sign loan disclosures, review the inspection reports and the appraisal, provide additional loan conditions and documents, and show up to sign loan documents about 5 to 7 days before the anticipated closing date. Buyers will also decide on what concessions are necessary from the seller if the inspections reveal issues that need to be addressed.
Earnest Money Deposit (EMD)
An Earnest Money Deposit (EMD) is a check from a buyer that accompanies his offer for a property. An EMD check proves a buyer’s offer is serious and in good faith, and it provides “consideration” to make an offer “valid.” The check is made payable to an escrow company, not to the seller. EMD amounts can vary from $1,000 to up to 3% of the purchase price, and the amount is applied to a buyer’s total down payment and closing cost requirements at close of escrow. Earnest Money Deposit checks should come directly from the buyer and not from a person who is not party to the transaction (such as a friend or relative).
Contingencies – Buyers Can Back Out of the Deal
In most cases, Realtors will have “contingencies” written into a purchase contract that allow buyers to back out of a transaction for a variety of reasons, including cold feet. These contingencies can be for inspections, an appraisal, a loan approval, or other things. The contingency period(s) can last from 5 to 30 days. Once buyers “remove contingencies,” however, they are obligated to buy the property; they can no longer back out because they are telling the seller that all contingencies have been met. Buyers risk losing their earnest money deposit if they back out of a transaction after removing contingencies. In competitive markets, very strong buyers will sometimes make offers with no contingencies at all. Such buyers risk having to front extra cash for appraisal shortfalls or other issues. Non-contingent offers present many risks and should be discussed with lenders and Realtors before they are made.
Escrow Companies act as a third party buffer between buyers and sellers, and they coordinate the transaction overall. Escrow companies order title reports and title insurance from the title company (see below). They collect and prepare the loan documents and draw up the necessary legal documents as well. They also collect all of the funds from the buyer and the lender and ensure all funds are dispersed properly. Escrow companies are licensed and highly regulated, so it is unlikely that they will ever disburse funds improperly or overcharge borrowers. We like to point this out because buyers and borrowers occasionally become unnecessarily concerned about improper funds handling when large sums are moving through escrow.
Also, because escrow companies are regulated, their fees are often similar to one another’s. Furthermore, most Realtors have relationships with experienced escrow officers who are highly vetted and skilled and therefore tend to foster much smoother transactions. Because of this, a buyer’s Realtor will typically recommend the use of a particular escrow officer and company when a contract is ratified. In most cases, buyers (and their Realtors) are allowed to choose which escrow company will manage a purchase transaction. In same case, sellers will designate the use of a particular escrow company in contract negotiations.
In Northern California, title companies often act as escrow companies too, and will provide both title and escrow services for the same transaction.
In Southern California, title and escrow companies are usually separate entities altogether.
Title - Companies, Reports and Insurance
In Northern California, title and escrow companies are usually one in the same, as mentioned above. Examples include Old Republic, First American, Chicago and Fidelity Title. In Southern California, escrow companies are usually separate entities from title companies, also as mentioned above. Title Companies provide title reports that show, among other things, the legal description of the property, all of the liens recorded against a property, and a “plat map.”
Title Companies also provide title insurance. ALTA Insurance (“lender’s policy”) is a guarantee your lender requires to ensure there are no other liens against the property when your mortgage is recorded. CLTA Insurance (“owner’s policy”) is your assurance that there are no claims for or against the property you are buying; CLTA ensures “clear title.”
Lenders require ALTA insurance, but they do not require CLTA insurance. We recommend both policies, however, because they are relatively inexpensive when bundled together, and we think the extra insurance both policies provide for a small fee is well worth it.
Closing Costs – Nonrecurring and Recurring
Nonrecurring closing costs include the one-time fees that buyers pay only at the time of purchase. These costs include the escrow fee, the title insurance, the appraisal fee, the underwriting fee, the notary fee, the recording fee, and the transfer taxes, among other things. These fees can range from $4,000 to $20,000 (or more) for a purchase with no discount points or origination fees, depending on the size of the purchase and the amount of transfer taxes.
