Buying a house | Refinancing
your house | Getting a
home-equity loan
For most people, a home is the biggest investment they
will ever make. However, few people do the research necessary to make a good
buying decision. The home-purchase process is extremely confusing for most
people. With a little bit of homework though, and some advice from family
and friends who have been through the process before, you can make this a
little easier on yourself. There is no substitute for taking the time to
educate yourself before you buy a house, which typically costs you 25% to
40% of your gross income!
- Looking for a house without getting
pre-approved.
Do not confuse pre-approval with pre-qualification. During
the pre-qualification process, a loan officer asks you a few questions and
then hands you a pre-qualification letter. The pre-approval process is much more
complete.
During pre-approval, the mortgage company does the same work as for full
approval, except for the appraisal and title search. Once you are
pre-approved, you become like a CASH BUYER and have more negotiating clout
with the seller. In some cases (especially in multiple offer situations),
being pre-approved can make the difference between buying a home and not
buying a home. In other instances, home buyers can save thousands of dollars
as a result of being in a better negotiating situation.
Most good Realtors will not show you homes until you are pre-approved
because they do not want to waste your time, their time, and the seller's
time. Many mortgage companies will pre-approve you at little or no cost.
They typically will need to check your credit and verify your income and
assets.
- Making verbal agreements!
If an agent tries to make you sign a written document that
is contrary to his/her verbal commitments, don't do it! For example: if the
agent says that the washer will come with the house, but the contract says
that it will not末the written contract will override the verbal
contract. In fact, written contracts almost always override verbal
contracts. Buying a house is a very complex process, but it's a lot easier
when everything is in writing.
- Choosing a lender just because she/he has the
lowest rate. Not getting a written good-faith estimate.
While rate is important, you have to look at the overall
cost of your loan. This includes looking at the
APR, the loan fees, as well as the discount and origination points. Some
lenders include origination points in their quoted points, while other
lenders add an origination point in addition to their quoted points. So when
one lenders says 2 points they mean 2 points, whereas another lender means 2
points plus 1 origination point.
The cost of the mortgage, however, cannot be your only criteria. There is no
substitute for asking family and friends for referrals and for interviewing
prospective mortgage companies. You must also feel comfortable that the loan
officer you are dealing with is committed to your best interests and will
deliver what he/she promises. Often, the company that has the absolute
lowest quoted rate may not be the best company for your mortgage business.
- Choosing a lender just because s/he is
recommended by your Realtor.
Your Realtor is not a financial expert. S/he may not know
what's the best loan for you. The Realtor only gets a commission when your
house closes. As a result, the Realtor may refer you to a lender that is
sure to close the loan, but not necessarily the lender that has favorable
rates or fees. Also, many Realtors refer you to their friends in the loan
business末who again may not be able to get the best loan for you. Even
if the Realtor is very professional and looking out for your best interest,
you should still do homework on your own.
We recommend shopping for a loan with at least 3 mortgage companies before
you make a decision. There are countless stories of consumers who wind up
paying higher rates or getting a loan program that was not right for them
because they blindly followed their Realtor's advice.
- Not getting a rate lock in writing.
When a mortgage company tells you they have locked your
rate, get a written statement which details the interest rate, the length of
the rate lock, and details about the program.
- Using a dual agent (an agent who represents the
buyer and the seller on the same transaction).
Buyers and sellers have opposing interests. In most normal
situations, dual agents cannot be fair to both the buyer and seller, and
they represent sellers more strongly than buyers. If you are a buyer, it is
much better to have your own agent who will be on your side. The only time
you should even consider a dual agent is when you get a price break from
using a dual agent. If that is the case, then tread carefully and do your
homework!
- Buying a house without a professional
inspection. Taking the seller's word that they have made repairs.
Unless you are buying a new house with warranties on most
equipment, it is highly recommended that you get a property inspection, a
roof inspection and a termite inspection. This way, you will know what you
are buying. Inspection reports are great negotiating tools when it comes to
asking the seller to make repairs. If a professional home inspector states
that certain repairs need to be done, the seller is more likely to agree to
do them.
If the seller agrees to do the repairs, have your inspector verify that they
are done prior to close of escrow. Do not assume that everything has been
done the way it was 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, but then
they have no time left to shop around.
- Signing documents without reading them.
Do not sign documents in a hurry. Whenever possible, try to
get documents that you will be signing ahead of time so you can review them.
It is advisable to ask for a copy of all loan papers you are signing a few
days ahead of the close of escrow. This way you can review them and get your
questions answered. Do not expect to read all the documents during the
closing. There is rarely ever enough time to do that.
- Making your moving plans too tight.
Example: you expect to move out of your prior
residence on a Friday and into your new residence over the weekend. So you
give notice to your landlord to end your lease on a Friday and arrange for
movers to come to your house on Friday. Then, your loan closing gets delayed
until the next Tuesday. You now may be homeless! New tenants could be
moving into your apartment, and the movers are going to charge you for
wasting their time. You could be forced to live in a motel for a couple of
days!
A Better Plan: allow for a 5-7 day overlap between closing and
moving. In the long run, it is not nearly as expensive and it will sure give
you peace of mind.
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- Refinancing with your current lender without
shopping around.
Your current lender may not have the best rates and
programs. There is a general misconception that it is easier to work with
your current mortgage company. In most cases, your current mortgage company
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. So even if you have been very good at making payments to your
existing lender, they will still have to do their verifications all over
again.
