Common (but Avoidable) Mortgage Mistakes

Common (but Avoidable) Mortgage Mistakes

Getting a mortgage is more complicated than ordering a pizza. Instead of deciding which toppings you want, you’re thinking about items such as the earnest money deposit and an escrow account. It’s a complex process, but we’re here to help.

Budget First

How much can you afford? Comparing your income with the rest of your expenses will tell you how much you can afford to spend on a monthly basis for a house.

If you don’t know where to start, try a mortgage calculator. If you’re making a purchase, these calculators ask how much you want to spend, how much you have for a down payment and give a credit estimate. In a refinance situation, a good calculator will ask questions of you. Do you want to shorten your loan term, lower your payment or take cash out based on your existing equity?

The calculator may not be perfect because it estimates, but you will get a good idea of what your potential mortgage payment would be, especially if you knew about how much to expect for taxes and insurance.

One important thing to remember when budgeting is to leave some money set aside for an emergency or rainy day fund. You want to make sure that if something unexpected comes up, you are covered.

Don’t Guess, Know

If you really want to know how much you can afford, the best recommendation is to get a preapproval letter. When you get preapproved, your lender will ask you some questions to determine your income and they’ll pull your credit report.

The credit report shows any outstanding debt payments you have and helps the lender determine your debt-to-income (DTI) ratio. Your DTI shows the percentage of your income that goes to debt payments like your car and credit card. This helps you determine how much you can afford to pay for a house.

Don’t Forget the Earnest Money Deposit

You likely know about the down payment. One thing people might think about less often is the earnest money deposit. This is given when the seller accepts your purchase agreement.

The earnest money deposit is a percentage of the sales price. It’s your show of good faith that you’re willing and able to purchase the house. It’s later applied to your down payment at closing.

You’ll Need Cash at Close

In addition to your down payment, there are several things you’ll have to pay for at closing that should be taken into account upfront. It’s pretty standard to have an origination fee, the fee charged by a lender for processing the application. You also have to pay for title insurance.

Odds are good that you’ll probably have to set up an escrow account to pay for taxes, insurance and homeowners’ association dues (if applicable). In order to get that started, you pay a certain amount upfront – usually a few months’ worth of your mortgage payments.

If you have an FHA loan, you also have to make an upfront payment of your mortgage insurance premium. The rate on this is slightly higher than your monthly premium payments.

Discount Points

You can lower your interest rate by paying for discount points at closing. A discount point is equal to 1% of the loan amount. (For example, on a $100,000 loan, one point is $1,000.) You can purchase parts of a point down to 0.125. You should be careful and do the math because pre-paying interest doesn’t always work out for everyone.

Let’s go over a basic scenario to give you an idea of how this works. Let’s say buying two points on a $200,000 loan ($4,000) saves you $200 per month in interest. In order to break even on the deal, you have to stay in your home for at least 20 months. After that point, it starts to be advantageous to pay for the points.

Rate Reality

There are a few realities you should realize about mortgage rates. Let’s get those out on the table right now.

You Can Help Your Rate

The Federal Reserve’s guidance has a lot to do with how mortgage bonds perform in the market, which affects how baseline rates are set.

As nice as it is to understand baseline rates, they don’t have as much effect on your personal interest rate as you might think. Factors you can control like your credit rating and your down payment make a big difference.

Lenders, mortgage or otherwise, are in the business of minimizing risk. If you can demonstrate your borrowing money from them is a good investment, you can get a lower rate because they expect it to pay off.

One factor that shows lenders you’re a good borrower is your credit score and history. If your credit history shows that you consistently make your payments on all your bills and that a history has been built up for a while, you likely have a higher score and a lower rate. Make sure you take a look at your credit score and report so that you don’t have any surprises.

The second factor that affects your rate in a major way is your down payment. The bigger your down payment, the less money lenders have to provide, which makes you a better risk.

Lock It In

Remember how I said the Federal Reserve and the bond market didn’t necessarily have a lot to do with your personal rate? There’s one big exception to that.

When the baseline rates go up, mortgage rates tend to go up for everyone. Not only that, but the baseline rates are tied to bonds like the 10-year U.S. Treasury, which fluctuates when it’s traded. If there’s enough movement in the market, lenders may have to make rate changes multiple times a day.

It’s especially important to be aware of right now because the Fed has sent signals that it’s strongly considering raising short-term interest rates from their current near-zero levels at its next meeting on December 16. When this happens, it’ll have a ripple effect throughout the bond market and will (probably) raise mortgage rates.

Here’s the good news: You can lock in your interest rate for a period of time when you’re ready to purchase or refinance. During this period, you’re immune from interest rate changes. Sure, rates could go down. They could also go up.

It’s important to take the step of locking in when you see a rate you’re comfortable with. You really don’t want to get caught with a higher rate by waiting too long.

Adjustable vs. Fixed Rates

Another thing that’s really important to know regarding your rate is whether it’s fixed or adjustable.

Fixed rates remain the same for the life of the mortgage. The rates of adjustable-rate mortgages (also referred to as ARMs) remain fixed for a period of time – for example, 5 or 10 years – and are adjusted annually based on market rates after that.

ARMs can be good if you’re not looking to stay in a particular home for long because you can start off at a lower rate and move to your next house before the rate starts adjusting.

If you like where you’re at and don’t want to take the risk of riding the market, you can always refinance into a fixed rate.

Payment Issues

Finally, there are a couple of mistakes to avoid that are easily made when making payments. Don’t forget to label the purpose of payments and include your loan number when sending a check.

Label the Payment

A common strategy people will use to save on interest is to pay a little extra toward their mortgage every month in order to pay off the mortgage sooner. Assuming your lender does not charge a prepayment penalty, you can specify that any extra amounts on the payment go toward paying off the principal.

Lenders may have different policies, but at Quicken Loans you can specify what a payment is for through the payment coupon, online through MyQL or over the phone. It’s important to note that you can only make an extra payment toward principal if you’ve already made the payment for the current month that’s due.

Include Your Loan Number

It’s getting to be the holiday season, so let’s give you the best gift scenario ever: Instead of giving you the same knit sweater, your mother is feeling particularly magnanimous and decides to pay your mortgage payment for the month. No problem, right?

Let’s say your mom had such a good experience refinancing her mortgage with Quicken Loans that she referred you when you were looking to buy your first place. Since you both have the same lender and it’s coming from your mom’s checkbook, they could mistakenly apply the payment to her loan. When writing a check, always be sure to specify the loan number in the “Memo” section.

Get a Mortgage Checkup

If we skip the physical and go to the doctor only when we’re sick, we risk the missed opportunity to catch things ahead of time and do preventative maintenance. At Quicken Loans, we recommend people get a mortgage review once a year to make sure they’re still in the right mortgage for their situation.