The Biggest Mistakes in Choosing a Mortgage
Article by Zack Ashan – The Mortgage Guru
People make a lot of mistakes when applying for a mortgage and here are the 4 most biggest ones. You can learn from the mistakes of others by knowing ahead of time what you should be discussing with your lender; you dont want to get into a deal that youll regret three to five months later!
Mistake #1: Not Repairing your Credit BEFORE you Apply for a Mortgage
Not asking for a credit report and fixing errors in the report is probably the biggest mistake home buyers make especially first time home buyers.
While a credit report is the be-all and end-all of your credit worthiness, it isnt foolproof. Things like clerical or typographical errors, or even cases of mistaken identity, can lead to innacuracies. If you spot any, dispute them immediately and submit written proof. Dont assume that a lender will take it into consideration that theres a mistake on your credit report. Remember, the lenders only look at the score and the comments in the report they really cant base their decision anything else.
On the other hand, if there arent any mistakes but your credit score has some dings in it, take the necessary steps to fix your credit by not incurring any new debt, paying your bills on time, and reducing your income-to-debt ratio. Dont ask a lender for a mortgage loan unless your credit is in tip top shape. Plan for around six months to have your credit report cleaned up before applying for a mortgage. If you need to repair your credit score, heres how:
Get a copy of your credit report from Trans Union, Equifax, and Experian (you can find them online). When you get your report, go over it carefully. Make a list of errors in your report. Any inaccurate information will affect your credit score. Keep records of your payments so you have something to show when the time comes for you to dispute your credit score.
Call the credit bureau and say you want to dispute your credit report. If they have a dispute form online, use it to dispute any erroneous information. You can also initiate a dispute in writing. Send them a letter indicating what it is you want to dispute and clearly outline the circumstances. Submit proof. The more evidence you submit, the better and faster the credit bureau can investigate.
While you wait for the credit bureaus response, stop incurring new debt. Pay cash for your purchases and avoid the temptation to use your credit cards.
Settle all delinquent accounts. Remember that your payment history plays a big role in your overall your credit score.
Reduce your debt-to-income ratio if your debt level is disproportionately higher than what you earn monthly, lenders tend to look at that as a red flag. Also, when you do get approved for a mortgage, your debt-to-income ratio will go up significantly. The rule of thumb is to try and keep all debt and mortgage payments at 43% of your income.
Mistake # 2: Not Getting Pre-Approved for a Mortgage
While getting a mortgage is not as difficult a task as many people think especially first time home buyers its not a good idea to assume that mortgage approval will be automatic.
I always advise my clients to get pre-approved for a mortgage loan before they even start house-hunting. Thats because pre-approval tells sellers that youre serious about buying (which helps you in negotiations). It also helps you know exactly how much you can spend and how much you cant. You dont have to worry about finding your dream home, and then discovering that your mortgage is not approved, or not at a competitive rate.
Its also REALLY important to know that theres a distinct difference between being pre-qualified and being pre-approved. Pre-qualification is a very easy process with usually no formality involved. The lender simply tells you how much you can borrow based on your income, debts and how much down payment youre prepared to make.
Pre-approval is a more stringent process and thats the one you want to focus on here. Really, its the equivalent of applying for a loan. If you want to get pre-approved for a mortgage, a lender will ask you for your tax returns, pay slips, a letter from your employer stating how you long youve held the job and how much you make. After you submit all the information required, the lender runs a credit check. If all is satisfactory, you get pre-approved.
Though different lenders have different policies, most lenders will give you a period of three months to find a property you like, and will guarantee the terms quoted to you. This is helpful, because if the rates go up, youre protected and if they fall, youll get the better rate!
Mistake # 3: Borrowing Too Much Mortgage
If you have a good credit history and solid employment, lenders will gladly offer you as much mortgage as youre willing to take. Thats a good news, bad news scenario!
Its great because it gives you a lot of clarity when it comes to house hunting. You know that youre going to be able to afford a home if one catches you eye. At the same time, having a pre-approved mortgage gives you more bargaining power (we covered this topic in our last lesson).
However, it can be tempting to take too much mortgage. Or in other terms: its easy to borrow more money than you actually need! And that can persuade you to buy a house that is, frankly, beyond your needs and your means.
Indeed, weve seen this happen in the US and theyre still recovering from that some experts say itll take several more years before the housing market corrects itself.
Fortunately, we havent suffered nearly the same way in Canada, but to say we were totally undamaged by the housing bubble is inaccurate. Many people were talked into (or talked themselves into) taking as much mortgage as they could, buying as much house as they could, and believing that it would appreciate and they could sell it in a few years at a profit. Many people discovered that this just wasnt the case.
Of course, it IS true that house is an investment, and a way of building equity. But if youre not an investor or a speculator, then you shouldnt use your primary house of residence to become one. Theres a lot of wisdom in the advice of living within your means. Dont overstretch your limit and get yourself in a financial quagmire, which will only cause stress and missed payments and hurt your credit score.
Mistake # 4: Not Shopping for the Best Mortgage Rate
Even if you dont really like shopping, you really want to make sure you shop around for the best mortgage rate.
There are a couple of ways you can do this. You can do it yourself and compare rates from different institutions. Dont limit your search to banks, either there are many lending institutions out there, all of whom are allowed to offer you a mortgage.
The other way is to work with a mortgage broker, who can submit your potential mortgage to a number of lenders and have them compete to offer the best rate and terms.
Remember not to make a final decision based on the interest rate alone. You have to study the actual mortgage contract. Look for things like prepayment options, flexibility, incentives, and other factors that make the deal more attractive.
Also be wary of cash back offers that lock you into long-term mortgages.
Some lenders like to sweeten the deal by offering a 5% to 7% cash back mortgage. This seems like a tempting offer, especially for first time home buyers who have a long shopping list for their new home appliances, furniture, etc.
But study the cash back offer carefully. Some banks will give you the cash up front but only if you choose a fixed rate mortgage of 5, 6, or 7 years. The problem with this is that if interest rates fall, youre going to have to cough up the higher interest rate that you signed into. A difference of 1% or 2% can make a significant difference in your mortgage payments and balance. Think about how much you can save if you didnt lock yourself into a long term. Yes, you can get out of it, but the penalties are hefty.
Plus, if you opt to move your mortgage during the term, in addition to the penalties youll have to pay which may actually be worth it if rates fall low enough youll probably have to pay back all of the cash you received as an incentive! Many first time home buyers arent aware of this, and find out only after they try and move their mortgage 5 years from when they signed it.
Again, make sure you read the contract or, better yet, work with a qualified mortgage broker like me who can help you make it through the rate maze.
About the Author
Zack Ashan — a.k.a. “The Mortgage Guru” — is a licensed Mortgage Broker based in the Greater Toronto Area. Zack’s personal mission is to help as many people as possible WIN the mortgage game, by providing them with clear, honest and valuable advice. Learn more about Zack and pick up his groundbreaking book “The Insider’s Guide to WINNING the Mortgage Game” at http://www.mortgage-guru.ca.