Published in: Mortgages | Oct. 18, 2018
11 Mortgage Mistakes to Avoid at All Costs
By: Christy Bieber
When you borrow for your home, you'll likely be taking on hundreds of thousands of dollars in debt that it will take well over a decade for you to repay.
The transaction can be a good one, provided you make smart choices about the home you buy and the mortgage loan you take on. Or, it can be a financial disaster that hurts your ability to accomplish financial goals at best and leads to foreclosure at worst.
To maximize the chances of the former occurring and your home turning out both to be a nice place to live and a good investment, you must avoid some big mortgage mistakes. Here are 11 errors you don't want to fall victim to when you take out your mortgage loan.
Not checking your credit well in advance of applying for a mortgage
Your credit score makes a dramatic impact on the mortgage rates you'll pay -- and on the total cost of your mortgage over time.
In fact, according to myFico, with a credit score between 680 and 850, you'd be able to qualify for a mortgage at 4.401% as of September 2018. On a $300,000 loan, this mortgage would come with a monthly payment of $1,502 and total interest costs would be $240,886.
But, if your score dropped around 100 points and was between 660 and 679, your $300,000 loan would come with a 5.02% interest rate, monthly payments of $1,614 and total interest costs of $281,088. You'd pay more than $40,202 more in interest with the lower score.
Check your credit in advance of applying for a loan because if your score is low you can take steps to try to raise it. These steps could include paying down debts or writing a goodwill letter to creditors asking them to remove a late payment from your record if you've generally paid on time. You can also catch any mistakes that might be on your report in time to try to correct them.
With the FTC reporting as many as 1 in 5 people have a mistake on their credit report, it's worth the effort to make a quick visit to AnnualCreditReport.com to make certain you don't have inaccurate information that could cost you.
Not getting pre-approved for a loan
Pre-approval -- which is different from pre-qualification -- is a process that involves a mortgage lender doing a preliminary check of your credit report and other financial details to determine if you'll be able to qualify for a mortgage and how much you can borrow.
Getting pre-approved helps you determine how much house you can afford so you won't waste time shopping for a home that's too expensive. You'll also be a more competitive buyer when you include a pre-approval letter with your offer, since sellers will know you're serious and likely to be able to close the deal.
Basing the amount you borrow on what the bank says you can afford
When you get pre-approved for a mortgage -- or apply for a loan -- the bank will decide how much it's willing to lend you. In many cases, however, the loan the bank approves you for may be larger than the amount you had planned to borrow.
While it can be tempting to upgrade your expectations and buy a costlier home if the bank agrees to give you more money, resist the urge to do this.
Instead, decide how much you can comfortably afford to spend by looking at your budget and your other financial goals. Then, stick to this limit -- even if the bank is willing to give you more -- so you don't end up house poor and forced to scrimp on other priorities that are important to you.
Making a down payment that is too small
When you apply for a conventional mortgage, it's traditional to put at least 20% down on a home. If you bought a $100,000 home, this would mean you put down a $20,000 down payment and borrow $80,000.
While FHA mortgages allow you to buy a home with a down payment as low as 3.5% -- and many conventional lenders allow you to put down as little as 10% -- almost every type of mortgage loan comes with substantial extra costs if you don't have that 20% down payment.
In most cases, these extra costs come in the form of premiums for Private Mortgage Insurance (PMI). PMI protects the lender in the event you default and the lender can't make enough by foreclosing to repay all you owe. Although PMI doesn't provide you with any protection, your mortgage lender will require you to pay for it as a condition of qualifying for a mortgage with a small down payment.
PMI typically costs between .5% and 1% of the total loan value each year, so you could pay thousands extra in costs. And this isn't the only reason not to buy a home with a low down payment either. When you buy a house with a small down payment, you put yourself at risk of owing more than you could sell the home for.
This means you couldn't sell unless the lender agreed to a short sale -- ruining your credit in the process -- or unless you could bring money to the table to pay off the loan despite selling for less than you owe. You don't want to be trapped in your house, so don't buy a home unless you have a substantial down payment.
Not shopping around for the best rates
Even a small difference in mortgage rates can make a big impact. For example, a $300,000 mortgage at 4.0% interest would have a total cost of $515,609 and your monthly payments would be $1,432 -- but at 4.25%, your total cost for the same $300,000 mortgage would be $544,016 and your monthly payments would be $1,511. Each year, you'd pay almost $1,000 more in payments -- and your loan would cost you almost $30,000 more.
There can be big differences from one lender to the other in terms of the interest rate you're charged, so get several quotes from trusted lenders before you decide who you'll be paying back for the next few decades.
Not understanding the difference between locking in your rate or floating your rate
When you're initially approved for a home loan, you have the option to lock in the rate that you're offered. A rate lock typically freezes the rate for around 30 to 60 days, although can sometimes last much longer. If you float your rate, on the other hand, an initial rate you're offered may not be the rate you ultimately end up with.
