With today's unprecedented low mortgage rates and home prices, you may be thinking of making the big leap into home ownership.
If you're a mortgage newbie, don't get caught making an error that could cost you big money. Here are five home financing mistakes that rookie homebuyers make, along with tips on how to avoid them.
1. Getting one or two mortgage quotes, tops
Why it's a mistake: Mortgage rates can vary a lot between lenders. According to MIAC, a mortgage and financial services industry analytics firm based in New York, N.Y., the variance can be 0.25 to more than 0.50 percentage points, depending on the loan type.
It's definitely worth your time to do a bit of comparison shopping now. How worth it? A mortgage calculator doesn't lie: On a $300,000 home loan at 5 percent, you'd be paying $279,767 in interest over 30 years. But at 5.35 percent, you'd pay an additional $23,320 in interest over the life of the loan.
How to avoid it: Don't assume the first lender you ask is giving you the most competitive rate. Get multiple quotes from qualified mortgage lenders.
2. Just caring about your ballpark credit score
Why it's a mistake: Literally a single credit score point could save or cost you thousands. Until recently, you didn't have to worry about your credit score as long as it was decent. Not so today. Mortgage pricing is assigned by credit score in 20-point tiers.
Is a borrower with a 679 FICO really a higher risk than one with a 680 score? Probably not, but all the same, Fannie Mae's Loan-Level Pricing Adjustment matrix shows that the person with the 679 score pays 0.75 percentage points more in loan fees. That's $2,250 more on a $300,000 mortgage!
How to avoid it: As soon as possible (before applying for your mortgage), get your free credit report and pay the nominal fee for your credit scores at www.annualcreditreport.com. Concentrate on fixing inaccuracies in the reports and paying down balances. Wouldn't you rather spend that $2,250 paying off credit cards than giving it to Fannie Mae?
3. Dismissing FHA loans as just for low-income buyers
Why it's a mistake: Federal Housing Administration (FHA) loans are not restricted to lower-income borrowers. In fact, they're not just for first-time homebuyers, either. FHA loans do limit the amount you can borrow, you must pay both an upfront and monthly insurance premium, and they can only be used for primary residences. However, FHA loans have several advantages:
- Required down payments range from 3.5 percent to 10 percent
- The loans are assumable when you sell your home. If mortgage rates increase, the ability to transfer your home loan to the new homeowner can give you a big advantage over other sellers
- Minimum credit scores range from 500 to 580, and credit scores don't influence pricing
- Underwriting is flexible
How to avoid it: Get in touch with a few FHA-approved lenders and ask them what they have available for you. Compare the numbers on FHA loans with conventional financing. You may be surprised.
4. Going after the lowest monthly mortgage payment
Why it's a mistake: A lower mortgage payment doesn't always represent savings. If a 15-year loan and a 30-year loan had the same mortgage rate, the 15-year loan would require a higher monthly payment than the 30-year loan. Yet you'd pay less in total interest on the 15-year loan.
It's not necessarily a bad move to choose a loan with a lower monthly payment, particularly if a higher payment would overburden you financially, but be aware that it may be coming with greater total interest.
It works the same with your credit card. Making the small minimum monthly payment to your credit card company just ensures that repayment is prolonged, and you'll rack up loads of interest payments in the process.
When you refinance your mortgage, watch out for the same bad logic of "lower payment equals savings." Even some loan officers perpetuate the refinancing untruth that your refinance pays for itself once the difference in your old and new monthly payments adds up to the closing costs of your new mortgage. When you refinance, the new loan often stretches the remaining balance over a new repayment term, and this longer repayment period is driving at least some of the so-called monthly "savings."
How to avoid it: By all means, keep your monthly payments low, but make sure you're comfortable with the total interest you're paying over the life of the loan. HSH.com's Tri-Refi refinance calculator lets you see the cash outlays clearly.
5. Fixating on the 30-year fixed rate mortgage
Why it's a mistake: To very conservative folks, traditional 30-year fixed rate mortgages are the only home loans to consider. However, especially for younger buyers, hybrid adjustable-rate mortgages (ARMs)--which give you a fixed rate for a specified number of years before becoming adjustable--may be better.
According to the National Association of Realtors' 2010 statistics, the average home seller in the U.S. owned the home for eight years. If you're younger, it's possible that you may need to be even more mobile for a job move or family change. If it's simply not very likely that you will keep your home for 30 years, why get a mortgage that assumes you will?
ARMs usually give you a 1 percentage point or greater discount from the 30-year fixed-rate mortgage. You can select a fixed rate for three, five or seven years and might save enough in interest throughout those years to pay for a car. Some mortgage experts suggest taking out an ARM, and during the fixed-rate period, paying the higher monthly payment as if you took out a 30-year fixed at a higher interest rate. This way, when the loan adjusts you'll be ahead of the game in paying both principal and interest.
A closely related myth is that adjustable rates always increase. If mortgage rates fall, ARM rates can adjust downward, too. Homeowners with ARMs today are finding that their mortgage rates have dropped into the 3 percent range.
How to avoid it: Think realistically about how long you might own your first home. When shopping for a mortgage, ask about ARMs and hybrid ARMs with various fixed-rate terms, and compare them to fixed-rate loans of various lengths.
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Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte. She graduated with high distinction from the University of Nevada with a bachelor of science in financial management.