How to Avoid Common Pitfalls When Applying for a Real Estate Loan
A real estate loan application is a major financial commitment, and the highest amount of care needs to be ensured in considering it. For first homebuyers and experienced investors in real estate, there’s complexity at every level, and mistakes could be expensive to afford. The following list of common pitfalls to be avoided while applying for a real estate loan will go a long way in helping you through this important step.
- Not Checking Your Credit Score in Advance
Your credit score is one of the most important things that lenders use when making decisions regarding your loan application for real estate. It reflects the level of financial responsibility and your history. Bad credit or a low score usually changes a lot in the conditions of a loan and, more costly if summed up through interest rates at monthly repayments for the term. In extreme conditions, a low score is capable of even leading to the complete rejection of your loan application.
The mistake many borrowers make is that they check their credit score too late in the day, usually just before applying for a loan. This leaves little or no time to fix the negative marks or errors on the credit report, therefore offering limited opportunities for improving the score and hence getting better terms on the loan.
Tip: It is to your advantage to have a credit check at least six months before you apply for a real estate loan. This prudent action will give you sufficient time to review your credit report for any errors and to have such entries corrected. That is, if poorer than you want it to be, you can take time to improve it through paying outstanding debts, keeping credit utilization low, and avoiding inquiries about new credit lines so as not to see a temporary drop in your credit score. This period also allows you to build a better credit history for yourself, which will lead to better loan offers.
- Ignoring How Important Pre-approval Is
Perhaps one of the most common but significant mistakes to be made in buying a house is the lack of a pre-approved mortgage. It helps you understand how much you can actually borrow and what it will cost you. Pre-approval is one step further than pre-qualification because, during the process, the lender will check your financial situation, which includes your credit score, your income, and debt levels, and base on these the maximum loan amount you qualify for.
Otherwise, you may end up wasting time and energy looking at homes that are outside of your budget, only to get frustrated later when you find out you can’t get the financing for your dream home. More importantly, in a competitive real estate market, pre-approval sets you apart from other buyers by showing the sellers you are a serious buyer who is ready financially.
Tip: Try to avoid all these pitfalls by getting pre-approved for a mortgage even before you begin house hunting. This process not only gives you a realistic budget to work from but strengthens your position in negotiations. Sellers like to consider pre-approved offers since that already signifies financial backing with fewer chances of hitches. Second, it can speed up the closure process since so much of the financial scrutiny is already well done.
- Underestimating Overall Homeownership Costs
Most people, when budgeting for their new home, consider only the mortgage payment, totally ignoring all the other significant costs of homeownership. While the mortgage payment is a major expenditure every month, it certainly isn’t the only one you will have. Besides your mortgage, homeowners have to pay property taxes, homeowner’s insurance, and routine maintenance. And then there are the repair costs-the older and more distressed the home, the higher the repair costs may be.
These added expenses dramatically affect your bottom-line budget, and unaccounted for can lead to financial strain or inability to make your mortgage payments. Often, many first-time homebuyers fail to account for these costs and end up buying a home that they can afford on paper but, in reality, cannot maintain.
Tip: To avoid such a mistake, use a full-featured mortgage calculator, one that will project all the costs that come with owning a home, from property taxes, homeowner’s insurance, and maintenance to possible repair costs. Consider these costs in the overall budget when you calculate how much house you can afford. It’s also wise to include an emergency fund that should be large enough to cover surprise repairs or more serious upkeep needs, so you won’t be surprised when such needs actually appear and put a crimp in your finances.
- Making Big Purchases Before Closing
Whу be surprised? It’s natural to get excited over moving into a new home, and the urge to start buying furniture, appliances, and other essentials once your offer is accepted might be overwhelming. Actually, making big purchases before closing on your loan is one of the costliest mistakes anyone can make. These purchases can increase your debt-to-income ratio, a key metric lenders depend on to decide whether you are able to repay the loan. The higher the debt-to-income ratio, the more likely this will raise red flags to lenders and may affect your interest rate or even void the loan approval altogether.
