Money
The link between your dream and reality in buying country property is money. (Darn it!) Before you start looking, three key questions must be answered:
1 . How much of your own money do you wish to spend?
2. How much money do you wish to borrow?
3. How much money are you willing and able to repay monthly, quarterly or annually?
Your definitive answers to these questions will determine the price range of the property you are seeking. Further, it will make available or eliminate the particular type of property you would like to buy.
If you are in a position to pay all cash (this might be regarded as un-American), the process is a simple one and the continuation of this chapter would be pointless. However, the majority of you will become involved in financing your purchase – so let’s explore the world of finance that awaits you.
The most common and “conventional” way of financing real estate is to borrow money from a banking institution, savings-and-loan association, insurance company or private individual over a period of years. The borrower gives the lender a mortgage as security for the loan. The mortgage is a formal document that creates a lien upon the real estate for payment of the debt. The borrower pays for the use of the money obtained a percentage of that sum known as interest which varies in amount depending upon the normal money-market conditions. The repayment of the debt is usually made in monthly installments for an agreed specified period of years. In the event that the borrower fails to meet his obligation, the lender may legally take the real estate and sell the property involved to satisfy the unpaid balance of the obligation.
For example:
- Total cost of property to be purchased $25,000
- Own funds available $5,000
- To be borrowed, known as a mortgage $20,000
Conventional mortgage financing available from major banking institutions and other loaning agencies usually requires the borrower to have from 20 percent to 35 percent of the total purchase price of the property available from their own resources before they will consider loaning the balance of from 80 percent to 65 percent of the amount required to consummate the purchase. This conventional type of financing usually requires the borrower to repay in monthly equal installments of both principal and interest the sum borrowed over a period of fifteen to twenty-five years.
The monthly payment to repay $20,000 computed at 7 percent interest over a period of twenty years would be approximately $155.06 per month. The same amount computed on the basis of twenty-five years would represent a monthly payment of about $141.36. Interest is computed upon the amount owing of the principal balance at the end of each month. Although the monthly payment remains the same, the net result is that a bit more of the total monthly payment is being applied each month to principal and less to interest as the principal balance is continuously reduced. Naturally, the longer you wish to take to repay the $20,000 the less the monthly payments will be, but you will be paying substantially more in interest costs.
If you wish to make your own computation for amounts less or more than $20,000, based upon a twenty-year repayment schedule at 7 percent interest, you may do so as follows: for every thousand dollars of borrowed money the monthly cost approximately for principal and interest will be $7.76.
A majority of loaning institutions require the borrower to pay monthly one-twelfth of the total property taxes and one-twelfth of the property insurance in addition to the principal and interest. These amounts are added to the regular principal and interest payments and the lending institution pays, on behalf of the borrower, his taxes and insurance as they become due throughout the years. This relieves the property owner of his responsibility to meet these payments personally. The funds set aside for taxes and insurance each month are placed into a special bank account known as an escrow account.
Conventional mortgage financing by institutions is usually not available for the purchase of “raw” or “undeveloped” land without buildings. Bank policies and many state laws limit the placing of mortgage loans to “on established property.” A borrower will find it extremely difficult to obtain conventional mortgage financing for property that is not generally well improved and modernized. The abandoned farm or home type structure without good plumbing, central heating, modern electricity, etc., will have little or no chance of passing inspection approval. The lending institution will probably advise that it might consider an application if the applicant wishes to improve the property first with his own funds and thereby meet the minimum requirements for consideration.
The right to repay in all or part the mortgage obligation before it becomes due, at any time during the term of the mortgage, must be a written consideration between borrower and lender. Be sure you have this right to do so and determine if that right is so granted with or without a penalty sum. No prepayment penalty is to your advantage!
Many banking institutions charge a sum of money for granting a mortgage, payable only once at the time the mortgage is granted, and computed upon the amount granted. This “extra cost” is known as points. Two points for a $20,000 mortgage would be $400. Try to avoid the institutions that require this extra sum.
The tighter the money market, the greater the possibility that you will have to become involved in paying these points.
It is general banking procedure to issue annually a statement to the borrower of all pertinent information pertaining to the mortgage activity for the statement period involved. The amount applied to principal, interest, taxes, insurance and various balances remaining will be clearly defined. These statements are extremely valuable in the preparation of income-tax reports. Your attorney will explain in detail all the various terms of your mortgage obligation. You should familiarize yourself with your rights and obligations pertaining thereto.
