• What are the most commonly made mistakes in buying or refinancing a house
• Should I refinance
• What is a FICO Score
• What is the difference between pre-qualifying and pre-approval
• What is a rate lock
• What is an APR

What are the most commonly made mistakes in buying or refinancing a home ?

If you're like most people, purchasing a home is the biggest investment you'll ever make. If you're considering buying a home, you're likely aware of the complexity of the endeavor. Because of the numerous factors to consider when purchasing a home, it's important to prepare as best you can. Some common home-buying principles and caveats are presented here for your consideration. By keeping them in mind, you'll help create a successful and more enjoyable experience. These Top Ten lists are by no means exhaustive. Since your home could cost you 25 to 40 percent of your gross income, it's important to conduct research, ask questions and study the process carefully.

Buying a home

1. Looking for a home without being pre-approved. As a potential buyer competing for a property, you'll have a better chance of getting your offer accepted by being as prepared as possible. Consider this hierarchy of preparedness:
   • Neither pre-qualified nor pre-approved
   • Pre-qualified
   • Pre-approved

The benefits available at each level can be easily understood when viewed from the seller's perspective. Imagine you're a seller in receipt of multiple offers to purchase your property. A complete stranger (buyer) is asking you to take your property off the market for at least the next two to three weeks while they apply for a loan. As the seller, lets consider the type of buyer you'd prefer to deal with.

Neither pre-qualified nor pre-approved

This buyer provides no evidence that they can afford to purchase your property. You may wonder how serious they are since they're not at least pre-qualified.

Pre-qualified

This buyer has met with a mortgage broker (or lender) and discussed their situation. The buyer has informed the broker regarding their income, expenses, assets and liabilities. The broker may also have seen their credit report. The buyer provided you with a letter from the broker stating an opinion of what the buyer can afford.

Pre-approved

This buyer has provided a broker written evidence of income, expenses, assets, liabilities and credit. All information has been verified by a lender. As a result, much of the paperwork for this buyer's loan has been completed. This buyer will probably be able to close quickly. They provide you with a letter (pre-approval certificate) from the lender. You're as certain as possible that this buyer can close.

As a potential buyer, you can see that being pre-approved will give you the best chance of getting your offer accepted. This is critical in a competitive situation.

2. Making verbal agreements. If you're asked to sign a document containing instructions contrary to your verbal agreements--don't! For example, the seller verbally agrees to include the washing machine in the sale, but the written purchase contract excludes it. The written contract will override the verbal contract. More importantly, your state may require that contracts for the sale of real property be in writing. Do not expect oral agreements to be enforceable.
3. Choosing a lender just because they have the lowest rate. While the rate is important, consider the total cost of your loan including the APR , loan fees, discount and origination points. When receiving a quote from a lender or broker, insist that the discount points (charged by the lender to reduce the interest rate) be distinguished from origination points (charged for services rendered in originating the loan).
   
   The cost of the mortgage, however, shouldn't be your only criterion. Have confidence that the company you select is reputable and will deliver the loan with the terms and costs they promised. If in the final hours of the transaction you determine that the lender has suddenly increased their profit margin at your expense, you won't have time to start again with a different lender. Ask family and friends for referrals. Interview prospective mortgage companies.
4. Not receiving a Good Faith Estimate. Within three business days after the broker or lender receives your loan application, you must receive a written statement of fees associated with the transaction. This is both the law and the best way to determine what you'll pay for your loan. Bring the Good Faith Estimate (GFE) with you when you sign loan documents. You should not be expected to pay fees which are substantially different from those contained in your GFE.
5. Not getting a rate lock in writing.  When a mortgage company tells you they have locked your rate, get a written statement detailing the interest rate, the length of the rate lock, and program details.
6. Using a dual agent--i.e., an agent who represents the buyer and the seller in the same transaction. Buyers and sellers have opposing interests. Sellers want to receive the highest price, buyers want to pay the lowest price. In the standard real estate transaction, the seller pays the real estate commission. When an agent represents both buyer and seller, the agent can tend to negotiate more vigorously on behalf of the seller. As a buyer, you're better off having an agent representing you exclusively. The only time you should consider a dual agent is when you get a price break. In that case, proceed cautiously and do your homework!
7. Buying a home without professional inspections. Unless you're buying a new home with warranties on most equipment, it's highly recommended that you get property, roof and termite inspections. This way you'll know what you are buying. Inspection reports are great negotiating tools when asking the seller to make needed repairs. When a professional inspector recommends that certain repairs be done, the seller is more likely to agree to do them.
   
