8 Mortgage Misunderstandings That Could Cost You

By Markets Fool.com



It's an exciting time when you set out to buy a new home. Don't assume you know all you need to know about mortgages, though; there are many mortgage misunderstandings that could cost you a lot.

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Here are eight misunderstandings to help set you straight:

  1. Ignoring your credit score. Your credit score has a major influence on the interest rate that lenders will offer you. If you don't have a good one, consider spending some time beefing it up before starting to buy a home. You might increase your score by fixing errors in your credit record, by paying bills on time, and by reducing your overall debt load. To understand the kind of difference your credit score makes in the interest rates you're offered, consider sample rates listed at MyFICO.com. When I checked it recently, it showed that if you were borrowing $200,000 via a 30-year fixed-rate mortgage, and you had a top FICO score in the 760 to 850 range, you might get an interest rate of 3.3%, with a monthly payment of $880, and total interest paid over the 30 years of $116,717. If your score was 630, though, your rate would be 4.9%, with a monthly payment of $1,064, and total interest of $183,174. That's $184 more per month -- $2,208 per year -- and a whopping $66,457 more in interest.

  2. Thinking it's not worth shopping around for a mortgage. Don't assume that you'll be offered pretty much the same deal wherever you go. Different lenders use different calculations when they assess you and offer you interest rates. Go ahead and check with your own bank(s) first, as they may give you a bit of a discount on the interest rate because you're a customer. But check with other banks, too -- and with credit unions, which often sport lower interest rates. You might also consult a mortgage broker. They often offer a wide range of loans, and can be especially helpful if you have an underwhelming credit record. Visit Bankrate.com, too, where you can look up the best rates in your area and beyond.

    Don't buy a bigger house than you can afford. Image: Bill Rape, Flickr.



  3. Getting a bigger mortgage than you can really afford. When you're house hunting, it will be tempting to look a bit beyond your price range. Don't buy a home that will be expensive enough to have you stretched thin financially. Some suggest spending no more than 25% to 30% of your gross monthly income on housing -- including property taxes and insurance -- but instead of relying on that broad guideline, take the time to figure out just what you can afford. Take into consideration your regular household expenses, such as food, utilities, transportation, insurance, travel, entertainment, auto maintenance, debt payments, contributions to savings accounts, and so on, and factor in other expenses, too, such as medical or automotive emergencies and the cost of prepping your old home for sale and setting up your new one. Buying less home than you can afford will give you a margin of safety, and help you be able to save.

  4. Getting pre-qualified, not pre-approved. Once you know what loan you want and from which lender, don't wait until you find the home of your dreams to start the paperwork. Get pre-approved for the loan before you go shopping. This has several advantages. First, through the process of working with a loan officer, you can determine just how much home you can afford to buy. Second, it will make you a more credible buyer, should you end up bidding against any other buyers for a home. Pre-approval means that the lender will have looked at your credit score, your employment, your financial health, and perhaps some tax returns -- and found you creditworthy.

  5. Getting the wrong kind of mortgage. Don't assume that a standard 30-year fixed-rate mortgage will serve you best. It might, but consider alternatives, too. For example, you need to decide between a 15-year or 30-year loan (other time frames are also available), and between a fixed-rate mortgage or adjustable-rate mortgage (ARM). Longer terms will give you lower payments, but you'll pay much more in interest over the life of the loan. If you're not comfortable with a 15-year mortgage's steeper payments, consider getting a 30-year loan that permits prepayments, and then aim to pay significantly more than you need to each month, in order to shorten the life of the loan. If you're not planning to be in the home long, an ARM could serve you best in today's low-interest-rate environment, as it can lock in low rates for a few years. If you think you'll be in the home for decades, though, it can be better to lock in a low rate for the expected long life of the loan -- especially because interest rates have started inching up.

    Aim to pay at least 20% down. Image: Pixabay.



  6. Making a small down payment. Putting less than 20% down on a new home means you'll have to take on an extra loan in the form of private mortgage insurance (PMI), which will increase your monthly payment. A low down payment might also result in a higher interest rate. It's particularly bad if home values drop during your ownership period, leaving you with an "underwater" mortgage, when you owe more than the home is worth. That can make it hard to sell the home.

  7. Paying off your mortgage early. It can be good to pay off your mortgage early, and not have a big loan on your shoulders -- especially as you enter retirement. But paying off your mortgage early is not always the best thing to do. If you don't have an emergency fund, for example, you're better off establishing and funding one with that extra money. That money could also go into retirement accounts. You will also give up mortgage interest deductions by paying off the loan early. If you're carrying any high-interest rate debt, such as credit card debt, paying that debt off early should be your priority.

  8. Thinking it's not worth refinancing. Finally, once you have a mortgage, don't assume that it's not worth refinancing. If the interest rate you might get on a new loan is about a percentage point lower than your current rate, it may well be worth refinancing. Crunch other numbers, though, and consider your big picture. If you don't plan to stay in the home long, refinancing will make less sense.

Spend a little time learning more about mortgages, and you might be able to save hundreds, if not thousands, of dollars.

The article 8 Mortgage Misunderstandings That Could Cost You originally appeared on Fool.com.

Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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