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By Tara-Nicholle Nelson | Broker in San Francisco, CA

4 Unexpected Mortgage Decisions Every Buyer Will Face (and How to Make Them)

The financial end of home buying is, for many, the most intimidating piece of the entire experience. Why?  Well, most of us don’t sign 30-year financial obligations on a daily basis. Plus, the consequences of poor decision-making in this particular area stand out as particularly disastrous.

There are a few obvious decisions involved in the mortgage process - like 15-year or 30-year loan term, fixed vs. adjustable interest rate and FHA or Conventional - which buyers tend to make by default, based on what they can qualify for, what they can afford, their risk tolerance and market dynamics.

But the truth is, deep within the home buying process there is a laundry list of additional, critical mortgage decisions every buyer must make. Don’t let them surprise you: here are four of the most important mortgage decisions you might not be expecting or conscious of, and some factors to consider in making the right choice for you.

1. Mortgage or not.  It might surprise you to know that about ⅓ of American home owners have no mortgage at all. And this is not all people who have diligently paid their mortgages off over a 30-year period of time; just last year the National Association of Realtors reported that about 30 percent of buyers are purchasing their homes with 100 percent cash. While many are investors, there are many, many others who have simply saved up, received windfalls, are using the proceeds from another home to buy this one, or are buying distressed properties at bargain basement prices they can afford to purchase without a home loan.

In fact, the question of whether to take a mortgage or pay all cash is actually one of the most frequently submitted questions I receive here on Trulia! While the decision is an individual one, it should account for at least the following considerations:
  • All-cash purchases are seen as more competitive in multiple offer situations, and often receive a discount.
  • All-cash home purchases can save thousands of dollars on loan-related closing costs, including origination fees and insurance coverage designed to protect the lender.
  • The freedom from having that largest of monthly expenses - a mortgage payment - is, essentially, priceless.
  • The largest tax advantage of home ownership is the deduction of your mortgage interest - if you forego a mortgage entirely, you also opt out of that tax benefit (though you are still able to deduct your property taxes).
  • There might be opportunity costs to investing most or all of your cash into your home - before doing so, financial advisors suggest that you ask yourself how you could be growing those funds if you invested them elsewhere.

If you do decide to buy a home all-cash, make sure you still obtain inspections and title and hazard insurance to obtain the same protections that a mortgage lender would insist on. Your agent, attorney, financial advisor and CPA or tax professional should all be involved in your decision-making process.

2. How much to put down. Like the decision whether to use a mortgage or not to finance your home’s purchase, the decision of how much money to put down on a home can seem obvious if you’re scraping together every available penny to come up with the minimum down payment amount you need. But this is not the case for every home buyer  - there is a pretty delicate decision-making process that those with even slightly-better-feathered nest eggs must go through in the process of deciding how much of their cash cushion to invest up front.

Most buyers think they’ve dealt with this decision at the very beginning of the home buying process, telling their mortgage provider that they’d like to put $X down and have a mortgage payment no greater than $Y-per-month. But many are surprised to learn that they can able to qualify for a home they’d like while putting less down and keep some cash in the bank, or that they may be able to afford a pricier home at the same payment level if they stretch the same cash to cover a lower percentage down payment. And the opposite is true: some who plan to put 10 percent down end up preferring to buy a less costly house and stretch the same down payment to 15 or 20 percent.

The primary deciding factor in this calculus tend to be affordability - all things being equal, the lower the down payment, the higher the monthly payment. But that is far from the only consideration that should be accounted for in deciding how much to put down on a home.

One of the more critical decision factors is the issue of private mortgage insurance or PMI (aka mortgage insurance premium or MIP, for FHA loans). If you drop below the 20 percent down payment level, your lender will add a mortgage insurance policy to your loan which protects them from the possibility that you may default on your loan - and they will add the cost of that policy to your monthly mortgage payment and/or closing costs. Mortgage insurance can add hundreds of dollars to your monthly mortgage payment, and can add thousands to your up-front closing costs, but it might also be tax deductible.

