Buying a Home: Loan Sweet Loan

Buying a home can seem daunting. There are so many things to keep track of and people to loop into the process. It leaves most buyers asking the questions “What should I research” and “What do I need to know to get the funds for a home?” Jose Torres, Interactive Brokers’ Senior Economist, joins Cassidy Clement, Senior Manager of SEO and Content to discuss the process of securing a home loan.

Summary – Cents of Security Podcasts Ep. 31

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers. And today I’m your host for our podcast. Our guest is Jose Torres at Interactive Brokers’ Senior Economist.  

Today, we’re going to talk about buying a home and securing a home loan. Buying a home can seem daunting. There are so many things to keep track of. And people to loop into the process. And many buyers ask many questions like what should I research and what do I need to know to even get the funds for a home? So we’re going to talk about that. All those questions and this process of securing a home loan. So welcome back to the program Jose. 

Jose Torres 

Great to be here, Cassidy. Hello everyone. 

Cassidy Clement 

So where does someone go for securing financing when buying a home? What goes into that decision of being even granted alone? 

Jose Torres  

Generally speaking, potential home buyers can go to most banks and also mortgage brokers to seek loans. And the decision really depends on the lender’s perspective on the applicant’s ability to make payments over the long term.  

Mortgage providers assess the following factors when determining if they should provide an individual with a mortgage. The credit rating is very important. It’s provided by credit agencies. The rating is based on an individual’s outstanding debt relative to net worth, monthly debt payments relative to income, length of employment at current employer, history of making loan payments and income relative to debt payments after the individual accepts the loan. Mortgage providers want to ensure that individuals will have sufficient income to pay their mortgage payment. And cover other necessary expenses, available savings to ensure that a mortgage applicant has sufficient assets for emergency and isn’t living paycheck to paycheck. Banks also consider the amount of money an individual will make toward the down payment. The larger the down payment, the more attractive the mortgage candidate is because it reduces the possibility that the home value may fall below the outstanding balance of the mortgage. Essentially speaking, those larger down payments pose a reduced risk to the financial institution. The lender. You know, that definitely helps an applicant’s prospects when seeking a mortgage. 

Cassidy Clement 

So what are the usual steps that a person would go through when securing the loan? Like usually people will think about, OK, we’re going to do some budgeting, maybe shop around for some pre-approval. There’s obviously going to be a ton of paperwork and some house hunting, but what are some usual things that come with this setup? 

Like is there an application? What is the shopping around aspect? I know we talked a little bit about this with car loans in a previous podcast about leasing versus buying, but what is the usual layout? What is the process there? 

Jose Torres 

Sure. So usually, mortgage providers will often provide a pre-approval based on a minimal screening process. The pre-approval is used by potential home buyers when meeting with agents to show that they have the ability to purchase a house. You know, it’s kind of like a letter showing the agent hey, you know, I’m not wasting your time. I’m a qualified candidate. Because you know, agents don’t want to go around shopping with buyers that aren’t going to get approved later. Once they sell or accept their buyer’s offer, the mortgage provider will have an appraiser assess the value of a house. And then provide a deep approval process. This requires the applicant to provide bank account statements, brokerage account statements, and paycheck stubs to verify the applicant’s finances. 

Oftentimes there’ll be other things to verify and that will depend. That’s on a lender-by-lender basis. Some lenders are easier, others are more tight. Generally speaking, those that are easier tend to have higher financing costs, whereas those that are tighter are a little more affordable. The bank will review the information and do a title check to ensure that there are no other individuals or organizations who claim to have an interest in the house. The bank will also ensure that the potential homeowner has secured homeowners insurance and, if needed, flood insurance with the mortgage provider as the lien holder, being the recipient of any insurance payments. The bank will also require that a survey of the property and the home inspection is conducted. 

Cassidy Clement 

So about how long does this process usually take? Because you had mentioned so many different things. In my life I’ve seen friends and family where the process can take a short period of time or like a month, two months, all different levels. Because you’re working from finding that lender, finding the house or an agent, sometimes making the offer, waiting for the acceptance maybe, getting an inspection. What kind of a timeline can people kind of look at for this because initially people may think I’m aggregating all this information on myself and I’m giving all of this background on why I’m a worthy person to get some financing for a home, but then it takes so long. So what’s the usual time frame that people can see? 

