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Navigating the Mortgage Maze
The Simple Truth About Financing Your Home
By Dale Vermillion, Jim Vincent
Northfield PublishingCopyright © 2009 Dale Vermillion
All rights reserved.
THE TOP 10 MORTGAGE Traps
Obtaining a mortgage creates the opportunity of home-ownership and all that goes with it: your own home, solid equity, a growing investment, even tax savings. But getting a mortgage can also be a complex and confusing process that includes obstacles and challenges, not unlike running a maze.
How do you navigate the mortgage maze? By having a map that helps you become aware of all the turns and sharp corners—those mistakes most first-time and repeat mortgage buyers make when they go to finance or refinance their home. Let's begin the process by looking at the top 10 mortgage mistakes homeowners make that get them caught in the traps.
Mistake #1: Making Rate the #1 Consideration
The Brunsons bought their home in the eighties when interest rates were high. They started with a 10 percent, thirty-year mortgage. Every time rates dropped, they refinanced. They just completed their eighth refinance and are down to a 5.0 percent interest rate, lower than any rate in the market! The Brunsons feel they have managed their mortgage very well and have saved themselves tens of thousands of dollars in payments over the years through the many rate reductions. Unfortunately, the Brunsons have actually lost hundreds of thousands of dollars without even knowing it. You see, although they have reduced their rate eight times, they have also extended their term eight times, paid fees eight times, and decreased their taxes eight times! The result: they have been paying for twenty-four years on their home, owe more today than they have ever owed, and are no closer to being debt free ... and retirement is twenty-four years closer than when they got their first mortgage! Although the Brunsons have the lowest rate they have ever had, they are in the worst position they have ever been!
Does the Brunsons' story sound familiar to you? Have you been a homeowner for several years and made this same mistake? How did this happen? We typically put our primary focus on interest rate and miss out on the real benefits of mortgage financing. It is the first question we generally ask and the one we put the most weight on when determining whether the loan is a "good deal." Believe it or not, the interest rate on a mortgage loan is not the number one consideration! For years I have taught mortgage professionals a simple concept: Rate Doesn't Matter.
I realize this sounds radical and ridiculous when you first hear it, but I will prove this concept to you throughout this book. In the mainstream media and by most mortgage loan officers, all we have ever been told is that rate matters! We have been programmed that rate is the primary consideration when borrowing—nothing is more important. That is not completely true. The truth is, when finding a mortgage loan that has true financial value, lasting monetary benefits, and good overall financial sense, the interest rate, although important, is only one of numerous criteria to consider—many of the others being equally or more important to the overall cost and benefits of the loan.
DID YOU KNOW?
A Good Faith Estimate (GFE) is just that—an estimate. It is not required to tell you what the actual rates, terms, fees, costs, and APR are going to be for the mortgage you ultimately get. Additionally, the GFEs are usually sent before the income is verified, appraisal is completed, and title is received. Changes in any of these could significantly change the terms of the mortgage loan the borrower was originally quoted. Many companies do not send a second GFE after final approval and, therefore, the borrower never sees the changes until the closing.
In most mortgage transactions, several considerations outweigh the interest rate—factors we will discuss and educate you on in detail. But for now, let me share with you a little-known fact:
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The rate you get on a mortgage loan is almost never the rate you actually pay.
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Mistake #2: The Payment Reduction Trap
The Williamses have decided to refinance their home to pay off their debts and reduce their payments. The bills have been mounting and they have come to the realization that they cannot afford their current payments comfortably. They max out their equity and consolidate several credit cards, an auto loan, a student loan, and their current mortgage into a new thirty-year loan. In doing so, they reduce their current total payments by $700 per month! They are pleased with their new payment andthink they have really helped themselves.
One year later they realize they actually put themselves in worse financial shape. Not only did they use the credit cards and run the balances right back up to the limits again, but because they had a free and clear title on the car they decided to use it to buy a new one. They thought they could afford it with their $700 payment reduction. In addition, to accomplish the lower payments while increasing the loan balance, they extended the term of the loan by five years when they refinanced. As a result, their overall debt and payments are now the highest they have ever been.
Most important, their consolidation loan did nothing in solving the real cause for their debt—their spending habits. Now they have less available cash and more debt, and they are further from a free and clear home than ever before!
This is the most common dilemma I have seen in my years in the mortgage business. This is a critical mistake that has destroyed marriages and homes. In our desire to improve our situation for the immediate future, we end up compromising our long-term security. Consolidating debt into a mortgage loan can be an effective and powerful way to use your home's equity if done correctly. However, when done incorrectly, it has devastating effects.