- Not doing a break-even analysis.
Find out what the total cost of the refinance is, then
figure out how much you will save every month. Divide the total cost by the
monthly savings to get the number of months you will have to stay in the
property to break-even on your refinancing costs.
Example: if your refinance costs $2000 and you save $50/month your
break-even is 2000/50 = 40 months. You should refinance if you plan to stay
in the house for at least 40 months.
Note: The break-even analysis only works if you are refinancing to
save money. If you are refinancing to switch from an adjustable to a fixed
or from a 30-year loan to a 15-year loan, it is much more difficult to
perform a break-even analysis.
- Not getting a written good-faith estimate of
closing costs.
Your mortgage company is required to provide you with a
written good-faith estimate of closing costs within 3 working days of
receiving the application.
- Paying for an appraisal when you think that the
house may appraise too low.
Have the appraisal company do a desk-review appraisal
(typically at no charge) to provide you with a range of possible values.
Your mortgage company can ask their appraiser to do this for you. Do not
waste your money on a full appraisal if you are doubtful about the value of
your house.
- Using the county tax assessor's value as the
market value of your house.
Mortgage companies do not use the county tax assessor's
value to determine whether they will make the loan. Instead, they use a
market-value appraisal which may be very different from the assessed value.
- Signing your loan documents without reviewing
them.
Do not sign documents in a hurry. Whenever possible, try to
get documents that you will be signing ahead of time so you can review them.
It is advisable to ask for a copy of all loan papers you will be signing a
few days ahead of the close of escrow. This way, you can review them and get
your questions answered. Do not expect to read all the documents during the
closing. There is rarely ever enough time to do that.
- Not providing documents to your mortgage
company in a timely manner.
When your mortgage company asks you for additional
paperwork, jump on it! Do not complain. They are trying to get you approved,
not trying to hassle you unnecessarily! Jump through the hoops as quickly as
possible. Borrowers who do not respond to requests for documentation quickly
enough can end up paying higher rates if their rate lock expires.
- Not getting a rate lock in writing.
When a mortgage company tells you they have locked your
rate, get a written statement which details 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" refinance. This leads to much 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) even when they are refinancing the
first mortgage. If you plan on refinancing your first, check with your
mortgage company to see if having a second will cause your refinance to get
turned down.
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- Not checking to see if your loan has a
pre-payment penalty clause.
If you are getting a "NO FEE" home-equity loan,
chances are that it has a hefty pre-payment penalty clause. This can be very
important if you are planning to sell your house or refinance in the next
3-5 years.
- Getting too large a credit line.
When you get too large a credit line, you can get turned
down for other loans, because some lenders calculate your payments based on
the available credit and not just the used credit. Having a large equity
line indicates a large potential payment, which makes it difficult to
qualify for loans. Note: this argument holds even if your equity line has a
zero balance.
- Not understanding the difference between an
equity loan and an equity line.
An equity loan is closed末i.e. you get all your money up
front and then make fixed payments on that loan, until you pay it off. An
equity line is open末i.e. you can get an initial advance against the
line and then reuse the line as often as your want during the period that
the line is open. Most equity lines are accessed through a checkbook or a
credit card. On equity lines, you only pay interest on the outstanding
balance.
Use an equity loan when you need all the money up front末e.g. home
improvement, debt consolidation.
Use an equity line if you have an ongoing need for money or need the money
for a future event末e.g. you need to pay for your child's college
tuition in three years.
- Not checking the lifecap on your equity line.
Many credit lines have lifecaps of 18%. Be prepared to pay
payments at higher interest levels if rates move upwards.
- Getting a home-equity loan from your local bank
without shopping around.
Many consumers get their equity line from the bank that they
have a checking account with. Use your bank, but shop around first.
- Not getting a good-faith estimate of closing
costs.
Your mortgage company is required to provide you with a
written good-faith estimate of closing costs within 3 working days of
receiving the application.
- Assuming that your home equity loan is tax
deductible.
In some instances, your home-equity loan is NOT tax
deductible. This may be the case if you make too much and fall into the AMT
trap, or if you have pulled out more than $100,000 cash from your home. Do
not depend on your mortgage company regarding this matter末check with an
accountant or CPA.
- Assuming that a home-equity is always cheaper
than a car loan or a credit card.
A credit card at 6.9% is cheaper than a credit line at 12%,
even after the tax deduction. To compare rates, compute the effective rate
of your home-equity loan, with the rate on a credit card or auto loan.
Effective rate = rate * (1 - tax_bracket)
Example : If the rate of the home-equity loan is 12% and your tax bracket is
30%, your effective rate is : 12% * (1-0.3) = 12%*0.7 = 8.4%
If your credit card is higher than 8.4%, then the equity loan is cheaper,
otherwise it is not.
Besides the interest rate, you may also want to compare monthly payments and
other terms of the loan.
- Getting a home-equity line of credit if 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) even when they are refinancing the
first mortgage. If you plan on refinancing your first, check with your
mortgage company if getting a second will cause your refinance to get turned
down.
- Getting a home-equity line to pay off your
credit cards if your spending is out of control!
When you pay off your credit cards with your equity line,
don't put your house on the line by going out and charging up those credit
cards again! If you can't manage the plastic, tear it up!
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