Large purchases that zero out your savings also makes it difficult to pay closing costs or other surprise expenses that may arise during the home-buying process. Lenders will very often check your financial situation again right before closing, and large changes can put your loan in jeopardy.
Tip: Avoid large purchases or major changes in your finances starting from the time your loan is approved until the time it closes. That means no major credit card buying sprees, but it also means no new credit accounts, no new loans, and no large withdrawals from your savings. You want to keep your financial picture looking as consistent as possible from the time of your loan application until closing to prevent complicating your loan.
- Not Comparing the Loan Offers
One of the biggest mistakes that borrowers commit is accepting the first offer that comes their way without shopping around. The difference in interest rates, fees, and terms on offer by different lenders can be huge; not comparing these options could see the borrower pay much more than they should over the life of the loan. Interest rates will, therefore, really impact your monthly payments and total amount you will pay over time; hence, getting the best deal is key.
In addition to the interest rates, they’ll charge a host of different fees for services like appraisals, credit reports, and origination fees. These can add up-so what initially seems like a small difference in rates could make more of a difference over time. You can potentially be leaving a couple of thousands of dollars on the table if you can’t negotiate a better deal because you don’t have anything to compare offers to.
Tip: Get loan estimates from at least three different lenders. Take the time to shop not only the interest rates but also the fees and the terms of the loans for each of the lenders. Be very careful not to focus too much on the monthly payment, but on the full cost of the loan over its duration. Ask all the lenders for a Loan Estimate that will detail all the costs associated with the loan; that would make it easier to compare. This due care can get you a loan which fits your financial situation and goals the best, probably saving you many dollars over time.
- Missing the Fine Print
The fine print of your mortgage agreement conceals some very vital information which, as time goes by, can have serious implications on financial health. Many times, borrowers are in a hurry to avail loans and tend to glance cursorily through the fine prints or not bother at all. This could lead to very unpleasant surprises later on, such as prepayment penalties that may cost you money in case you decide to pay your mortgage off early, or ARMs that reset at higher interest rates after some initial fixed period. Such resets can make your monthly payments jump, stretching your budget.
Other loans may involve the lender charging other fees if certain conditions are fulfilled, or they may require you to carry various kinds of insurance. When these are not considered, it may lead to unforeseen expenses or constraints, which needn’t have occurred had the problems been noticed sooner in the process.
Tip: This is very important: take the time to read and understand all the loan documents before you sign on anything. Never be afraid to ask your lender or some kind of financial professional to clarify a term or condition which sounds unclear or wordy, including but not limited to how interest rates will be calculated, one’s rights in the case of inability to pay, or any hidden fees. Being fully informed about your mortgage details will keep you away from any surprise costs and conditions that can put your finances in jeopardy over the life of the loan.
- Without Contingency
Life is certainly not without its uncertainties, and financial upsets, such as job loss, medical emergencies, or major car repairs, can befall one at any moment. Events of this nature can seriously impact one’s ability to pay his or her mortgage-especially if he or she has nothing set aside in case of contingencies. Of course, without a contingency plan, you will be faced with some very tough decisions, including whether to miss mortgage payments, tap retirement savings, or even consider selling your home under duress.
It can add to your financial burden, too, which in turn may make you further away from getting up in case of a setback. If worse comes to worst, inability to plan for such emergencies may lead to foreclosure, ruining your credit score and plunging into financial troubles that are not that easily overcome.
Tip: Consider using these risks as an opportunity to create an emergency fund-a pool of money that generally should include three to six months’ worth of living expenses, including your mortgage payment. This money serves as a financial cushion and enables you to make your mortgage payments in the event of some unexpected financial challenge. Also, explore the purchase of insurance policies to hedge against these risks, such as disability or critical illness insurance policies, to further protect your financial security. The peace of mind you will derive from having a good backup plan will put you in an even better position to weather any financial storms.
