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The 11 Greatest Mistakes in Financing |
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1. What’s So Special? Aren’t all Lenders and Mortgage
Companies the Same? Aren’t all Lenders required to adhere to
the same standards and guidelines?
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This is an excellent question. I constantly find that there
is a great deal of misunderstanding relating to the fact
that every lender has a set of guidelines which have
basically been cast in stone. At our office we sometimes
refer to these as “the They Sayers...” An example of this is
“..They say you can’t get a mortgage if you’ve just changed
jobs or employers.”
There are many different types of generic guidelines which
form the basis for mortgage approvals. In effect, these are
“rules” which lenders use as their baseline for evaluating
loans. The most popularly known guidelines are FHA, VA, FNMA
(commonly referred to as “Fannie Mae”), and FHLMC (commonly
referred to as “Freddie Mac”).
These guidelines and procedures change frequently and many
lenders will deviate from these guidelines in order to
obtain a special competitive advantage. These guidelines are
quite extensive. As an example, our company subscribes to a
service which provides FNMA and FHLMC guidelines. These are
stored in our computer and the memory required to store this
information in, is over 20 megabytes!!
As a consumer, it is critical that you select a loan officer
who has a good understanding of the basic guidelines. In
addition, you should select a loan officer with access to
lenders who have the ability to deviate from standard
financing guidelines. You can make a big mistake by going to
a lender who only offers one method of financing your home.
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2. I’m better off going to a lender that has “in-house”
underwriting - right?
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Many mortgage financing sources will boast that they can
just step down the hall to their underwriter and get an
expedient (presumably affirmative) loan approval. This also
tends to give one the false belief that an underwriter who
works within the same company is willing to be a little more
flexible.
I have found that the exact opposite is probably a more
accurate assumption. In-house underwriters seem to need to
be more cautious to avoid any implication of impropriety.
Some lenders even have a policy that underwriters reviewing
branch office files must be more strictly evaluated. In some
cases, it is even company policy for the loan officer and
underwriter to avoid directly discussing a loan file.
Situations may also arise where there is a long standing
personality conflict between a loan officer and an
underwriter. |
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3. I should apply at my bank for my mortgage. After all,
they have all of my checking, savings and other accounts.
Won’t it be simpler for them to provide my mortgage? Won’t
they offer me a special deal and give me some type of
preferred rate? |
Typically a commercial bank will own a separate business
entity which shares the bank’s name and happens to offer
mortgage financing. It is important to note that it is a
separate business entity and that this subsidiary does not
typically offer any special considerations for bank
customers. Interest rates, loan costs and programs are
normally the same as what the bank’s mortgage company would
offer to any prospective customer - regardless of where they
bank. There are rarely any special considerations given in
terms of how a bank’s mortgage subsidiary will evaluate your
application for a mortgage loan.
The bank’s mortgage subsidiary does not have any special
access to your financial records as you might expect. In
other words, the bank’s mortgage subsidiary must request
your financial records (to verify account balances, loans,
etc.) from the bank just as any other mortgage company. This
means that your loan process will not be simplified or
viewed in any context different from any other applicant
making a request from a bank’s mortgage subsidiary.
The perception of most people who go to their bank’s
mortgage subsidiary is that their loan payments will always
be made to their bank; thus, all of the individual’s banking
needs will be “under one roof.” Most bank’s mortgage
subsidiary sell their loans on the secondary market and may
sell the loan servicing just as any other mortgage company
will.
Another important consideration is that a typical bank
mortgage subsidiary works with a small number of mortgage
products. You will not find a wide variety of programs and
your loan officer may not have a good comprehension of all
of the different programs offered. It is doubtful that they
can adequately advise you as to the best program for your
needs. It is possible that you or the property you are
buying may need to have special underwriting to approve your
loan application.
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4. I must avoid Private Mortgage Insurance (PMI) at all
costs. This means that I’ll have to put 20% down. After all,
mortgage insurance is just a waste of money ...I don’t get
anything in return for buying mortgage insurance.
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Private Mortgage Insurance is required for most loans that
exceed a loan to value of 80%. Private Mortgage Insurance
insures the lender in the event that you default on your
mortgage payment and the lender is forced to sell your
property at a loss.
We are very fortunate in that mortgage insurance companies
have created a number of different types of plans. Over the
years, the cost of mortgage insurance has actually declined.
It used to be that a borrower had to pay as much as 1% of
the loan amount up front and then pay a significant amount
each month. Mortgage insurance companies now offer plans
which require a very small amount at closing together with a
regularly scheduled payment each month.
Deciding whether you should liquidate some assets to put as
additional down payment (to avoid the cost of mortgage
insurance) requires that you evaluate what you loose by
liquidating those assets. Many clients also find that paying
other debts is better than applying additional cash towards
the down payment. Paying off credit cards and car loans may
improve cash flow more that avoiding Private Mortgage
Insurance.
