Home Mortgage Advice: Six Critical Steps

A little over a week ago, we brought you a list of five steps consumers can use to avoid getting into trouble with a mortgage. Now, we bring you a separate list - of six steps - courtesy of another financial expert.

As TheStreet.com notes, there’s plenty of blame to go around for the current bad credit home loan market mess, but borrowers should look in the mirror to find where to start.

Here are six very common mistakes made during the new home loan process. Avoiding these can help you avoid foreclosure and save a bundle.

Mistake 1: Believing You’re Qualified for the Home Loan When You Aren’t

Good news! The mortgage lender says you’re qualified for the loan. Or is it good news? If you have applied for an adjustable-rate mortgage (ARM), the lender probably qualified you on the basis of an initial interest rate, or “teaser rate.”

The initial rate you pay is fixed for a set period, such as one, three or five years. After that, the rate is likely to increase, since the initial rate is artificially low.

There have been calls from Capitol Hill for lenders to qualify borrowers at the “fully indexed rate,” or what the mortgage rates would be if it were reset today.

But the mortgage lending industry is resisting this reasonable requirement.

It is up to you, the borrower, to consider how high the interest rate could possibly go, and whether you could still afford to pay the mortgage under that circumstance. Ask your home loan lender to supply, in writing, a list showing what your home loan payments would be at various rates, including the highest possible.

Mistake 2: Not Considering Taxes or Insurance

In addition to the principal and interest portion of your home mortgage payment, chances are that your home loan payment will include a portion for property taxes and insurance.

It is quite common for the property taxes on a home to jump substantially. In many areas of the country, taxes are reassessed the year after a home is purchased or construction is completed.

Mistake 3: Taking an ARM Simply Because a Mortgage Lender Recommends It

Adjustable-rate mortgages usually have a fixed-rate period, after which the rate is based on an index and a margin. For example, the index might be the Federal Reserve’s published one-year Treasury rate (4.90 percent as of April 26).

With a typical margin of 2.75 percent, your rate could be as high as 7.65 percent if the loan were repriced today. Borrowers often choose adjustable-rate mortgages because the rates are lower - initially - than rates for fixed-rate mortgages.

Many people often fall for the sales pitch that if you’re only planning on living in the house for three years, the adjustable-rate is better. And if you decide to stay longer, you can always try mortgage refinancing.

The problem is that these plans have a way of not working out. You may well stay in that house much longer than you originally planned, or find that refinancing is an ugly option if rates are significantly higher when the loan rate begins to adjust, or if property values have not risen.

Mistake 4: Misunderstanding Private Mortgage Insurance

Lenders will generally require you to pay for private mortgage insurance if your down payment is less than 20 percent. If you can swing it, you really should put down at least 20 percent when you buy (or get a less expensive home).

PMI provides no protection for the borrower, but it does protect the home loan lender if, in the event of foreclosure, the lender is unable to sell the home for a price sufficient to pay off the loan.

The PMI is added to the mortgage payment. If you put down 10 percent and have an excellent credit score, the rate is usually about 0.05 percent.

Going back to our $200,000 mortgage example, the PMI would be $83 per month. The lender will require PMI until the loan has been paid down sufficiently for the loan-to-value ratio to be 80 percent.

You may be able to have PMI removed sooner if you make additional principal payments on the mortgage, or if your home increases significantly in value.

Mistake 5: Not Considering the Loan Term

Taking a shorter-term mortgage could save you quite a bit in interest, so it’s key once again to consider the language of mortgage loans. The term is one of the key components of any home loan.

While 30-year home loans are the most common, many people take 15-year loans. Not only will the mortgage be paid off 15 years earlier, but the rate is likely to be lower. And while you might not stay in the home 15 years, whenever you sell, your equity percentage will be higher.

Mistake 6: Not Picking a Less Expensive House (or SUV)

Finally, you need to consider just how much you are spending and why. In the real estate boom, it was not uncommon to take extraordinary measures when buying the most expensive home one could possibly afford.

These measures included no down payments, taking interest-only mortgages or option payment (negative amortization) mortgages, in the belief that their homes would just keep increasing in value.

Maybe you don’t need to buy the biggest possible house. Maybe you don’t need to buy an SUV that costs more than half your annual salary. Consider living below your means. Not only will it save you money and (hopefully) lead to a more comfortable retirement, it’ll reduce stress.

SOURCE: TheStreet.com