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Q:
What are the most commonly made mistakes in buying or
refinancing a house?
If you're like most people, purchasing a
home is the biggest investment you'll ever make. If you're
considering buying a home, you're likely aware of the complexity
of the endeavor. Because of the numerous factors to consider
when purchasing a home, it's important to prepare as best you
can. Some common home-buying principles and caveats are
presented here for your consideration. By keeping them in mind,
you'll help create a successful and more enjoyable experience.
These Top Ten lists are by no means exhaustive. Since your
home could cost you 25 to 40 percent of your gross income, it's
important to conduct research, ask questions of many different
resources, and study the process carefully.
Buying a home
- Looking for a home without being pre-approved. As a
potential buyer competing for a property, you'll have a better
chance of getting your offer accepted by being as prepared as
possible. Consider this hierarchy of preparedness:
- Neither pre-qualified nor pre-approved
- Pre-qualified
- Pre-approved
The benefits available at each level can be easily
understood when viewed from the seller's perspective. Imagine
you're a seller in receipt of multiple offers to purchase your
property. A complete stranger (buyer) is asking you to take
your property off the market for at least the next two to
three weeks while they apply for a loan. As the seller, lets
consider the type of buyer you'd prefer to deal with.
Neither pre-qualified nor pre-approved
- This buyer provides no evidence that they can afford to
purchase your property. You may wonder how serious they are
since they're not at least pre-qualified.
- Pre-qualified
- This buyer has met with a mortgage broker (or lender)
and discussed their situation. The buyer has informed the
broker regarding their income, expenses, assets and
liabilities. The broker may also have seen their credit
report. The buyer provided you with a letter from the broker
stating an opinion of what the buyer can afford.
- Pre-approved
- This buyer has provided a broker written evidence of
income, expenses, assets, liabilities and credit. All
information has been verified by a lender. As a result, much
of the paperwork for this buyer's loan has been completed.
This buyer will probably be able to close quickly. They
provide you with a letter (pre-approval certificate) from
the lender. You're as certain as possible that this buyer
can close.
As a potential buyer, you can see that being pre-approved
will give you the best chance of getting your offer accepted.
This is critical in a competitive situation.
- Making verbal agreements. If you're asked to sign
a document containing instructions contrary to your verbal
agreements--don't! For example, the seller verbally agrees to
include the washing machine in the sale, but the written
purchase contract excludes it. The written contract will
override the verbal contract. More importantly, your state may
require that contracts for the sale of real property be in
writing. Do not expect oral agreements to be enforceable.
- Choosing a lender just because they have the lowest
rate. While the rate is important, consider the total cost
of your loan including the
APR
, loan fees, discount and origination points. When receiving a
quote from a lender or broker, insist that the discount points
(charged by the lender to reduce the interest rate) be
distinguished from origination points (charged for services
rendered in originating the loan).
The cost of the mortgage, however, shouldn't be your only
criterion. Have confidence that the company you select is
reputable and will deliver the loan with the terms and costs
they promised. If in the final hours of the transaction you
determine that the lender has suddenly increased their profit
margin at your expense, you won't have time to start again
with a different lender. Ask family and friends for
referrals. Interview prospective mortgage companies.
- Not receiving a Good Faith Estimate. Within three
business days after the broker or lender receives your loan
application, you must receive a written statement of fees
associated with the transaction. This is both the law and the
best way to determine what you'll pay for your loan. Bring the
Good Faith Estimate (GFE) with you when you sign loan
documents. You should not be expected to pay fees which are
substantially different from those contained in your GFE.
- Not getting a rate lock in writing. When a
mortgage company tells you they have locked your rate, get a
written statement detailing the interest rate, the length of
the rate lock, and program details.
- Using a dual agent--i.e., an agent who represents the
buyer and the seller in the same transaction. Buyers and
sellers have opposing interests. Sellers want to receive the
highest price, buyers want to pay the lowest price. In the
standard real estate transaction, the seller pays the real
estate commission. When an agent represents both buyer and
seller, the agent can tend to negotiate more vigorously on
behalf of the seller. As a buyer, you're better off having an
agent representing you exclusively. The only time you should
consider a dual agent is when you get a price break. In that
case, proceed cautiously and do your homework!
- Buying a home without professional inspections.
Unless you're buying a new home with warranties on most
equipment, it's highly recommended that you get property, roof
and termite inspections. This way you'll know what you are
buying. Inspection reports are great negotiating tools when
asking the seller to make needed repairs. When a professional
inspector recommends that certain repairs be done, the seller
is more likely to agree to do them.
If the seller agrees to make repairs, have your inspector
verify that they are done prior to close of escrow. Do not
assume that everything was done as promised.
- Not shopping for home insurance until you are ready to
close. Start shopping for insurance as soon as you have an
accepted offer. Many buyers wait until the last minute to get
insurance and do not have time to shop around.
- Signing documents without reading them. Whenever
possible, review in advance the documents you'll be signing.
(Even though some specifics of your transaction may not be
known early in the transaction, the documents you'll sign are
standard forms and are available for review.) It's unlikely
that you'll have sufficient time to read all the documents
during the closing appointment.
- Not allowing for delays in the transaction. In a
perfect world, all real estate transactions close on time. In
the world we live in, transactions are often delayed a week or
more. Suppose you asked your landlord to terminate your lease
the day your purchase transaction was scheduled to close. A
day or two before your scheduled closing date, you discover
your transaction is delayed a week. In a perfect world, no one
is inconvenienced and your landlord is willing to work with
you. More likely, however, your landlord is inconvenienced and
angry. Will you be thrown out? Will you have to find interim
housing for a week or more? The eviction process takes a
little time, so the Sheriff won't immediately remove you, but
this type of stress-producing episode can be avoided. How?