Most of the time I find that you are better to keep your
money working for you in investments other than your home.
Your cash (properly invested) in some growth or income
oriented fund will earn significantly more that the
offsetting expense of mortgage insurance. In addition, I
find that most people feel more comfortable in being
slightly more diversified in their investment strategy.
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5. I’m under contract to buy or build a home. The closing
is scheduled beyond the normal times to lock in on an
interest rate. I’d like to select my lender now and begin
the loan process. The best way to compare different lenders
is to call around and ask what each one is offering on a
normal lock-in basis. This will give me an indication of who
will have the “best deal.”
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This is the worst way to decide what lender you should
select given this specific situation. Lenders are just like
any other business in that the product they are offering is
for sale is subject to price changes which are constantly
being modified by their suppliers. By the time you get in a
position to obtain a commitment (lock-in) for a specific
rate and program you might find that that particular lender
is no longer offering the best choice.
Family Lender, Inc deals with many lenders on a national
basis. It is not uncommon for a lender to be offering
extremely competitive rates one day. For no apparent reason,
this same lender may just arbitrarily decide to get
completely out of the market by raising rates. We find this
happening all of the time. Lenders do this for a variety of
business reasons which are beyond the scope of this article.
The point is that you must be in a position to take
advantage of whatever opportunities exist in terms of rate.
In addition to rates you should also consider the
opportunities created by the constant flow of new loan
products. Consumers benefit by the constant creation of new
financial products. As an example, think of all of the
mutual funds looking for our investment dollars. The
mortgage business is very similar. There are new products
created each week.
If you are not experienced in evaluating loan programs it
can remind you of a Clint Eastwood movie... “The Good, The
Bad, and The Ugly!” The reality is that many of these new
programs have excellent benefits which can translate into
significant dollar savings for you.
You should begin your loan process with a company and
individual with the knowledge and expertise to locate a
competitive rate and advise you on the most appropriate loan
program to suit your specific needs.
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6. I’m purchasing my first home. My available investment
cash is minimal. This means that I must get an FHA loan -
right?
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There are many disadvantages to an FHA loan:
1) mortgage insurance is very expensive,
2) the process is incredibly bureaucratic, and
3) interest rates on FHA loans are normally higher than
convention rates.
There are several advantages to an FHA loan:
1) it is possible to add some of the costs of financing to
your loan amount,
2) the mortgage insurance premium can also be added to the
loan amount,
3) FHA underwriting guidelines are more liberal on your debt
to income ratio (you can possibly qualify for a slightly
higher loan amount). Notice that most of the advantages
increase how much you can borrow. You are (essentially)
leveraging yourself into a higher debt position just to
compensate for a couple of factors. One can probably
negotiate with the seller of a property to pay closing costs
when negotiating the purchase of a property.
As noted previously, lenders are constantly creating new
loan programs. One of the current focal points for new
programs is related to the first time homebuyer market. Many
barriers to home financing for first time purchasers have
been removed from the process to the extent that first time
purchasers should definitely examine the benefits to
conventional financing. One thing is clear - in the long
term conventional financing will be much more cost effective
due to interest rates and higher mortgage insurance
associated with FHA mortgages.
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7. It is important to get a detailed estimate of closing
costs from all lenders I call since loan closing costs will
vary widely from lender to lender.
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Costs associated with purchasing your real estate are not
controlled by the lender. I refer to these costs as
“acquisition costs.” These include expenses such as attorney
fees, title insurance, survey, recording fees, appraisal,
and termite inspection. These are costs which anyone should
spend when purchasing a home regardless of loan amount or
lender. All of these expenses are provided by independent
professionals who are not affiliated with your prospective
mortgage lender. It can be very confusing if you compare
these expenses item by item to estimates prepared by
different lenders. Based upon individual experience each
loan officer will offer their best estimate as to what each
of these costs may be and there will be some differences
between individual loan officers.
When your loan officer prepares the estimate of closing
costs they will also include an estimate for establishing
your escrow account for the future payment of taxes,
insurance, and mortgage insurance (if applicable). Property
taxes are set by the appropriate government taxing
authority. Unfortunately, property taxes are not negotiable.
Premiums for homeowners insurance are set by the insurance
company you select.
All mortgage lenders will require that you pay your first
year homeowners insurance plus two additional months at
closing. All lenders work off a schedule based upon the time
of year that you close in determining how much is placed
into the escrow account at the time of closing to calculate
how many months of property taxes need to be set aside. For
this reason, your total costs for setting up your escrow
account will not vary between lenders. Again, based upon
individual experience each loan officer will offer what they
believe is a reasonable estimate of your monthly taxes and
homeowners insurance.
The most accurate method to compare lenders (in terms of
closing expenses) is to ask about their specific fees for:
Loan Origination, Underwriting Fees, Tax Service Fees, etc.
