Your home is the single biggest purchase you will ever make, though college tuition is a close second. The mortgage loan is the largest single loan almost all of us ever sign, and ignorance truly costs you. Here are six things you should know before you sign your mortgage.
How Much Interest Matters
The interest rate on a mortgage matters quite a bit. If your mortgage rate is a quarter point higher, you’ll pay $20 or so more per month on a $200,000 thirty year loan. A 1% interest rate difference costs you $50 per month more per $100,000 you borrow. However, you should also factor in the price you will pay over the loan term. For example, it is worth it to pay an extra $200 per month to have your home paid for in 15 years if you plan on staying in the home forever.
One word of warning – stay away from interest only loans. You’re not building equity and home ownership with an interest only loan, and you may not be able to afford to refinance later if you can barely afford the home today. Be wary of adjustable rate loans, since you risk the mortgage rate spiking in the future to something you cannot afford. If you take out an adjustable rate mortgage, never make only the minimum payment.
The Cost of Rolling Costs into the Loan
A common mistake with mortgages involves home buyers rolling in costs like closing costs, inspection fees and even personal debt into their home loan. They look at the monthly cost and ignore how much more they will pay over the life of the loan due to 15 or 30 years of interest on the $3,000 fees they didn’t want to pay up front. For a 30 year mortgage at 4%, that $3000 you rolled into the loan turns into $4000. The costs are even greater if you take out a higher interest rate loan in place of a down payment in the hope of eventually rolling it into a consolidated home loan.
The Cost of Home Ownership Is Far More Than the Mortgage
The home you buy and mortgage terms you agree to have such a large impact on your long term financial outlook that the book “The Millionaire Next Door” said not to buy a home three times your annual realized household income. For first time home purchases, a home worth 1.5 times the annual household income makes it easier to pay down and keep even if you face job losses.
Spend more than this on a home with its attendant mortgage payments and house upkeep, and it is almost impossible to build wealth. The side benefit of the more modest home is the lower local expectations to spend money on everything from status symbols to services.
The costs of the home are not just the mortgage payment, but proper taxes, homeowners’ insurance, home repairs and utilities. Use a PITI payment calculator to determine how much you’ll actually pay each month to maintain your home. Don’t buy a home that takes you to the 30% PITI limit most lenders set, since this risks all of your money going into the property and its upkeep. A better choice is buying a home where the PITI is 25% of your gross monthly income. This ensures that you don’t have to choose between going into debt or paying the mechanic versus being late on the mortgage payment.
The Pros and Cons of Escrow Accounts
Before you sign a mortgage and agree to let your lender handle various bills via escrow, look at the pros and cons of it. Many lenders require the large lump sum payment each month collected in escrow before they pay your insurance payment or property taxes, but some charge a fee for this. Others fail to keep up with what is owed, and you could be hit with an extra assessment to cover the 10% rise in property taxes or charged a late fee by the insurer because the escrow payment didn’t cover the homeowner’s insurance premium. It is your responsibility to inform the escrow account holder if you change insurers, and relying on the default monthly option could cost you the modest discount if you switch to six month or annual payments for insurance. If you are responsible with money, consider skipping escrow and paying your own homeowners’ insurance and taxes.
Don’t Pay for What You Don’t Need
Review the mortgage policy before you sign. Will they automatically cancel private mortgage insurance if your loan to value ratio exceeds 20%? Or will they continue to charge PMI until you ask them to stop? Don’t pay for a biweekly mortgage service when you can pay extra each month in principle on your own. If you are planning on automatic payments of your mortgage or PITI, ask for a discount from the mortgage company for doing so but never pay for such a “service”. If you’re asked to pay points up front, ask how much the interest rate will be reduced in return.
Review the loan to see if they are adding creative fees that aren’t really necessary like warehousing fees. Skip the optional home warranty unless the seller is paying for it, since anything that truly needed fixing should have been fixed before you moved in.
Be careful of mortgage brokers surprising you with last minute fees they say are necessary to close on the loan. Remember that all mortgage fees are negotiable, and ensure that the mortgage lender isn’t charging you for things you already paid for out of pocket like an inspection or survey. Title fees may be essential, and you may receive better protection if you pay more, but challenge documentation fees, credit review fees, underwriting fees and other fees. Always reject loans that require a fee for you to prepay your mortgage.
Know What You Are Signing and When Not to Sign
If someone will not let you read the forms in detail, walk away. You have the right to a legal review of mortgage documents, and if you have questions, don’t rely on the mortgage company’s legal opinion. After all, you’re legally obligated to the contract as written, not as described by someone who may be wrong or deliberately misleading you. If anyone tries to make last minute changes to the loan documents, take the forms and leave. If the mortgage lender or broker won’t give you copies of the documents for safekeeping, leave. Never, ever sign blank forms.
Realize how the interest rate matters to the loan, as well as loan terms. Understand the cost of the mortgage per month and over the life of the loan, as well as how much you will literally pay for rolling costs into the loan. Know the costs of home ownership, including insurance, taxes, utilities, and maintenance. Understand the pros and cons of escrow accounts and when it is better for you to pay these bills yourself. Don’t pay fees that you aren’t required to pay, and negotiate everything. Know what you are signing and understand the documents; if you don’t understand it or have concerns, don’t sign.