Terminate your lease one week after your real estate
transaction is scheduled to close. That way, if there is a
delay in closing your transaction, you have some leeway. This
approach might cost a little more, then again, it might not.
- Refinancing with your existing lender without shopping
around. Your existing lender may not have the best rates
and programs. There is a general misconception that it is
easier to work with your current lender. In most cases, your
current lender will require the same documentation as other
companies. This is because most loans are sold on the
secondary market and have to be approved independently. Even
if you have made all your mortgage payments on time, your
existing lender will still have to verify assets, liabilities,
employment, etc. all over again.
- Not doing a break-even analysis. Determine the
total cost of the transaction, then calculate how much you
will save every month. Divide the total cost by the monthly
savings to find the number of months you will have to stay in
the property to break even. Example: if your
transaction costs $2000 and you save $50/month, you break even
in 2000/50 = 40 months. In this case you'd refinance if you
planned to stay in your home for at least 40 months.
Note: This is a simplified break-even analysis. If you
are refinancing considering switching from an adjustable to a
fixed loan, or from a 30-year loan to a 15-year loan, the
analysis becomes much more complex.
- Not getting a written good-faith estimate of closing
costs. See item number four above.
- Paying for an appraisal when you think your home value
may be too low. Have the appraisal company prepare a desk
review appraisal (typically at no charge) to provide you with
a range of possible values. Your mortgage company's appraiser
may do this for you. Do not waste your money on a full
appraisal if you are doubtful about the value of your home.
- Using the county tax-assessor's value as the market
value of your home. Mortgage companies do not use the
county tax-assessor's value to determine whether they will
make the loan. They use a market-value appraisal which may be
very different from the assessed value.
- Signing your loan documents without reviewing them. See
item number nine above.
- Not providing documents to your mortgage company in a
timely manner. When your mortgage company asks you for
additional documents, provide them immediately. They are doing
what's necessary to get your loan approved and closed. Delays
in providing documents can result in a costly delays.
- Not getting a rate lock in writing. When a
mortgage company tells you they have locked your rate, get a
written statement which includes the interest rate, the length
of the rate lock and details about the program.
- Pulling cash out of your credit line before you
refinance your first mortgage. Many lenders have cash-out
seasoning requirements. This means that if you pull cash out
of your credit line for anything other than home improvements,
they will consider the refinance to be a cash-out transaction.
This usually results in stricter requirements and can, in some
cases, break the deal!
- Getting a second mortgage before you refinance your
first mortgage. Many mortgage companies look at the
combined loan amounts (i.e., the first loan plus the second)
when refinancing the first mortgage. If you plan on
refinancing your first loan, check with your mortgage company
to find out if getting a second will cause your refinance
transaction to be turned down.
- Not knowing if your loan has a pre-payment penalty
clause. If you are getting a "NO FEE" home-equity loan,
chances are there's a hefty pre-payment penalty included.
You'll want to avoid such a loan if you are planning to sell
or refinance in the next three to five years.
- Getting too large a credit line. When you get too
large a credit line, you can be turned down for other loans
because some lenders calculate your payments based upon the
available credit--not the used credit. Even when your equity
line has a zero balance, having a large equity line indicates
a large potential payment, which can make it difficult to
qualify for other loans.
- Not understanding the difference between an equity loan
and an equity line. An equity loan is closed--i.e.,
you get all your money up front and make fixed payments until
it is paid if full. An equity line is open--i.e., you
can get numerous advances for various amounts as you desire.
Most equity lines are accessed through a checkbook or a credit
card. For both equity loans and lines, you can only be charged
interest on the outstanding principal balance.
Use an equity loan when you need all the money up front--e.g.,
for home improvements, debt consolidation, etc. Use an equity
line when you have a periodic need for money, or need the
money for a future event--e.g., childrens' college tuition in
the future.
- Not checking the lifecap on your equity line. Many
credit lines have lifecaps of 18 percent. Be prepared to make
payments at the highest potential rate.
- Getting a home-equity loan from your local bank without
shopping around. Many consumers get their equity line from
the bank with which they have their checking account. By all
means, consider your bank, but shop around before making a
commitment.
- Not getting a good-faith estimate of closing costs. See
item number four above.
- Assuming that your home-equity loan is fully
tax-deductible. In some instances, your home-equity loan
is NOT tax deductible. Do not depend on your mortgage company
for information regarding this matter--check with an
accountant or CPA.
- Assuming that a home-equity loan is always cheaper than
a car loan or a credit card. Even after deducting
interest for income tax purposes, a credit card can be cheaper
than a credit line. To find out, compare the effective rate of
your home-equity line with the rate on your credit card or
auto loan.
Effective rate = rate * (1 - tax bracket)
Example: The rate of the home-equity line is 12 percent,your
tax bracket is 30 percent, your effectiverateis: .12 * (1 - .3) = .12 * .7 = .084 = 8.4
percent.
If your credit card is higher than 8.4 percent, the equity
loan is cheaper.
- Getting a home-equity line of credit when you plan to
refinance your first mortgage in the near future. Many
mortgage companies look at the combined loan amounts (i.e.,
the first loan plus the second) when refinancing the first
mortgage. If you plan on refinancing your first, check with
your mortgage company to find out if getting a second will
cause your refinance to be turned down.
- Getting a home-equity line to pay off your credit
cards when your spending is out of control! When you pay
off your credit cards with an equity line, don't continue to
abuse your credit cards. If you can't manage the plastic, tear
it up!
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