Bad mortgage advice could cost you tons of money and time.
Are you thinking about buying or refinancing a home in the near future? If so, chances are you’re getting all kinds of advice from well-intentioned friends and family.
Just remember to keep this important piece of advice in mind: Don’t listen to everything you hear. According to industry professionals, some words of wisdom are not wise at all.
To help you separate the bad advice from the good, check out five common statements that should cause you to cover your ears immediately.
Bad Advice No. 1: “A 30-year fixed-rate mortgage is best for everyone.”
The common perception is that a 30-year fixed-rate mortgage is always the best option, because it typically offers lower monthly payments than other shorter-term mortgages. But the kicker is that interest payments over the course of the loan can be quite substantial when compared to mortgages with shorter terms and lower interest rates.
Consider this example based on rates from Freddie Mac, as of March 20, 2014:
A 30-year loan on a $200,000 property with a 4.32 percent interest rate has a monthly payment of $992 and interest payments totaling $157,153 over the life of the loan. On the other hand, a 15-year loan for the same property with a 3.32 percent rate has monthly payments of $1,412 and yields $54,187 in total interest paid. So by opting for the shorter mortgage, you could save more than $100,000 in interest, which is worth it if you can meet those higher monthly payments.
Whether or not a 30-year fixed mortgage is the right choice depends on the borrower’s goals and financial situation, says Houtan Hormozian, vice president of Crestico Funding, a Los Angeles-based mortgage brokerage firm.
For example, if you have cash saved up for job, family, or medical emergencies and you already have college and retirement funds set up, then a 15-year mortgage might be a better option. Without money saved up, losing a job or an expensive surgery could deal a hard blow to someone’s finances, including their ability to make mortgage payments.
Bad Advice No. 2: “Stay away from adjustable-rate mortgages.”
An adjustable-rate mortgage (ARM) is a loan with an interest rate that is fixed for a period of time then adjusts, causing the ARM payments to increase or decrease.
ARMs get a bad rap, because they’re seen as risky products that contributed to the housing bubble, easy credit, and ultimately, the subprime mortgage crisis.
“The 30-year fixed-rate mortgage is the most popular type, because everyone is afraid of adjustable [rates],” Hormozian says.
In fact, only 3 percent of homebuyers chose adjustable-rate mortgages in the first half of 2013, reports Freddie Mac. With that low figure it’s easy to get scared off, too. But the fear associated with ARMs is somewhat unjustified, according to Hormozian.
“Depending on the consumer, circumstances, and knowledge of their economic situation, there could be an ARM that fits them,” says Frank Percival, board president of the Washington Association of Mortgage Professionals.
One major benefit of an ARM is that it typically will have a lower interest rate than fixed-rate mortgages at the outset. For example, a 5/1 ARM will have an initial fixed rate for the first five years then adjusts afterward.
This is a great option for homeowners who plan on moving out of their house before the rate adjusts. However, this does carry some risk, since personal finances and the condition of the housing market may make moving difficult in a set amount of time.
So choosing an ARM may come down to your financial situation and your aversion to risk. Percival explains that if a homebuyer with a 5/1 ARM saves $200 a month in interest compared to a 30-year fixed mortgage, it may make sense to choose that type of loan. However, if someone wants to err on the side of caution, given the risks discussed, a 30-year fixed mortgage might be the more sensible choice.
Bad Advice No. 3: “If your home is underwater, consider a short sale.”
“When the housing market was bad a year or a year and a half ago and the values of homes were low, people were encouraged from realtors [and] buddies at work to walk away from their home,” says Percival. He calls this “one of the worst pieces of advice in recent history.”
If desperate homeowners took that advice, they would usually do a short sale on their home. What exactly is that? It’s a real estate transaction in which a lender agrees to let the borrower sell his or her property for less than – or “short” of – what is owed on the mortgage.
Even if your home is underwater, it’s a bad idea, asserts Percival. If homeowners can still afford to make their mortgage payments, then they shouldn’t do a short sale.
“People who didn’t have medical emergencies or lose their jobs were dropping their keys and leaving their homes,” Percival says. This is a dumb choice, he adds, since it’s possible that their home value could go have gone up.
Plus, if you do a short sale, you may have to wait several years to qualify for a home again, says Percival. The reason? Because a short sale usually lowers your credit score just as a foreclosure would, according to myFICO, the consumer division of FICO. Shortsellers may be able to qualify for a mortgage in as little as two years, but this may depend on a variety of factors, like how much you are able to put down.
Beyond your own finances, short sales have a far-reaching effect, according to Percival.
“Every short sale or foreclosure reduces the value of every home in the neighborhood,” he says. “If folks would have waited for the recovery to kick in and housing prices to go up, they could have sold it at a profit. People just wanted to walk away from debt.”
Bad Advice No. 4: “An FHA loan is your only option.”
First-time homebuyers are particularly susceptible to bad advice. For example, homeowners who can’t afford a large down payment may hear that a government-backed FHA loan is their only option, since the down payment requirement can be as low as 3.5 percent of a house’s purchase price. But that’s not necessarily the case.
