Typical of most transactions, one of the first questions is usually, "what is your method of payment?" This is true in the real estate industry as well. To purchase a home, you will either need to pay in cash or seek out a mortgage loan. In either case, you will need a letter to start your homebuying process.
Pay In Cash
Before you decide to pay in cash, it is highly recommended that you check in with a financial planner and/or a mortgage lender to ensure that paying in cash is the best use of your funds given current interest rates, any outstanding loans, and your financial goals. If you still decide to pay in cash, you will need a written proof of funds letter from the bank in which the majority of your funds are located stating that you have the funds to cover the purchase price of the home you are making an offer on including closing costs. It is good idea ahead of time to ensure that your funds are available in cash and consolidated into one account for ease of transfer.
If you use a financial planner, you should let them know that you are starting the process of buying a home before you see a mortgage lender. This will allow you to confirm how much cash you have available for a down payment, alerts them to make cash available for a down payment in the near future, tells them that they will need to take into account your new mortgage payments, and provides a check-in on your overall financial goals. In addition, they may have some recommendations for mortgage lenders for you to use.
In the past, it was common to have to pay down the purchase price of a home by 20%. This down payment was meant to reduce the risk of lending for the mortgage bank by lowering the loan amount and ensuring a non-risky borrower. The advantages of paying 20% down today is that you will not be required to pay mortgage insurance, have lower monthly payments, potentially have access to lower interest rates, and lenders will want to compete for your business. However, buyers will be happy to know that according to the National Association of Realtors, in 2018 first time homebuyers paid an average of 7% down and repeat homebuyers paid an average of 16%. The amount required is dependent on the loan type. By paying less for a downpayment you can reap the advantages of maintaining your savings, budgeting for closing costs, homeowner’s insurance and property taxes, and setting up your new home with new furniture, appliances, and initial repairs. Be prepared to discuss with your mortgage lender and financial planner what the best options are for you. Also, ask them what the best strategy and timing is for you to liquidate any assets in preparation for making a down payment.
Having a prequalification, preapproval, or 90% letter in hand is your first goal of the homebuyer process. Please note that the definitions of prequalification and preapproval can vary from lender to lender and are often used interchangeably. Both terms are usually meant to indicate how large a loan you are able to secure. This letter is necessary to show a Realtor that you are ready to buy and no longer in the “just shopping” phase. In fact, some homeowners won’t allow any buyers in their homes without a preapproval letter. In the State of Alaska, as per the Purchase and Sale Agreement, buyers have seven days to provide evidence of mortgage approval. So, it is best to have this evidence available in advance especially if multiple offers are on the table. There is nothing worse than finding the perfect home and losing out because you weren’t 100% ready.
Interview Mortgage Lenders
We know that there are a few mortgage lending institutions online. While some of them may offer competitive rates and may be worth considering in the end, we highly recommend that you first meet with a mortgage lender locally, in person. Mortgage lending is a highly competitive market with rates and terms that change daily. You will want to meet with someone that can assess your personal situation and talk you through the best options for you, some of which may only be available to Alaskans.
You can start at your current banking institution, but please know that while it may be great at banking, they may not be the best at mortgage lending. In addition, finding the right person to manage your loan application is critical to ensuring a smooth transition. You want someone that does their best to find the best loan type with the lowest rate and does everything they can to ensure your loan closes and closes on time. Please visit our list of Real Estate Resources or ask your friends and family for recommendations. Interviewing 2-3 mortgage lenders is ideal in learning all the options available to you, getting a feel for which option will fit your financial situation the best, and which lender can explain things to you the best. In an initial consultation, a mortgage lender should advise you which loans you qualify for, how much home you can afford, what your monthly payments will be and what you should expect throughout the home buying process. Taking the time to do this homework upfront will ensure that you close on your next home and that you don’t pay more than you should have for it.
Once you have decided on a bank make sure you ask what their cut off time is for same day wire transfers. You will need to make sure you know this the day before closing when you need to transfer funds prior to closing.
Protect Your Credit Score
We recommend waiting 2-3 weeks between meeting with lenders as the lender will need to pull your credit report in order to give you an accurate preapproval letter. If your credit is pulled by various lenders in the same week it could affect your credit by a few points. If you wait a few weeks between having your credit pulled it generally won’t affect your credit.
What You Need to Prepare
Each lender has slightly different requirements regarding what documentation they need from you for the preapproval process, but in general, expect to provide the following items:
A completed application provided by the lender
The two most recent months (or a quarterly statement) of any asset information listed on the application i.e. checking, savings, 401(k), mutual funds, individual stock accounts, IRA’s, etc.
Most recent month of a paystub
Past two W2s (i.e. 2019 and 2018)
Past two U.S. Tax Returns (i.e. 2019 and 2018 Federal Tax Returns)
2019 and 2018 Corporate Tax Returns (if self-employed and you own over 25% of the company)
Getting a Preapproval Letter
Generally, once you submit the above items to your lender, their mortgage underwriter will verify your identification, check your credit history, and assess your financial situation to assess the risk of lending money to you. The lender may ask for additional documentation. They are not trying to be difficult by asking for additional documentation, rather, after the housing bubble burst in 2007-2009, underwriters became much stricter regarding the loan approval process. As a result, more documentation is needed today than it was 10 years ago. You should receive a preapproval letter within 2-3 business days.
In addition to receiving a preapproval letter which shows the amount you can afford to purchase, you should ask your lender to show you what that preapproval amounts to in terms of a monthly mortgage payment plus any PMI, taxes, and insurance. That way you can make sure you are comfortable with what your monthly housing payment will be given any other financial goals and obligations such as car loans, retirement planning, college savings, etc. If you aren’t comfortable with the payment, please contact your lender and work to find a payment that works best for you. Remember just because you can afford it, doesn’t mean you should. Once you have your ideal payment, you can finalize your preapproval letter and revise your search with the new purchase price.
It should be noted that preapproval letters are good for about four months. You will want to make sure that you keep your finances in sound order during this time meaning that you don't do anything to jeopardize your credit score. If you are still searching for a home after four months, you will want to renew your preapproval letter.
Mortgage lenders are required to provide you with a Loan Estimate (LE) within three days of receiving your preapproval. The LE provides an estimate of the closing costs you’ll need on top of your down payment and shows exactly what fees the mortgage lender is charging you. Make sure you understand these fees. Generally, we estimate closing costs to be approximately 2-3% of the purchase price of the property. Your mortgage lender can provide you with more detailed estimates based on your exact preapproval price. Remember, these closing costs are due the day before closing (except for the appraisal and inspection fees which are due on the day those services occur) and are on top of your down payment. If you are buying a $500,000 property and putting down 20% towards the loan you’ll need to have $117,000 cash available at closing ($100,000 for your down payment, $15,000 for the closing costs, plus $ 2,000 for overage).