A mortgage is often the single biggest loan someone obtains in his or her lifetime, typically costing tens of thousands of dollars in interest alone. Therefore it’s especially important to avoid some of the key mistakes that many home buyers make throughout the process of finding a lender and acquiring a home loan.
Here are five of the biggest errors home buyers make when obtaining a mortgage:
Having Unreasonable Expectations
Home buyers often look at only the mortgage payments for their dream homes and think they’re affordable. But it’s important to calculate the mortgage payments, as well as the taxes and insurance. Many lenders want these total housing costs to not exceed 30% of a borrower’s gross income. Home buyers should get preapproved for a loan before they start shopping to understand how much house they can afford.
Not Shopping Around
While 1 or 2 percent may not sound like a large amount, when it comes to a mortgage, the difference adds up. Consider: Home buyers who get a $300,000, 30-year mortgage at a 4% interest rate pay about $215,000 in interest over the life of the loan — but home buyers with poorer credit who get a mortgage for the same amount but at a 5% rate pay about $64,000 more in interest over the life of the loan, despite only having an interest rate that’s one percentage point higher.
It’s important for home buyers to shop around for reputable lenders offering low interest rates and low closing costs. Borrowers typically pay between two and five percent of the purchase price of the home in closing costs.
Not Reviewing Credit Scores
Lenders look at home buyers’ credit scores to help determine what interest rate they’ll charge. Home buyers should be aware of and, if necessary, improve their credit scores before securing a loan.
Credit scores range from 300 (poor) to 850 (excellent) and are calculated by looking at a person’s past payment history (35%), amount owed (30%), length of time he or she has had credit (15%), new credit (10%) and types of credit (10%).
Lenders typically offer borrowers with credit scores of 720 and higher the lowest rates. Consumers who have less-than-ideal scores should pay their bills on time, pay down big debts such as credit cards and avoid taking out multiple new credit lines at once. Plus, they should correct any errors on their credit reports that are bringing down their scores.
Not Being Financially Prepared
When applying for a mortgage, lenders ask home buyers for financial records such as their past two years’ tax returns, proof of assets, proof of income, bank and brokerage accounts and other financial documents. It’s important that buyers understand not only which documents they’ll be asked to provide, but also how lenders are reviewing their financials.
Lenders generally check that borrowers have a steady job history of two or more years at the same company or in the same field, sufficient income to pay housing costs and a debt-to-income ratio less than 40%; the debt-to-income ratio is the amount of monthly debt a person has compared to his or her monthly income. So, a home buyer who pays $1000 per month for debts — including the new estimated housing expense — and brings in $4000 per month in gross income would have a debt-to-income ratio of 25% (1000/4000).
Lenders also review a home buyer’s bank accounts for multiple overdraft fees, which may be a red flag for lenders that the buyer can’t manage his or her money well. Note that buyers can often get a lower interest rate not only by having solid financials and a good credit score, but also by paying a down payment greater than 20% of the cost of the home.
Not Sourcing All Funds
Many home buyers think they have all their financials in order only to have a lender ask for a paper trail or source for their funds. Lenders get nervous when they see large cash deposits, gift money and regular transfers of money, and often ask buyers to show documentation for the source of the money, be it a side job or a gift. If the money is a gift, home buyers need to show where the money came from and get a signed letter stating that the money is a gift and not a loan.
In summary, it’s not difficult to avoid the major mortgage mistakes commonly made by home buyers. A well-prepared buyer should fully understand how much home he or she can afford before shopping for a mortgage, shop around for reputable but low-cost lenders, review credit scores and financials before applying for the loan, and have a paper trail for all funds.
Photo Credit: Woodley Wonderworks
I took my time when I decided to buy my own home, I gave myself six months to get all the paperwork and deposit in order and used every trick in the book to further improve my credit score. I then used 6 months to find the best cheapest rate available. I was able to get a mortgage on 2.27% fixed for five years which was incredible. At the beginning the best I could get was 3.9%, the difference of 1.63% gives me a saving of $490! It pays to be patient. Thanks for sharing this valuable information.
So many people do not think about the total cost. You have to factor in property taxes and insurance, which can add up quickly!
All good points Len, and I take for granted you meant to write “reports” instead of “scores” in suggestion #3.
I think this is less important than the five you mention, but another tip is to ask your loan officer to do a “rapid re-score” analysis. This process can reveal simple, easy changes you can make to your financial picture–say pay off $750 in credit card debt–that can bump your score above the threshold to qualify for a slightly lower rate. Even a 1/8% rate reduction can translate to big bucks over the life of a mortgage. Once you make the change, the loan officer can make a request for an expedited credit score update, and voila, you’re golden.
We just completed our home purchase and we found that this time around versus 7 years ago when we last bought a house – there was a lot more documentation required when we went through the process. Luckily we locked our 30 year rate when it was below 4%, we had all of our financial information ready to go, and our credit scores were both excellent.
Things we had to supply this time around – like you mention – a lot more financial information about all of our accounts, 3 years of taxes, and then we had to supply gift letter for a gift we received from my wife’s parents. Then since I’m a blogger getting a lot of smallish deposits, I had to constantly confirm where those funds were coming from.
All in all not a pleasant process, but we came out of it with a great rate and a great home!
I agree with the last point of establishing the sources of funds. It is a good idea to gather all the funds in one place but there should be a proper paper trails for all of them.
Came across this article on Deseret News…very useful information for new home buyers. Its very important that buyers pay attention to the APR and the closing costs and not just the interest rate. Here’s another good mortgage calculator with taxes and insurance: http://usmo.org/
Buyers really need to get themselves pre approved before they start shopping. Having a lender analyze your credit, income, and assets is crucial to knowing (and understanding) how much you can afford and qualify for…