One of the first steps to purchasing a new home is making sure you can finance the deal. Shopping around for a mortgage is a must-do for any homeowner-to-be, yet most people are prone to making mistakes that result in getting the wrong mortgage for their needs. Here are eight mortgage secrets to keep in mind while shopping for a loan.
The lowest interest rate mortgage is not always the best deal.
Unfortunately, interest rate alone cannot be relied on to make the best mortgage financial decision. Mortgage rates can be artificially reduced by adding upfront discount points or adjustable rate features that may not make good financial sense in context of your situation.
APR doesn’t tell the whole story.
Annual percentage rate, or APR, attempts to deal with some of the inadequacy of mortgage interest rate alone by factoring in up-front fees and potential future rate adjustments. But unfortunately APR has limited value because it does not consider how quickly a mortgage principal is paid down. Additionally, APR bases future rate and payment adjustments for adjustable-rate mortgages on current index rates rather than forecasted future rates.
Beware of low payments.
Mortgage payments are important in terms of affordability, but relying on payment alone to select the best loan can lead to disastrous consequences. Monthly payment can be manipulated to enhance affordability by extending the term, adding up-front closing costs or adding adjustable rate features, all of which can negatively impact your wealth.
You can avoid costly mistakes by asking yourself a simple question—how long do I expect to live in this property? Time matters because mortgage interest rates are intimately tied to time. Longer-term fixed-rate loans have higher interest rates. Shorter-term fixed-rate loans have lower interest rates. If you got a 30-year fixed loan when you only planned on owning a property for 5 years, you paid too much for your mortgage.
Financing closing costs can hurt you in the long run.
Lenders will from time to time dismiss up-front costs of a mortgage by adding those costs to the loan amount. If you are financing closing costs, you are paying for the closing costs with the equity in your property. And because of interest charges, you can expect to pay double or triple the initial cost of the closing costs over the life of the loan.
Longer-term mortgages cost much more and build equity much slower.
Borrowers don’t always realize that by selecting a longer-term mortgage they will be choosing to pay dramatically higher interest charges over the life of the loan. While shorter-term mortgages will almost always have a higher payment, that difference in payment is working for you by going directly toward reducing your principal balance. In addition, shorter-term loans almost always have a lower interest rate, which also reduces total costs over the life of the loan.
Don’t overlook total cost.
Total cost is the sum of all costs, including interest charges and closing fees, over the life of a mortgage. With all of the things to consider in a mortgage, it is easy to overlook cost. Many borrowers don’t realize that there are two portions of the mortgage payment, one that works for you and the other that works against you. The principal portion of your mortgage payment works for you because it helps build equity in your property. The interest portion of you payment is working against you because it goes directly to the bank. Total cost is the amount that you will pay towards your mortgage over its life that is not working for you because it’s going to someone else. So when calculating the total cost of a mortgage, always take into consideration how much interest you will pay to the bank in addition to the various fees and other closing costs.
Consider impact on wealth with “Net Benefit.”
Your choice of mortgage is one of the most important financial decisions that you will make in your lifetime. Different mortgages can have dramatically different wealth outcomes that cannot be determined by looking at payment or rate alone. The right mortgage could literally create tens of thousands of dollars in wealth for you over its lifetime. Net Benefit projects how your wealth will grow, both in terms of equity and payment savings, over the life of your mortgage.