Jose Torres 

Well, the general rule of thumb is that when a seller and buyer agree to a price, that process usually takes a month and for the lender that requires shifting from a pre-approval to a full approval, which of course means the lender scrutinizes a person’s finances a lot more and wants to pretty much know everything that’s going on with the person’s finances. 

Cassidy Clement 

So when the person is going to the point of yep, I’m doing it. I am going to get the house or I want to get the house. What are some ideas that they should have in mind when shopping around for loans? Because initially it may seem that most are the same in terms of set up payments and interest. But you know, not everybody’s the same. Some banks will be different. Some credit unions will be different. So what should they think about when shopping around or are they all really kind of the same setup? 

Jose Torres 

Actually, no. There’s a lot of variances between different lenders. Shopping around for the most attractive terms can definitely be advantageous. Sometimes you have online lenders, similar to how at Interactive Brokers, we run our operation. We’re a low-cost provider of financial services. 

A lot of times you’ll find that same kind of business model. A low cost, low interest, low fee lender that’s mostly online and a lot of times they’ll offer you better interest and better fees and that’s really what it’s all about, right? How much are you paying in interest and how much you’re paying in fees from origination to other fees? As well as interest of over the life of the loan. And then oftentimes it’s important to understand too that the person who’s lending you the money for the house may sell that loan to another lender at some point in the secondary market.  

Similar to what we see here at Interactive Brokers all the time. You know, folks exchanging bonds, exchanging stocks, exchanging CD certificate deposits, right? We see that all the time and that same thing could occur with mortgages where for example, a financial institution sells a loan to another financial institution just because they feel like it or they want to open up cash for another opportunity or they want to reduce their mortgage risk, another one wants to increase their mortgage exposure, etcetera, etcetera. 

Cassidy Clement 

So really, as you start to shop around or research we can say and you just generally find a quote for what you’re looking for, you may see interest rates being comparable, but like as you mentioned, there’s different caveats with it. There may be different fees or closing costs, maybe they factor in your insurance and so many other things. You want to look for something that’s definitely more favorable in the long run for you and your situation. So how long do these loan terms usually last or the length we could say of the debt? 

Jose Torres 

Sure. So the duration is mostly 30 years and the reason is that for most working people, given that the US property market is so expensive, a lot of people want to live here in the United States. And that makes the real estate market really pricey. There’s a lot of demand from all over the place. But when you’re talking about folks that pay their mortgage with their paycheck, often times you’ll find that on a 15-year term, the payment is too high.  

So most people- they go for the 30-year because that’s kind of comparable to what rent is. Kind of feels like rent. So if you’re renting for $1500 and you have a $1500 mortgage, it’s kind of on par. Where like if you do 15 years maybe that kind of $1500 mortgage is more $2500 or $2600 then all of a sudden you’re a little unanchored when it comes to paychecks and shelter costs. So, that’s why the mortgages here are over 30 years and lenders have significant risk because most of those mortgages are fixed rate. Unlike in some other nations, like in the United Kingdom or in Canada, where they have a lot of floating rate mortgages. So if rates go up, then the housing costs for the residents go higher from an interest perspective.  

So for the lender, if interest rates go a lot higher then they’re in a tough predicament because if they issued a lot of mortgages at 3 or 4% and now rates are 7%, they think back and say, gee, if I would have just waited a year or two and issued all these loans, that’s 7% instead of 4%. I’d be in a better position, right? And that’s what we’re seeing a lot of now. Most people bought homes when rates were low. So a lot of lenders have been stuck with, 2 or 3% mortgages in an environment today where mortgage rates are north of 7%.  

Cassidy Clement 

Going back to your first response there, you kind of have short term mortgage, which is more aligned with fewer total payments. The larger sum trying to pay off that piece as fast as you can, but the long-term mortgages, those are the lower monthly payments. They may take more time, but that is what a majority of people tend to be used to when it comes to like a rent equivalent, or we’ll say easily easing into that homeownership pool.  