Talk with your mortgage broker and tax professional to get a personalized understanding of how these costs and offsets would look, at various down payment levels. Ask your mortgage broker to give you loan scenarios with 5%, 10%, 15% and 20% down, if you want a concrete understanding of how your monthly payment and cash required to close will vary based on your down payment.

The decision of how much cash to put down should also be made with thought to how much cash you’ll want to have in reserves, to:
    • cover rainy day possibilities like disability and job loss
    • pay for the expenses of bringing a fixer-upper home into shape
    • and to account for the inevitable upgrading and maintaining the property.
(Some of these expenses can be hedged against, with things like disability insurance, long-term care insurance and home warranty plans.)

Also, the down payment decision requires many buyers to make decisions about alternative sources of assets, and the implications tapping into them for down payment money might trigger:  
  1. Down payment assistance programs: For instance, first-time buyer down payment assistance programs offered by many city and county governments seem attractive, but may require repayment in the event you sell or rent the home out in the 10, 20 or 30 years following the grant, and may also impose additional limitations on the type and location of the home you can purchase.  
  2. Retirement accounts: Additionally, some buyer/borrowers look to borrow down payment funds from their own 401K accounts or to draw cash out of their IRA accounts, each of which strategies has its own potential tax and strategic implications to take into account, which should be discussed at length with a retirement planner and a tax advisor in advance.
  3. Gift money: On another note, taking gift or loan money from relatives can activate gift money requirements from lenders that require you to put a certain level of cash in from your own funds - or require your donor to provide their own asset statements documenting the source of the funds. Gift money may also trigger relationship issues which should be considered deeply before accepting such a gift.  
  4. Wait and save: Of course, many buyers seeking to crank up their level of down payment cash will simply decide to save up more cash, in an effort to make their mortgage more affordable, be able to afford a pricier home or compete more effectively against other, cash-flush home buyers in a market where demand is high.  Because it may take months, even years, to save enough to make a big boost to your down payment, even these folks need to factor in how home prices and interest rates are likely to change in the time it will take to save those funds.

3. Impound account - or not. In loans with impound accounts, the buyer’s monthly mortgage payment to their lender includes not only the mortgage principal and interest, but also a monthly proration toward their property taxes, homeowners’ insurance and/or homeowners’ association (HOA) dues. The lender then deposits these funds into an “impound account” and makes the respective payments directly to the third parties involved, when they are due. Impound accounts have grown in popularity over the last decade, largely due to the uptick in FHA loans, which require them.  Other considerations in favor of having an impound account include the convenience of making only one payment, versus paying all these different bills, and the financial planning convenience of only having to budget for one line item toward housing, versus three or four.

On the other hand, impound accounts can also put your mind on financial autopilot with respect to these other bills, and can set homeowners up for big, bad surprises when their tax or insurance costs rise. For example, lenders may actually pay a property tax increase before adjusting your mortgage payment to account for it, so by the time you get wind that your taxes have gone up, you are forced to repay the overage plus pay the increased monthly allotment for future tax bills. This can result in a hefty, seemingly sudden change in your monthly mortgage payment obligations if you don’t pay close attention to your tax statements when they come from the County.

Additionally, some homeowners appreciate having the control over when they pay their insurance and property taxes. Those who are paid on commissions or otherwise have irregular income might like to be able to pay their property taxes once or twice a year and have the lower monthly payment possible with a no-impound mortgage. As well, mortgages with impound accounts often require a couple months’ worth of property tax, insurance and HOA payments to be collected at closing, jacking up the cash the buyer is required to bring to the closing table - sometimes by thousands of dollars.

4. What’s really important to you?  This is a decision which many home buyers make unconsciously, but it’s a critical one which deserves very deliberate, conscious attention. Many buyers got one of the #1 takeaways of the recession, which is that it is their own, personal responsibility to determine what they can afford, by running their own monthly budget and telling their mortgage professional how much they can spend every month toward their housing costs - rather than passively accepting the mortgage lender’s guideline-driven math that says what you can afford.