   If the seller agrees to make repairs, have your inspector verify that they are done prior to close of escrow. Do not assume that everything was done as promised.
8. Not shopping for home insurance until you are ready to close. Start shopping for insurance as soon as you have an accepted offer. Many buyers wait until the last minute to get insurance and do not have time to shop around.
9. Signing documents without reading them. Whenever possible, review in advance the documents you'll be signing. (Even though some specifics of your transaction may not be known early in the transaction,  the documents you'll sign are standard forms and are available for review.)  It's unlikely that you'll have sufficient time to read all the documents during the closing appointment.
10. Not allowing for delays in the transaction.  In a perfect world, all real estate transactions close on time. In the world we live in, transactions are often delayed a week or more. Suppose you asked your landlord to terminate your lease the day your purchase transaction was scheduled to close. A day or two before your scheduled closing date, you discover your transaction is delayed a week. In a perfect world, no one is inconvenienced and your landlord is willing to work with you. More likely, however, your landlord is inconvenienced and angry. Will you be thrown out? Will you have to find interim housing for a week or more? The eviction process takes a little time, so the Sheriff won't immediately remove you, but this type of stress-producing episode can be avoided. How? Terminate your lease one week after your real estate transaction is scheduled to close. That way, if there is a delay in closing your transaction, you have some leeway. This approach might cost a little more, then again, it might not.

Refinancing your home

1. Refinancing with your existing lender without shopping around. Your existing lender may not have the best rates and programs. There is a general misconception that it is easier to work with your current lender. In most cases, your current lender  will require the same documentation as other companies. This is because most loans are sold on the secondary market and have to be approved independently. Even if you have made all your mortgage payments on time, your existing lender will still have to verify assets, liabilities, employment, etc. all over again.
2. Not doing a break-even analysis.  Determine the total cost of the transaction, then calculate how much you will save every month. Divide the total cost by the monthly savings to find the number of months you will have to stay in the property to break even. Example: if your transaction costs $2000 and you save $50/month, you break even in 2000/50 = 40 months. In this case you'd refinance if you planned to stay in your home for at least 40 months.
   
   Note:  This is a simplified break-even analysis. If you are refinancing considering switching from an adjustable to a fixed loan, or from a 30-year loan to a 15-year loan, the analysis becomes much more complex.
3. Not getting a written good-faith estimate of closing costs. See item number four above.
4. Paying for an appraisal when you think your home value may be too low. Have the appraisal company prepare a desk review appraisal (typically at no charge) to provide you with a range of possible values. Your mortgage company's appraiser may do this for you. Do not waste your money on a full appraisal if you are doubtful about the value of your home.
5. Using the county tax-assessor's value as the market value of your home. Mortgage companies do not use the county tax-assessor's value to determine whether they will make the loan. They use a market-value appraisal which may be very different from the assessed value.
6. Signing your loan documents without reviewing them. See item number nine above.
7. Not providing documents to your mortgage company in a timely manner.  When your mortgage company asks you for additional documents, provide them immediately. They are doing what's necessary to get your loan approved and closed. Delays in providing documents can result in a costly delays.
8. Not getting a rate lock in writing.  When a mortgage company tells you they have locked your rate, get a written statement which includes the interest rate, the length of the rate lock and details about the program.
9. Pulling cash out of your credit line before you refinance your first mortgage. Many lenders have cash-out seasoning requirements. This means that if you pull cash out of your credit line for anything other than home improvements, they will consider the refinance to be a cash-out transaction. This usually results in stricter requirements and can, in some cases, break the deal!
10. Getting a second mortgage before you refinance your first mortgage. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first loan, check with your mortgage company to find out if getting a second will cause your refinance transaction to be turned down.

Getting a home-equity loan/line

1. Not knowing if your loan has a pre-payment penalty clause. If you are getting a "NO FEE" home-equity loan, chances are there's a hefty pre-payment penalty included. You'll want to avoid such a loan if you are planning to sell or refinance in the next three to five years.
2. Getting too large a credit line. When you get too large a credit line, you can be turned down for other loans because some lenders calculate your payments based upon the available credit--not the used credit. Even when your equity line has a zero balance, having a large equity line indicates a large potential payment, which can make it difficult to qualify for other loans.
3. Not understanding the difference between an equity loan and an equity line. An equity loan is closed--i.e., you get all your money up front and make fixed payments until it is paid if full. An equity line is open--i.e., you can get numerous advances for various amounts as you desire. Most equity lines are accessed through a checkbook or a credit card. For both equity loans and lines, you can only be charged interest on the outstanding principal balance.
   