Recurring closing costs include any costs that recur after the purchase closes. These costs include prepaid interest, property taxes, hazard insurance, and HOA dues. Recurring costs are significantly larger if there is an “impound account” b/c lenders will collect four to ten months of property taxes and up to fourteen months of hazard insurance up front to fund the impound account.
The existence of an impound account or a large transfer tax can significantly impact the total amount of closing costs.
For a $600,000 purchase with no impound account or transfer taxes, the total closing costs (recurring and nonrecurring) can be as low as $8,000.
For a $600,000 purchase with an impound account and significant transfer taxes (in a City like Oakland) the closing costs could be as high as $20,000.
Every homebuyer in California will be liable for property taxes after they purchase a property. We often estimate property taxes at a rate of 1.25% per year against the purchase price of the property. Tax rates do, however, vary from city to city by 0.5% or more, but we use 1.25% as an estimate because it is a relatively accurate average for most areas.
Property taxes are due twice per year. The first installment comes due on November 1st to cover the last six months of the year (July 1st – December 31st), and the second installment comes due on February 1st to cover the first six months of the year (January 1st – June 30th). Taxes are collected by the county in which a property is located.
A few examples of prepaid property taxes are below.
If a purchase closes on March 31st and the seller has already paid the second installment of taxes, the buyer will have to reimburse the seller for the three months of property taxes that he has paid ahead.
If a purchase closes on February 28th and the Seller has not paid his second installment, the seller will actually have to credit two months of taxes to escrow, and the buyer will have to pay the remaining four months of property taxes owed.
Homeowner’s, Hazard, or Fire Insurance
All lenders require homebuyers to obtain homeowner’s or hazard insurance when they purchase a property. The cost of the coverage can vary depending on the size of the home, the size of the deductible and the terms of coverage. Homeowner’s insurance costs range from about $750 to $1,500 per year for most homes in California. Often a buyer’s auto insurance carrier will offer a discounted rate if a buyer bundles his auto and homeowner’s insurance. When buyers find an insurance agent and policy they like, they simply need to provide the insurance agent’s name and phone number and we will procure the necessary proof of insurance. For buyers looking for a reputable company and a knowledgeable insurance agent, we recommend Kevin Hennessy with Farmers Insurance at (925) 944-3588.
Escrow or Impound Accounts
Impound accounts are usually required when a buyer’s down payment is 10% of the purchase price or less. Impound accounts are always required for FHA and VA loans. An impound account is set up to allow a buyer to pay his property taxes and his hazard insurance on a pro-rata monthly basis instead of on a semi-annual or annual basis. For example, if property taxes are $6,000 per year, and hazard insurance is $1,000 per year, a buyer would have a total of $7,000 to divide into twelve monthly payments of $583 per month. Buyers would simply add the $583 to their principal and interest payment and make the larger payment to their lender each month. The lender will then make property tax and hazard insurance payments for the buyers.
Impound accounts substantially increase recurring closing costs (see above) because they require escrow officers to collect an additional three to eight months of property taxes and up to a full year of insurance to “pad” the impound account to make sure there is enough money in the account when the property tax and insurance payments actually come due.
Closing Cost Credit
Most lenders allow sellers to pay a buyer’s closing costs in the form of “credits.” These closing cost credits can cover both recurring and nonrecurring closing costs, and they can equal as much as 6% of the sales price. Such credits are not, however, a “free lunch.” If someone buys a house for $400,000 and has the seller credit back 3% of the price ($12,000) for closing costs, the seller is really only netting $388,000. That buyer therefore could also pay $388,000 for the house with no seller credits, and the seller would still be equally satisfied.
The advantage of a closing cost credit is that it allows a buyer to keep more cash in his pocket. For example: if a cash-strapped FHA buyer is purchasing a $500,000 home, the closing costs will be in the $10,000 to $15,000 range. If the buyer does not have the extra cash to cover the closings costs, he can request a credit from the seller. Sometimes it is necessary to increase the offer price somewhat in order to ensure the seller is willing to extend the credit.
In competitive markets, sellers are often not willing to extend credits irrespective of price. In these situations, cash-strapped borrowers can also request lender-credits. Lenders, like JVM Lending, can also help cover closing costs, but such credits often result in slightly higher interest rates.
