Mortgage Insights Blog

Most people whose homes are destroyed by fire have insurance policies designed to cover the cost of replacing the home and all it contained.

But whether the insurance policy actually delivers on the hope of rebuilding a home can depend on how good a job homeowners - and their insurance agents - have done setting up the policy and keeping it current.

A good insurance policy must be based on up-to-date information about a home, experts say, and includes provisions to rebuild a home so that it meets current building safety standards.

Insurance companies base the coverage limit in most homeowners' policies on what they judge to be the replacement cost of a home and all its contents. To calculate that cost, they gather information about the size, location, building materials and contents of a home. They plug that into a database that tells approximately how much it would cost to rebuild and replace that home.

Replacement costs for a Santa Clara County home could range from about $200 a square foot to $500 or more, said Ron Lewis, an independent insurance broker with the Jack Healey Insurance Agency in San Jose.

But it's easy for the calculation to be wrong, or just out of date. It's up to homeowners to decide whether their coverage is adequate, and keep their insurer informed of changes that would affect their need for coverage.

For example, homeowners who elaborately remodeled their kitchen but never increased the coverage limits on their policy might find that if the house is destroyed, their policy wouldn't stretch to cover the cost of rebuilding the fancier kitchen.

Another thing to watch out for: Some homeowners' policies cover the costs of rebuilding a home so that it meets standards set by current building codes. Without such coverage, the homeowner pays the difference to rebuild the home so it's up to code.

The California Department of Insurance has no estimate of what portion of the state's homeowners have insurance policies that are not sufficient to replace homes in the event of a total loss, said Molly DeFrank, a spokeswoman for state Insurance Commissioner Steve Poizner. But of the 285 complaints the department received after the Southern California fires in October, 21 percent were related to under-insurance, she said.

Ron Lewis said it would not surprise him if many more homeowners than that were underinsured.

"If it was 50 percent it wouldn't surprise me," he said. And by underinsured, he means many homeowners' policies could fall 20 or 25 percent short of covering the cost of rebuilding and replacing their homes and personal property.

Part of the problem, he and others say, is that not enough homeowners review their policies every year, or even know what they cover.

Lewis said homeowners should review the "property disclosure" form insurance carriers are required to provide customers. This is where insurers spell out what they mean by replacement costs; some insurers, for example, will pay out 20 or 50 percent more than the coverage limit if the home must be rebuilt.

Part 3 of our 5 part series: It's surprising how many consumers make the same credit scoring mistakes over and over again. In an effort to educate consumers on credit and credit scoring, we've compiled 5 common credit scoring mistakes into a list that defines each mistake and explains why they are bad and how to avoid them. We will be releasing one per day. Here is:

Credit Mistake #3: Settling Accounts

One of the most common mistakes consumers make is assuming that 'settling' with a lender is a great way to save a little cash.

Unfortunately, they don't realize what that a 'settled' indicator in their credit reports is actually derogatory.

"Settling" is a term used in the consumer credit industry that means accepting less than the amount you owe on an account. For example, if you owe a credit card company $5,000 but you can't pay them the full amount then they will likely make you a deal for less than that full amount. They have "settled" for less than the full amount, which is likely much less than you contractually owe them.

This may seem like a good idea because you save quite a bit of money but as far as the credit scoring models are concerned, this is just as negative as other severe late payments.

The only way to avoid the damage to your credit scores is to arrange a deal with the lender to report the account as 'paid in full' as opposed to 'settled'. If they don't agree then it's in your best interest to figure out how to pay them in full or else be prepared to suffer the damage to your credit for the next 7 years.

It's also important to understand that if the account has already made it to the collection phase, the damage is already severe and settling won't really make a difference. Settling is only an option if the account has already made it to a severe delinquency state.

It's surprising how many consumers make the same credit scoring mistakes over and over again. In an effort to educate consumers on credit and credit scoring, we've compiled 5 common credit scoring mistakes into a list that defines each mistake and explains why they are bad and how to avoid them. We will be releasing one per day. Here is:

Credit Mistake #1: Closing Credit Cards Accounts

This is probably THE biggest credit mistake that consumers make. What you may find surprising is that closing credit card accounts can hurt your credit score almost as badly as missing a payment.

Not only is this the number one on the top five credit scoring mistakes, it's also number one on the list of credit myths.

Ironically, most consumers make this mistake based on poor advice from a mortgage lender as a strategy for improving their credit scores. A word of advice people, when you're dealing with something as sensitive as your credit and credit scores, make sure you do your homework before trusting some of these so called 'industry experts' before following through with their advice.

There are two important reasons why you should not close credit card accounts:

1. Eventually, the accounts will fall off of your credit reports - The information in your credit reports are subject to certain rules in regards to how long it can remain in the report. In most cases, credit information will remain in your credit reports for seven years from the account's DLA or date of last activity.