Less obvious are all the decisions that are built into the exercise of making a monthly budget, complete with a number of trade-offs. If you become frustrated by losing out to other offers or are unable to find a home that meets your wish list within your price range, return to the fundamental decisions you made, consciously or less so, during the budgeting process:
  • How much did you set aside for discretionary expenses like food (yes - you have to eat, but no - you don’t have to eat out 3 nights/week), travel, entertainment, clothing and other personal purchases?  
  • Do those allocations jive with how much you care about those items vs. your home?  
  • Can you cut $50 on one line item, or $100 on another and reallocate it toward housing, to get yourself closer to the home you really want?
  • Better yet: can you get superfrugal for 3 or 6 months and eliminate entire line items of expenses, like a credit card or other bill?

I know a married couple who was recently in tears over their inability to stretch their budget to beat out other offers for the homes they liked. Between the two of them, they own 3 near-new vehicles and a rarely-ridden Harley Davidson that just sits in the garage. When I gently suggested that selling a car and the bike might free up cash that could make the difference in allowing them to buy the sort of home they want, it was like a light switch flicked on!  They had lived with these luxuries for so long they had never seriously considered downgrading them to uplevel their house hunt.

At every point in the mortgage decision-making process, you are making subsconsious decisions about what is most important to you: your home or any of the other things you could be spendinthose dollars on. My recommendation is that you make those decisions consciously, based on values and priorities that are consistent with your vision for your life, and your dreams for your family.

Agents/Owners/Buyers: What surprise mortgage decisions have you been faced with? How did you make them? Any regrets or advice?

