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FINANCIAL ARTICLES |
8 Big Mortgage Mistakes & How To Avoid Them
You can borrow too much or prepare too little. You can misjudge terms or
overestimate your credit. With so much at stake, it’s no wonder so much can go wrong.
Liz Pulliam Weston
Applying for a mortgage can be a daunting experience. It’s not enough that you’re agreeing to take on the biggest debt of your life, one that represents two to three times your annual income. You’re also confronted with piles of paperwork, flurries of fees and a tidal wave of terms, from amortization to title insurance, whose meaning is fuzzy at best.
“Whether it’s a professor at Stanford or a ditch digger,” said San Francisco mortgage broker Leon
Huntting, “most people don’t understand the loan process.”
In this confusing and pressure-filled atmosphere, it’s easy to make some mistakes. Here are some
common ones that lenders and mortgage brokers see, and what you can do to prevent them.
1. Not fixing your credit Mortgage
brokers say they’re confounded at the number of buyers who
apply for a mortgage with their fingers crossed, hoping their
credit will allow them to qualify for a loan.
Before
you even think about applying for a mortgage, obtain copies of
your credit report and your FICO credit score. Your FICO score
is the three-digit number that’s used in 75% of
mortgage-lending decisions. You can order your FICO score on
the Web for a fee of $12.95, which includes a copy of your
credit report. (See link at left.)
Doing this at least
six months in advance should give you plenty of time to
challenge any errors on your report and ensure that they’re
removed by the time you’re ready to apply for a loan. You can
also see the legitimate factors that are hurting your score
and do something about them, such as paying off an overdue
bill or paying down credit card debt.
2. Not looking for first-time home buyers’
programs These programs, typically sponsored by
state, county or city governments, often offer better interest
rates and terms than you’ll find among private lenders, said
mortgage consultant Diane St. James. Some are tailored for
people with damaged credit, while most can help people with
little saved for a down payment.
Some of these
resources are listed on St. James’ educational Web site, ABC
Mortgage Consulting (see link at left). You can also call the
housing agencies for your state, county and city to see what
they offer.
3. Not getting
pre-approved for a loan Many first-time borrowers
confuse being “pre-qualified” with being “pre-approved.”
Pre-qualification is a pretty casual process, where a lender
tells you how much money you probably can borrow based on how
much money you make, how much debt you already have and how
much cash you have for the down payment.
Getting
pre-approval, by contrast, is a much more rigorous process and
involves actually applying for a loan. You typically submit
tax returns, pay stubs and other information. The lender
verifies the information and checks your credit. If all goes
well, the lender agrees in writing to make the loan.
In
a hot or even warm real estate market, the house hunter who is
only pre-qualified is a cooked goose. Home sellers and their
agents give much more weight to offers being made by buyers
who already have a loan lined up.
4. Borrowing too much money Many
people take out the biggest loan they possibly can, figuring
that their incomes will eventually increase enough to make the
payments comfortable. But few first-time buyers have any clear
idea of how expensive homeownership can be. Not only will you
shell out more for mortgage payments than you probably did for
rent, but you’ll also need to cover property taxes and
homeowners insurance, as well as higher bills for utilities,
maintenance and repairs than you faced as a
renter.
Lenders are perfectly willing to let you
overextend, knowing that you’ll probably forgo vacations,
retirement savings and new clothes for the kids rather than
default on your mortgage.
“Mortgage money … is way too
easy to get,” said Ted Grose, president of the California
Association of Mortgage Brokers. “People tend to overbuy … and
that can really stress family life. It’s also a formula for
foreclosure.”
Instead of going to the edge of
affordability, consider limiting your housing costs --
mortgage payments, property taxes and homeowners insurance --
to 25% or so of your gross income. That’s a much more
sustainable level for most people, financial planners say,
than the 33% lenders are typically willing to give
you.
5. Not shopping around for
rates and terms Mortgage broker Allen Jackson of
Bristol Home Loans in Bellflower, Calif., sees too many
borrowers with decent credit getting stuck with loans meant
for people with poor credit. So-called “subprime” loans are
often more profitable, so less ethical mortgage brokers may
push them.
If the borrower doesn’t know what the
prevailing interest rates are for someone with their credit
standing, Jackson said, they can easily pay thousands of
dollars more than they need to. You can see a listing of loan
rates by credit score at MyFico.com, and a comprehensive
listing of prevailing rates and fees can be found in MSN
Money’s Banking area.
Even people with a few dings
on their credit can often qualify for better loans than
they’re typically offered, said Grose of 1st Mortgage Advisors
in Los Angeles. He believes most of the people being shunted
into government loan programs, such as Federal Housing
Administration (FHA) loans, would pay less if they used
mortgages now being offered by private-sector
lenders.
6. Paying junk fees
Lenders can boost their profits by adding on a
variety of fees. Some may be legitimate, some may be inflated
and others may be pure fluff. Lenders may charge for “document
preparation,” for example, when all that involves typically is
having a computer spit out a form. Or they may charge $150 for
a credit check that cost them $15.
The time to
challenge junk fees is not when you’re about to sign the loan
papers. Use a mortgage broker or call a number of lenders to
compare their loans. Ask about the interest rate, the “points”
charged to get that rate (each point is 1% of the total loan
amount) and any other fees the lender charges. Then you can
compare terms.
Once you’ve selected a lender, you’ll be
given a good-faith estimate of closing costs, which should
include any fees being charged. Ask about each fee, and try to
negotiate down the ones that seem excessive.
If the
lender won’t negotiate, “take that estimate to someone else,”
St. James said. “I’ll bet they can beat
it.”
Unfortunately, this doesn’t absolutely guarantee
you won’t face junk fees when it comes time to sign the loan.
Many borrowers complain that they still face higher costs than
were originally estimated, and so far the federal government
has done little to prevent the practice. You can try
challenging junk fees at this point, but most likely you’ll
have to bite the bullet and pay the fees to get your
loan.
7. Not planning for closing costs
The day you’re scheduled to get your loan,
known as closing, you’ll also be expected to write a check for
a number of expenses, which typically include attorney’s fees,
taxes, title insurance, prepaid homeowners insurance, points
and other lenders’ fees. Together, these are known as closing
costs, and the total can be eye-popping: somewhere between 2%
to 7% of the selling price of the house.
"Usually, when
people see the closing costs, they’re like a deer in the
headlights,” said mortgage broker Huntting, who works for
Pacific Guarantee Mortgage. “It’s much more than they ever
think it’s going to be.”
Plan for closing costs by
getting a good-faith estimate from your lender as early in the
loan process as possible. Make sure you have the cash on hand
(or rather, in your checking account) and that it doesn’t
“disappear” before closing because of sloppy bookkeeping or a
last-minute emergency.
8. Not having enough cash on hand after closing After
borrowing too much, and scraping together every last dime for
closing costs, many home buyers have nothing left in the bank
to pay for anything unforeseen happening --and something
unforeseen always happens.
“It costs so much just to
move in,” Grose said. “Then the water heater
breaks.”
Some people are so tapped out by the process,
Jackson said, that they’re not able to make their first
mortgage payment on time. That’s why “more and more lenders
are requiring [borrowers have] three months’ reserves AFTER closing,” Jackson
said.
That’s a smart idea for borrowers, anyway. Having
three months’ reserves, which means a fund equal to three
months’ worth of expenses, will help you handle the added
costs of homeownership with much less stress.
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