When an account is open, the DLA will continue to update each month and the open account will never reach that seven-year mark.

If you close the account, the DLA will stop updating and the clock will start ticking. Eventually the account will be completely removed from your credit reports.

Why would this be a bad thing?

It's simple - you never want to get rid of old, positive information in your credit reports. This information actually helps your credit scores.

Credit scores want to see this positive account information. They want to see your long, perfect history of making your payments on time because this information significantly helps your credit scores.

This information significantly helps your credit scores so why would you ever want that history to disappear? You wouldn't! Here's an analogy for you: let's say you made straight A's in high school. What if the record of that perfect scholastic accomplishment were permanently deleted seven years after you graduated? Would you ever want that history deleted? Of course you wouldn't. The same is true for the credit reporting environment.

So, what should you do with old credit cards that you don't use any longer?

What you don't want to do is to let the account become inactive. When this happens, the credit card companies aren't generating any revenue for your account.

Eventually they'll close the unused account because you're more of a liability than an asset. You can prevent this from happening by using the card every few months for low dollar purchases like dinner or a tank of gas.

When the bill comes in, just pay it in full. If you do this, it will ensure that the account will never be closed and you'll always get credit for your good payment history.

2. You could cause a spike in your revolving utilization and tank your scores - The percentage of your available credit in comparison to the debt you owe is a very important factor in calculating your credit scores.

This is often called "revolving utilization," or your debt-to-limit ratio.

For example, if you have an open credit card with a $1,000 credit limit and a $500 balance then you are using 50% of your available credit. This means that you are 50% utilized on this particular credit card.

Now lets add a second credit card to the mix.

Let's say you have another open, but unused credit card account with a $1,000 limit and a $0 balance. This would put your total revolving utilization at 25% because you have $2,000 in available credit limits and $500 in total balances.

If you divide your total balances by your total credit limits, you'll get your total aggregate revolving utilization: $500 divided by $2000 equals .25 or 25%.

So how will closing unused credit cards hurt your credit score? When you close an account, the amount of available credit decreases, which could result in a higher revolving utilization and lower your score.

Let's use the example from above and close the second unused credit card account. When you close the account, you remove it from any utilization calculation and now you're stuck with one open credit card account with a $1,000 limit and a $500 balance.

This caused your utilization to go from 25% to 50%.

Remember, you divide the total balance by the total available limit so $500 divided by $1,000 is .50 or 50%. As this percentage increases, your credit score decreases.

When you're talking about several unused credit cards with high limits, you can just imagine what closing credit card accounts could do. I've seen consumers go from a 10% utilization to almost 100% utilization because they closed all of their credit card accounts except the one they were currently using.

Big mistake.

Buying a home for the first time is both exciting and nerve-racking. It is something everyone dreams of, but it is also a huge commitment. Before you contact a local real estate agent who can take you on a tour of local homes open houses, start by getting pre-approved by a local mortgage broker or lender. A pre-approval is more involved than just a simple pre-qualification, but once you are pre-approved you will have a more realistic expectation of the price range that you should be looking into and puts you in a better position with sellers when you make an offer.

If you’ve set a timetable for buying a home, make an effort to pay down your credit card debt before applying for a loan. Your debt will have a major impact on how much you can borrow. Also, be sure to take the time to research all the different types of home loans available. For instance, be sure that the lender or mortgage broker you contact will help you find out if you qualify for a Veterans Affairs loan, Fannie Mae or Federal Housing Administration loan, which requires a smaller down payment. And, some lenders even offer special programs for first-time buyers and others can direct you to down-payment assistance programs available to low-income earners through state, county and community redevelopment offices such as CalHFA.

After determining your mortgage options and possible down-payment assistance programs, you should think about how much of a down payment you can realistically afford. If you don t have much money saved, you may be able to arrange a loan from a parent or relative who is willing to help out. Experts advise that your annual mortgage payment, taxes and homeowner s insurance should not exceed 28 percent of your gross income. As you calculate how much you can put toward a down payment, be sure to set aside three to five percent of the home s value for closing costs and remember to keep some money in reserve for extra mortgage payment, furnishings, moving expenses, etc.

Once you have a comfortable price range in mind you should begin contacting local Realtors who can make recommendations of neighborhoods where you think you might like to live based on your particular search criteria. Decide which features in a home are most important to you and write them down. For example, if you cook a lot a big kitchen may be a priority. For couples with children a location with a good school district is a must. Some features like a fireplace, patio or large dining room may not be that important to you.

The next step is to drive through the neighborhoods as recommended by your real estate agent and take notes of the homes for sale that catch your attention along with the distance to schools and the overall feel of the neighborhoods. You can save time and gas by doing some preliminary research online and by looking through the real estate listings on-line (www.mlslistings.com) and in local newspapers.