   Use an equity loan when you need all the money up front--e.g., for home improvements, debt consolidation, etc. Use an equity line when you have a periodic need for money, or need the money for a future event--e.g., childrens' college tuition in the future.
4. Not checking the lifecap on your equity line.  Many credit lines have lifecaps of 18 percent. Be prepared to make payments at the highest potential rate.
5. Getting a home-equity loan from your local bank without shopping around. Many consumers get their equity line from the bank with which they have their checking account. By all means, consider your bank, but shop around before making a commitment.
6. Not getting a good-faith estimate of closing costs. See item number four above.
7. Assuming that your home-equity loan is fully tax-deductible. In some instances, your home-equity loan is NOT tax deductible. Do not depend on your mortgage company for information regarding this matter--check with an accountant or CPA.
8. Assuming that a home-equity loan is always cheaper than a car loan or a credit card.  Even after deducting interest for income tax purposes, a credit card can be cheaper than a credit line. To find out, compare the effective rate of your home-equity line with the rate on your credit card or auto loan.
   
   Effective rate = rate * (1 - tax bracket)
   Example: The rate of the home-equity line is 12 percent,your tax bracket is 30 percent, your effectiverateis:  .12 * (1 - .3) = .12 * .7 = .084 = 8.4 percent.
   If your credit card is higher than 8.4 percent, the equity loan is cheaper.
9. Getting a home-equity line of credit when you plan to refinance your first mortgage in the near future. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first, check with your mortgage company to find out if getting a second will cause your refinance to be turned down.
10. Getting a home-equity line to pay off your credit cards when your spending is out of control! When you pay off your credit cards with an equity line, don't continue to abuse your credit cards. If you can't manage the plastic, tear it up!

Should I refinance ?

The most common reason for refinancing is to save money. Saving money through refinancing can be achieved in two ways:

1. By obtaining a lower interest rate that causes one's monthly mortgage payment to be reduced.
2. By reducing the term of the loan, thus saving money over the life of the loan. For example, refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments, but the total of the payments made during the life of the loan can be reduced significantly.

People also refinance to convert their adjustable loan to a fixed loan. The main reason behind this type of refinance is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.

A third reason why homeowners refinance is to consolidate debts and replace high-interest loans with a low-rate mortgage. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumers loans are not tax deductible, while a mortgage loan is tax deductible.

The answer to the question "Should I refinance?" is a complex one, since every situation is different and no two homeowners are in the exact same situation. Even the conventional wisdom of refinancing only when you can save 2% on your mortgage is not really true. If you are refinancing to save money on your monthly payments, the following calculation is more appropriate than the rule of 2%:

1. Calculate the total cost of the refinance––example: $2,000
2. Calculate the monthly savings––example: $100/month
3. Divide the result in 1 by the result in 2––in this case 2000/100 = 20 months. This shows the break-even time. If you plan to live in the house for longer than this period of time, it makes sense to refinance.

Sometimes, you do not have a choice––you are forced to refinance. This happens when you have a loan with a balloon provision, but with no conversion option. In this case it is best to refinance a few months before the balloon comes due.

Whatever you choose to do, consulting with a seasoned mortgage professional can often save you time and money. Make a few phone calls, check out a few web sites, crunch on a few calculators and spend some time to understand the options available to you.

What is a FICO Score ?

A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. Fair, Isaac began its pioneering work with credit scoring in the late 1950s and, since then, scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrowers credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed. The Federal Trade Commission has ruled this to be acceptable.

Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information which best predict future credit performance. Developing these models involves studying how thousands, even millions, of people have used credit. Score-model developers find predictive factors in the data that have proven to indicate future credit performance. Models can be developed from different sources of data. Credit-bureau models are developed from information in consumer credit-bureau reports.

Credit scores analyze a borrower's credit history considering numerous factors such as:

• Late payments
• The amount of time credit has been established
• The amount of credit used versus the amount of credit available
• Length of time at present residence
• Employment history
• Negative credit information such as bankruptcies, charge-offs, collections, etc.

There are really three FICO scores computed by data provided by each of the three bureaus––Experian, Trans Union and Equifax. Some lenders use one of these three scores, while other lenders may use the middle score.

Frequently Asked Questions (FAQs)

How can I increase my score? While it is difficult to increase your score over the short run, here are some tips to increase your score over a period of time.

• Pay your bills on time. Late payments and collections can have a serious impact on your score.
• Do not apply for credit frequently. Having a large number of inquiries on your credit report can worsen your score.
• Reduce your credit-card balances. If you are "maxed" out on your credit cards, this will affect your credit score negatively.
• If you have limited credit, obtain additional credit. Not having sufficient credit can negatively impact your score.

