Like millions of other Americans, my wife and I are upside down on our home mortgage – i.e., the amount we owe exceeds our home’s value. If I had it to do over again, rather than buy with $0 down, I would rent, save money, and buy only after it made more financial sense than renting. If only I could go back in time to alter our decision to buy!
Oh well, our plan moving forward is to pay off our mortgage early and stay put until prices trend upward.
As an aside, if you want more information on buying a home vs. renting you can check out Laura’s view of the buy vs. rent dilemma, as well as my opinion on the same thing.
Mistake #1 – Zero down mortgage
So many new homeowners made the mistake of entering into a zero down mortgage. If you cannot afford a down payment of at least 20%, lenders typically require either a 2nd mortgage or carrying private mortgage insurance (PMI).
One positive result of the housing crisis has been a huge scaling back of the zero and low down payment mortgages, which has been a large contributing factor of plummeting home sales. Nowadays people who don’t have any money cannot buy houses. Go figure, right?
2nd mortgages and Private Mortgage Insurance (PMI):
Private mortgage insurance (PMI) is insurance payable to a lender or trustee for a pool of securities that may be required when taking out a mortgage loan. It is insurance to offset losses in the case where a mortgagor is unable to repay the loan and the lender is not able to recover its costs after foreclosure and sale of the mortgaged property. Typical rates are $55/mo. per $100,000 financed, or as high as $1,500/yr. for a typical $200,000 loan. (source)
A second mortgage (commonly used as an alternative to PMI) is a secured loan that is subordinate to another loan (your 1st mortgage) against the same property. The 2nd mortgage typically carries a significantly higher interest rate and is typically used as part or all of the 20% down payment. The higher rate is a reflection of increased risk to the lender, and results in much higher interest costs to the borrower over time.
We fell into this trap like so many others. We wanted to get into our new home now, and were ready to employ any creative financing necessary to make it happen… And so we entered into a 2nd mortgage for 25% of the purchase price (75/25 loan.)
To avoid a costly 2nd mortgages or PMI, save at least 20% of the purchase price of the home.
Mistake #2 – Buying high and selling low
Whether you’re trying to time the stock market or time real estate transactions, buying low and selling high should always be the goal. In a bad market the temptation to do the opposite can be powerful.
Take my housing situation, for example. I hate the fact that we have debt at all, and am very tempted to sell, despite the fact that we would have to take a loss! I’m tempted to sell our house for a loss and then rent for much less than our current mortgage payments and pay off our remaining debt while renting.
Though getting out from under the mortgages is tempting, I decided against it for mathematical reasons. If we were to sell now, we would not only lose money on the transaction, but we’d have to pay cash to our lender. If I could wind up even money, I would sell tomorrow. Instead, we are doing the next best thing… Making our 2nd mortgage the next victim of our debt snowball.
The faster we can reduce our amount owed, the sooner we can sell without any out-of-pocket costs. Our hope is that the housing market will bounce back in the mean time, affording us the option to sell for gain.
To avoid selling your home for less than you owe, increase mortgage principal payments and wait for the market to rebound.
It is worth mentioning that we cannot control market conditions, so we should spend our energy focusing on the factors that we can control:
- Once you have high interest consumer debts under control, focus your debt snowball on reducing your mortgage – and look into refinancing your mortgage to see if rates are attractive as you may be able lock in a lower rate. If you have a 2nd mortgage, pay it off ASAP. Those of you with PMI should also focus on reducing your mortgage principal to speed your ability to drop the PMI once your principal is reduced below 80% of the home value.
- Make property upgrades that raise the value more than the amount they cost to implement. DIY projects can cost very little, yet yield superb ROI.
Most who fall victim to either of these housing and mortgage blunders end up paying dearly. I hope this article will help future homebuyers avoid the same mistakes. For our next home purchase, my wife and I intend to save 100% of our payment before buying… But that is a post for another day!