Cash to Close/When to Bring in Your Money
Cash to close is the total amount of funds a buyer needs to bring into escrow before a transaction closes. These funds include the entire down payment and all closing costs. It is extremely important that buyers know where these funds are coming from before getting into contract, as all lenders require that every dollar that goes into the cash to close be sourced and paper-trailed. Cash to close funds are usually paid in increments – for example, 1% of the price when the offer is accepted, an additional 2% of the price when contingencies are released, and all remaining funds when loan documents are signed three to five days before close of escrow.
We will use a $400,000 FHA purchase with a 3.5% down payment and $12,000 in closing costs as an example. This buyer would likely write a $4,000 (1% of the price) personal check as an earnest money deposit with his offer. He will then likely increase his total deposit to $12,000 (3% of the price) when he releases his contingencies. He will also be responsible for all remaining funds to close when he signs his loan documents. The final deposit will include the remaining $2,000 required for the down payment and the $12,000 of closing costs, or $14,000 in total. For this example, the total cash to close for the entire transaction, including the earnest money deposit and the deposit increase, is $26,000.
Escrow companies will often accept personal checks for initial deposits but when buyers sign loan documents and are required to bring in the final funds to close, escrow companies usually require cashier’s checks or bank wires to ensure funds are “good,” as there is no time to wait for a personal check to clear.
Closing or Close of Escrow
In the vernacular of most Realtors, a purchase “closes” on the day it records. The process often works like this: Buyers sign loan documents at the escrow company about three to five days before closing. The escrow company sends the loan documents back to the lender for a final review that can take a day or two. After the final review, the lender will wire the entire loan amount to the escrow company the day before closing. The day after the lender wires the money, or “funds the loan,” the escrow company records all of the new information (buyers’ names on title, the deed of trust/mortgage, etc.) at the county recorder’s office and the buyers own the home. That is the “closing date” in the minds of most real estate agents. It is on this date that the escrow company disperses funds to the seller, and the buyers get the keys to their new home (usually from their Realtor). Note: In the lending world and depending on the state, the term “closing date” varies from the signing date to the recording date. The above description, however, sets out the general perspective of most Realtors in California. It should also be noted that transactions can record and close on the same day that they fund.
Inspections are necessary to ensure that there are no health and safety issues and that a home will not be in need of major repairs after close of escrow. Inspections can be done for any one or more of the following items: pest, roof, well, soil, septic tank, and natural hazards. The cost of or payment for the inspections and the cost of any recommended or required repairs is negotiable between the buyer and the seller. If an inspection report calls out significant damage or any health and safety issues, lenders will require that repairs be made prior to close of escrow, unless a property is purchased “as is.” An “as is” purchase is a purchase offer with no inspection contingencies.
If a purchase is not “as is” and inspections illuminate significant repair needs that buyers were unaware of at the time of their offer, they can use the inspection report as a reason to back out of their purchase (see “Contingencies” above). Buyers can also use inspection reports as a reason to renegotiate the terms of their offer, such as a seller credit for closing costs or a reduced price.
Mortgage insurance is a monthly premium that buyers will generally be required to pay if their down payment is less than 20% of the purchase price. Mortgage insurance associated with conventional loans is known as “private mortgage insurance,” or PMI, and mortgage insurance associated with FHA loans is simply called “mortgage insurance.”
For an FHA Loan, buyers pay mortgage insurance in two ways: (1) an Up-Front Mortgage Insurance Premium of 1.75% of the loan amount is added on to your loan; and (2) a monthly mortgage insurance premium of 0.85% of the loan amount divided by 12 (in most cases), and this is permanent in most cases.
For conventional loans with loan-to-value ratios over 80%, there are 3 options for PMI: (1) Monthly PMI; (2) Single Payment or Lump Sum PMI; and (3) Lender Paid PMI.
Lump Sum or Single Payment PMI involves paying a single sum at close of escrow to permanently cover PMI with no monthly PMI payments required. We discourage this option typically because if a borrower refinances within a few years of purchase, he will not get his lump sum PMI reimbursed. When homes are appreciating quickly, borrowers can often simply refinance out of PMI when their “equity cushion” hits 20%.
