As a Real Estate Broker, I work with many experts during a buying/selling transaction. Today, I have called on one such expert, Joseph Meerbaum. As a Mortgage Broker, Joseph knows the financial aspects of a real estate deal, inside and out. I asked him to give us some tips about applying for a mortgage.
8 Big Mortgage Mistakes and How to Avoid Them
by Joseph Meerbaum
Applying for a mortgage can be a challenging experience. For many people, buying a home or a commercial property is going to be the largest purchase of their life and the mortgage, their largest debt, because especially for those buying a home, the debt can be 2-3 times their annual income.
When applying for a mortgage, potential buyers are confronted with piles of paperwork, flurries of fees and obtuse terms like amortization, and title insurance, whose meaning is fuzzy at best. Whether somebody is a Harvard professor or a ditch digger, most people are confused by the mortgage process and in this pressure filled atmosphere it is easy to make mistakes. What I’d like to discuss with you today is a list of the common mistakes that I see both as a Mortgage Broker and as a lender, and what people can do to avoid them.
Mistake #1: Not fixing your credit score
When working with Real Estate Brokers, I recommend that once they bring in a prospective buyer, they introduce me at the beginning of the process. We have to first understand what their financial situation is, how much of a property they can afford, and whether it is to live in as a primary residence, a second home, or an investment property.
There are many people who walk in and apply for a mortgage with their fingers crossed, hoping that their credit score will somehow let them squeak by to qualify for a loan. So the first thing I recommend people do, is to get copies of their credit report, specifically what is called the FICO credit score. FICO is the 3-digit number used in 75% of residential mortgage lending decisions. FICO stands for Fair Isaacs Company which was the company that developed the algorithm that is used today to compute the score.
There are typically three major credit reporting agencies, and all three scores are used. What the banks typically do is eliminate the high and low scores and use the middle score. If it is a husband and wife applying for a loan, they will take the 6 scores between the two of them and do the same thing, throw out the 2 highest and 2 lowest and keep the middle scores.
This should be done at least 6 months prior to applying for a mortgage, allowing the prospective borrower/purchaser plenty of time to challenge any errors on the report and ensure that they are removed by the time they are ready to apply for a mortgage. There are also legitimate factors that are hurting the score such as overdue bills or credit card debt. Six months allows time to correct these factors which will improve your score.
Mistake # 2: Not looking at first time homebuyer programs offered by the State, County, and/or City Governments
These programs typically offer better interest rates and terms than you will find among private lenders. Some are tailored to people with damaged credit and most can help people with little saved for a down payment.
Mistake # 3: Not getting prequalified for a loan
Prequalification is a more casual process. It is where the Mortgage Broker will estimate how much money a person can borrow based upon their income, their debt, and their cash available for a down payment. Basically, it’s done through an interview where we do rough calculations.
Preapproval is a much more rigorous process and actually involves applying for a loan. In the pre-approval process the borrower submits tax returns, pay stubs and other information. The bank then verifies this information, checks the credit and based on the information, it actually makes an agreement to make a loan. That is not a binding commitment, but is sort of an initial approval.
In a hot or a warm real estate market, the prospective buyer who is only prequalified is not in as strong a position as one that is preapproved. When the market is heating up it is always good to have that information done so when there is a prospective house or property, the buyer and their Broker walk in with a very prepared package, which leads to a quick transaction.
Preapproval was more common prior to 2006, but is less common today as banks are less likely to do it.
Mistake # 4: Borrowing Too Much Money
Many people take out the largest loan they possibly can figuring that their incomes will eventually increase enough to make the payments comfortable. First time homebuyers especially, do not have a clear idea of how expensive owning a home can be. Not only will you spend more money on mortgage payments than you paid on rent, but you also need to cover property taxes, homeowner’s insurance, as well as higher bills for utilities, maintenance and repairs that you typically do not face as a renter. Instead of going to the edge of affordability, generally speaking, lenders would like you to keep your housing costs, which are defined as your mortgage cost, property taxes and homeowner’s insurance, to 25-30% of your gross income. That is the general conservative ratio. Today I’m seeing the trend closer to 33%.
Mistake # 5: Not shopping around for rates and terms, or working with a Mortgage Broker who will do that for you
There have been cases, especially prior to the 2008 banking fiasco, when we saw many people who had decent credit getting put into loans meant for people with poor credit. The result was that people were getting loans very quickly but they were retaining higher interest rates than they necessarily had to. When you walk into a lender specializing in loans to people with damaged credit, that is all they have to offer. If you work with a Mortgage Broker, he/she will be able to work with many lenders and guide the application to the bank that will give the best pricing terms per the borrower’s individual needs. So-called sub-prime loans were more profitable, so the less ethical lenders were pushing them. The bottom line is that the borrower doesn’t know what the prevailing interest rates are for someone with their credit standing and debt/income ratio. They can easily overpay thousands of dollars more than they need to.