Are there specific items that people should keep in mind when starting the process of looking for a home and a home loan? Obviously, there’s the basics. What’s my budget? As we said before, what’s in your area and you said like, are you in an area that your real estate cost is going to be very through the roof because it’s not only nationally sought, but globally. But you know, words that float around a lot in this in the answers to this question. Fixed-rate mortgage adjustable-rate mortgage-what are your thoughts on what people should look for when initially starting? 

Jose Torres 

Well, one thing is they should definitely look at their credit and make sure that they’re shopping around with the best possible credit score at the time. Sometimes that requires taking a month and paying down your credit cards or whatever the debt you have as much as you can. That can immediately boost your credit, and that takes about 30 to 45 days. 

 One important consideration, and we spoke a little bit about this earlier is assessing the interest rate because even a small difference among rates over 30 years can lead to a much larger interest expense over the life of the loan. So that’s really important. The ability to lock in an interest rate while the mortgage provider is underwriting the loan is also important. This feature protects the home buyer from a potential increase in rates that may occur during the approximate one-month period in which the mortgage is being finalized, right? So, if you’re with your lender today, right and rates are at 7%, you want to lock that in with your lender today. Because if rates go to 8%, then all of a sudden now your affordability is different now. Now your monthly payments on the house you want are higher and stuff like that. So locking in is very important and that’s a feature that of course, it comes at a cost. Through fees, you know.  

Lenders know that they’re taking a risk by locking in. Negotiating a lower rate is also important if possible. If rates decline, while the mortgage provider is underwriting the loan, the mortgage provider may offer to lower the original interest rate. Closing costs are such a huge deal, Cassidy. A lot of folks look at a house and they say ok, this house costs 300 grand, I need 20% down more or less. In some cases, if you have an FHA loan, if you never bought a house before, you can put down 3.5%. So they see they see 300,000, 3.5%, you know, they think that, ok, I only have to come to the table with 10 grand or so roughly, right? Or in the 20% case, I need to come to the table with sixty grand roughly. The issue is that closing costs are significant and they’re very expensive. And I’ve actually seen- I was actually a realtor during college guys, I don’t think any of you guys knew that, but I was a realtor during college. You see a lot of people actually walk away from the table when they see what the closing costs are, because they could be staggering.  

On that 300 grand house, for example, closing costs, depending on where in the country you are, but just off the cuff estimate could be between $8,000 on the low end and $30,000 at the high end, so that changes your math dramatically in terms of coming to closing with enough cash. Oftentimes also to push sales, the lender and your agent aren’t even going to tell you how much the closing costs are going to be because they’re a little scared sometimes that maybe you won’t want to go through with the deal. So sometimes at a day or two before closing, you know, people are calling family members, people are trying to get as much cash as they can because they need that extra 10 or extra 20 grand to close the deal. So that’s a critical consideration when home buying is closing costs. 

Cassidy Clement 

So what exactly goes into closing costs? Like what makes up that A + B + C equals closing cost? Like what goes into that that homebuyers should consider or at least maybe research before they get there? 

Jose Torres 

Sure. So title transfer fees are a big deal. Your broker fee is also part of that. Taxes are part of that as well. And depending on where in the country you are, sometimes there are line items that folks have just never heard of, you know? But they could add up, but mainly it’s title transfer costs, legal fees, broker fees and then other miscellaneous costs. 

Cassidy Clement 

So essentially as most of us learn after 18 in America, the American dream comes with an asterix and it’s fees. If you want to buy a home, there are going to be fees. If you want to go and rent something, there are going to be fees. There always are, but it’s very important to think about that, especially when you take out a loan that we talked about that could last 30 years. It’s concerning if you don’t read everything! 

Jose Torres 

Cassidy, one other fee that I forgot to mention because there’s so many and that’s why closing costs are significant, but one other fee is those loan origination fees, right? 