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Comments

By Helen Oliveri,  Thu Sep 6 2012, 10:00
Great Advice Tara.
By Icarus,  Thu Sep 6 2012, 10:07
I would have titled this Four Aspects of Mortages you Really Need to Think About
By Chuck Taylor,  Thu Sep 6 2012, 10:48
Yes some rock solid advice for home buyers and nice to have it reiterated. Hope all realestate professionals can use this to guide their clients. NOW TARA, talking about MIP and short sales. Do we have an article showing where a bank is more likely to foreclose than do a short sale?
By David Sheir,  Thu Sep 6 2012, 11:07
Well written article.
By Debra Gurin,  Thu Sep 6 2012, 11:46
Wow- talk about in a nutshell- super info!
By Cynthia Limjoco,  Thu Sep 6 2012, 11:56
Pls refer to By Chuck Taylor Thu Sep 6/12. Is there an article where a bank is more likely to foreclose than do a short sale? Would appreciate to hear on this. Thank you/C. Limjoco 9//6th.
By Bfleming15,  Thu Sep 6 2012, 11:58
I'm a first time home buyer( seeking to buy) this information was great. It help me out a lot. It's great to be inform. thanks
By Gene Neal,  Thu Sep 6 2012, 12:01
Good article and I am a Mortgage Broker.
By Betty Prokos,  Thu Sep 6 2012, 12:49
This article on mortgages, covered the many aspects to mortgaging that most buyers are not familiar with.The more informed a buyer is about all the costs of buying property, the better.
Buyer surprises at closing are very unpleasant. Insist on a "good faith estimate" from several lenders before you decide.I give this advise to as many of my buyers who will listen.You don't buy the first property you see.Don't take the first mortgage you're offered.
By Maggie Hawk,  Thu Sep 6 2012, 13:08
I especially like item number 4. When I'm working with a Buyer, I usually make the comment upfront that I can't find their ideal home--no agent can. The decision of which home to purchase is theirs and theirs alone, and most likely it will involve some compromise. I then go on to explain that, unless they have unlimited funds (and few of us do), the home-buying process will force them to examine their priorities and discover what's really important to them. For most couples, home buying puts them in a position where they need to talk to each other about what their individual likes and dislikes are. It's a valuable exercise, and can turn into a learning process for all of us--Buyers and Realtor.
By I. Shiffman,  Thu Sep 6 2012, 13:31
I'm an old mortgage broker. During my career very few if any loans I negotiated were foreclosed on -. Now in order to get a mortgage loan you have to jump through hoops and give blood before you are approved. It was a lot easier 20 or so years ago and that was before the real estate holocaust. What I am saying is there is way too much red tape and a real turnoff.
By Karl LeBlanc (281) 298-5322,  Thu Sep 6 2012, 13:40
The mortgage industry has over corrected itself . The red tape is more important than what is a common sense .
By Mary King,  Thu Sep 6 2012, 13:45
I'm a real estate agent and agree with all the above.
I would also like to comment on the fact that if it's a choice between paying cash on a property or leveraging it, then as a Buyers Agent I can tell you that it is so much easier to get a lower bid accepted with all cash, for obvious reasons. Great article, as always!
By Sue Augustus,  Thu Sep 6 2012, 14:02
Don't forget to guide those, who qualify, to a VA mortgage! I don't think you can beat it.
By Ellen Derby,  Thu Sep 6 2012, 15:01
the surprise question we faced when we bought our home 11 years ago was do we want to lock into the mortgage rate today (in the bank to do some paperwork) or wait until the actual closing. At the time the mortgage rates were fluctuating every few days. It was asking us to take a gamble on sticking with what we knew, vs hoping the rate would drop or risking a rise. It wasn't a nice feeling.
By Pgrant66,  Thu Sep 6 2012, 15:11
Great article! Thank youn for your advice. This is a definate guide for me. I am a first time home buyer still searching for the right home.
By Chris Carter, MORTGAGE LENDER,  Thu Sep 6 2012, 15:40
Buyers should know that if they opt out of escrow/impound, their rate may increase by .25. This is one of the questions that should be asked right up front.
By Bill,  Thu Sep 6 2012, 15:42
I would like you to include information on VA loans as well. We are searching for a house now using my VA certificate. What unexpected hurdles might I encounter?
By nurselili83,  Thu Sep 6 2012, 16:27
Thanks for the advice. I'm getting a second good faith estimate tomorrow!
By Juliealdarondo,  Thu Sep 6 2012, 18:27
I'm looking to rent a townhome, I like HOWELL BRANCH COVES but before for 3 bedrooms 2 bath the monthly rent was $840.00 but right NOW its $100.000 and something.any how for that price I should by a townhome no rent.pleases give me an advise.
Thank you
Julie
By Bfleming15,  Thu Sep 6 2012, 18:35
Is it nessesary to have a home warranty vs home insurance?
By Steve Turkopp,  Thu Sep 6 2012, 18:59
Excellent advice Tara. Some of these things I hadn't even considered. You've given me a lot to think about.
By Dawn Welters,  Thu Sep 6 2012, 19:16
My question is for FHA why is it required to pay home insurance through them if i would save on monthly expenses by using someone else? I get a better rate with my own insurance agent for being a teacher, having multiple policies and payroll deduction so it's still not a bill i have to think about every month as it is automatic. I would much rather prefer to go with him and save money since I've done business with him. Do you absolutely have to use who the lender says use?
By Rose,  Thu Sep 6 2012, 20:10
Great article! It provided a lot of valuable information and a lot of "food for thought." Thank you for offering this service.
By Rose,  Thu Sep 6 2012, 20:10
Great article! It provided a lot of valuable information and a lot of "food for thought." Thank you for offering this service.
By Mayra Espinosa 650-996-8961,  Thu Sep 6 2012, 21:13
Great post Tara, I am sending this article to all my buyers. Thanks for sharing!
By oheneselorm,  Fri Sep 7 2012, 00:51
Great Article. I will need to read it for the second time
By Craig,  Fri Sep 7 2012, 07:10
Well written, and a lot of great facts and ideas. One thing that I would like to add, however, regarding the deduction of mortgage interest as a tax advantage. Using this tax advantage as a primary reason for taking out a mortgage, or not paying off a mortgage early, is something we often hear. The truth is, if a person were not paying mortgage interest, that person could give the exact same amount of money to a charitable organization and be entitled to the same tax advantages as mortgage interest, and probably do a lot more good in his or her community. Of course you would want to consult with your tax advisor regarding charitable donations and whether the organization to which you intend to donate is an organization that qualifies for deductible donations. Just a thought.
By Clara Freeland,  Fri Sep 7 2012, 08:34
Very informative! I'm thinking we should give a copy of this article to prospective buyers we are working with to help inform them. Thanks for the information!
By Mark Acantilado,  Fri Sep 7 2012, 09:17
IMO, Getting a mortgage or at least any type of loan would do help improve your credit rating - provided that you pay on time and give a positive feedback from your lender. In this case, whenever you plan to get another mortgage loan after completing your current - you may get pre-approved faster and get better rates to your loan.


