Getting a mortgage is no simple task: It's a complex and time-consuming process, and perhaps one of the most significant events of our lives, at least in financial terms. Here are ten potential pitfalls to avoid:
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1. Not Checking Your CreditLong before you begin searching for a mortgage, you should know where you stand in the credit score department. After all, a bad credit score can bump up your mortgage interest rate several percentage points or leave you with no approval at all. Be sure you check your credit early on (several months in advance) in case any changes need to be made to get it back up to snuff.
2. Applying for New Credit Alongside the Mortgage: In this same vein, be sure to avoid applying for any other type of credit before and during the mortgage application process. Whenever you apply for new credit, you're seen as a greater credit risk, at least initially. If you happen to apply for a credit card or auto loan around the same time you apply for a mortgage, your credit score might get dinged enough to kill your eligibility or bump up your interest rate.
3. Failing to Look at the Total Housing Payment: A mortgage payment consists of principal, interest, taxes, and insurance (PITI). A common mistake made by prospective home buyers is not factoring in their property taxes and insurance premium into their overall mortgage budget. The debt-to-income ratio (DTI ratio), used to determine if a borrower will qualify for a certain mortgage payment, is calculated by dividing the proposed cost of PITI by gross monthly income. A $1,200 homeowner’s insurance policy would add $100 per month to an escrowed mortgage payment.
4. Not Seasoning Your Assets: The bank or lender will want to see that you can actually pay your mortgage each month. But without seasoned assets, those that have been in your own account for at least a couple months, you could be out of luck entirely. Some borrowers seem to think they can transfer funds from a relative's account days before applying, but this simply won't fly once the underwriter uncovers the paper trail.
5. Job Hopping: Another key to mortgage approval is steady employment and income. An underwriter will want to know that the income you bring in every month is consistent and expected to continue into the foreseeable future. So don't jump from job to job too much before applying for a mortgage. If it's in the same field, it shouldn't be a deal killer, but a career change will lead to problems. If you're thinking about jumping ship, wait until you've closed your mortgage first.
6. Not Getting Pre-Approved: Good preparation is the key to a good mortgage. Before shopping for a home, make sure you can actually qualify for financing by getting a pre-approval. A mortgage pre-approval is more robust than a simple pre-qualification because the bank pulls your credit and looks at your income, assets, and employment. Your DTI ratio will also come into play to ensure you know exactly how much you can afford. With this pre-approval, you will also get a written commitment from the lender that will show home sellers you're serious about the purchase.
7. Not Shopping Around: But just because you're pre-approved with one bank doesn't mean you need to obtain financing from them. Be sure to shop around with multiple banks and lenders and even consider a mortgage broker. A broker can shop your rate with a number of banks concurrently and find you the lowest rate with the best terms. Don't be one of the many consumers who obtains a single mortgage rate prior to applying. Comparison shop as you would for anything else you buy. And don't forget to factor in closing costs!
8. Chasing Exotic Loan Programs: Shop around for the lowest rate and closing costs, but not at the expense of your mortgage. Anything that sounds too good to be true most likely is. If the payment seems too low, you might be paying interest-only or even negatively amortizing, meaning your mortgage balance is growing each month. It's best to keep it simple and go with a loan program you can get your head around, like a fixed-rate mortgage.
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9. Forgetting to Lock Your Rate: Keep in mind that a mortgage rate means very little if it's not locked-in. If you're happy with your rate, lock it. Mortgage rates change daily and sometimes several times daily. All those mortgage quotes you obtain are just quotes until you actually tell the bank, lender, or broker to “lock it in.” Once locked, your rate is guaranteed for a certain period of time, be it 7 days, 15 days, or a month. But never assume your rate is locked until you get it in writing!
10. Not Reading Your Loan Documents: Finally, it's your responsibility to read and accept the terms of your new mortgage. Sure, it might be a pain to go through all the loan documents at signing, but it's a bigger pain to sign up for something you don't want or agree with. Take the time at closing to ensure you understand everything you're signing, and thereby agreeing to. And don't be afraid to ask questions! Otherwise, you could wind up with a mortgage with predatory terms and no place to turn.
Colin Robertson is the author of several finance websites aimed at helping consumers save money, including The Truth About Mortgage and The Truth About Credit Cards, which includes his popular credit score range.