I can recall a number of years ago a senior officer at a bank shared this story with me. He had a client to whom he had given a rate who said, “Oh, I got an amazing rate over the internet. Thank you for your help.” The client went and applied for a mortgage online. 3-4 weeks passed by and the loan was moving along when suddenly they got a phone call from a lender in the midwest saying, “I’m sorry, Mr. Jones, we won’t be able to go through with your loan. We don’t lend on co-ops.” The person was buying a co-op and the bank in the midwest didn’t lend for co-ops as they are not necessarily popular all over the country. The banker’s client was stuck because he had a closing imminent. He came back to the banker and they were able to close the loan and not lose the transaction.
The point is, applying for a mortgage, especially online can look deceptively easy, but you don’t know what questions you are supposed to be asking and you don’t know what you are missing. It is like trying to file your income taxes on your own. Theoretically you can do it, but realistically, if you buy a home every 5 -10 years, you can’t know enough compared to experts in the business who devote their careers to it.
Mistake # 6: Paying junk fees
Unscrupulous lenders add to their profit by tacking on a variety of fees. Some could be legitimate, some may be inflated, and others could be just pure fluff. We see that going on with advertised rates. If you open up the newspapers you might see really, really low interest rates but what you should be careful about is when they give you a low rate, they have fees tacked on at the closing. A lot of people show up at the closing and sign the document without really reading it. That’s where they get into trouble because the time to challenge the so called “junk fees” is not when you are about to sign the loan papers. You need a Mortgage Broker to compare the fees of lenders. He can discuss with you the interest rate, the points charged to get the rate, each point being 1% of the total loan amount and any other fees. Remember, the Mortgage Broker works for the borrower. When you walk into a bank, the banker works for the bank.
Once you have selected a lender, you will be given what is called the good faith estimate of closing costs and that should include all the fees being charged. We also include a fees worksheet which breaks down every single charge. The figures in these documents cannot be altered prior to the closing. After reviewing the good faith estimate and the fee worksheet, if a fee seems excessive or questionable, talk to the bank, talk to the Broker, and if there is no satisfaction go to another lender.
Mistake # 7: Not planning for closing costs
The day that is scheduled to get your loan, which is typically the day that you purchase your property, is known as the loan closing. The borrower is expected to write a check for a number of expenses which can typically include attorney’s fees, taxes, title insurance, prepaid homeowner’s insurance, points and other lender’s fees. Together those are collectively known as the closing costs and they can range from 2%-7% of the price of the house. Now 2-7% is a big range, but generally speaking, the lower priced home is going to be closer to 5-7%; the higher priced home is going to be closer to 2-3%.
When people see their closing costs, one Mortgage Broker described it as “a deer in headlights.” The way to plan for closing costs is by reviewing the good faith estimate with your lender or Broker as early in the loan process as possible. The borrowers need to have adequate cash on hand to cover all the closing costs necessary in order to have a smooth transaction.
Mistake # 8: Not having enough cash on hand AFTER the closing
After borrowing too much money and/or scraping together every last dime for closing costs, many homebuyers have little or nothing left in the bank to pay for anything unforeseen. And something unforeseen always happens. That’s why many lenders are requiring borrowers to have at least 3 months reserves at the closing, which is basically 3 months worth of expenses, such as principal interest, taxes and insurance.
As a Broker, my clients are the borrowers and I’m not proprietary. If I need to bring in a local bank, I do it. If I need to work with an investment bank, a credit union, a community savings bank, whatever it is, we bring them in. That is the benefit that a person has whether he is buying a home, second home, investment property or commercial property. All the things that we discussed above, apply to any type of transaction, whether one is buying a commercial building, or a home. It’s a universal story.
Joseph Meerbaum is an attorney by profession and has been in the real estate business for about 30 years. He has worked in real estate commercial, industrial, retail, real estate development, real estate asset management, institutional real estate asset management, that is with commercial properties in New York, Manhattan, and all over the country. Twelve years ago, he formed a company called Lionsgate Finance where he is CEO.
Joseph Meerbaum, Esq. | CEO
Lionsgate Finance, Inc.
Real Estate & Franchise Finance
Debt Placement | Investment Sales | Advisory Services
555 Fifth Avenue |14th Floor | New York, NY 10017
T: 212.378.1720 | F: 917.677.4801
jm@lionsgatefinance.com | www.lionsgatefinance.com
Mendy Lipsker
Mendy Realty Inc. 822 Montgomery St
Brooklyn, NY 11213
Phone: 646.662.5454
email: info@mendyrealty.com
website: mendyrealty.com