- Not locking in interest rate
The interest rates of the mortgage market are very volatile and change with numerous different factors that surround the economy. These rates can increase between the period of time that you applied for the loan and the date of actual closing, which might raise your monthly payment amounts and the overall cost of your loan. You may be facing a much higher rate than you thought if you haven’t locked in your interest rate, and that could lower your whole budget and even change long-term financial planning.
Others will wait, hoping the rate will continue to fall, and this could be a gamble. If the interest rates move the wrong way, you’ll wish you’d taken that better rate when you could have. You might think a tiny increase in the interest rate won’t make much of a difference, but it really can over time on a 15- or 30-year loan.
Tip: When you find an attractive interest rate for your loan, go ahead and lock it in with your lender. A rate lock is a commitment that your interest rate will not rise before closing-if market rates go up. Rate locks usually come in terms of time, such as 30, 45, or 60 days, so timing it with your expected closing date can be important. Others may also offer a “float down,” where you can lock in a lower rate if you happen to get a rate decrease during your lock period. You can discuss these and other options with your lender to make a decision that’s best for your situation, so that you’re locking in the best rate and protecting yourself from possible increases.
- Picking the Wrong Type of Loan
The mortgage landscape consists of a number of different loans, fixed-rate mortgages, adjustable-rate mortgages, interest-only loans, and government-backed loans like FHA and VA loans included, all aimed at fulfilling particular financial needs and goals. Each loan has its benefits and drawbacks, and one wrong choice has a potential for reaping significant, far-reaching consequences.
A good example of these could be that the ARM may grant a far lower initial interest rate, but this could go extremely high at the end of the fixed period and force increased monthly payments well out of your budget. This is contrasted with the fixed-rate mortgage, which offers stability in the form of consistent payments, though it may have a higher initial rate compared to an ARM. Some borrowers choose a loan based exclusively on having the lowest rate or the lowest monthly payment without considering how their financial situation may change overtime or how the structure of the loan may affect them at some point in the future.
Tip: Take the time to work with your lender or a mortgage broker to weigh options and understand the implications of each of your loan choices. It’s not just about the interest rate and monthly payment; it’s also about how long the loan is for, any potential rate adjustments, and special programs to which you could be applying-such as FHA or VA loans. Consider your long-term financial goals: how long you want to stay in the home, income stability, and your risk tolerance. You can choose the right type of loan to not fall into a financial hole, and the mortgage will fit into your general financial strategy.
- Not Budgeting for Closing Costs
Among the more common, yet underestimated, elements in the buying of a home are closing costs. Generally, these expenses range from 2 to 5% of the purchase price. These include loan origination fees, appraisal fees, title search and title insurance fees, and other such administrative fees. Thus, on a house priced at $300,000, closing costs can be anywhere between $6,000 to $15,000-and if you do not budget for them, it may just come as quite a surprise.
These additional fees catch many borrowers off guard, and the rush to scrape up the money at the last minute can be a real challenge. In extreme cases, it could entail taking out an additional loan or using savings that should cover other costs associated with the house, such as renovations or furniture. Being unprepared for closing costs can even lead to delays in your closing date due to added stress in an otherwise convoluted process.
Tip: Plan for closing costs as an element of your overall budget when buying a house from the start. Your lender will more than likely give you a Loan Estimate at the beginning of the process, which can outline a rough estimate of closing costs. Get a head start on preparations based on that estimate, by setting aside needed funds. It is also prudent to build in some extra room in case there are fees that may pop up unexpectedly. Some purchasers do negotiate with the seller to pay partial or full closing costs, so make sure you discuss that with your real estate agent. Additionally, the better prepared you are, the smoother you will be able to meet these expenses without additional financial stress at the end of your house-buying experience.
Conclusion
Getting a real estate loan is an important step in the process of buying a home, and avoiding these common traps will save you time, money, and a whole lot of stress. With some proactive work on your end to do some research and communicate with your lender, you will get a loan that fits your needs and puts you on the path to successful homeownership.
