Question: If I purchase an as-is home to renovate myself, what are the best financing options available to me?

Answer: This is Part 2 of the question I answered last week about buying a home as-is. I asked one of the area’s top lenders, Troy Toureau of McLean Mortgage to provide a detailed response. Troy is a fantastic resource for any of your mortgage questions/needs. The following is his response:

If you want to own a home in Arlington or other areas surrounding the city, there is a lot of competition. The good news is that there are older homes requiring updates that many home buyers ignore, while newer, higher-priced properties often attract multiple offers.

Focusing on the renovation-ready market can expand your choices and perhaps give you access to a better location. The process of renovating can also give you a home that is more custom-tailored to your tastes and needs.

Financing a home that you will renovate is a bit more complex than a standard purchase loan. The good news is that there are several options that will help you achieve your goals of upgrading and/or customizing the house for your needs:

Construction Loans

If your renovations are projected to cost over $100,000, you can opt for a construction-permanent loan, based on the value of the home after the renovations are completed. Here is an example:

  • Purchase Price: $450,000
  • Renovation Budget: $150,000

In this case, your total needs are $600,000 and you can obtain a loan of up to 95% of that amount. You will receive the money at closing for the purchase, and then the remainder of the money in draws paid directly to the construction company as the work is completed. When the work is done, you do not have to finance the home again, as this “one-time-close” construction loan will automatically convert to a permanent loan. Larger down payments will be needed for larger loan amounts. Note that there are additional costs associated with construction loans because the appraisal is more complex and there are costs for periodic inspections and draws.

As an additional option, you can opt for a traditional construction loan and refinance into a permanent loan after the work is complete. While this will result in more costs by adding a refinance transaction, you will have more choices for permanent financing on the back end.

Other Financing Options

For renovations under $100,000, there are two good strategies:

  • If you are planning to put 20% or more down on a $600,000 loan, you can simply reduce your down payment to 10%, or even 5%, conserving your cash for the renovations. Here is an example:
    • $600,000 Purchase Price with 20% Down: $120,000
    • $600,000 Purchase Price with 5% Down: $30,000
    • Available funds for renovations: $90,000
    • In addition, the renovations may give you a higher appraised value to help eliminate the mortgage insurance costs associated with lower down payments.
  • If you do not have the cash assets for a large down payment, you can close on the property and then obtain a second mortgage or home equity line-of-credit (HELOC) after closing. To do this, you’ll need to find a bank that will lend the money based upon the renovated value of the house.

In today’s real estate market, especially in high-demand areas, it pays to explore all of your options. If you would like to discuss some of these options when you are considering purchasing a new home and/or renovating an existing home, feel free to contact me at ttoureau@mcleanmortgage.com or (301) 440-4261.

Troy Toureau, Vice President of Production, NMLS #5618
www.AnyHomeLoans.com | 11325 Random Hills Road, Suite 400, Fairfax, VA 22030
McLean Mortgage Corporation | NMLS #99665 (www.nmlsconsumeraccess.org) Equal Housing Lender

Question: Are there any special loan programs in Arlington or Virginia that I should look into?

Answer: The Virginia Housing Development Authority (VHDA) offers a great loan program that includes closing cost and down payment assistance. There aren’t any Arlington-specific loan programs available, but some special programs are made available based on your income and sale price based on the local (Arlington) averages, which are both high. There is a specific Arlington Housing Grant Program available for those who qualify and I’m happy to send additional information on this program if you are interested, but there are too many caveats/requirements to provide specifics here.

As usual, when I get financing questions, I like to turn to one of Northern Virginia’s top lenders, Troy Toureau of McLean Mortgage, to provide a detailed response.

Take it away Troy…

Despite the many changes in home financing which have occurred during the past decade, one important fact has never changed:  The government has several programs to help buyers purchase a home. Here is a quick summary of the major “government sponsored” home financing alternatives. 

The Virginia Housing Development Authority

Authorized by the Federal Bond Subsidy Act, this state agency issues bonds, which enables it to offer below market interest rates and government down payment assistance on mortgages.  VHDA offers several programs and most recently has issued a Grant program, which can help with closing costs and a down payment.  The VHDA can also issue Mortgage Credit Certificates, which will help defray the cost of the payment by providing a tax credit for a certain amount of interest paid.

VHDA requires that the homebuyer has not owned a home in the past three years and also has maximum income and asset limits. For those purchasing in certain targeted areas, there is flexibility with regard to these restrictions.   The income limits in the Washington, DC area are $121,900 (2-person families) or $142,300 (3+ person families) and the sales price limit is $500,000. There are some targeted areas in Arlington County and if you are interested in knowing whether a property is in a targeted area, emailttoureau@mcleanmortgage.com.

