For most Americans, the purchase of a home is the single largest investment made during their life. In order to make the dream of home ownership a reality, most rely on mortgage financing. Americans owe more than $8 trillion in mortgage debt, with the average mortgage balance sitting at just over $154,000, according to the Federal Reserve.
With so much at stake, homebuyers must be careful to make good choices when taking on such a significant financial commitment. Avoiding the mortgage mistakes noted below can help keep you on the right track when purchasing your next home or refinancing your mortgage.
•Applying for new credit and a mortgage at the same time: Consider avoiding anything that might adversely affect your credit rating when shopping for a new mortgage — especially additional credit cards or auto loans. Remember, every point counts and it may mean the difference between being approved or denied for your loan.
It is a good idea to review your credit report prior to applying for a mortgage so that you are aware of your current FICO score. This will also give you the opportunity to address any inaccuracies on your report. Do your best to build your credit score in advance of searching for a new loan as this may help reduce your borrowing costs.
•Letting the lender determine what you can afford: Remember, just because the bank will lend you the money, doesn’t mean that you can afford to pay it back. Too often borrowers assume that a bank approval represents the green light to finance as much as possible. Keep in mind that lenders focus a lot of attention on debt-to-income ratios without factoring in other living expenses.
Consider reviewing your budget to ensure that you will still be able to afford the mortgage even if your income were to drop by 25 percent. Also, make sure you are able to save 10 to 15 percent of your income before making any mortgage payments. Remember, buying a home and saving for retirement should not be mutually exclusive goals.
•Failing to shop around: When it comes to financing a home, being a good consumer is critical and comparison shopping can help improve your chances of getting a better deal. Many times borrowers fail to review all their financing options. Instead, they often choose to finance their home purchase at the same institution where they have a checking or savings account. While it doesn’t hurt to speak to your bank regarding their loan programs, failing to shop around could result in a rate that is over 0.75 percent higher. An interest rate differential of 0.75 percent on a $200,000 30-year mortgage could result in more than $30,000 in additional fees paid during the life of the loan. Consider using online resources such as bankrate.com or even Zillow to review a complete list of alternatives. Also remember to consider all closing costs and fees as they can really add up.
•Using an exotic mortgage: From negative amortization loans and adjust rate mortgages to interest only financing and liar loans, exotic mortgages played a significant role in the 2008-2009 financial crisis. While it is true that there are fewer exotic mortgages available, it is still possible to get yourself into trouble by choosing a loan with terms that initially sound too good to be true.
Adjustable rate mortgages (ARM) or interest only mortgages are a good example. It is important for borrowers to avoid being tempted to select a loan simply because it offers a low rate. While non-traditional loans can be helpful for some borrowers, it may be wise to stick to a traditional fixed-rate mortgage. With most analysts agreeing that interest rates will be rising slowly over time, an adjustable rate mortgage or ARM may become costly in the future. Exotic mortgage products can lead some borrowers to take on more debt than they would otherwise be able to afford, so be careful when considering these loans.
Educating yourself on the nuances of the mortgage selection process can help protect you from costly mortgage mistakes. Doing your homework, comparison shopping and maintaining a common-sense approach may help reduce your financing costs over the long term. Since everyone’s situation is unique, consider speaking to your adviser to determine the most appropriate approach for you.
Kurt J. Rossi, MBA, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm Practitioner & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com, www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.