Sunday, September 6, 2009

Prime time to refinance your mortgage

You can borrow too much or prepare too little. You can misjudge terms or overestimate your credit. With so much at stake, it’s no wonder so much can go wrong.

By Liz Pulliam Weston

Applying for a mortgage can be a daunting experience.

It's not enough that you're agreeing to take on the biggest debt of your life, one that represents two to three times your annual income. You're also confronted with piles of paperwork, flurries of fees and a tidal wave of terms, from amortization to title insurance, whose meaning is fuzzy at best.

"Whether it's a professor at Stanford or a ditch digger," said San Francisco mortgage broker Leon Huntting, "most people don't understand the loan process."

In this confusing and pressure-filled atmosphere, it's easy to make some mistakes. Here are some common ones that lenders and mortgage brokers see, and what you can do to prevent them.

Not fixing your credit

Mortgage brokers say they're confounded at the number of buyers who apply for a mortgage with their fingers crossed, hoping their credit will allow them to qualify for a loan.

Before you even think about applying for a mortgage, obtain copies of your credit report and your FICO credit score. Your FICO score is the three-digit number that's used in 75% of mortgage-lending decisions. You can order your FICO score on the Web for a fee of $14.95, which includes a copy of your credit report.

Doing this at least six months in advance should give you plenty of time to challenge any errors on your report and ensure that they're removed by the time you're ready to apply for a loan. You can also see the legitimate factors that are hurting your score and do something about them, such as paying off an overdue bill or paying down credit card debt.

Not looking for first-time home buyers' programs

These programs, typically sponsored by state, county or city governments, often offer better interest rates and terms than you'll find among private lenders, said mortgage consultant Diane St. James. Some are tailored for people with damaged credit, while most can help people with little saved for a down payment.

Some of these resources are listed on St. James' educational Web site, ABC Mortgage Consulting. You can also call the housing agencies for your state, county and city to see what they offer.

Not getting pre-approved for a loan

Many first-time borrowers confuse being "pre-qualified" with being "pre-approved." Pre-qualification is a pretty casual process, where a lender tells you how much money you probably can borrow based on how much money you make, how much debt you already have and how much cash you have for the down payment.

Getting pre-approval, by contrast, is a much more rigorous process and involves actually applying for a loan. You typically submit tax returns, pay stubs and other information. The lender verifies the information and checks your credit. If all goes well, the lender agrees in writing to make the loan.

In a hot or even warm real estate market, the house hunter who is only pre-qualified is a cooked goose. Home sellers and their agents give much more weight to offers being made by buyers who already have a loan lined up.

Borrowing too much money

Many people take out the biggest loan they possibly can, figuring that their incomes will eventually increase enough to make the payments comfortable. But few first-time buyers have any clear idea of how expensive homeownership can be. Not only will you shell out more for mortgage payments than you probably did for rent, but you'll also need to cover property taxes and homeowners insurance, as well as higher bills for utilities, maintenance and repairs than you faced as a renter.

Lenders are perfectly willing to let you overextend, knowing that you'll probably forgo vacations, retirement savings and new clothes for the kids rather than default on your mortgage.

"Mortgage money … is way too easy to get," said Ted Grose, president of the California Association of Mortgage Brokers. "People tend to overbuy … and that can really stress family life. It's also a formula for foreclosure."

nstead of going to the edge of affordability, consider limiting your housing costs -- mortgage payments, property taxes and homeowners insurance -- to 25% or so of your gross income. That's a much more sustainable level for most people, financial planners say, than the 33% lenders are typically willing to give you.

Not shopping around for rates and terms

Mortgage broker Allen Jackson of Bristol Home Loans in Bellflower, Calif., sees too many borrowers with decent credit getting stuck with loans meant for people with poor credit. So-called "subprime" loans are often more profitable, so less ethical mortgage brokers may push them.

If the borrower doesn't know what the prevailing interest rates are for someone with their credit standing, Jackson said, they can easily pay thousands of dollars more than they need to. You can see a listing of loan rates by credit score at, and a comprehensive listing of prevailing rates and fees can be found in MSN Money's mortgage loan center.

Even people with a few dings on their credit can often qualify for better loans than they're typically offered, said Grose of 1st Mortgage Advisors in Los Angeles. He believes most of the people being shunted into government loan programs, such as Federal Housing Administration (FHA) loans, would pay less if they used mortgages now being offered by private-sector lenders.

Paying junk fees

Lenders can boost their profits by adding on a variety of fees. Some may be legitimate, some may be inflated and others may be pure fluff. Lenders may charge for "document preparation," for example, when all that involves typically is having a computer spit out a form. Or they may charge $150 for a credit check that cost them $15.