In addition to the VHDA Grant program, VHDA provides a variety of options to help first time buyers finance a home.  These include VHDA loans guaranteed by Virginia and insured by the Rural Housing Service requiring no-money down.  The VHDA FHA-Plus Program provides a second mortgage for those who need closing cost and down payment assistance and the conventional VHDA alternative requires a down payment of only 3.0% with private mortgage insurance.  Keep in mind that the three-year history, income, and asset limits noted above still apply.

The Veterans Administration (VA)

VA loans require no down payment and no monthly mortgage insurance.  Closing costs can be paid by the seller or through a lender rebate. The homebuyer must be a veteran or active military.  National Guardsman and Reservists are also eligible for the program. There is no requirement for the veteran to be a first time homebuyer and no maximum income or asset requirements. 

The Federal Housing Administration (FHA)

FHA loans require a 3.5% down payment, which can be met with grants through VHDA or other housing agencies, if available. FHA also allows the down payment to come from a gift from a relative and closing costs can be paid by the seller or through a lender rebate.  There is no requirement for the applicant to be a first time homebuyer and no maximum income or asset requirements. 

Fannie Mae and Freddie Mac

The conforming agencies both have programs designed to facilitate homeownership for low-to-moderate homebuyers. The requirements vary depending upon the agency, but generally a 3.0% down payment is required and there are maximum income requirements that vary by location. Credit score requirements tend to be slightly more restrictive under these programs, as compared to FHA and VA Loans.

Government aid for home ownership does not end with these programs.  Homeowners of primary residences can deduct interest and real estate taxes from the taxes. This lowers their taxable income and thus their effective housing payment.  We suggest you consult with an accountant or financial advisor to discuss all of the tax benefits of home ownership.

If you would like to know if you qualify for one or more of the government sponsored homeownership alternatives, contact Troy Toureau of McLean Mortgage Corporation at301-440-4261 or ttoureau@mcleanmortgage.com.  NMLS ID #5618.  McLean Mortgage Corporation| NMLS ID #99665|(www.nmlsconsumeraccess.org)

Question: I haven’t accumulated enough savings for a 20% down payment, but want to take advantage of low interest rates and stop paying rent. I’ve been told that some of the lower down payment mortgage options include Mortgage Insurance, but don’t fully understand the concept and whether it’s the right decision. Can you provide some insight and explain the pros/cons?

I’ve received a few questions over the past month about mortgage insurance and decided to enlist the expertise of a veteran mortgage advisor, Troy Toureau of McLean Mortgage for this week’s column.

What is mortgage insurance?

Mortgage insurance is offered by either the government or private insurance companies to enable lenders to offer smaller down payments on loans. Before mortgage insurance existed, many had to pay a minimum of 20% down to purchase a home, which made homeownership unaffordable for many Americans. Mortgage insurance covers lenders for losses up to a certain amount if a borrower defaults on their mortgage.

There are two types of mortgage insurance available:

  1. FHA mortgage insurance: FHA is a government program, which requires a down payment of as little as 3.5% of the sales price, and mortgage insurance is required on FHA mortgages, regardless of the amount of down payment.
  2. Conventional mortgage insurance: Conventional mortgages are home loans that are not insured or guaranteed by the government, as in the case of the FHA mortgage example. Many conventional loans are sold to Fannie Mae or Freddie Mac and thus follow these entities “conforming” guidelines.

Conventional or private mortgage insurance enables lenders to offer conventional loans with a minimum down payment of 3.0% to 5.0%. Most 3.0% down conventional mortgages are restricted to low-to-moderate income borrowers.

What is the cost of mortgage insurance?

The cost of mortgage insurance will vary greatly, depending upon several factors:

  1. The mortgage insurance alternative selected
  2. The amount of the down payment
  3. The type of the mortgage such as a 30-year or 15-year loan
  4. The qualifications of the borrower, especially the credit score
  5. Whether the mortgage is an FHA or conventional loan

In addition, depending upon the alternative selected, the cost of mortgage insurance can be an upfront fee, an additional monthly payment, or financed into the loan amount or interest rate. Or the cost may be represented by some combination of these alternatives.

 

What are the alternatives and the advantages of each?

There are a wide variety of mortgage insurance alternatives. In this case we’ll compare two major alternatives. Conventional mortgage insurance paid monthly and conventional mortgage insurance in which the cost of insurance is paid through a higher interest rate.

These examples are for illustration only:

Monthly example: $300,000, mortgage insurance rate of .40%. The monthly payment would be $100.00 per month.

Higher interest rate example: $300,000 mortgage and 0.375% added to the interest rate: approximately $65.00 per month in additional payment monthly.