DID YOU KNOW?
Many borrowers pay more in costs and fees for their mortgage loan in the first few years than they gain in savings and benefits.
The primary mistake the Williamses made in consolidating their debts was putting too much focus on payment reduction. The extra cash flow they achieved created a false sense of security and led to their creating new debt. This also led to a five-year extension on their mortgage and dozens of years on their consumer debt. In other words, they increased both the amount and the length of their debt—two critical mistakes—all in the name of payment reduction. They never had a long-term financial plan in place to get out of debt or to own their home free and clear. Finally, they never sought counsel on managing their budget and spending habits to avoid getting back into trouble with their debt.
A proper consolidation loan can actually lead to debt reduction, term reduction, tax reduction, and substantial savings both short-and long-term. This kind of borrowing, combined with the proper budgeting, can lead to debt-free and financially astute living. This should be our ultimate goal with any mortgage transaction! The Bible says it best in Romans 13:8: "owe nothing to anyone—except for your obligation to love one another." Now that would be a life worth living!
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Our primary objective in every mortgage transaction should be to borrow in a way that reduces debt, improves financial stability, and helps us get debt free in as short a time as possible!
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Mistake #3: Focusing on Short-term Gain
Millions of unsuspecting borrowers between 2004 and 2006 purchased or refinanced homes during the mortgage "boom" at high loan to values (loan amounts that exceeded 90 percent of the customer's property value), when interest rates had reached all-time lows, property values had reached all-time highs, and lending programs were the most aggressive in U.S. history. Many of these borrowers, in an attempt to capitalize on the lowest possible interest rates, financed their loans through adjustable rate mortgages (ARMs) or "option-arm" mortgages with attractive rates that were fixed for only two-or three-year initial terms or had interest-only options.
In addition, many borrowed against their growing equity to get cash for short-term purposes. Unfortunately, the higher rate adjustments for those ARMs came during the mortgage and real estate "bust" that began in late 2006 and continued for more than two years, as interest rates escalated, property values plummeted, and availability of high loan-to-value programs evaporated. The result: Borrowers faced significant payment increases, and they could neither afford the higher payments nor obtain new financing to correct the situation. As of this writing, many homeowners are struggling through this situation, and some have even lost their homes in the process.
The soaring foreclosures in 2007 and 2008—foreclosure filings jumped 75 percent from April 2007 to April 2008—teach us that getting a mortgage for short-term gain with no regard for the long-term impact can be a devastating mistake! Most of us tend to look only at our short-term needs and situation when financing. As a result, we go into a mortgage transaction with a single thought in mind—solve today's problem or take advantage of today's opportunities. How many of these thoughts enter your mind or lips when borrowing?
"Right now I just need to focus on lowering my monthly payment(s) so I can pay my bills."
"Wow, rates are really low on adjustable rate mortgages, so I think I'll go with that for now and refinance to a fixed rate later."
"I just want to pay off those creditors as soon as possible so I can get them off my back."
"I want my dream home now."
"I just need to make sure my payments don't exceed $1,500, because that's all I can afford today."
When we go into a mortgage transaction with this kind of short-term mind-set, we make costly mistakes. Focusing only on the short term puts us in a position to make bad choices. We ignore all other factors that lead to the overall value of the loan in order to achieve that one singular goal now—whether the goal is a lower payment, a lower interest rate, or a dream home. In the long term, this always proves to be costly.
Mistake #4: Missing the "Big Picture about Debt"
The Ahmads are considering a mortgage refinance. They have over $30,000 in consumer debt, but do not want to include it in any refinancing because it is "personal" debt, not mortgage debt. They plan to pay off the debt balances with the payment savings they will receive from their mortgage refinance. They refinance their existing thirty-year mortgage to a new thirty-year mortgage and reduce their payments by $200 per month. Three years later they have even more consumer debt than when they originally refinanced. The money they saved just never made its way to pay off the consumer debt. So much for their plan ...
Have you been struggling with making payments on your debt for years and have had the equity to pay it off but just never felt it was the right thing to do? If so, you are like the Ahmads and many other families. We tend to compartmentalize our debt: categorizing our mortgage debt as one kind of debt, installment loans as another, and credit cards as still another. Most treat all personal (consumer) debt separately from mortgage debt. The fact is that debt is debt. All of it is owed and has to be paid back!
DID YOU KNOW?
