June 29, 2018
June 29, 2018
Even though it seems like a simple process on the surface, applying for a mortgage can be surprisingly complicated. This is particularly true if you only sort of know what’s going on. There are at least seven mistakes to avoid when applying for a mortgage. And if you can avoid them, you will also avoid what could be the worst of the mortgage experience, as well as prevent serious problems after closing.
If you are going to apply for a mortgage, you always need to get a copy of your credit report – and your credit score – before doing so. That will provide you with a valuable time to fix any mistakes that your credit report may contain.
This is an extremely important preliminary step. Your ability to qualify for a mortgage, as well as the interest rate you’ll get, is closely aligned with your credit score. A single wrong entry can drop your credit score by 20 to 50 points, causing you to pay a higher rate and a higher monthly payment.
This can easily happen if there is a recent late payment, or if a past due balance appears on your credit report. Should that happen, reviewing your credit report in advance will give you the time that you need to correct the error and improve your credit score.
This can include buying more house than you can comfortably afford, assuming that relatives will come up with money for a down payment, or even co-signing your mortgage. It can also be a problem with income. For example, if you’re overly optimistic in calculating your income, you may be surprised when a mortgage lender comes up with a considerably smaller amount.
This can happen if you exaggerate overtime or bonus income, or enter your income based on a raise or promotion that has not yet happened. It’s even possible that you may assume that you will be able to pay off a loan based on funds that are never available.
When making a major purchase, such as a home, it’s always best to be at least a little bit conservative in your planning and assumptions.
There’s a lot more that goes into homeownership than just a monthly house payment. There are also utility payments, as well as repairs and maintenance. You should also fully understand and appreciate that the cost of those secondary expenses tends to rise with both the size and the value of the property.
If you assume that a $1,500 per month house payment is the only significant expense that you will have as a result of buying a new home, but the actual cost is $2,000 per month when utilities and repairs and maintenance are added, you may find that you are unable to comfortably afford the house.
This problem is typically avoided by the lender requirement for cash reserves. But that rule is not always enforced, and sometimes new homeowners find a way of spending those reserves, rather than saving them for a future income shortfall. And the result is that you may find yourself in a cash crunch after buying the house.
Even apart from lender closing requirements, you should always plan on having an emergency fund set up when you are a homeowner. Not only may you need it to cover a future monthly house payment, but there are always those unexpected repairs, such as a new furnace or a water heater. An adequate cash reserve can keep a problem from turning into a full-blown crisis, that might even threaten your ability to afford the home.
This can take the form of running up credit cards for homebuying incidentals or even applying for a loan for a new car. Apart from the fact that either of these debt situations can threaten your ability to afford the home, there is more than a slight possibility that the lender will find out about these new debt obligations either after you apply, or even after you are approved.
Lenders frequently pull credit reports after the fact, and often just before closing. If they find new loans, your loan may be sent back to underwriting, which could change the outcome.
It’s always important to understand that a mortgage loan approval is not set in concrete. Should significant changes developed in your financial profile between the time of application and closing, the lender may either modify or even revoke your approval. For that reason, it’s very important that your credit situation remains constant throughout the loan process. This is especially true if your qualification for the loan that you need is a tight squeeze to begin with.
The time to review mortgage documents is anytime between loan application and just before closing. New homeowners are sometimes “surprised” to find out how much money they need to close only a day or two before closing because they did not read the good faith estimate that was provided to them at application, and quite possibly even afterward. They may even be surprised to learn that the loan that they have is a balloon mortgage or an adjustable rate mortgage (ARM) because they never bothered to read the truth in lending statement (TIL) that was also provided to them either at loan application or by mail.
Make sure you read and understand all documents related to your mortgage application and loan closing as soon as possible. Reviewing them at the closing table, or ignoring them until after the closing, is too late.
To save a quarter point or a half point on the interest rate, borrowers will sometimes revert to taking either a balloon mortgage or an ARM. While minimizing the interest rate you will pay is important, it always has to be considered in the context of the additional risk that you are taking on with a specific mortgage type.
Balloon mortgages may have lower rates than fixed rate mortgages, but they come with an accelerated due date. For example, they may require either a refinance or a complete payoff after just five, seven, or 10 years. If you don’t expect to be in a position to do either or to sell the property outright, then you will be unprepared for the risk that comes with a balloon mortgage.
The same is true with an ARM. The rate will adjust after five or seven years and could rise by as much as two percentage points. If it does, you could be looking at a significant payment shock – even one that you cannot afford. Worse, the interest rate will adjust each year after the initial fixed rate period. As it does, it can go way beyond the rate you have originally.
A 15 to 30-year mortgage may have a slightly higher interest, but they are also completely risk-free mortgages. For that reason, they are usually a better alternative than chasing after a loan type that has a slightly lower interest rate.