10 Mistakes To Avoid When Financing A Home

Buying and financing a home is the most important personal financial decision an individual will make in their lifetime. Over a lifetime, the average homeowner may pay one-half of a million dollars or more in mortgage interest—many times more than any other single expense. In addition, much of the wealth of the nation lies in real estate. Over two-thirds of American families own their own home, while our country has the lowest savings rate in the industrialized world.

As significant as these statistics are, the process and substance of home finance remains a mystery to the average American. We tend to know much more about our automobiles and the loans that finance these vehicles than we do about mortgages that make our home purchase possible. How many Americans are familiar with the formulas for mortgage qualification or the workings of adjustable rate mortgages? Because of our unfamiliarity, many Americans pay too much for their mortgages or have no idea if they are making the right decision in relation to their personal financial situation. We tend to pay too much because we tend to make up to ten essential mistakes when involved in the homebuying process:

1. We do not have a relationship with a lender. An individual formulates a multitude of professional relationships in his or her lifetime. These include a doctor, attorney, accountant, financial planner and even a car dealership. We tend not to have a relationship with a mortgage lender because the need for the home finance transaction arises much less frequently than our trips to other professionals such as a tax preparation specialist. In the past, homeowners averaged a new home loan once every seven years. With the advent of adjustable rate mortgages and refinances, this average has been shortened significantly. If you have no relationship with a qualified mortgage lender you are much less likely to find qualified advice when the need arises. When rates go down and you are one of many trying to join the hordes of those refinancing homes, you will have little time to develop a relationship with a qualified professional.

2. We have no idea whether the lender we pick is qualified. Since we do not tend to have long-term relationships, we do not tend to shop for the right reasons. We know how to ask about a mortgage company’s rates (or, at least we think we do)—but not the background of the company or the individual with whom we are dealing. For example, what is the experience level of the loan officer? Do you know that in many states there is no licensing, education, and/or experience requirement for loan officers? While it is typical for a real estate agent to be required to take a course and pass a test in most states, loan officers may be hired off the street. You are about to make the most important financial decision you may ever make. Would it not make sense to go over the resume from the person with whom you are working? Would it not make sense to check references?

3. We do not know how to shop for a mortgage. Most homebuyers know how to ask: what is your rate on a mortgage? We do not know how to ask about lock options, miscellaneous fees, annual percentage rates, or even the variety of programs available. One example would be options for avoiding mortgage insurance. If we put less than 20% down on a home financed with a conventional mortgage, we may need private mortgage insurance. Many lenders have programs that do not require this insurance.

4. We do not know enough about mortgages in general—especially how the choices might affect our economic gains or losses. Since we do not know about mortgages, it is not likely we will know how to shop or what to look for in a mortgage. We tend to know that there are fixed rates and adjustables. We do not know that there are options which may require less of a down payment or closing costs. We tend to be clueless when asked how the down payment might affect our overall rate of return on our investment in the long run. This relates to the concept of leverage—the less we put down, the greater the return in the long run if the home appreciates. The longer we stay in a home and do not refinance the original mortgage, the more likely we will see a gain on any points we pay. If we refinance or sell in a short period of time, any points paid will result in a loss. How many home shoppers know how to calculate the time frame necessary to break even on the dollars invested in points?

5. We think we know what type of mortgage we would like—without knowing all the options. Many of us begin by shopping for a 30-year fixed mortgage or a one-year adjustable because we are familiar with only one or two options and we have made our decision on our preference. There are several additional major mortgage types which should be considered. Are you familiar with buydowns, long-term adjustables and 20-year mortgages?The best option for you may change with your own evolving economic condition or changes in the economic environment surrounding you. For example, are you going to be in a home for a long time?

Changing spreads between short and long term rates can make adjustable rate mortgages more attractive during certain time-periods. Even within the adjustable rate family, certain economic conditions can make one adjustable more attractive than another. The point here is that you should not shop for a particular type of mortgage. You should work with a professional to evaluate which is best for you under the present economic scenario. If we could predict the future of interest rates, the process would be easy.

6. When we refinance our mortgage, we forget about the long-term. With lower interest rates, everyone thinks that we come out ahead when we refinance. Many times we use the equity in our homes to finance our car purchases and more. It seems very attractive to lower the car payment from $500 monthly to $200 by stretching out the loan’s term. In reality, every time we refinance purely for a lower rate and/or payment, we stretch out the mortgage’s term and slow down the process of building equity.

7. We have no idea how the mortgage approval process works. Many of us sign a contract to purchase a home and then address the idea of obtaining a mortgage. Most do not know that it makes more sense to obtain a mortgage approval first. This helps our own piece of mind while we shop and also increases our bargaining power with the seller. Getting a mortgage after we sign a contract is virtually going through the process backwards. In addition, if problems do arise during the approval process, this allows us to confront these problems up-front with plenty of time since we do not have a settlement date staring us in the face. Knowing more about the process also would help us in solving these problems. If a lender suggests that we pay off debts or obtain a co-signer in order to qualify for the mortgage, do you know enough about the process to know whether there may be other alternatives? Will you have time to react at this point in the process?

8. We do not know that the lock options may be as important as the rate. Most shoppers have no idea that many lock options exist. There are options which allow us to lock in the rate and points for 15, 30, 45, 60, 90 or more days. Some of the lock options may cost money up-front. These up-front fees may or may not be applicable to the final closing costs. Other options allow us to lock in a rate and then relock if rates go lower before settlement. Many people shop different companies in order to save $250 in points and then make the wrong decision with regard to lock options. Considering the volatility of the interest rate markets, the wrong lock option may cost many thousands of dollars.

9. We do not know what to ask the lender with regard to the services he or she offers. We assume that all mortgages are the same. One 30-year fixed mortgage is the exact same as another. It is not the variance of mortgages we are referring to. It is the quality of service that is delivered. For example, many lenders offer quick approval programs that will allow these lenders to render a decision in a few days. Other lenders may struggle with your application for weeks or months. Some lenders process and approve your loans with their own staff. Others send their loans to other lenders for processing or approval. Finally, many lenders are much more likely to service the loans they close while others sell most or all of the servicing.

We are not advocating here which is the best mode of service. For example, a smaller broker that sends your loan to a larger lender might offer you a wider range of programs than a bank. The important thing is that you are aware of what services are available and that tradeoffs must be made in order to make a final decision.

10. We are intimidated by the whole process. Buying and financing a home seems to be a very large task—one which most of us would rather avoid. The reason we become intimidated is that we are not knowledgeable regarding the subject of mortgages. The mortgage decision is important enough to spend some time learning. Certainly, it is as important as learning about the latest four wheel drive vehicle. With knowledge comes confidence. With confidence comes power. Remember how we all felt about personal computers ten years ago?...?

If you would like to get the answers to these items and more contact one of our experienced loan officers. Click here