Don’t get too carried away with the first couple of homes you see. Take the time to shop around and make sure you’ve explored different neighborhoods to get a clear idea of what is available both in new and pre-owned homes. Condos, townhomes and courtyard homes are other options you may want to explore if having a big yard isn’t a priority, but these properties usually come with extra housing expenses such as homeowner association dues.

Talk with several real estate agents and choose one that you feel comfortable with. For first-time buyers, having an agent who is patient and who can explain the intricacies of the buying process is critical. Be sure and stick to your budget as you have other homeowner expenses such as property taxes, hazard insurance, mortgage insurance, and even homeowner association dues to pay besides your mortgage.

Don’t be disillusioned if you don’t get the first house you make an offer on. Let the real estate agent guide you to other suitable listings and keep looking. And be prepared to deal with feelings of panic and confusion once your offer is accepted and the mortgage is approved. Your mortgage broker and real estate agent will help guide you through the steps leading up to the closing.

1. Before you start looking for a home, get pre-qualified for a loan. Banks, credit unions and mortgage bankers make home loans; mortgage brokers process them. The lenders will take an application, process the loan documents, and see the loan through to the funding stage.
2. If you have marginal or bad credit, consult your lender. You may be able to qualify for a loan depending on how long ago and what reason(s) caused the bad credit. A lender should be able to advise you on whether your credit history will prevent you from qualifying for a home loan.
3. You will need a down payment. Down payment requirements vary depending on the type of loan. Many down payment assistance programs exist. These programs may loan or grant you the funds necessary for the down payment. Consult with a lender about programs available in your area.
4. You will need funds for closing costs Closing costs are charges for services related to the closing of your real estate transaction. They include, but are not limited to:
• Escrow fees charged by the company handling the transaction
• Title policy issuance fees charged by the title insurance company
• Mortgage insurance fees
• Fire and homeowners insurance
• County Recorder fees for recording your deed
• Loan origination fees

Consult your lender for an actual estimate of these costs, as well as information about loan programs which can assist in financing your closing costs

5. Some loans have "points" and some do not. A point is a loan origination fee equivalent to 1% of the loan amount. Together with the interest rate they constitute the yield on your loan for the lender. Some lenders charge a higher interest rate to compensate for charging no points. It is important to comparison shop lenders to make sure your loan is at a competitive yield.
6. Should you select a mortgage with a fixed rate or an adjustable rate? The answer to this question depends on whether mortgage rates are at a high or a low point when you purchase, and on how long you plan to live in the home. If rates are high, an adjustable rate might be attractive since subsequent rate drops could reduce your monthly payments. Additionally, lenders may offer a low rate during the first few years of an adjustable mortgage to make it appealing to you. If interest rates are low you might want to take a fixed rate to protect yourself against the possibility of rising interest rates.
7. Be aware of the two main types of loan categories.
• Conventional Loans. Conventional mortgage loans are available with fixed or adjustable interest rates. Some loans may require mortgage insurance.
• Government Loans. These include Federal Housing Administration (FHA) fixed and adjustable rate mortgage loans, and Veterans Administration (VA) fixed rate mortgage loan
8. If you are a low or moderate income homebuyer, there are special programs designed to help you. These loans are available through private lenders, as well as local and state housing agencies, like the California Housing Finance Agency (CalHFA). Most lenders specializing in real estate mortgage loans are aware of these types of loan programs.
9. Why might I have to pay mortgage insurance? Mortgage insurance protects the lender from potential loss if you should default on your mortgage loan payment. Generally, conventional loans that require larger down payments do not require mortgage insurance. Mortgage insurance is always required on FHA mortgage loans.
10. Many organizations offer home loan counseling to prospective homebuyers. These organizations provide classes for homebuyers to cover the steps to homeownership. They will cover home selection, realtor services, lenders, loan programs, homeownership responsibilities, saving for a down payment, and other important pieces of information. Many first-time homebuyer programs require homebuyers to attend this type of class to be eligible for selected programs.

Under the new Economic Recovert Act of 2008, home buyers who  have not owned a home in the last three years will be eligible for a tax credit equal to 10 percent of the property's purchase price up to a maximum of $7,500.

Here’s how it works:

• The credit is $3,750 for married couples filing separately. Unmarried people who jointly purchase a home will be able to divide the $7,500 credit.

• This program is actually a loan, which home buyers must repay over 15 years at zero percent interest beginning in the second year after they purchase the home. A home buyer who qualified for the whole credit would pay $500 for 15 years or about $41.67 per month.

• The credit applies only to homes purchased on or after April 9, 2008, and before July 1, 2009.

• High-income home buyers don’t qualify: Eligibility begins phasing out for single filers with adjusted income of more than $75,000 and $150,000 for joint filers. It completely phases out at $95,000 for singles and $170,000 for married couples filing jointly.