At first blush, opting for a higher interest rate in this case would be the best option. However, there are other factors involved:

  • In both cases the interest on the mortgage or the separate mortgage insurance payment is likely to be tax deductible. However, if your income is higher than $110,000 annually, the monthly mortgage insurance payment may not be deducted from your taxes. In addition, the deduction of separate mortgage insurance payments is extended on a year-to-year basis by Congress and thus has not been made permanent.
  • Monthly mortgage insurance can be cancelled after a certain period of time with some restrictions such as keeping current on your payments. The payment can be cancelled:
    • When the loan reaches 80% of original sales price based upon regular amortization (the lender must do so automatically when it reaches 78%); or
    • When the loan reaches 75% of the present value of the property and two years of payments have been made; or
    • When the loan reaches 80% of the present value of the property and five years of payments have been made.
    • If the loan is an FHA loan, mortgage insurance can never be cancelled unless a 10% down payment was made at the time of purchase.

This means that if the home was purchased below market value, significant improvements are made to the home, or if the owner is going to pre-pay the mortgage, one may have to pay the monthly mortgage insurance payment for as little as two years before cancelling it. When you roll the mortgage insurance cost into the interest rate, you would have to pay until the loan is paid off in the long-term or the home is sold or the loan is refinanced.

Can I avoid mortgage insurance and still make a low down payment?

There are options to eliminate mortgage insurance altogether by getting a second mortgage on the property. Here is an example:

  • $400,000 sales price, 10% down payment, $360,000 mortgage with mortgage insurance.
  • $400,000 sales price, 10% down payment, $320,000 first mortgage with a $40,000 second mortgage and no mortgage insurance.

Like the choice of mortgage insurance options, there are advantages and disadvantages with both alternatives, besides the difference in payments. For example, while the mortgage payment is more likely to be tax-deductible under the first and second mortgage scenario, you must pay on a second mortgage until it is paid off or is refinanced, while the mortgage insurance may be cancellable in the future.

In addition, the second mortgage is likely to be at a higher interest rate as compared to the first mortgage and also could either be amortized over 15-years requiring a higher payment, or an adjustable rate mortgage whose rate may change in the future. Thus, the home purchaser must consider additional benefits and costs besides the difference in payments.

The decision of whether to pay mortgage insurance or not and what alternatives to choose is complex and will change based upon the situation, including the qualifications of the buyer and the nature of the transaction. That is why it is so important to obtain the advice of an expert mortgage advisor before you purchase a home.

Thank you Troy for answering this week’s question. If you’d like to discuss mortgage insurance or any other mortgage strategies with Troy, he can be reached atttoureau@mcleanmortgage.com or on his cell at (301) 440-4261.

Troy Toureau, Vice President of Production, NMLS #5618
www.AnyHomeLoans.com | 11325 Random Hills Road, Fairfax, VA 22030
McLean Mortgage Corporation | NMLS #99665 (www.nmlsconsumeraccess.org) Equal Housing Lender

If you’d like a question answered in my weekly column, please send an email toEli@RealtyDCMetro.com. To read any of my older posts, visit the blog section of my website at http://www.RealtyDCMetro.com.

Eli Tucker is a licensed Realtor in Virginia, Washington DC, and Maryland with Real Living At Home, 2420 Wilson Blvd #101 Arlington, VA 22201, (202) 518-8781.

Question: Are funding fees on VA loans eligible for seller credits?

Loans guaranteed by the Department of Veterans Affairs are known as VA Loans (Who thought VA stood for Virginia? Be honest…) and provide current and former servicemembers with an opportunity to purchase a home with as little as 0% down. In addition to the normal closing costs (title fees, transfer taxes, etc), a Funding Fee is charged at settlement, which is equal to anywhere from 1.5-3.3% of the loan amount. It’s a fee paid to the VA on every loan to offset the cost of loans that default. It’s the same concept as Mortgage Insurance, but much cheaper.

In a previous column, I explained how buyers can negotiate for seller credits to reduce or eliminate the out-of-pocket expense of closing costs at settlement. Fortunately, the Funding Fee falls into this category, along with the rest of the standard closing costs associated with a VA loan, and buyers are eligible to have all of these costs covered by the seller. In theory, if a buyer is able to negotiate 100% of closing costs paid by the seller and chooses a 0% down payment loan, a home can be purchased cash-free (until the first monthly payment).

If you’re unable to negotiate seller credits to cover the Funding Fee and are concerned about having the cash to pay for closing costs, you’re also allowed to roll the Funding Fee into your mortgage so that it becomes part of your monthly payment.

Arlington Veterans Affairs (VA) loans by the numbers:

  • In 2015, 218 of 2,893 purchasers (7.5%) used a VA loan. By comparison, 2,038 used a Conventional loan (70%). I’m actually a little surprised by this; I would’ve thought a higher percentage of purchases in Arlington would use VA loans.
  • The average sold price for homes purchased using VA loans was just over $581,000
  • The type of housing purchased using VA loans was pretty evenly split between single family (detached), townhouse, and condo
  • The maximum loan amount for Arlington (and the rest of the Northern VA counties) is $625,500, but there are ways to increase the loan amount by putting more money down.

