Home Financing Advice

If there’s one topic that current and prospective homeowners have questions about, it’s home financing. About 6 months ago, my sister purchased a home but finding relevant loan advice proved a real challenge. Zillow has some great financing articles in our new wiki to address the basics. Financing might not be the most interesting topic of conversation for many, but when taking out a loan for $500,000 — or more in some of the nation’s expensive markets — it seems home buyers should know where to get the most relevant information and what it means.

Since I am unqualified to speak to the complex subject of home financing, I thought I’d ask Dan Melson, who is an active loan officer and real estate agent in the San Diego area. Why did I pick Dan? First of all, we like him because he hosted the 2nd Carnival of Real Estate. Second, and more importantly, he actively writes fantastic mortgage articles at Searchlight Crusade. I asked him the following questions that I think many home owners and current home buyers have in their search for the best loan:

• What should a first-time home buyer look for when comparing and contrasting loans from different sources?
• What are the biggest mistakes you see first-time home buyers make?
• When do 50-year mortgages make sense?
• What do you think about Adjustable Rate Mortgages (ARMs)?
• Is there a certain number people should be looking at when determining if they should refinance?

Hit the "Continue reading" link below for Dan’s responses to the financing questions above; hopefully you will find the answers as useful as I did. Dan has a wealth of great content on Searchlight Crusade blog if you’d like to learn more regarding refinancing or mortgages. If you have further questions, Dan’s e-mail can be found on his blog. 

Here’s my Q&A with Dan of Searchlight Crusade:

Q: What should a first-time time home buyer look for when comparing and contrasting loans from different sources?
1) Make certain you are really comparing the same type of loan.  Asking about the industry standard name for the type of loan you are contemplating helps.  Even if you don’t know what it means, the other loan officers you talk to will. 
2) There is always a trade off between rate and cost for the same type of loan.  One lender’s trade offs will be different than another lender’s, but you always have a range of choices, even with the same lender.  Just because one loan has a lower rate or lower payment doesn’t make it a better loan.  Find out the total cost of getting that rate, and figure out how long it will take you to recover costs via the lower interest rate.  Given how often most people refinance, a higher rate with a higher payment but lower costs is often the better bargain.  There is no sense in paying four points for a loan you are only likely to keep for two years.

Q: What are the biggest mistakes you see first-time time home buyers make?
Three most common disasters:
1) Buying or wanting a more expensive property than they can afford.  Any competent loan officer can get you a loan that you can not afford, but you still have to face the consequences later, and these consequences can be well buried.  Find out what you can really afford with a sustainable loan, and stick to it.  Settling for a lesser property is much smarter than buying something you cannot afford in the long run.
2) Not shopping around for services. Even if you trust your brother-in-law the real estate agent, or your sister-in law-the loan officer, shopping around gives them concrete reasons to stay honest.  The worst mess I ever cleaned up was caused by someone’s favorite uncle trying to make too much money, and the niece was blissfully unaware until her husband brought me into it - six weeks after it should have closed.
3) Believing that because someone puts some numbers onto a Good Faith Estimate (Mortgage Loan Disclosure Statement in California) that they intend to deliver that loan on those terms.  This is, unfortunately, not the case in the industry at large. If they do not guarantee their quote in writing, the Good Faith Estimate (or Mortgage Loan Disclosure Statement) is garbage, along with all of the other standard forms that you get with  it.  The only form that the law requires to be accurate is the HUD-1, which you do not get, even in preliminary form, until the loan is closing.  Big national lending institution everyone has heard of? Doesn’t mean a thing.  Ask the hard questions, and do not permit yourself to be distracted.

When do 50-year mortgages make sense?
Perversely, rates on 40-year amortizations are usually comparable to interest only, and fifty year amortization rates are usually higher. Nor are any of the these usually a good choice for a purchase money loan.  All three are strong indicators that you are trying to buy too expensive a property for your budget.  See Common Mistake Number One above.

What do you think about Adjustable Rate Mortgages (ARMs)?
I am a big fan of certain ARMs in most markets.  Most of the time, a fully amortized 5/1 ARM will be at least one full percent lower on the rate than a comparably expensive thirty year fixed, and the vast majority of people refinance within five years anyway.  Why pay for thirty years worth of insurance that your rate won’t change when you’re likely to let the lender off the hook within a few years anyway?  With that said, however, right now (late November 2006) the spread in rate is only about a quarter of a percent or less between a 5/1 ARM and a thirty year fixed - and at the low cost end of the spectrum, the thirty year fixed may actually be less expensive for the same rate, so I’m recommending thirty year fixed rate loans quite a bit right now.

Is there a certain number people should be looking at when determining if they should refinance?
Forget payment.  With no other information to go on, I would bet that someone trying to get you to refinance based upon a low payment was pushing a bad loan, and probably low-balling the payment as well. Once again, you’ve got to have a good conversation with the loan officer.  Look at the the money you will save from the lower interest rate - the interest charges to a loan.  If you’re saving half a percent on a $400,000 loan, that’s $2000 per year.  Compare this to the cost, and how long the rate is good for - or how long you’re likely to keep it, whichever is less.  If the cost is zero - and true zero cost loans do exist - you’re ahead from day one.  However, if it costs you $12,000, it’s going to take you six years to break even, and most folks will never keep the same loan six years in their lives.  Since there is no way to know for sure unless your prospective lender will guarantee the quote as to rate, total cost, and type of loan, you need to go in to final signing with the idea firmly in your mind that unless they can show both the cost and the benefit, you’re going to walk out without signing.  Indeed, many companies are very adept at pretending costs don’t exist, and hiding costs at closing.  Industry statistics: over half of all potential borrowers won’t even notice discrepancies at closing, and of the ones who do, eight to nine out of ten will just sign anyway.  This rewards people who lie to get you to sign up.  Haul out the HUD-1 form at closing and make certain it conforms to what you were told when you applied.  Most don’t, and the loan officer knew it wouldn’t when you signed up.  Read the Note carefully also, before you sign.