A long time ago, my husband and I purchased our first house.
At the time, we were both young and relatively inexperienced in the world of personal finance. We were eager to get into a property. And we listened to the advice of a mortgage broker ready and willing to help us with our purchase.
Unfortunately, we inadvertently ended up making two big mistakes due to our reliance on the so-called professional and our lack of knowledge about the long-term implications of our decisions concerning our real estate purchase. If you're thinking of buying property of your own, understanding the errors we made could potentially help you make more informed choices and avoid falling into the traps we did. Here's what those were.
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1. Taking out an adjustable-rate mortgage
Our mortgage broker encouraged us to take out an adjustable-rate mortgage (ARM) when we bought our property. Specifically, it was a 5/1 ARM, which meant the initial rate was guaranteed to remain stable for just the first five years. After that time, it would begin adjusting annually, based on the movement of a financial index.
We easily could have afforded the payments on a 30-year fixed-rate loan. Our rate would have remained the same for the entire payback period with that option. But the rate was lower on the ARM, so our broker encouraged us to choose it to bring down our monthly payment and pay less interest up front.
The only problem, of course, is that when it got close to the end of five years, rates were higher than they'd been when we initially purchased. Faced with uncertainty over how high they could go -- and unhappy with how expensive our loan could become -- we opted to refinance ASAP.
Refinancing meant accepting a rate and monthly payment that weren't just higher than we were currently paying but also higher than we could've qualified for four years prior. We also had to pay a second set of closing costs upon refinancing, which totaled several thousand dollars and ate up a lot of the interest we'd saved by having the more affordable loan for the previous four years.
Now, an ARM isn't always a mistake. If you will definitely move or refinance before your rate begins adjusting and the rate on the ARM is considerably lower than on its fixed-rate counterparts, it may make sense to take advantage of the savings the ARM offers. But it's risky, and opting for uncertainty in your mortgage could easily be a mistake you regret, just as we did.
2. Making a 10% down payment
The other big mistake we made was making just a 10% down payment. We wanted to get into a house ASAP after getting married, and we found one we loved. As a result, we didn't want to wait until we'd saved up more money to put down.
Unfortunately, putting less than 20% down on the home meant we were responsible for buying private mortgage insurance (PMI). This added a few hundred dollars to our monthly bill as PMI payments usually come at a yearly cost of around 0.5% to 1% of the total borrowed. PMI didn't provide us any protection but rather protected our lender in case of foreclosure -- but we had to pay for it anyway.
Each month, the PMI premiums took a chunk of cash out of our budgets that we couldn't use for other things. We regretted the choice because we could have bought a less expensive property or waited a little bit longer to purchase and avoided this unnecessary expense.
Again, buying with a small down payment isn't a mistake in every situation. If you live in a very expensive area and it's the only way to get on the property ladder, it may be worth incurring PMI costs to become a homeowner. That's especially true if you can get into a property likely to increase in value quickly. But if you can avoid incurring additional housing costs, doing so is often a better bet.
Now, we were actually lucky that the worst things that happened with our real estate purchase were an inconveniently timed refinance, a slight increase in our rate, and a few extra thousand dollars in PMI payments.
An ARM that becomes unaffordable could easily result in foreclosure, while a small down payment could leave you owing more than your home is worth and unable to sell or refinance without bringing cash to the table. Neither happened in our situation, but they could have -- and they're risks worth considering when purchasing a home of your own if you're faced with the same decisions my husband and I were.