Some homeowners might be surprised that getting a conventional loan might be better suited – and easier – for them than an FHA loan, says Aaron Vantrojen, president of the Arizona Association of Mortgage Professionals, says.
The standards to qualify for an FHA loan have tightened, says Vantrojen. Plus, the FHA loan has become more expensive in recent years due to its rising mortgage insurance premium (MIP).
According to the U.S. Department of Housing and Urban Development, the mortgage insurance on an FHA loan must be carried for the life of the loan. On the other hand, the private mortgage insurance (PMI) on conventional home loans can be dropped when equity in the home reaches 20 percent, Vantrojen says.
As a result of dropping the insurance premium, homeowners can save thousands of dollars in the long run. “The annual mortgage insurance for FHA loans is so high, we are trying to get people into conventional loans if they qualify,” Vantrojen says.
The biggest advantage FHA loans have over conventional loans is the low down payment requirement. But conventional loans, with a 5 percent down-payment required, might be a better deal when you factor in the mortgage insurance payments, says Vantrojen.
“I will always look at options for conventional loans [for homebuyers],” says Vantrojen, president of Geneva Financial, a mortgage banking firm based in Tempe, Arizona. “The guidelines for conventional loans are changing, and a person who couldn’t qualify for one a month ago might be able to qualify now.”
Bad Advice No. 5: “Trust me, I know what I’m talking about.”
If you’re in the market for purchasing a home loan and in need of a little guidance, you might want to think twice about listening to someone who tells you: “Trust me, I know what I’m talking about.”
“One of the most common mistakes is not getting advice from a mortgage investment advisor,” says Hormozian. “Any time you don’t seek advice from a professional, you could be in trouble.”
But not all mortgage professionals are created equal, which is why Hormozian says homebuyers should make an effort to consult and get the opinions of established mortgage advisors, licensed mortgage companies, and reputable professionals when they are ready to purchase a loan.
“At the end of the day, my job is to make sure my client will have a comfortable life and a sound investment,” Hormozian says. “If I feel they are going to have a hard time making a payment or living up to that liability, I have to advise against it.”
For example, if someone tells you it’s a great idea to buy investment property as a source of instant income, you better consider the source. Instead of talking to real estate agents, homebuyers should talk to unbiased resources, who could help them avoid potential mortgage heartaches, says Vantrojen.
“Do your due diligence, talk to industry professionals – people who have been real estate investors and [who] can tell you the highs and lows of owning real estate,” he explains.
If owning a new home for you and your family is a main objective, Percival says it might be a good idea to check whether you are dealing with licensed mortgage professionals. He suggests verifying mortgage loan originators (MLOs) and their MLO license numbers through the National Mortgage Licensing System (NMLS), which performs this service for free.
Some banks show an uptick, but often, the loans are harder to get.
Seeking money for a pressing need or unexpected expense? A TV commercial airing these days from U.S. Bank suggests a solution: A home equity line of credit.
The spot may be reminiscent of the housing bubble for some, but it also represents a sign of the recovery.
“A small fraction of banks are actually reporting they’re seeing stronger demands for home equity lines of credit over the last 3 months,’’ says Keith Leggett, vice president and senior economist at the American Bankers Association.
“The lenders are still going to be cautious, but the fact that you are seeing lenders actually tip toe back into that water is an indication that the housing market has probably stabilized and is actually beginning to recover,” he says. “Lenders would not be going into this market if they viewed (that) housing prices were scheduled to drop further.”
ComericA bank says it’s seen an increase in home equity lines of credit in Orange County. The bank had a 55 percent rise in applications for them as of mid-October this year compared with the full year 2011, and a 36 percent increase in money taken out by borrowers, bank spokeswoman Nancy Tovar Huxen said. There was a 74 percent jump in home equity credit applications in September year to date over the same period ending September 2011, and a 68 percent increase in money taken out.
BOOM VS. BUST
During the housing bubble, many homeowners used their home like ATMs. Income documentation and a healthy amount of collateral often were not deemed necessary. Home prices were soaring.
But since the crash, the rules for such credit, as with other types of loans, have tightened significantly.
“They’re being very careful about who they’re giving that loan to,’’ says Houtan Hormozian of the Orange County Association of Mortgage Professionals. “Banks definitely don’t give them out like they used to.’’
Now homeowners typically need a 720 FICO score, at least 20 percent equity in the home, and documentation of income and mortgage payment stability, mortgage brokers say. And home equity lines of credit don’t come cheap: Average fixed interest rates were 6.68 percent as of Oct. 5, down from 7.06 percent a year ago, according to HSH Associates, which collects data on the mortgage market.
So who qualifies for a HELOC nowadays?
U.S. Bank officials say though the bank’s commercial is airing now, their careful lending practices haven’t significantly changed, and that the bank continued to give out home equity lines of credit even after the housing crash.
“It’s really for the crème de la crème,’’ says Dave Haub, president of CMC Lending in Garden Grove, of typical guidelines for the loans. “There’s not a lot of people who have the equity. It’s almost for the people who really don’t need it.”
PAYING IT BACK
But borrowers who took out home equity lines of credit in the past could face trouble ahead. In a couple of years, more than half of these loans will begin amortizing.