Making mistakes when buying a toaster is a mere learning experience. Oh well, it’s a $40 purchase. Try harder next time. Home buying mistakes, on the other hand, could cost you thousands of dollars in unnecessary expenses, or even push you into a full-scale financial emergency.
That’s why you need to do everything you can to avoid such costly errors. Awareness is your ally. After all, the best way to avoid a potential pitfall is to know about it ahead of time. So let’s examine some of the most common blunders made by home buyers.
Home Buying Mistakes to Avoid in the ‘New’ Landscape
The mortgage and housing industry has changed dramatically since the boom years of 1995 – 2006. For one thing, local market conditions are all over the place. Inventory is rising in some cities while falling in others. The same goes for home prices. On top of that, new mortgage rules and restrictions are squeezing many would-be borrowers out of the market. It’s a new era, and it calls for a new set of dos and don’ts.
Here are some of the biggest home buying mistakes to avoid in 2014.
1. Failing to establish a monthly housing budget
Quick, tell me how much you can comfortably afford to spend on housing costs each month. (Hint: “comfortably” means that you can still afford a night out once in a while, as well as savings / retirement contributions.) Give up? If you don’t know, you’re not ready to buy a house.
Skipping over the budgeting process is like wearing a financial blindfold. You might stumble along for a few steps, but you’ll eventually go off track. This is one of the most common home buying mistakes, especially among first-time buyers. How can you avoid it? Start by taking a cold, hard look at your current debt load in relation to your net monthly income. How much debt can you realistically add to that?
2. Not checking your credit reports and scores
Another pop quiz. What’s your current credit score? If you don’t know, you’ve got some more homework to do. Credit scores are one of the most important qualification criteria for mortgage applicants. This three-digit number partly determines whether or not you can get approved for a loan, and also how much interest you’ll pay. Two important details, yes?
You should know where you stand before applying for a loan. This kind of insight gives you more bargaining power. For instance, if you know you have excellent credit, but a lender offers you a higher-than-average interest rate, you’ll have the confidence to keep shopping around. The reverse is true as well. If it turns out you have a marginal score, you’ll probably have to take the first offer that comes along.
3. Assuming you can qualify for a home loan
Anyone with a steady job can qualify for a home loan, right? Wrong. That might have been true during the boom years, but not anymore. Do you carry too much debt in relation to your income? Sorry, no loan for you. Credit score in the mid to low 500s? No loan for you.
There are dozens of reasons why you could be denied financing. So don’t make the common home buying mistake of assuming you can qualify for a mortgage loan. Find out where you stand. Check your credit score, as mentioned above. Measure your debt-to-income ratio. Talk to a lender about your options. Get pre-approved for a loan. Don’t just assume.
4. Accumulating too much debt beforehand
Debt-to-income (DTI) ratios are a big deal these days. Lenders are scrutinizing debt burdens more so than in the past. This is partly a response to new lending rules that reward lenders for capping DTI ratios at 43%. Lenders also have less appetite for risk these days, and heavy debt loads have “risk” written all over them.
What does this mean? It means that if your debts use up too much of your monthly income, you might have trouble getting approved for a home loan. This is the kind of home buying mistake that accumulates years before you even apply for a mortgage. If you’re already buried in debt, you might have to pay it down before a lender will approve you.
5. Thinking your lender is your financial advisor
Let’s get this straight. Mortgage lenders are not financial advisors. They are only concerned with your future financial stability for as long as they hold on to the loan — and that might not be very long. Most lenders sell their loans into the secondary mortgage market as soon as possible, to increase liquidity and reduce risk.
The point is you should not think of your lender as a partner or advisor. It’s another home buying mistake to avoid. They are selling a product to make money. Plain and simple. As a borrower, you need to establish a budget for yourself (see item #1 above) and be your own advocate through the entire process.
6. Ignoring your mortgage options
Adjustable-rate mortgage loans can be a money-saver in the short term, but an unpredictable risk in the long term. FHA loans offer smaller down payments, but require mortgage insurance that pumps up your monthly payments. All home loans have certain pros and cons associated with them. That is why you must thoroughly research them before you talk to lenders. After all, you could carry the loan for three years, ten years, twenty years or more. That kind of commitment warrants a bit of homework, don’t you think?
7. Not getting pre-approved for a loan
Will you be able to qualify for a mortgage loan? If so, how much will the lender lend to you? Mortgage pre-approval is the next best thing to a crystal ball, when it comes to answering these home buying questions. This is when a mortgage lender reviews your financial situation (credit score, debt levels, income and assets) to see if you’re a good candidate for a loan. They’ll also tell you how much they are willing to lend, based on your financial situation.
Granted, pre-approval is not the same thing as a final approval. A lot can happen between being pre-approved and actually closing on a loan. But it does give you some valuable insight into your borrowing capacity. It also makes sellers more inclined to accept your offer.
8. Putting too much stock in pre-qualification
“Sweet! I got pre-qualified through a mortgage lender’s website. This means I’ll get a loan, right?” Not always.
In fact, most online “pre-qualification” forms are merely lead-generators with window dressing. You plug in some basic information about your monthly income and expenses, and the website says you could be qualified for a loan up to X dollars.
Pre-qualification is the lender’s way of saying you might qualify for a certain amount, based on your income level. But it usually doesn’t include verification of income, assets or debts. This all-important verification process comes later, during pre-approval (sometimes) and underwriting.
The bottom line is, you’re not fully approved for the loan until the mortgage underwriter says so. Celebrating prematurely is a common home buying mistake to avoid. Keep the champagne on ice until you get the “clear to close” signal from the underwriter.
9. Paying mortgage interest points for a short stay
You’ve probably heard about home buyers “paying points” at closing in order to get a lower interest rate. This is a common strategy that could work out to your advantage over the long term.
It works like this. You pay a certain amount of money up front, in the form of pre-paid interest. In exchange, the lender agrees to lower your mortgage rate. This can save you money over the long term. But it’s not a short-term strategy. If you pay points at closing and then sell or refinance the house within a few years, you’ll end up losing money. To avoid this kind of home buying mistake, you need to understand how interest points work, and how long it takes to reach the “break-even” point for long-term savings.
10. Not using a real estate agent
As a home buyer, you’re not required to use a real estate agent. You could navigate the entire process on your own, legally speaking. You could do your own market research, write your own purchase offer, and negotiate the sale price. The question is, do you have the experience needed to do these things effectively? If not, you could end up wasting both time and money.
In a typical real estate transaction, it is the seller who pays the buyer agent’s commission. So why wouldn’t you opt for professional guidance? An experienced agent can help you avoid many of the home buying mistakes mentioned in this article, as well as other potential pitfalls.