Beware of Hidden Costs With Buyer Assistance
Buyer assistance is a great way to get into your first home, and it’s important to understand the costs.
This article is not about avoiding buyer assistance programs. It is about knowing the short and long term costs, and other potential financial risks.
- Buyer Assistance to Good to Be True?
- Great Reasons for Using a Buyer Assistance Program
- Hidden Costs of Buyer Assistance
- Avoiding Surprises with Buyer Assistance
- Cost Effective Low and No Down Payment Options
Buyer Assistance to Good to Be True?
The general rule is that if it sounds too good to be true, it probably is. Well, in the case of buyer assistance, you’re probably right.
Now, don’t get me wrong. I’m not saying that buyer assistance programs are not good, because they can be.
My warning is more about working with a loan officer that is not experienced enough to have this conversation with you.
With almost 2o years experience guiding new home buyers into their first home, I have read a lot of underwriting guidelines for buyer assistance programs.
While my professional experience is limited to National and California buyer assistance programs, I have found that these concerns are common all over the Country.
I take calls from home buyers every day, and the result is always the same. After explaining how buyer assistance programs work, most folks will do just about anything to avoid using one.
The reason is that there is always a cost, and there is always a catch. Are there programs out there that might not have a high cost or a “catch”? Absolutely. We’ll cover those too in this article.
Great Reasons for Using Buyer Assistance
It really shouldn’t be a big surprise that buyer assistance isn’t free money. There’s no such thing as free, especially when it comes to lending money to someone that doesn’t have a down payment.
If you truly cannot save up or get a gift for the minimum down payment required to buy a home, a buyer assistance program can definitely help you.
Again, I’m not saying that these programs will not help, because they help many people that have no other options.
It all just comes down to the math. I can confidently say that in almost all cases, it makes sense to use a buyer assistance program if you do not have money for a down payment.
When you factor in leverage on your actual investment, equity growth, and the tax benefits, it will always outweigh the cost us using a buyer assistance program to get you into the home.
Buyer assistance programs come in many forms, with many different qualification guidelines. It’s important that you work with a loan officer that is an expert at working with first time home buyers.
As long as you’re making an informed and educated decision, you can manage your expectations, and avoid surprises in the future.
Hidden Costs of Buyer Assistance
When I talk about the hidden costs of buyer assistance, I don’t mean they are unethical or trying to sneak in unnecessary costs.
In most cases, it’s just that your loan officer does not have enough experience to be able to explain to you all of the risks and benefits of using the program.
Here are common costs that most first time home buyers are never even told about.
Higher Interest Rates
Many buyer assistance programs require you to qualify for a specific first mortgage loan offered by buyer assistance provider. The buyer assistance is then typically approved after qualifying for the first mortgage.
Most buyer assistance programs are paired up with a first mortgage which is usually a Conventional, or FHA first mortgage.
These first mortgages almost always have higher interest rates to the tune of 1% higher is common! This is a hidden cost that most buyers do not realize.
Borrower paid fees are common with buyer assistance programs. With a traditional mortgage, the lender typically pays the loan officer when they submit a loan to that investor.
Buyer assistance programs do not typically pay the loan officer or lender, which means they are forced to charge these fees directly to the consumer.
The justification most often given for these fees being imposed on you as the homebuyer, is that the assistance program will cover the higher cost of the loan.
Silent Second Mortgages
A silent second mortgage sounds like a great idea at first. You get a loan to cover the down payment on the home, and there is a little, or no interest rate, and no payments due on the silent seconds.
What’s not to like, right? Well, it depends on how far into the future you can see. Let’s just assume that the silent second mortgage has a zero interest rate. Good new is, that loan will never be bigger than it is today.
The bad news is, you are making payments every month with out making payments on your silent second loan. Fast forward to the future, and you might need to take $25,000 out of your equity to do some much needed home improvements.
You now have to pay back the buyer assistance program. So, instead of only borrowing $25,000, you now have to borrow more than you need, to pay back the buyer assistance loan.
This may not be a big deal, or maybe it is. Especially if your silent second has an interest rate. Most of these buyer assistance programs have low, simple interest rates.
To figure out how much your loan will grow, simply multiply the interest rate, by the amount of original loan.
A 3% interest rate on a $7,000 silent second is ($7,000 x 3%) is $210 a year. Not a lot of money at first, but getting up to 10 or more years into the loan, and it starts to build up.
Equity Share ClausesDeed Restrictions
On average, home values increase approximately 5% a year in a normal market. Some areas can appreciate faster, some areas can appreciate slower.
If you bought a home for $300,000, at a 5% annual increase in equity, let’s do some quick math:
- First Year After Buying – $300,000 x 5% = $15,000 – New home value is $315,000
- Second Year After Buying – $315,000 x 5% = $15,750 – New home value is $330,750
- Third Year After Buying – $330,750 x 5% = $16,537 – New home value is $347,287
- Fourth Year After Buying – $347,287 x 5% = $17,664 – New home value is $364,951
- Fiver Years After Buying – $364,951 x 5% = $18,248 – New home value is $383,199
Now you understand what I mean when I say that it makes mathematical sense to buy a home, even if you have to use a buyer assistance program.
In this $300,000 purchase price example, you’re looking at over $80,000 in equity after only 5 years.
Now imagine if you weren’t entitled to that equity. I have run across more than one buyer assistance program that included an equity share clause. This clause may entitle the buyer assistance provider with a percentage of your equity if you try to sell or refinance your home.