Many individuals who are selling their property wish to take back a mortgage in part payment of the total purchase price of the real estate. If the seller does not require more cash down than you are able to advance, you should give consideration to this method of financing, providing the terms are within your budget. If the seller does take part payment of the purchase price in the form of a mortgage, this is known as a “purchase money mortgage.” There are many tax advantages to the seller by going this route if he is selling his property at a substantial gain. Sellers who are extremely desirous of disposing of their real estate property that does not meet normal conventional bank financing may have no other alternative than to offer financing themselves. This is especially true in the sales of “raw” or “unimproved” land. Bank or institutional type of financing is the most recommended method, if available. Private financing presents potential problems in the area of continuity of both borrower and seller, estate problems, misunderstandings of payments due; it is usually of shorter duration in terms of years to repay.
It is to your distinct advantage to have the right under prearranged conditions to have a portion of the mortgaged property released from the mortgage lien in the event you wish to dispose of a portion thereof by sale or transfer. Let us assume that you wish to erect a home or other building on a portion of the property under mortgage. It would be impossible for you to obtain clear title or new financing for this project unless that portion of the property was released from the original mortgage.
Most conventional mortgage agreements will require that you fully insure the mortgaged property and the buildings located thereon, against all known perils. In the event of destruction of any of the buildings, the insurance proceeds must be used to replace within a reasonable period of time the buildings lost or damaged, or the insurance proceeds will be paid to the institution or individual holding the mortgage as reduction of amount owed.
The normal procedure to obtain a conventional mortgage loan involves the filing of an application with the lending institution. The real estate broker or attorney will prepare the application from information you supply. The application usually involves submitting a statement of your financial condition (all that you own and all that you owe, in detail), employment and personal data, credit, banking and personal references, and statement relating to amount to be borrowed and repayment schedule of details in reference to your proposed purchase, including purchase price.
The lending institution will make an appraisal of the property, review your credit status, and issue a notice of rejection or commitment usually within thirty days from the time of making application. Although mechanically very sophisticated, rural banking is extremely personal. My suggestion would be that you take the time to meet the bank officers personally. They have a deep regard for community obligations and it is to your advantage that a personal relationship develop from the start. It will provide the bank with an opportunity to react to a human being, not just an application. It may seem like a time inconvenience, but it certainly is worth the effort. Do not expect the bank to act as your appraiser without submitting a formal mortgage application. It just is not usually done.
Most financial institutions do not reveal to the borrower their opinion of market value in the event the mortgage application is denied. Local bank policies, attitudes and appraisals do differ. It is for this reason that you may have to make more than one application for financing, if your first attempt is unsuccessful. Certain banking institutions specialize in conventional mortgages, while others are more concerned with commercial type financing and do not cater to the mortgage business. Be guided generally by your real estate broker or attorney in all phases of financing your purchase.
Metropolitan area banks do not usually wish to become involved in out-of-the-area financing unless they have branch facilities available in the community in which you anticipate purchase. Most rural areas are served well by local financial institutions and are desirous of satisfying the needs of the people coming into the community.
You may be assured that the contents of your mortgage application and credit information will be thoroughly investigated. Don’t gild the lily or give misinformation! Take the time and effort to explain the reasons for any unfavorable credit history. Many times there are logical and reasonable explanations for what might appear on the surface to be damaging evidence.
Answer promptly all correspondence from the mortgage application. Be sure to write a thank-you note or make a personal phone call to the banking officers upon receipt of notice of approval of the application. Little things mean a lot in the country.
Federal law requires that the borrower execute what is known as a “disclosure statement.” The loaning institution itemizes all interest and other charges and the borrower acknowledges this information by executing this statement.
The loaning institution will place particular emphasis on the cash or liquid position, the income, present debt status, and past banking experience of the applicant. Many borrowers take the position that, if the property is substantial, the loaning institution is not taking any risk if they have the property as security for the loan. The lenders are concerned with protection, yes, but are equally adamant in their decision not to become involved with delinquent or troublesome mortgages. Foreclosing a mortgage and constant requests for back payments are costly and annoying procedures for loaning institutions. The ability of the borrower to pay from current income or reserve funds in the event of illness, unemployment or economic.