According to BusinessWeek, U.S. households in 2008 owed almost $14 trillion, nearly equal to the annual output of the U.S. economy. According to the Federal Reserve Statistical Release on Consumer Credit, as of August 7, 2008, revolving debt increased at an annual rate of 7.4 percent in 2008 compared to 2.9 percent in 2003. In addition, "credit-card debt has been growing much faster than the economy—more than 8 percent in the final two quarters of 2007 and over 7 percent in May, 2008."
King Solomon addressed this situation in Proverbs 22:7 by saying, "Just as the rich rule the poor, so the borrower is the servant to the lender."
Did you know that through a mortgage loan you may actually be able to use your personal debt to eliminate all of your debt faster? Did you know that in many cases credit card debt is as long in term as many mortgages? Although debt is a "bad" thing, as a homeowner with equity, it can temporarily be a good thing, because it provides a means to actually leverage your payments and convert them into a far greater financial position. This is done by taking the high payments you are making on your existing debt, including your personal debt, and converting them into a mortgage loan that can create reductions in payment, term, and taxes, and possibly provide additional cash. We will teach you how to do this in detail later in this book. The key is in knowing how to borrow properly.
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Debt, when properly leveraged, can be converted directly into payment reduction, additional cash, increased tax deductibility, and term reduction with little or no initial cost!
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Mistake #5: The Equity Asset Trap
Mr. Jones has a $300,000 home with a $175,000 mortgage. He is looking to refinance his mortgage to a lower rate in order to lower his payments. He also would like to get $10,000 to complete some important improvements around the house. Mr. Jones qualifies for a loan that allows him to borrow up to 80 percent of his home's equity, which means he could get up to $65,000 cash. However, he wants to retain his equity as a safety net in case something unforeseen happens, so he only borrows the minimum of what he needs.
A year later, Mr. Jones loses his job. He is given only thirty days' pay and has no other job prospects. Six months later he is still out of work. He is financially strapped and behind on all of his bills. If only he had some cash in reserve! He has lots of equity in his home, but no way to access it because he cannot qualify for a mortgage loan in his current state. The only possible way he can get out of this situation now is to sell his dream home. Unfortunately, if he does so, not only does he have to uproot his family, but he still will not qualify for a loan to buy a new one.
If he had utilized his equity during his refinance and drawn out cash for investment, he would have had access to the cash as an emergency fund to get him through until the house sold. Unfortunately, all that equity is doing him little good right now.
Our home is the greatest asset that most of us will ever have. Our home's equity is what I refer to as our "hidden savings account." it is an asset that, if used properly, can be converted into cash for sound purposes. However, many people never take advantage of that opportunity. They treat their equity as a dormant asset just sitting there for a "rainy day." The fact is that your equity is here today, but can be gone tomorrow, as is evident in the cyclical increases—and decreases—in home values in the past decade (and even earlier). The problem with the declines in property values is they remove equity from homeowners—and once you lose equity you may not get it all back. Let me give you an analogy about a stock investment to really bring this point home.
DID YOU KNOW?
In the U.S. Census Bureau and Department of Housing and Urban Development's Current Housing Reports for 2005, it was estimated that there were 74,931,000 owner-occupied single-family homes in the United States. Of those, 24,776,000 (33 percent) were free and clear homes. Based on a median sales price of $240,900 in 2005, that represented 5.9 trillion dollars in unused equity from those homes alone.
Let's say you have stock in an investment account valued at $50,000 today. What's your stock's worth? You are probably thinking, That's a dumb question—it's worth $50,000! Actually, it's not! It is a stock—so it has value only on paper. In the real world it has real value only when you convert it to cash and make it a liquid asset.... It's worth nothing until you cash it in!
Equity works exactly the same way—your equity is worth nothing to you until you access it. To convert it from its dormant asset state to a liquid asset you have to "cash it in." This is a principle the majority of people miss and one we will discuss in great detail. There are two key principles when cashing in your equity:
1. Only cash in your equity for sound investment purposes with proper direction and advice, in conservative investments that protect the cash (and your equity).
2. Borrow in a way that allows you to reduce the balance on your mortgage faster so as to reestablish your equity and eliminate your debt at the same time.
Although these two rules appear to be at odds with each other, you can accomplish both if you borrow properly.
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When used properly and financed correctly, your home's equity can be used to achieve major life goals, such as college funding and retirement, while both offsetting the interest costs and accelerating the term reduction.
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Excerpted from Navigating the Mortgage Maze by Dale Vermillion, Jim Vincent. Copyright © 2009 Dale Vermillion. Excerpted by permission of Northfield Publishing.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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