Top 6 Mortgage Mistakes and how to avoid them

During the 2007-2009 financial crises, the United States economy crumbled because of a problem with mortgage foreclosures. Borrowers all over the nation had trouble paying their mortgages.

What happened or caused this mess?  See some of the biggest mortgage mistakes that homeowners make.

1. Adjustable Rate Mortgages
Adjustable rate mortgages seem like a homeowners dream. An adjustable rate mortgage starts you off with a low interest rate for the first one, two, three to five years. They allow you to buy a larger house than you can normally qualify for and have lower payments that you can afford in those beginning years. At some point in the future the interest rate resets to a higher market rate. Many homeowners thought that’s no problem because borrowers can just refinance to a lower rate once it resets. The problem is what if they can’t refinance?

When housing prices dropped, borrowers found that they were unable to refinance their existing loans. This leaves many borrowers facing high mortgage payments that are two to three times their original payments. The dream of home ownership quickly becomes a nightmare. Other times the rate available for a refinance is the same as the new current rate for the borrower making a refinance impractical because there is no savings.

Make sure you can afford the higher payment or don’t take the adjustable rate just to get a bigger house.  Enjoy the reduced payment for the first couple of years and put that money aside in a savings plan.

2. No Down Payment
During the subprime crisis, many companies were offering borrowers no down payment loans to weakly qualified borrowers. The purpose of a down payment is twofold. First, it increases the amount of equity that you have in your home and reduces the amount of money that you owe on a home. Second, a down payment makes sure that you have some skin in the game. Borrowers that place down a large down payment are much more likely to try everything possible to make their mortgage payments since they do not want to lose their investment. Many borrowers who put little to nothing down on their homes find themselves upside down on their mortgage and end up just walking away. They owe more money than the home is worth. The more a borrower owes, the more likely they are to walk away.

While a no down payment loan is more risky for a Lender a borrower should make sure they can afford the payment.  Usually this is not the cause of a foreclosure but just makes it easier for a borrower to walk away from the property

3. Liar Loans
The phrase “liar loans” leaves a bad taste in your mouth. Liar loans were incredibly popular during the real estate boom prior to the subprime meltdown that began in 2007. Mortgage lenders were quick to hand them out and borrowers were quick to accept them. A liar loan is a loan that requires little to no documentation. Liar loans do not require verification. The loan is based on the borrower’s stated income and/or stated assets.

They are called liar loans because borrowers or loan officers have a tendency to lie and inflate their income so that they can buy a larger house. Some individuals that received a liar loan did not even have a job! The trouble starts once the buyer gets in the home. Since the mortgage payments have to be paid with actual income and not stated income, the borrower is unable to consistently make their mortgage payments. They fall behind on the payments and find themselves facing bankruptcy and foreclosure.

4. Longer Amortization
You may have thought that 30 years was the longest time frame that you could get on a mortgage. Are you aware that some mortgage companies are offering loans that run 40 years now? Thirty five and forty year mortgages are slowly rising in popularity. They allow individuals to buy a larger house for much lower payments. A 40-year mortgage might make sense for a young 20-year-old who plans to stay in their home for the next 20 years but it doesn’t make sense for a most people. The interest rate on a 40-year mortgage will be slightly higher than a 30 year. This amounts to a whole lot more interest over a 40-year time period, because banks aren’t going to give borrowers 10 extra years to pay off their mortgage without making it up on the back end.

Borrowers will also have less equity in their homes. The bulk of payments for the first 10 to 20 years will primarily pay down interest making it nearly impossible for the borrower to move. Besides, do you really want to be making mortgage payments in your 70′s?

Generally if you can’t afford a 30 year mortgage you should probably stay away from a 40 year mortgage.

5. Exotic Mortgage Products
Some homeowners simply did not understand what they were getting themselves into. Lenders came up with all sorts of exotic products that made the dream of home ownership a reality. Products like interest only loans which can lower payments 20-30%. These loans let borrowers live in a home for a few years and only make interest payments. Pick-a-Pay loans let borrowers decide exactly how much they want to pay on their mortgage each month.

The catch is that with an Interest Only loan, eventually the Lender is going to want you to start paying principal.  When that happens the payments are going to go up significantly.  Many people just thought they could then refinance the problem away.  Problem was that they couldn’t get refinanced.   The Pick-a-pay product  is also known as negative amortization product. Instead of building up equity, borrowers are building negative equity.  Because they are not even paying enough to cover the interest cost on the loan they are increasing the amount that they owe every month until their debt comes crashing down on them like a pile of bricks. Exotic mortgage products have led to many borrowers being underwater on their loans.

6. Greed
In the movie Wall Street, the character Gordon Gecko is quoted as saying, “Greed, is Good”.  Quite frankly what happened is many homeowners felt they had to get in to the market and buy a home in hopes that they could sell it in a short period of time and make some serious money.  Many had no idea what they were doing.  Shows like “Flip this House”, “Property Ladder” and others became popular and many borrowers felt they were missing out.  If these idiots on TV can do it why can’t I.

Many overbought, over improved and spent money they never had in hopes of making it big.  Problem is that few ever reached that point.

The Bottom Line
As you can clearly see, the road to home ownership is riddled with many traps. If you can avoid the traps that many of the past borrowers fell into then you have a better chance of not falling in to the same or similar trap.