Avoid these common mistakes if you’re refinancing or buying

Mortgage rates are near record lows—borrowers could find 30-year fixed-rate mortgages below 3.4% recently. But very low interest rates are not enough to guarantee that borrowers will get great mortgage deals when they buy homes or refinance. They also must steer clear of these mortgage mistakes…

MISTAKE: Ignoring the age of your old loan when refinancing. If you’re 10 years into a 30-year mortgage when you refinance to a new 30-year loan, you will have to make 10 additional years of payments to pay it off—and when it comes to loan payments, time is money.

Example: You might think that you’re saving a fortune if you refinance a 6% 30-year fixed mortgage with 20 years remaining into a new 3.75% 30-year mortgage. And assuming an original loan amount of $150,000, your monthly payment would indeed drop from $904 all the way to $619. But because you’re adding 10 additional years of interest payments, you’re actually costing yourself money over the life of the loan. With the old mortgage, the remaining payments would have come to around $217,000—but with the new one, you’ll pay around $223,000, plus perhaps $3,000 in closing costs. That’s a net loss of around $9,000.

Better: Unless your primary goal is to free up cash in your current budget, strongly consider opting for a mortgage shorter than 30 years when you refinance. In the example above, you could refinance that 6% 30-year mortgage to a new 20-year mortgage at 3.5%. That would reduce your monthly payments to $775 without extending your loan payments. You would make a total of around $186,000 in loan payments to pay off the loan—and even with $3,000 in closing costs, you would save around $28,000 in the long run.

MISTAKE: Buying a car or changing jobs before you close on your mortgage. The loan-approval process doesn’t really end when your mortgage is approved. Your lender is likely to reconfirm your employment and financials in the week before your loan closes—Fannie Mae’s recently implemented Loan Quality Initiative now requires lenders to track changes in borrower circumstances between the application date and closing, for example. Your lender might back away from a previously approved loan or alter the loan’s terms if it discovers that you have changed jobs or taken out a car loan—potentially even if you’ve acquired a new credit card.

Better: Delay doing anything that could significantly alter your credit score or employment history until after the mortgage closes.

MISTAKE: Assuming that the lowest advertised mortgage rate must be the best deal. You really can’t compare mortgage offers simply by comparing interest rates—a lender could quote a low rate by jacking up the loan’s closing costs.

Better: When you contact lenders, don’t ask, “What’s your rate?” Instead ask, “What’s your 30-year fixed rate with zero points if I lock it in for 60 days?” Even if that isn’t exactly the mortgage you end up choosing, phrasing the question this precisely increases the odds that you’re comparing apples to apples when you get quotes.

MISTAKE: Letting a lender charge you hidden points. Just because a lender tells you that a mortgage has low or no points doesn’t guarantee that it has low or no fees. Points are a type of fee charged as a percentage of the loan amount. Some lenders instead charge steep flat fees—rather than fees calculated as a percentage—so they can tell borrowers that their loans have low or no points without technically lying.

Better: When a lender quotes you loan terms, first ask if there’s a “discount fee,” “origination fee” or “broker fee.” These are the labels lenders typically use when they try to hide points in the form of flat fees. Also, immediately request a written good-faith estimate of the mortgage’s terms. Lenders are required to provide good-faith estimates within three days of receiving a loan application, but borrowers can and should request these estimates as early as their initial contact with the lender. Read the estimates to confirm that there are no steep undisclosed fees.

MISTAKE: Allowing rates to float too long rather than locking them in. Borrowers typically either lock in a mortgage rate with a lender when their loan is approved or allow the rate to “float”—remain unfixed until closing. Because rates have been trending generally downward for years, many borrowers opt to let their rate float—that is, to remain unfixed until closing—in hopes that rates will continue to decline between approval and closing. That’s a poor gamble in today’s ultralow-rate environment. Rates indeed might fall slightly, but they already are so low that they couldn’t possibly fall far. On the other hand, there’s at least a small chance that rates could rebound significantly, perhaps if the economy suddenly showed strong signs of life.

Caution: Although you don’t want to gamble that rates will not rise by the time you close, you also don’t want to lock in a rate too early in the process because then your lock-in window could expire before your mortgage closes. If that happens, you might have to pay a significant penalty to extend the lock-in…or it may not be possible to extend the lock-in, leaving you stuck with whatever rate is available on your closing date.

Better: Before locking in a rate, ask the lender what your options will be if you overrun the lock-up period. Also ask if it’s possible to initially allow the rate to float, then later lock it in, perhaps a few weeks down the road.

True, there’s some risk that interest rates could increase before you lock in, but odds are good that they won’t climb very far if you postpone only a few weeks. The odds of a significant increase are much greater if you overrun a 30- or 60-day lock-in, because significantly more time will have passed. (Lenders might offer longer lock-in windows as well—perhaps 90 days—but only at significantly higher interest rates.)

MISTAKE: Choosing an adjustable-rate mortgage (ARM) because you expect to sell the home before the interest rate resets. Rates quoted on ARMs are inevitably lower than those of fixed mortgages. Lately, borrowers could find 5/1 ARMs (ARMs that offer fixed rates for the first five years, followed by annual rate adjustments thereafter) at around 2.8%, compared with 3.4% for 30-year fixed mortgages. There is no downside to choosing that 5/1 ARM if you sell the home before the rate resets in five years. Trouble is, people are not very good at predicting how long they will stay in their homes.

Better: Chose a fixed-rate mortgage, and lock in today’s very low rates even if you do expect to move before an ARM’s rate resets. Interest rates are likely to climb substantially from today’s historically low levels over the course of the coming decade, making ARMs not worth the risk if there’s any significant chance that you still will own the home after the loan’s rate resets.

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