The time to challenge junk fees is not when you're about to sign the loan papers. Use a mortgage broker or call a number of lenders to compare their loans. Ask about the interest rate, the "points" charged to get that rate (each point is 1% of the total loan amount) and any other fees the lender charges. Then you can compare terms.

Once you've selected a lender, you'll be given a good-faith estimate of closing costs, which should include any fees being charged. Ask about each fee, and try to negotiate down the ones that seem excessive.

If the lender won't negotiate, "take that estimate to someone else," St. James said. "I'll bet they can beat it."

Unfortunately, this doesn't absolutely guarantee you won't face junk fees when it comes time to sign the loan. Many borrowers complain that they still face higher costs than were originally estimated, and so far the federal government has done little to prevent the practice. You can try challenging junk fees at this point, but most likely you'll have to bite the bullet and pay the fees to get your loan.

Not planning for closing costs

The day you're scheduled to get your loan, known as closing, you'll also be expected to write a check for a number of expenses, which typically include attorney's fees, taxes, title insurance, prepaid homeowners insurance, points and other lenders' fees. Together, these are known as closing costs, and the total can be eye-popping: somewhere between 2% to 7% of the selling price of the house.

"Usually, when people see the closing costs, they're like a deer in the headlights," said mortgage broker Huntting, who works for Pacific Guarantee Mortgage. "It's much more than they ever think it's going to be."

Plan for closing costs by getting a good-faith estimate from your lender as early in the loan process as possible. Make sure you have the cash on hand (or rather, in your checking account) and that it doesn't "disappear" before closing because of sloppy bookkeeping or a last-minute emergency.

Not having enough cash on hand after closing

After borrowing too much, and scraping together every last dime for closing costs, many home buyers have nothing left in the bank to pay for anything unforeseen happening --and something unforeseen always happens.

"It costs so much just to move in," Grose said. "Then the water heater breaks."

Some people are so tapped out by the process, Jackson said, that they're not able to make their first mortgage payment on time. That's why "more and more lenders are requiring [borrowers have] three months' reserves after closing," Jackson said.

That's a smart idea for borrowers, anyway. Having three months' reserves, which means a fund equal to three months' worth of expenses, will help you handle the added costs of homeownership with much less stress.Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

These 18 tips can help cut the stress of taking out a mortgage -- and get you into a house you can afford.

What's the best way to pay for the biggest purchase you'll likely ever make?

You can be sure of two things: It's harder to get a mortgage now than it was a year ago, and the fine print can have life-changing consequences.

  • First, visit MSN Money's Home Affordability Calculator, which considers your income and debts, even your credit, before figuring out the maximum amount you should borrow. It may not be as much as some banks will lend you, but it should be within your means to repay. You can get an idea of what's available here.

Once you've got an idea of how much you can afford to borrow:

  • Gather your paperwork before you meet with a lender.
  • Get preapproved for a mortgage. Unlike "prequalifying," preapproval means you have a loan lined up, which makes your offer more attractive to sellers. You don't have to accept a loan from a company that preapproves it.
  • If you suspect interest rates are going to rise before you close, pay to lock your rate in place.
  • Consider buying discount points to reduce your interest rate only if you plan to be in the house long enough to recoup that money and then some.
  • If you're a first-time homebuyer or are low-income, look for financing through your local or state board of housing. The federal Department of Veterans Affairs offers help for military personnel and veterans.
  • In today's tighter credit market, you'll need a down payment.

Dozens of mortgage products are available. You have to decide which one best fits your spending plans. (See "Which mortgage is best for you?") Consider these and compare them:

  • 30-year fixed rate. Compared with an adjustable-rate mortgage, or ARM, you'll pay a slightly higher interest rate but have the comfort of knowing it won't change over the life of the loan. Consider a 15-year mortgage to save thousands in interest if you can afford a higher monthly payment.
  • ARM. Sometimes known as "hybrid" loans, ARMs offer a low fixed rate of interest at the beginning of the loan, followed by rate adjustments that are tied to an index. For instance, a 5/1 loan has a fixed rate in the first five years and a rate that's adjusted every year after that. These mortgages may work well for people who plan to move or refinance their homes with a fixed-rate mortgage before the interest begins to ratchet up. (See "How to deal with a rising home payment.")
  • Option ARM. You can pay the full interest and principal due each month or just the interest, or make a partial interest payment. The third option is particularly hazardous because the unpaid interest will be added to the principal you owe. (See "Ouch! Your house payment just doubled.")
  • Interest only. You pay only interest for the first five years or so and both interest and principal in the remaining 25 years. Another version is the interest-only fixed-rate mortgage. Like ARMs, you'll end up with substantially higher monthly payments unless you sell or refinance your home. If your income can support only the interest payment, rather than principal and interest, you should not be buying a home. Further, with home values falling across the country, you could quickly find yourself "upside down" -- owing more than the house is worth.