I hope the veterans and active duty military residents of Arlington had a great Memorial Day Weekend. Thank you for your service!

Question: Will new FHA owner occupancy ratios change the way condo associations view rental caps?

Owner Occupancy Ratio Requirement Likely to Decrease from 50% to 35%

Last month I wrote about rental caps in condo buildings, noting that oftentimes condo boards decide to implement a rental cap in order to meet the FHA loan requirement that the percentage of owners living in the building vs renting their unit must be 51% or more.

This month we got news that this burdensome ratio is likely to be reduced to 35%, making affordable condo ownership more accessible for buyers and giving owners more control over their investments. In a 427-0 vote, the House passed the Housing Opportunity Through Modernization Act to reduce FHA restrictions, which includes a clause to reduce the owner occupancy ratio from 51% to 35%. Although the bill still has to pass the Senate and be signed by the President, the landslide vote bodes well for this change.

Condo Boards Should Reconsider How They Determine Rental Cap Rates

Most people agree that quality of life and building conditions deteriorate as the percentage of renters increase and many condo boards will choose to maintain current cap rates for this reason. However, cap rates are often set around 45-50%, using FHA requirements as a guideline.

If the bill passes and 35% becomes the new FHA requirement, condo boards should reconsider the reasons behind their rental cap rates. Without data available that shows when rental caps have a positive effect, it’s guesswork. What if the biggest dip in quality of life/building condition occurs when 30% of the building is rented and there’s not much change after that? In that case, Boards using a standard 45-50% cap rate are restricting owners without the well-intentioned benefits. What if the decrease in quality of life/building condition is linear? In that case, one could make the same argument for a 1% rental cap as a 70% rental cap.

My point isn’t that rental caps are a bad idea (in theory) or that Boards are complicit in implementing them, but that the FHA owner occupancy ratio is really the only empirical reference point being used. If the bill does pass and the ratio decreases to 35%, Boards should strongly consider adjusting their caps accordingly.

On a related note, if your condo is not approved for FHA loans (check here), many property management companies charge $500 to $1,000 to file and process an application, but some local lenders offer it as a free service. I know that Jake Ryon of First Home Mortgage (jryon@gofirsthome.com) offers it. There’s little required by the Board and it can be completed in just a couple of months.

Question: I believe the value of my home has increased substantially. Can I leverage this to remove the (Private) Mortgage Insurance from my mortgage?

Before responding, let me catch everybody up on some basics:

  • Jake Ryon of First Home Mortgage explains (P)MI simply as “an additional payment a borrower has to pay to offset risk to the lender when the down payment doesn’t equal 20% or more of the sales price or appraisal value, whichever is lower”
  • It’s included when the Loan-to-Value (LTV) is above 80%. LTV is the amount of your loan divided by its value. In other words, the value minus your down payment (80% LTV = 20% down payment). This is the basis for today’s question – if the value of a home increase, the LTV decreases (more owner equity), and may allow a borrower to remove (P)MI.
  • The monthly cost is based on factors that include LTV, credit score, and loan size. Generally monthly payments range from about .25%-2% of your loan balance, divided by twelve
  • Conventional loans = Private Mortgage Insurance (PMI); FHA loans = Mortgage Insurance (MI)

If you have PMI on a conventional loan…

Per Jake Ryon of First Home Mortgage, you can request that it be removed when the LTV hits 80% based on payments against the original value or the value of the home has increased enough to bring the LTV to 80% or less. For example, if the original value of your home was $500,000 and you currently have $450,000 left on the loan, a new appraised value of $562,500 would result in a new LTV of 80% and your loan servicer may agree to remove PMI. Some key points:

  • You cannot have a late payment within the last two years
  • The request must be made in writing to your servicer (who you make payments to)
  • If you’re making the case based on increased value, you’ll need the loan servicer to order a new appraisal, at your expense
  • It’s ultimately the loan servicer’s choice whether or not to remove the PMI

It will be automatically removed when:

  1. You reach 78% LTV on the original value of your home
  2. You reach the midway point of your loan and have not reached 78% LTV (e.g. 15 year mark on a 30 year loan)

If you have MI on an FHA loan…

If your FHA loan was created after June 3, 2013 and your original LTV was 90% or higher, your mortgage insurance cannot be removed at any point during the life of the loan and the only way to remove these payments is to refinance into a new loan once you can attain an LTV of 80% or less. If your mortgage was created before this date, your MI will be automatically removed at 78% LTV.

If you’d like a question answered in my weekly column, please send an email toEli@RealtyDCMetro.com.