All lenders will offer a different set of scheduled fees and
each has a tendency to establish unique names for each of
these fees. It is important to make sure to obtain all of
these loan charges and fees.
You should also compare discount points charged by various
lenders if you are considering advance payment to reduce
your interest rate. Discount points may be paid at closing
to reduce the interest rate of your loan over the term of
your mortgage.
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8. I’m building a new house. I need to make sure I get a
“construction/perm” loan. This will avoid the huge costs
associated with two loan closings. By getting a
“construction/perm” loan, I can lock in on a rate that will
be good well into the future. This allows me to take
advantage of what are the prevailing rates within the market
at this time. |
Doesn’t this sound a lot like “... I’m going to have my cake
and eat it too ...?” There are numerous problems associated
with this approach.
With some planning on the front end you can keep closing
costs to a minimum when financing your construction loan and
then refinancing your permanent loan.
Most construction to permanent loans will not make
commitments to lock in on prevailing market rates for the
time required to build a new home. Even when they do make
such commitments there are finite time periods which must be
met in order to take advantage of a rate. The problem with
this is the fact that it is difficult to accurately forecast
a completion time when building a new home. If your home is
completed later then the final commitment date for the loan,
you will loose your interest rate and be at the whim of the
market.
If a bank offers a “convertible” program, ask what the rate
would be today if you had completed your home and were ready
to lock in to their conversion option. You will find that
this rate is significantly greater than what is available to
a mortgage broker.
Mortgage rates can improve between the start of construction
and completion. Will your construction to permanent program
give you the benefit lower rates? Probably not.
The point is that it is best to deal with someone who can
offer you the most flexibility so that you can be certain to
have what is the best situation for your specific needs.
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9. I’ve been told that the best type of program is to get
a fixed rate loan. I’ve also heard that I should get a
fifteen year loan if there is any way I can manage the
additional monthly expense. |
You should get together with an expert who can explain the
different types of loan programs. Each program may have its
own series of special benefits for you and your specific
situation. I have found that when considering such an
important decision that it is best as if you have explored
all possibilities. It may well be that a fixed rate is the
best type of loan program. It may also be that you can save
significant amounts of money by exploring alternative
adjustable programs, balloon programs, and others.
In this day and time there are almost as many different
programs as there are housing options. A few of the
considerations you should consider are anticipated time in
the home, available asset base, current income situation vs.
future income situation, etc. It’s wise to know that you
have picked the most appropriate program based upon what is
actually occurring in your life at this time.
If you pay off a loan in fifteen years versus thirty years
you will obviously save a lot of money in interest expense.
It is important to note that this savings is due to the
repaying the loan in half the time. The savings is not due
to a significant savings in interest rates. You would expect
that there would be a much lower rate since the loan has a
quicker repayment and, therefore, a loan with less risk. The
difference in interest rates is not that significant. Rates
on fifteen year loans may be 1/4% to 3/8% better than thirty
year rates. Payments on fifteen year loans will be
approximately 25% higher on a monthly basis.
I have had many clients select a fifteen year mortgage only
to discover that the monthly payments are just a little too
high for their budget.
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10. I’m considering refinancing. I’ve been told that I
must get a rate which is at least 2% lower than my current
rate to justify the expense of refinancing.
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Nobody seems to know where this mysterious 2% rule of thumb
came from. I have never found anyone who can actually
explain why one needs to save 2%.
The facts are that most of this decision goes back to what
your specific objectives are for looking into refinancing.
You might be considering a home improvement. You might be
trying to consolidate some of your other debts. You might be
exploring an alternative method for financing your child’s
education. There are many different reasons to consider
refinancing your home loan.
The reasons for considering your refinancing may overshadow
your concern over complying with some kind of guideline
you’ve heard about.
To determine if it makes sense to consider refinancing you
should carefully review the available options. Review how
much the refinancing transaction will cost you. Despite the
fact that you can add it “back into the mortgage” it is
still costing you something. You also need to carefully
review what this potential transaction may mean to you in
terms of your monthly budget and cash flow. Only after
examining these variables is it possible to evaluate whether
the refinance makes sense.
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11. When I’m negotiating on the purchase of my new home,
I should focus simply on buying the home as cheaply as
possible and disregard any offers of concessions for
financing by the seller of the property.
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Closing Costs are a significant portion of the cash which is
required for you to purchase the property. Depending upon
the purchase price, it is possible for costs to run as high
as 2% to 5% of the purchase price. It is important for you
to be aware of these costs and determine whether you will
pay for them by writing a check at closing or have the
seller pay them as part of your agreement to purchase the
property.
Most lenders allow the seller to pay closing costs up to
certain limitations. In my opinion, this is the most
overlooked benefit buyers have at their disposal. You will
be able to get much more bang for buck if you allow the
seller to pay your closing expenses.
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