A rate lock often costs you money, with the longer the lock, the higher the cost. The cost of a rate lock may be a percentage of the mortgage, or a flat fee. You may pay no fee or a very small one -- typically around .25% to .5% of the total loan cost -- for a rate lock lasting less than 60 days but costs can rise if you seek a long rate lock to protect you if you expect it will take a long time to buy a home.
It makes sense to lock in your rate if you think interest rates will rise before you close on your home. But, if interest rates drop, you won't be able to take advantage of those lower rates if you have a rate lock.
One big benefit to a rate lock, though, is that you'll have certainty in how much your mortgage payments will be as long as you close within the lock-in period.
Failing to pay attention to mortgage fees
Obtaining a mortgage can be a costly endeavor. You'll have to pay for an appraisal of the home you want to buy, a credit check, and sometimes an origination fee or application fee.
Pay careful attention to exactly how much different lenders charge as there can be a big variation from one lender to another. Be sure to factor in these fees when determining the total cost of each loan you're considering.
Not understanding mortgage points
Mortgage points essentially allow you to pre-pay interest by buying down your mortgage rate. Typically, one point drops your rate by .25 and costs 1% of the total amount you're borrowing, so you'd pay $1,000 for each $100,000 in loan costs.
Pre-paying interest by buying points lowers your monthly payment, but it takes time to break even. For example, if you took a $200,000 loan, one point would cost you $2,000. If that point dropped your loan balance from 4.5% to 4.25%, you'd reduce your monthly payment from $1,013.37 to $983.88. Your monthly payment would be $29.49 smaller -- and you'd need to make 68 of these smaller payments for the monthly savings to make up for the $2,000 you paid up front.
Once you were in your home for at least 68 months, you'd enjoy the interest savings and lower monthly payments for the rest of the time you have the loan.
The longer you plan to be in your home, the smarter it is for you to buy points to reduce the interest you pay. If you stayed in your home for 30 years after paying that point to reduce your interest rate from 4.5% to 5.25% on your $200,000 loan, you'd end up saving a total of $10,616.40 over the life of the loan -- all from your initial $2,000 up front payment.
It's important to understand points not only to make an informed choice about whether to pay points when you buy your home but also because you want to make sure you compare apples-to-apples when shopping for a mortgage. If one lender offers you a loan at 4.25% with no points and the other offers you a loan at 4.25% if you pay a point, the first lender is offering you a better deal.
Taking out a new loan before your mortgage closes
Buying a house can be a time consuming process, and you may find yourself facing expenses associated with moving. You may be tempted to take out a new loan to finance new furniture or a moving truck, or may decide to put a bunch of big costs on your credit card.
The only problem is, this could affect your debt utilization ratio and potentially impact your ability to close on your mortgage. Until you've actually signed the papers and your home purchase has been completed, refrain from doing anything that affects the amount lest you run into this issue.
Switching jobs before you close on your loan
Switching jobs could also raise red flags with lenders and could cause your mortgage approval to be rescinded.
Lenders want proof of employment and they consider only steady, reliable income when determining how much you can borrow. A last minute change in your work situation could cause your deal to fall apart, so try to stay in your position until you close on your loan.
Taking a mortgage you don't understand
When you start shopping around for a mortgage, you'll find different options for the type of loan. For example, you could take a 15-year fixed rate mortgage, a 30-year fixed rate mortgage, an adjustable rate mortgage (ARM), or various other types of exotic mortgages, such as an interest only loan or a balloon loan.
Fixed rate mortgages are typically your safest option. A fixed rate mortgage means your rate stays the same the entire time you're paying back your loan -- your rates never rise or fall and your payments won't ever change.
While a 15-year mortgage has a lower interest rate than a 30-year mortgage, the payments are more expensive because you're paying off your home in a shorter time. Often, it makes sense to opt for a 30-year mortgage even if you plan to pay off the loan early, because you'll have more flexibility in case a day comes when you can't make those higher payments.
Adjustable rate mortgages are much riskier than fixed rate mortgages. When you take an ARM, you're offered an introductory rate that's typically lower than the rates on a fixed-rate loan. The introductory rate is locked in for a period of time. If you take a 5-1 ARM, your rate is locked in for the first five years, but can change once per year thereafter. If you take a 7-1 ARM, on the other hand, your rate would be locked in for seven years and then can change once per year.
While it can sometimes make sense to take an ARM to take advantage of the lower introductory rate, understand the risk that your mortgage payments could rise. And, as for other mortgages such as interest only or balloon loans, these almost never make sense as the risk of foreclosure or loss is too great.
Whatever loan you decide to take, make sure you understand exactly what your payments will be, how long you have to pay back the loan, and whether your payments can change before you agree to borrow.
Avoiding mortgage mistakes is easy
Now, you know how to avoid 11 big mortgage mistakes that could make your home purchase more costly than it needs to be. Avoiding these mistakes is easy -- you just need to start saving for a down payment ASAP and steer clear of pitfalls such as taking out a mortgage you don't understand. By taking the time to do the process right, you can maximize the chances you'll end up with a loan that's right for you.
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