Mark T | http://www.agentcampus.com
By Bonita Gillis, CNE AGENT,  Fri Sep 7 2012, 12:13
Great info, Tara. So important that buyers research options early, and ask their lender to spell out some options IN WRITING on an Estimated Fee Sheet very early on. This way buyers can actually SEE the numbers and make better sense of the info.
By Gloria Janeen Smith,  Fri Sep 7 2012, 13:02
My current lender charges a substantial fee (!!!) if you choose to pay your own taxes and insurance. That led me to set up an impound account, even though I had to pay more at closing. At least the impounds would go to pay necessary expenses and be refundable, unlike a one-time fee!
By Dwayne R. Saunders,  Sat Sep 8 2012, 15:28
Good info, Tara, thanks! I plan to share these thoughtful comments with clients and friends. FHA, Conventional & VA available loan options are good to consider when buying a home. With mortgage interest at historically low rates, buying a home in today's market is the right move for some.
By ccnz4enaz,  Sat Sep 8 2012, 22:20
We are also looking at FHA, Dawn Welters, and I THINK you are confusing the Mortgage insurance with Home Owners Insurance. If I'm not mistaken, Mortgage Insurance has to do with the bank's security if you default (kind of like a PMI) which is paid with your mortgage as part of your house payment. And then, Home Owners Insurance is what our financial guru called "Hazard Insurance". This type of insurance you would get through your own company to cover losses for fire and theft.(etc) If I am incorrect, I hope one of the agents posting here or maybe Tara can clear this up for both of us. Good luck Dawn...happy house buying....(and great article as usually Tara thank you so much from all of us who are still learning)
By sevrin77,  Sun Sep 9 2012, 20:35
a section on "using a reverse mortgage to purchase a home" would be a good addition to your article here.
By Voices Member,  Sun Sep 9 2012, 23:07
yes, very useful advice.
By Judith Watkins,  Mon Sep 10 2012, 10:03
Ain't that the truth!! Prospective Buyers should be aware of the many options that are available. Good article. I will definitely forward it to my Buyers.
By Mark Acantilado,  Tue Sep 11 2012, 04:12
Perhaps, their best option are looking for best and trustworthy realtors/lenders in their area .
By Manisha Jain, Broker, Realtor,  Tue Sep 11 2012, 18:36
Agree with you completely !
By Bridgette Grice,  Wed Sep 12 2012, 13:14
Agree
By Manuel Ramirez,  Tue Sep 18 2012, 23:48
Very interesting and useful as m agree too. Thanks a lot for sharing it.
By Marc,  Mon May 20 2013, 03:28
I also went and visited O’Reilly Open Source Conference, and I enjoyed every minute of it. High quality lectures and discussions. Add: http://chexsystemsremovals.com/what-you-need-to-know-about-no-chexsystems-bank-accounts/
By Maggie,  Sun Oct 5 2014, 00:38
Thanks for such a detailed advice. I come under the category of a home buyer. Equity or Down Payment is what to look into the most when it comes to home equity mortgages ( http://www.5yearmortgagerate.com/understanding-credit/ ). This is because higher the down payment lesser is the burden of debt. Thanks for the article!

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