It costs to originate the loan, the staff that’s working on your loan and also, you’re locking in that rate, that’s a risk to the lender. So the lender is going to hit you with loan origination fees. So you have loan origination, you have title transfer, you have broker fees and you have miscellaneous fees and also some taxes as well. 

Cassidy Clement 

So all of that and then you hopefully get to sit back at the place you just bought and enjoy it and hopefully you’re happy with loan that you were able to get. That was really insightful. Great, great points. Jose. Thanks for joining. 

Jose Torres 

My pleasure. And also if I may, one additional, well, a few, maybe a few additional points. We’re in an inflationary environment, so I think rents are going to keep going higher. So owning a home even though affordability is so stretched actually helps you hedge your rent. 

And it’s a powerful wealth builder, you know? Over those 30 years, a lot of people, after seven or eight years, they have equity built up in their homes. They borrow from that, and then they become a landlord, they buy a little duplex or something or sometimes an apartment building with six or eight apartments units, you know? So there’s a lot of flexibility with being a homeowner. Also taxes you know, with the high interest rates, you get to deduct so much of that on your taxes.  

And again, the wealth building over time. Every time you make a payment, part of that payment is going into your pocket via the principal, whereas when you’re making a rent payment, albeit you have a lot of convenience, but you’re not really seeing a lot of that money back via taxes or via wealth gains.  

And even though the housing market has been really front loaded, you’ve had a lot of growth in home prices since the pandemic. It’s been staggering. I want to say 40 to 50% off the top of my head. Even though you’ve had those gains. And even if gains from here on out are subdued, maybe around 3 or 4%, that’s still something to consider. 

Cassidy Clement 

Yeah, absolutely. I mean, inflation impacts a lot and we actually did a podcast on inflation. Quick shout out and plug for that. But yeah, going into the process of looking to buy a home and then hopefully securing any lending for that. I think I speak for a lot of millennials, where some people say, I don’t know if I’m even going to be able to do it because we’ve lived in a time where the economy has been rather tumultuous, or at least going into adulthood, it’s been tumultuous. ut you know, fingers crossed, hoping for better days and hopefully lawn for my dog to run around on one day. 

Jose Torres 

Well, let me tell you something else now! Another important point. So with the millennials, we do not have the benefit of living through a period where rates have just gone down, down, down, down, down, down, down. And asset prices have just gone up, up, up, up, up, up, up. We don’t have that benefit, but we have other benefits and there’s a lot of shortages out there for entrepreneurship, for dynamic active work. Side hustles don’t pay like they used to. Being a landlord is not a good, profitable opportunity in the short term right now because your rents are barely going to cover your mortgage, right?  

So a lot of those opportunities that we hear the baby boomer generation talking about. Oh, yeah, just buy properties and rent them out. You’ll get rich. They don’t exist now. Those are passive income prospects, but what we do have is a labor shortage and we have a lot of opportunities. I’ll repeat it again, entrepreneurship, dynamic, active work. Engineering, finance, medicine, software. A lot of opportunities for us out there. And just because things are expensive doesn’t mean that we can’t push ourselves to produce more goods and services at a high quality. And acquire those assets and make our society better and make the economy grow faster. 

Cassidy Clement 

Yeah, of course. I mean, I think most people who listen to this podcast hopefully are looking to move forward on the path for financial independence and getting more wealth or assets for themselves. But that’s a really good point. I think a lot of millennials out there, like I said, we, I’m one of them, are wondering, oh, I hope one day I can get one of those nice houses out there. But yeah, thanks for joining us on the pod. 

Jose Torres 

Yeah, it’s my pleasure. And another thing to look forward to is who owns all the homes? We’re under supplied for sure, but at some point, those homes need to be sold or transferred to the younger generation. So that’s another thing. More medium to long term, not something that gets overly excited about, but just a fundamental economic dynamic that’s occurring. 

Cassidy Clement 

Yeah, hopefully one day. So for our listeners out there, you can learn more about an array of financial topics for free at ibkrcampus.com. Follow us on your favorite podcast network and feel free to leave us a reading or review. Thanks for listening, everyone.