10 Common Mortgage Mistakes and How to Avoid Them

Buying a home is the most expensive purchase most of us will ever make, and a mortgage is probably the biggest debt we will ever carry. That's why it's important to avoid common mortgage mistakes that leave you paying more than you should. Instead, be informed and get a great rate for an affordable property you love. If you’ll be in the market for a new home soon, make sure you avoid the following mortgage mistakes.

1. Not Building or Fixing Your Credit Before Applying

Before you start the homebuying process, ensure your credit score is in good shape. At least six months before you go to your first open house, visit AnnualCreditReport.com and request a copy of your credit report from each of the big three reporting agencies: Experian, Equifax, and TransUnion. (You can get a free copy from each of the three main credit bureaus yearly.)

Review the reports and pay off any delinquent bills as soon as you can — before you begin the mortgage preapproval process. If you see any errors, dispute them immediately because any mistakes could lead to a higher mortgage rate or even a loan rejection. In addition to your credit reports, also keep an eye on your credit score. Some banks and credit cards now offer the most widely used credit score, the FICO score, as a monthly perk for their customers. (Note that these are not always the most accurate, and don’t be surprised if the score on your report doesn’t match the apps.)

Most mortgage lenders require a minimum credit score of 620 to obtain a home loan, but 740 or above is ideal. If your score is lacking, spend six months to a year improving it. To find out how to increase your credit score to buy a house, check out our guide. 

Pro tip: After becoming preapproved for a loan, try not to make any changes to your credit, good or bad, including closing or opening credit card accounts. This can adversely affect your approval for a mortgage loan.

2. Not Shopping for the Best Rate

The average consumer searches for the best deals on groceries, services, furniture, and cars, but assuming all interest rates will be the same is a big mortgage mistake. You'll want to get quotes from multiple lenders to find the best deal. Check with a local bank and a credit union and get an online quote or two. Credit unions offer creative mortgages that can save you money.

However, keep in mind that every time a lender pulls your credit to give you a quote for a mortgage interest rate, it will damage your credit score. You can minimize the potential damage to your credit score by getting all quotes within 14 days, so it doesn't look like you're applying for multiple loans from multiple lenders each time.

3. Making Yourself “House Poor”

Committing too much of your monthly income to housing-related costs is a common mortgage mistake that leaves you little or no money left over for anything else. So, when figuring out how much house you can afford, factor in other important expenses aside from bills — things like saving for retirement, emergency expenses (medical, car repairs, and so on), and even the cost of furnishing your brand new home.

Spending less than 25% to 28% of your pretax income on housing is the fundamental rule for determining how much you can truly afford to pay. Make sure to include in your housing costs not just mortgage payments but insurance fees, taxes, and any homeowners’ association fees. What the bank says you can afford (based on how much they'll lend you) may not be what you can afford to live comfortably. Many first-time homeowners are surprised by all the expenses associated with owning a home, so it's crucial that you are prepared with a realistic budget before you buy.

4. Failing to Get Preapproved

Getting preapproved for a mortgage is important before you start looking for your new home. By doing this, you can get an idea of what kind of home you can afford and what the monthly payment might be like. Getting preapproved can also help avoid the disappointment of losing a house you’ve fallen in love with. It may even give you a competitive edge if there are multiple offers on the same property. A seller will feel more confident selecting a bid from someone with mortgage preapproval over a person who hasn’t even begun the process. Remember, what the bank thinks you can afford and what you can afford may be two different numbers.

5. Forgetting About the Loan-to-Value Ratio

Your loan-to-value (LTV) ratio is essential to getting an appropriate loan because it determines how much a lender will give you. To determine the LTV ratio for a home you're considering, divide the desired loan amount by the home’s market value, then multiply that number by 100. The higher the percentage you get, the higher the risk the lender considers the loan. A popular mortgage mistake is trying to obtain a loan with an LTV ratio higher than 80%, as many lenders will reject the application. Know your loan-to-value ratio before applying for a specific amount of money.

6. Putting Too Much or Too Little Down

Generally, you need to have a down payment of between 5% and 20% to qualify for a conventional loan. And if you put down less than 20%, your lender will typically require you to have private mortgage insurance (PMI) — an extra cost that can add $100 or more to your monthly payments. It can take two to seven years to build enough equity to lower the outstanding balance to cancel the PMI.