What if there is an error on my credit report? If you see an error on your report, report it to the credit bureau. The three major bureaus in the U.S. , Equifax (1-800-685-1111), Trans Union (1-800-916-8800) and Experian (1-888-397-3742) all have procedures for correcting information promptly. Alternatively, your mortgage company may help you correct this problem as well.

What is the difference between pre-qualifying and pre-approval?

A pre-qualification is normally issued by a loan officer, who, after interviewing you, determines the dollar value of a loan you can be approved for. However, loan officers do not make the final approval, so a pre-qualification is not a commitment to lend. After the loan officer determines that you pre-qualify, he/she then issues you a pre-qualification letter. This pre-qualification letter is used when you are making an offer on a property. The pre-qualification letter indicates to the seller that you are qualified to purchase the house you are making an offer on.

Pre-approval is a step above pre-qualification. Pre-approval involves verifying your credit, down payment, employment history, etc. Your loan application is submitted to an underwriter and a decision is made regarding your loan application. If your loan is pre-approved, you are then issued a pre-approval certificate. Getting your loan pre-approved allows you to close very quickly when you do find a house. A pre-approval can help you negotiate a better price with the seller, since being pre-approved is very close to having cash in the bank to pay for the house!

What is a rate lock?

You cannot close a mortgage loan without locking in an interest rate. There are four components to a rate lock:

1. Loan program.
2. Interest rate.
3. Points.
4. Length of the lock.

The longer the length of the lock, the higher the points or the interest rate. This is because the longer the lock, the greater the risk for the lender offering that lock.

Let's say you lock in a 30-year fixed loan at 8% for 2 points for 15 days on March 2. This lock will expire on March 17 (if March 17 is a holiday then the lock is typically extended to the first working day after the 17th). The lender must disburse funds by March 17th, otherwise your rate lock expires, and your original rate-lock commitment is invalid.

The same lock might cost 2.25 points for a 30-day lock or 2.5 points for a 60-day lock. If you need a longer lock and do not want to pay the higher points, you may instead pay a higher rate.

After a lock expires, most lenders will let you re-lock at the higher of the original rate/points or current rate/points. In most cases you will not get a lower rate if rates drop.

Lenders can lose money if your lock expires. This is because they are taking a risk by letting you lock in advance. If rates move higher, they are forced to give you the original rate at which you locked. Lenders often protect themselves against rate fluctuations by hedging.

Some lenders do offer free float-downs––i.e. you may lock the rate initially and if the rates drop while your loan is in process, you will get the better rate. However, there is no free lunch––the free float-down is costly for the lender and you pay for this option indirectly, because the lender has to build the price of this option into the rate.

What do you do if the rates drop after you lock?

Most lenders will not budge unless the rates drop substantially (3/8% or more). This is because it is expensive for them to lock in interest rates. If lenders let the borrowers improve their rate every time the rates improved, they spend a lot of time relocking interest rates, since rates fluctuate daily. Also they would have to build this option into their rates and borrowers would wind up paying a higher rate.

Lock-and-shop programs.

Most lenders will let you lock in an interest rate only on a specific property. If you are shopping for a house, some lenders offer a lock-and-shop program that lets you lock in a rate before you find the house. This program is very useful when rates are rising.

New-construction rate locks.

Most lenders offer long-term locks for new construction. These locks do cost more and may require an up-front deposit. For example, a lender might offer a 180-day lock for 1 point over the cost of a 30-day lock, with 0.5 points being paid up-front, as a non-refundable deposit. Most long-term new-construction locks do offer a float-down––i.e. if rates drop prior to closing, you get the better rate.

What is an APR?

The annual percentage rate (APR) is an interest rate that is different from the note rate. It is commonly used to compare loan programs from different lenders. The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. Typically the APR is found next to the rate.

The APR does NOT affect your monthly payments. Your monthly payments are a function of the interest rate and the length of the loan.

The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the "true cost of a loan." It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.

If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan. Right? Wrong!

Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. The best way to compare loans in the author's opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.

The reason why APRs are confusing is because the rules to compute APR are not clearly defined.

What fees are included in the APR?

The following fees ARE generally included in the APR:

• Points - both discount points and origination points
• Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
• Loan-processing fee
• Underwriting fee
• Document-preparation fee
• Private mortgage-insurance

The following fees are SOMETIMES included in the APR:

• Loan-application fee
• Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)

The following fees are normally NOT included in the APR:

• Title or abstract fee
• Escrow fee
• Attorney fee
• Notary fee
• Document preparation (charged by the closing agent)
• Home-inspection fees
• Recording fee
• Transfer taxes
• Credit report
• Appraisal fee

An APR does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock may have a lower APR than a lender who offers you a 60-day rate lock!

Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs.

Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs. A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.

Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!

Conclusion :
Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.