With so many types of mortgages to choose from, it's essential to understand the terms of the loan before you sign:

  • Will the interest on your ARM be adjusted every year, every six months or every month?
  • Is there a cap on the interest? Does the cap apply to the first adjustment or only to subsequent adjustments? Is there a cap on your payments, which could cause your obligation to soar?
  • Does the mortgage include prepayment penalties or balloon payments?

Private mortgage insurance, known as PMI, can cost hundreds of dollars a month.

  • You can avoid having to buy private mortgage insurance (which protects the lender, not you) by putting down at least 20% on your home.
  • You could also take out what's known as a piggyback loan. Your primary loan would cover the first 80% of the value of your house. A piggyback loan is a second mortgage that would cover the remainder, usually at a much higher interest rate.
  • If you have to buy private mortgage insurance, ask to have it canceled when you've reduced your loan balance to 80% of your home's appraised value. Once you've reduced your loan balance to 78%, the lender must cancel your PMI unless you're considered a credit risk.

If you already have a mortgage, you may be tempted to refinance when interest rates drop. (See an estimate of your growing home equity here.) Don't make a decision based simply on the availability of lower rates. Would you actually pay less when you figure in the closing costs?

If you've got a hint we haven't included or find a factual error, let us know by sending an e-mail to

Which mortgage is best for you?

© Corbis
The right loan is out there. You just have to examine its terms and your situation before deciding it is the one that fits perfectly.

Mortgage lenders offer many features and restrictions that can be added to a variety of mortgage programs, but the following eight mortgage loans are the basic types you will encoun

ter. No single loan is best for all circumstances; some loan types work better than others, depending on individual circumstances and lifestyles.

Buying for the long haul

Loan: 30-year fixed rate.

Why: Financial peace of mind can be worth the higher interest rate that comes with an interest rate that

won't change for three decades.


with good but inconsistent income

Loan: Option adjustable rate mortgage (ARM).

Why: These loans, considered among the riskiest offered in recent years, originally were designed for people with incomes that vary a lot from month to month. Each month you have a choice of payments: the full amount needed to pay off principal and interest as scheduled, an amount that covers only the interest owed that month, or an even smaller amount that doesn't even co

ver interest owed.

In a month in which your earnings are lean, you might choose to make one of the lower payments, even though that actually adds to the amount of debt you must eventually pay back. In a month of strong earnings, you could choose to make the full payment. Over time, however, your required payments could rise significantly if you have frequently chosen to make only the smaller payments.


ancing (15-20 years before retiring)

Loan: 15- or 20-year fixed or ARM.

Why: You can retire the loan before you retire from your job. A fixed rate generally has a higher interest rate than an adjustable but will give you more certainty in budgeting. However, if ARMs are significantly cheaper and your income can handle possible payment increases, you could save with the adjustable rate.

More from

MSN and

Recent graduate with strong earnings potential

Loan: One-year ARM.

Why: Stretch your dollars with low interest rates during the years when your income is at its leanest. Your rate can go up (or down) each year, but interest-rate caps will limit that change to a predictable amount, and your rising income should be able to handle it. Watch out for loans that don't cap the interest rate but instead cap your payment. They could cause your indebtedness to grow even as you make monthly payments. ARMs also come in varieties that adjust -- up or down -- every six months or even more frequently.


Loan: No- or low-documentation loan.

Why: Though you'll pay a higher interest rate, not having to produce paycheck stubs or employer references, which you would be expected to supply when applying for a traditional loan, can be a huge help to those with variable incomes.

Planning to live in home 4 or 5 years

Loan: A 5/25 hybrid loan.

Why: If you won't keep the loan longer than five years, why pay extra to lock in an interest rate for a longer period? If you do end up staying longer, you can either refinance or live with an interest rate that adjusts every year.

Job relocation for a short run

Loan: Interest-only mortgage.

Why: While these loans can be risky for novice borrowers or those stretching to afford a home, they can be a smart tool for financially sophisticated borrowers who already have assets built up. Monthly payments are low because you're not repaying principal, so you can afford a larger loan. If you eventually sell the home for less than you paid, however, you could have to take money out of savings to pay back the full amount owed on your mortgage.

Active duty military or veteran

Loan: VA loan.

Why: The Department of Veterans Affairs offers loan guarantees that allow qualified military personnel and veterans to take out mortgages for as much as $417,000 with zero down payment. In Alaska, Hawaii, Guam and the U.S. Virgin Islands, that loan amount goes up to $625,000.

This article was reported and written by Elizabeth Razzi for