I once had an experience where a home owner used a buyer assistance program that had an equity share clause. He was trying to take $25,000 for home improvements. The terms of his assistance loan required him to pay $75,000 of his equity to pay back the initial $7,000 loan.
Can you imagine? Needless to say, he did not want to borrow $100,000 when he only needed $25,000. Ever since this experience almost 15 years ago I specifically look to make sure there is not equity share clause.
Equity share clauses are most common with very large down payments or deeply discounted sales price.
When the home is selling for less than market value, that home will often have a deed restriction. Essentially, you hold title to the home with a deed that restricts you from selling the home at a profit, and can only sell it to another eligible home buyer.
Depending on terms of the deed, you are essentially giving up your equity in exchange for a lower sales price. This is a great program for folks that will not ever move from the home, or have been fully informed about the terms of this loan,
Avoiding Surprises with Buyer Assistance
You’ve already done 90% of the preparation necessary to avoid surprises if you’re considering using buyer assistance. Just by reading this article you already know more than most, including loan officers.
The best advice I can give you is to READ THE GUIDELINES. The guidelines for the buyer assistance program is online and usually pretty accessible.
Just know that you should be cautiously optimistic going into anything that sounds too good to be true. Knowing there can be a catch or future hidden costs, or even being stuck in a higher interest rate, is more than half the battle.
Cost Effective Assistance Alternative Options
When using a traditional loan without buyer assistance, the lender has the ability to help you pay closing costs. This is done by taking a higher interest rate, which generates a closing cost credit.
In my personal experience, if you can come up with the down payment, let the seller, your agent, and/or the lender cover your closing costs. Due to underwriting guidelines, the down payment can only come from you, an assistance program, or a gift from a close relative.
Low Down Payment Conventional Mortgage
Many people believe that you need a 20% down payment to use a Conventional loan. This couldn’t be further from the truth. Conventional loans offer options as low as 3% down, with discounted mortgage insurance and closing costs.
Fannie Mae HomeReady and Freddie Mac’s HomePossible and HomeOne all offer 3% down payment options for first time buyers. These loans feature reduced private mortgage insurance rates, as well as a cap on closing costs.
Some of these programs have income limits depending on the County that you are buying in. Other Counties have no income limits at all.
Make sure your loan officer has experience with both of these programs because it is quite common that one program will have restrictive income limits, while the other program has no income limits and is available to anyone buying in the County.
Home buyers with a credit score higher than 740 may also be shocked at what a payment looks like if you use lender paid, tax advantage mortgage insurance (lender paid = included in rate).
No Down Payment Loans
It still surprises me that eligible service members are not aware of their VA home loan benefits. This loan program offers 100% financing if you’ve been honorably discharged, and meet the minimum VA service requirements.
One of the least understood 100% financing loans available today is the USDA rural development loan. In some cases, if the appraised value comes in higher than the purchase price, you can even finance your closing costs up to a maximum of 102% of the contractual purchase price.
While a VA loan requires borrower eligibility, a USDA loan has geographic and income limitations. The property must be located in a USDA eligible area, and you must not exceed the income limits for that County.
If you meet buyer assistance income limits, there’s a very strong chance that you will also meet USDA income limits. This is the first thing I would check – Is the property located in a USDA eligible area?
CRA – Community Reinvestment Act
The Community Reinvestment Act (CRA) requires that FDIC insured lending institutions lend a percentage of their mortgage loans at reduced interest rates in low to moderate income areas.
CRA areas can be defined by zip code, City, or County. These programs are more rare than other buyer assistance programs, and typically will not only reduce the interest rate, and not contribute to down payment requirements.
Working with a Mortgage Expert
Choosing the best mortgage based on your qualifications requires that you work with a professional loan officer that has experience with all of the options that are available to you.
All mortgage companies are NOT created equal. Big box lenders that advertise on TV, radio and the internet, often only target a very narrow qualifying criteria.
These popular lenders spend millions of dollars on marketing and advertising, only to dump you into a call center and put you in the hands of an inexperienced customer service telemarketer.
Big box lenders try to convince unsuspecting consumers that it’s the lender that matters, and never mention the fact that your loan officer is the gateway to you getting the best mortgage.
As a first time home buyer, you should avoid these types of lenders at all costs if possible. They do not offer lower rates or better service, but they do have more money to convince you that they do.
Your loan options as a first time home buyer are limited to the experience of the loan officer that you are working with.
If you are unfortunate enough to end up on the phone with an inexperienced loan officer, they may not even tell you about these incredible 3% down payment conventional loans.
I see this all the time. Inexperienced loan officers will simply push you into the mortgages that they know, and rob you of the options that may be available to you.
Set Yourself Up for Success
The absolute first step to buying a home is to get your financing ducks in a row before you start looking for home. This means working with a mortgage professional.
Once you find an expert loan officer that you trust, ask them for an introduction to a local real estate agent that they trust. Even if the loan officer is not from the community that you’re buying in, they will still be able find an agent that rises to the level of professionalism you deserve.
Not sure where to find a professional loan officer that you can trust? You’re in the right place!
If you have any questions or comments about this topic, feel free to leave a comment below, or you can shoot me an email at firstname.lastname@example.org.
Now sure how to identify a professional loan officer? Watch these expert interviews I’ve done with professional loan officer friends of mine.
I firmly believe that once you hear how a professional loan officer communicates, it will help you to avoid silly mistakes and errors that are common with inexperienced or uneducated loan officers.