Lender paid PMI is a feature where borrowers take a higher interest rate in lieu of PMI. Lenders effectively pay the lump sum PMI payment on behalf of the borrower in exchange for a higher rate. Borrowers often think they are getting a better deal with lender paid PMI because they are avoiding PMI, but they are really just getting stuck with a higher rate for the life of their loan no matter how much their home appreciates. We often discourage lender paid PMI too.
Monthly PMI ranges from 0.2% to over 1% of the loan amount, paid over 12 months, depending on loan-to-value, credit, loan amount, etc. Borrowers can petition out of PMI once they have sufficient equity, but many lenders require them to retain the PMI for a minimum of two years irrespective of appreciation.
First/Second Combo Loans
First/second combo loans are first and second mortgage loans that fund concurrently or at the same time. The first mortgage is typically at a loan-to-value of 80% or less, and the second mortgage accounts for the loan-to-value portion above 80%. This type of financing allows buyers to avoid PMI requirements as well as jumbo loan restrictions. For example, a 90% loan-to-value purchase of a $700,000 home can be structured as a $560,000 1st mortgage and a $70,000 2nd mortgage. Because the first mortgage is at 80% loan-to-value, PMI is not required.
Combo loan financing requires a minimum of 10% down, and the credit and income guidelines are stricter.
How JVM Gets Paid
JVM gets paid if and only if a buyer’s loan closes. We typically quote interest rate options with “no discount points.” The no discount points or “no points” option will usually be associated with a higher rate. With the no points option, our entire commission is earned when our mortgage bank sells the loan to an investor for a premium on the secondary market. We typically do not recommend that borrowers pay points to buy down their interest rate because the return on investment is too small. If buyers do opt to pay points, a 1% discount fee will buy down an interest rate by approximately a 1/4%, depending on loan type and market conditions.
When to Pay Discount Points or Buy Down the Rate
A discount point or origination fee is typically used to buy down an interest rate, as discussed in above sections. “One point” equates to 1% of the loan amount, and usually buys an interest down by about 1/4%, depending on market conditions.
We recommend paying discount points if the following four conditions are present: (1) rates are generally considered low, and are not expected to drop further; (2) borrowers expect to stay in the home for more than 4 years; (3) borrowers do not expect to refinance in the near future for any reason; and (4) borrowers can afford to pay the points (they have the cash). It typically takes about four years to make up a one point charge with the savings from a lower rate. Note also that points are usually tax deductible in the year of the purchase, so this makes paying points somewhat more attractive.
Actions to Avoid After Getting Pre-Approved
The below list includes actions that should be avoided after getting pre-approved. These actions do not always disqualify borrowers, but they do prevent lengthy delays and the need for additional time-consuming paperwork.
1. DO NOT have relatives deposit “gift funds” into your account. It is best to have them deposited directly to escrow instead. If they are deposited into your bank account, we will need a copy of your donor’s bank statements in order to “paper-trail” the transaction.
2. Do NOT make large deposits that cannot be explained. All “large deposits” must be explained and/or “paper-trailed.” Deposits as small as $500 that are from mattress money, untraceable foreign bank accounts, or cash payments of any kind can render an entire bank account invalid and unusable for qualifying. If you need to make large deposits that are difficult to “paper-trail”, contact us for “coaching” or advice. Keep a paper-trail for every large deposit you make.
3. Do NOT take on new debt.If you increase credit card balances or finance a vehicle, your debt ratios will be adversely impacted, reducing your maximum purchase price.
4. Do NOT take days off if paid “hourly.” If your debt ratios are high or near the limit, even a single day off work can push you out of your qualifying range.
5. Do NOT spend liquid assets. Pre-approval software relies on specific liquid asset levels; pre-approval amounts can change if liquid assets are significantly reduced.
6. Do NOT miss payments on any debts reporting on a credit report. Even though this is relatively obvious we like to remind buyers that missing any monthly payments can sharply reduce their credit score, and their qualification amount.
7. Do NOT co-sign for someone else’s debts. Even if you are just a “co-signer”, the debt will still show up on your credit report. You will be responsible for that debt and the payments (unless we can show twelve canceled checks from the person making payments, in most cases).