FHA loans require upfront mortgage insurance that can be rolled into the amount borrowed, as well as an annual premium that is a percentage of the loan balance. FHA loans require mortgage insurance until the loan is paid in full. Plus, lower down payments will mean higher monthly mortgage payments, which can put a strain on many people's monthly budgets.

While paying a larger down payment has many benefits — like a wider selection of mortgage lenders, lower interest rates, and a lower monthly payment — too large of a down payment is an uncommon mortgage mistake that can have drawbacks. In the short term, financial emergencies can leave you scrambling to find money that's now tied up in a mortgage, especially when you have closing costs to pay on a home. In the long term, it can put your financial footing on thin ice, assuming you’ve emptied a large portion of your savings for the larger down payment.

7. Not Understanding Your Mortgage Terms and Ignoring APR

Don’t just sign on the dotted line without fully understanding all the terms and fees you'll be bound to. Some lenders advertise low interest rates, but they compensate for them with high fees that aren't always obvious in the contract. You need to compare the annual percentage rate (APR) from the loan estimate form your lender must provide to see which mortgage really costs the least. The APR includes lender fees and shows the loan's true cost.

If you don't fully understand the documents you're about to sign, ask a lawyer, your real estate agent, or even a family member or friend to review the terms of the loan with you. You can do this ahead of time, but even if you get to the moment of signing and still don't understand something, it’s better to ask for clarification than to sign something that doesn’t make sense to you.

8. Failing to Negotiate “Junk Fees”

While you’re investigating rates, don’t forget that a common mortgage mistake is overlooking those that come packed full of junk fees. Some, such as your county recording fee, are likely fixed, but many of them can be negotiated down or altogether removed.

The key is knowing what to expect so you can take action. Before your closing, you should be provided with a “good faith estimate” of the fees. Ask your lender to review what they are for and then see if you can negotiate a lower price. Ask your real estate professional to help you with the negotiation process. These are a few of the fees likely to have the most wiggle room:

1. Loan origination fee
2. Application fee
3. Broker fee
4. Underwriting fee
5. Sign-up fee
6. Document preparation fee
7. Messenger fee

9. Forgetting About Closing Costs

It's easy to become focused on how much you need to borrow to buy the house you want and forget about costs that come later in the home-buying process that could break your budget. On average, closing costs can make up 2% to 6% of a home's total price, and since the closing stage can be a hectic time for home buyers, it's easy to overlook this mortgage mistake. If an inspection reveals any issues that need to be addressed by the owner, closing costs might change towards the end of the sale. However, you can deduct a rough estimate of these costs from your total available funds before you get preapproved for a loan, which also can help you clarify how much home you can afford.

10. Choosing the Wrong Loan Type

A quality mortgage lender will help you find a loan type that fits your situation and needs. However, it's still possible to be seduced by a loan that seems attractive but is ultimately not good for you. For example, the monthly payments on an adjustable-rate mortgage (ARM) may seem very attractive at first, but if you're planning on living in the home for longer than 10 years, it may end up costing you more later as rates fluctuate and rise. Alternatively, choosing a loan with long-term amortization, like 35- and 40-year mortgages, probably isn't a good choice for older buyers and those not planning to stay in their homes very long. 

Assuming you need a standard mortgage when you qualify for a Federal Housing Administration (FHA) loan is another common mortgage mistake, as the latter could provide you with better loan terms. Also, it’s a good idea to avoid negative amortization loans, which allow you to put off interest payments to the future They can have low upfront costs, but they can make it easy for the loan repayment amount to grow larger than your home’s value, leading to defaulting on your mortgage and massive debt.

Funding Your New Home

Even some of the best mortgage lenders need your help to find you the loan that's right for you. Familiarizing yourself with these mortgage mistakes can help you be aware of what to look out for when financing your home purchase. When you do find the right loan type and terms, your new home will be a source of enjoyment for years to come, instead of an unnecessary financial burden.

Once you get approved for a mortgage loan, learn how to negotiate a home warranty with a seller to gain further financial protection. And when the home sale is finally complete, check out our new homeowner checklist.

The contents of this article are provided for general guidance only. First American Home Warranty does not assume any responsibility for losses or damages as a result of using this information.