10 biggest mortgage mistakes
CLICK HERE TO FIND A MORE RECENT VERSION OF THIS STORY ON THE BIGGEST MORTGAGE MISTAKES.
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 pitfalls like letting the bank decide how much house you can afford or failing to check your credit before you try to buy.
These mistakes can cause you to pay more than you need to, prevent your loan from closing or even lead to foreclosure and bankruptcy.
Don’t let the unfamiliarity and enormity of taking out a home loan scare you.
People make smart mortgage choices every day. They get home loans with great interest rates, low fees and predictable, fixed monthly payments, and they make a budget ahead of time and think about their long-term plans so they don’t get in over their heads.
Our guide to the mortgage mistakes you should avoid will turn you into a savvy borrower so that owning your home will be a joy, not a burden, and will help you achieve long-term financial security.
By Amy Fontinelle
Interest.com contributing editor
October 14, 2014
Fixed-rate loans are no longer priced at record lows, so you might be tempted to grab an adjustable-rate mortgage.
But unless you're planning to move within five to seven years, you'll be better off sticking with a fixed-rate loan.
Mortgages remain historically cheap, so if you take out a fixed-rate loan now, you may never have to worry about refinancing. An ARM might offer you a lower payment now, but it will eventually reset, most likely at a higher rate.
"There is a lot of risk if rates rise and you cannot get out of the ARM at the right time," says Phillip Christenson, a chartered financial analyst and owner of Phillip James Financial, a financial planning and investment management company in Plymouth, Minnesota.
You might not be able to refinance or afford the new payment once rates rise. Or the housing market could make it difficult to sell.
Our extensive database of current mortgage rates is a good place to start your search for a fixed-rate loan. It allows you to quickly and easily compare the lowest available rates and fees from dozens of lenders.
The sale price you agree to pay for the home isn't the true cost of owning the home.
First, look at your mortgage amortization schedule to see the total amount of principal and interest you’ll pay.
It can be eye-opening to see that borrowing $250,000 for 30 years at 4.30% will cost you $445,384. Use our mortgage calculator to estimate your payments over the life of a loan.
Also learn about the property tax system in your community to see when taxes can increase and by how much. Property taxes can add thousands of dollars to the cost of your home each year.
You’ll additionally be responsible for homeowners insurance, possibly mortgage insurance, all the ongoing costs of furnishing and maintaining a home, and maybe some monthly bills you didn’t directly pay as a renter, like trash and water.
If your home is in a special flood hazard area, your lender will require you to carry flood insurance, which will add hundreds annually to your homeownership costs. Prices vary by location.
Your lender is not a good judge of how much house you can afford. Banks are in the business of maximizing their earnings, not making sure you don't overextend yourself.
If you rely on a bank to set your price range, you will most likely find yourself in over your head, says Jamie Pandolfo, senior mortgage consultant with Flat Branch Home Loans in St. Louis.
Banks will qualify you based on your gross (pretax) income. They don't account for monthly expenses such as insurance, utilities and child care when determining your maximum approval amount, she says.
"It’s best to start by creating a budget and determining a comfortable monthly payment," Pandolfo says.
Generally, you should not spend more than 28% of your pretax income on principal, interest, taxes and insurance.
Lenders usually assume you can spend as much as 36% to 45% of your pretax income on all debts, including your house, student loans, credit cards and car loans, but you should stick to the low end of that range.
Think about the long run when setting your budget, and set yourself up to be comfortable even if you change jobs, have kids or experience another significant change.
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 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.
Just because a seller has accepted your offer and a lender has approved your mortgage doesn’t mean your home purchase is a done deal.
There are a number of behaviors to avoid before you close, says Richard Whitman, vice president of mortgage lending at Texas Trust Credit Union in north Texas.
Don’t quit your job; lenders want to see two years of consistent employment, he says, and they’ll verify it just before closing.
Don’t open new credit cards, take out new loans or use more of any existing credit lines. If you have more debt, you won’t be able to borrow as much.
You shouldn’t even make large purchases with cash because lenders want to see that you have enough savings to keep paying your mortgage in an emergency.
And if you didn’t lock in your rate and interest rates go up, you might qualify for less than you need to buy the home.
Finally, don’t miss any deadlines for returning loan paperwork.
Some lenders advertise low interest rates but make up for them with high fees.