8. Do NOT file taxes with a tax liability owing, or with less income than in previous years. This applies to self-employed borrowers primarily, particularly during tax season. We always base our qualifying income on the most recent filed tax returns, and we must prove that all tax liabilities are paid. We recommend that borrowers file an extension when possible if they are making offers during tax season. Please consult with us for additional explanation.
Supplemental Property Taxes
Supplemental property taxes often create significant confusion for new homebuyers. When someone purchases a property in California, the County Assessor is required to immediately re-assess the property for property tax purposes. This re-assessment usually correlates to the purchase price. This re-assessment process, however, can often take over six months.
At the time of purchase, lenders and escrow companies usually base property tax payments on the property tax bill of the current owner or seller. Problems arise because the seller’s property tax bill usually correlates to the price the seller paid for the property, which is often much less than the price the buyer is paying for the property. Buyers often mistakenly believe that the property tax payment estimate at the time of purchase accurately reflects their actual property tax liability. This is usually not the case.
Buyers should expect a “Supplemental Tax Bill” from the County Assessor anywhere from three to nine months after purchase, depending on the county. This supplemental bill could be a sizable amount if the seller’s property taxes were relatively low. Buyers need to know they are responsible for paying the supplemental taxes, even if they have an “Escrow or Impound Account” (see above). Buyers should contact their loan servicer as soon as they receive a Supplemental Bill.
Supplemental Tax Bills can also cause confusion when new buyers refinance into a new loan six to twelve months after a purchase. Sometimes a borrower’s housing payment will appear to increase even if he or she is refinancing into a lower rate. This is because lenders are basing the new housing payment on the new property tax liability, while borrowers are still basing their housing payment on the seller’s property tax liability (that is too low).
Closing Process Overview
CLICK HERE to review the basic steps required to close your loan once you are in contract.
The When, What, and Where of Signing Papers, and the Closing Process Again
Disclosures need to be signed when we submit a borrower’s loan to our underwriter. Disclosures include the loan application, the interest rate, the closing costs, and other forms to comply with our industry’s many regulations. These forms are not binding in any way, they can be signed anywhere, and we do not need originals. Faxed or emailed copies are fine.
Closing Disclosure or CD After a loan is formally approved by an underwriter, borrowers will be sent an additional disclosure known as the CD that must be acknowledged or signed electronically before lenders can draw loan documents (in most cases). The CD is similar to the initial disclosures and it is sent to ensure closing costs have not changed significantly. It is also not binding, and borrowers are not allowed to sign loan documents until three business days have passed from the signing of the CD.
Loan Documents will be emailed to the escrow/title company by our documents drawer after the loan is formally approved and after ALL conditions are met. The escrow officer receives the lender’s loan documents and prepares them for signing. This is a lengthy process that requires working out all the numbers including interest, property taxes, hazard insurance, lender fees, remaining down payment funds, etc. Once the “signing package” is ready, the buyers will go to the escrow office or title company to sign all of the loan documents. This too is a lengthy process because there are so many forms to sign. Buyers typically wire their remaining funds or “cash to close” on the day they sign.
The Funding Package consists of the signed loan documents and all other necessary documents prepared by the escrow officer after the borrowers have signed. The funding package needs to go back to our funding department (typically via overnight mail) so our funder can review everything to ensure the file is complete and ready to fund. Lenders “fund” loans by wiring money or loan proceeds to escrow once they are satisfied that all final funding conditions have been satisfied.
The Recording of the deed of trust (or mortgage) and the grant deed (which transfers title to the new owners) typically takes place at the County Recorder’s Office the day after a loan funds, as mentioned above. This is when buyers formally become owners of their new home. Their names are on “public record” as the legal owners of the property they just bought.
The Closing Process of Receiving and Preparing Loan Documents (by Escrow), Signing Loan Documents (by Buyers), Funding the Loan (by Lender), and Recording (by Escrow) takes three days at best, and sometimes over a week.
We encourage all buyers to also review our FAQ page.
*Our JVM Buyer’s Guide is meant to be a guide only and its accuracy is not guaranteed.