The 7 biggest mortgage mistakes to avoid
A mortgage is the biggest debt most of us will ever carry, and a home is the most expensive purchase we will ever make.
That's why it's so important to avoid mistakes that cause you to pay more than you should.
Don't let the unfamiliarity and enormity of taking out a home loan scare you.
People make smart choices every day. They make a budget to see what they can afford, then get home loans with great interest rates, low fees and predictable, fixed monthly payments.
Avoiding these mortgage mistakes will be a big step toward making home ownership a joy, not a burden, and put you on the path to long-term financial security.
Mistake 1. Making yourself house-poor.
Committing too much of your monthly income to housing-related costs means that you have little or no money left over for anything else.
Replacing a worn-out car. Saving for retirement. Building a college fund for the kids. Even buying furniture for your home is beyond your means.
All in all, it's a pretty crummy way to live that turns homebuying into a mistake you regret almost every day.
Spending less than 28% of your pretax income on housing is the first, most fundamental, rule for determining how much you can truly afford to spend.
If you earn $75,000 a year, that means you shouldn't devote more than $1,750 a month to mortgage payments, insurance premiums and association fees.
Where you live, how much you make and other unique circumstances can make a big difference in how much of your income you can — and must — commit to housing.
This story on how much house you can afford provides a more detailed look at how much you should spend.
Mistake 2. Ignoring the true cost of homeownership.
Owning your own home comes with new expenses that surprise many first-time buyers.
Each year, budget 1% to 2% of your home's purchase price for routine maintenance. If your home costs $250,000, expect to spend $2,500 to $5,000 annually on unglamorous purchases like a new water heater or having your furnace serviced.
Some years you'll spend less. When that happens, set the money aside for pricier items like a new roof.
The older your home and the larger it is, the more you'll spend.
Property taxes also add to the cost of homeownership each year. Learn about the property tax system in your community to see what current rates are, when taxes can increase and by how much.
If your home is in a special flood hazard area, your lender will require flood insurance. Prices vary by location.
Mistake 3. Not shopping around for the best loan.
Do you check prices with several airlines before buying a plane ticket? Read the grocery store circulars to see who has the lowest prices?
Devoting a little time to finding the best possible mortgage can save tens of thousands of dollars in fees and interest over the life of the loan.
Yet a report from the Consumer Financial Protection Bureau says nearly half of Americans seriously consider only one lender or broker before applying for a mortgage. And about 75% fill out an application with only one lender.
Why are so many of us failing to comparison-shop?
"It is a surprising finding, and it suggests that they're still fairly intimidated by the mortgage transaction," Richard Cordray, head of the government bureau, told NPR. "Or they're a little distracted because, at the same time, they're picking out a house."
Our extensive database of current mortgage rates is a good place to start your search. It lets you quickly compare the lowest available rates and fees from dozens of lenders.
Mistake 4. Ignoring APR.
Some lenders advertise low interest rates but make up for them with high fees.
You need to compare annual percentage rates from lenders' truth-in-lending disclosure forms to see which mortgage really costs the least.
APR includes lender fees and shows the loan's true cost.
A $100,000 30-year fixed-rate loan with an interest rate of 3.85%, where the lender charges two points, a 1% origination fee and $1,500 in other closing costs, has a 4.215% APR.
The same loan at 4.05%, with no points, a 1% origination fee and $800 in other closing costs, has a 4.199% APR.
The first loan looks cheaper because of its lower interest rate, but it costs more in the long run and requires you to bring more cash to closing.
Mistake 5. Putting little to nothing down.
Most lenders require 20% down to get their best rates and avoid paying mortgage insurance — an extra cost that typically adds $100 or more to your monthly payments.
Although borrowers must pay the premiums, mortgage insurance protects the lender, not you. If you fail to make the payments and must be foreclosed on, the mortgage insurer will cover a percentage of the lender's loss.
Private mortgage insurance on conventional financing costs 0.20% to 1.50% of the outstanding loan balance each year.
FHA mortgage insurance charges an up-front premium of 1.75% that can be rolled into the amount being borrowed and an annual premium of 0.85% of the loan balance.
Once you agree to a loan with mortgage insurance, you're stuck with paying the premiums for years to come.
It typically takes two to seven years to build enough equity, or sufficiently lower the outstanding balance, to cancel private mortgage insurance.
FHA loans require mortgage insurance until the loan is paid in full.
Mistake 6. Not checking and fixing your credit reports.
Checking your credit report with all three major credit bureaus — Equifax, Experian and TransUnion — is free through annualcreditreport.com.
Free credit-monitoring services like those offered by Credit Karma and Quizzle also give customers access to one bureau's report.
It's important to examine your credit reports carefully, because any mistakes — and they are depressingly common — could lead to a higher mortgage rate or even loan rejection.
If possible, check your credit six months to a year before you apply for a mortgage to give yourself plenty of time to fix errors and make changes that will improve your score.
Using less than 20% of your available credit card limit each billing cycle (yes, even if you pay your balances in full and on time), paying down loans with large balances and making all of your loan payments on time are easy ways to improve your credit score.
With below-average credit, the only loan you might qualify for is an FHA loan, which has expensive mortgage insurance premiums for the life of the loan.
Mistake 7. Not going with a VA loan if you qualify.
We think VA loans are the best mortgages for pretty much anyone who can qualify for one.
Millions of veterans, along with those on active duty, including the National Guard and reserve units, are eligible.
Among the advantages:
- The VA makes sure buyers don't overpay for a home and that it's move-in ready, without any costly, unexpected problems.
- It requires no down payment on purchases up to $417,000 in most areas and yet charges no mortgage insurance.
- The VA tightly restricts the type and amount of closing costs.
- Interest rates are very competitive, even if you have relatively poor credit and lots of debt.
How competitive? In most cases, you'll pay the same interest rate as borrowers with a 760 credit score and a 20% down payment.
The only financial drawback to a VA loan is what's called the funding fee, which can range from 1.5% to 3.3% of the amount you're borrowing.
The fee can be added to the loan so you won't have to pay for it up front. If you have a service-connected disability, the funding fee is waived.