A big mistake consumers make is being swayed to choose a particular lender based on these abnormally low promotional rates, says broker Michael Mahon, general manager and broker of HER Realtors in Columbus, Ohio.
You need to compare annual percentage rates between mortgage offers to see which one really costs the least.
APR includes the lender’s 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 2 points, a 1% origination fee and $1,500 in other closing costs has a 4.215% APR.
The same $100,000 loan with an interest rate of 4.05%, no points, a 1% origination fee and $800 in other closing costs has a 4.199% APR.
While the first loan looks cheaper because of its lower interest rate, it not only costs more in the long run, it also requires you to bring more cash to the table.
Lenders are required to disclose APR on a Truth-in-Lending disclosure form. Read it.
Who wants to move twice? If you’re moving from one house to another, you might be tempted to buy the new home before selling your current one.
This can be a mistake unless you have considerable cash reserves, says certified financial planner Curtis W. Chambers, founder and managing member of Chambers Financial Group in Clearwater, Florida. An unsold home with a mortgage can mean carrying two loans.
"I see this happen all the time, and it can be a tremendous source of stress. It is usually easier to buy a home than to sell one," Chambers says.
Once you sell, you’ll have a 30- to 60-day closing period to find a new home and make a seamless transition, assuming both closings go smoothly.
If they don’t, or if you can’t find your new home that quickly, put all your nonessential belongings in storage and look for a monthly rental.
It will be a hassle, but it will eliminate the risk of carrying two mortgages and relieve the pressure to buy any new house instead of the right new house.
If you’re putting little to nothing down — say, 3.5% with an FHA loan or 5% with a conventional loan — you’re looking at several potential problems.
"Such loans require private mortgage insurance and provide the homeowner little or no real equity in the property," says Bennie D. Waller, professor of finance and real estate at Longwood University in Farmville, Virginia.
PMI typically costs $20 to $50 per month per $100,000 borrowed. Conventional loans let you cancel PMI once you accumulate 20% equity, but FHA loans require mortgage insurance until the loan is paid in full.
Putting almost nothing down also makes it easy to end up underwater. If home values drop even slightly, you’ll be unable to move or refinance without bringing thousands of dollars to closing.
In a rising housing market, however, you can come out ahead by paying PMI on a conventional loan until you have enough equity.
The PMI premiums may cost less than the higher home price you’ll pay if you wait until you’ve saved up a larger down payment.
Educated borrowers look at their budgets and calculate how much they can afford to spend before they go house shopping.
But knowing what you can afford isn’t the same as knowing what the bank will let you borrow based on your income, debts, credit score and current lending conditions.
Often, consumers will go house shopping and find the perfect home before visiting a lender, says Richard Whitman, vice president of mortgage lending at Texas Trust Credit Union in north Texas. They don’t keep track of their credit and aren’t aware that it isn’t where it needs to be to qualify for a mortgage.
With no real idea of what a bank will lend you, you might be looking at homes and neighborhoods that you'll never be able to get a loan for.
And in competitive markets, sellers won’t take your offer seriously without proof of preapproval.
Talk to at least three lenders and get preapproved. It’s free and lets you make a competitive bid.
A conventional, fixed-rate, 15-year mortgage is the cheapest option for most borrowers who qualify.
But if you’re eligible for a special loan, first-time homebuyer grant or other program, you could get a better mortgage or free cash.
VA loans are available to veterans, anyone on active duty and those in the National Guard and reserve units.
VA mortgages have lower credit score requirements, lower interest rates, no mortgage insurance, higher loan maximums and no minimum down payment.
Many homebuyers who don’t think they’re eligible for homebuying assistance do, in fact, qualify.
You can earn up to 120% of the area median income and still be eligible for some money-saving programs from nonprofits, state and local governments and even banks.
Some programs require you to work for a public-sector employer, live in a certain area, complete a housing counseling program or be a first-time homebuyer, meaning someone who hasn’t owned a home in the last two to three years.
You might even get the best deal with a loan from the bank of mom and dad.
Wise home-buying never changes: It's about figuring out what you can afford, how much you can put into a down payment and then sticking to your plan.
Click here to get started.
You'll soon discover that when you were a renter, you had the easy life. Owning a home is a lot of work. Here are 7 surprises for new owners.
Click here to get started.