A lot of people made mistakes in buying homes and shopping for mortgage financing in recent years. The current foreclosure crisis makes that pretty clear. So how do you avoid repeating their mistakes if you're looking to take advantage of the current combination of low housing prices and interest rates, either to buy a new home or refinance an existing mortgage?

To address this concern, the Federal Reserve recently released five key recommendations for consumers who are shopping for a mortgage. These apply both to buying a new home or refinancing an existing mortgage; the basic rules are the same in both cases.

Some of these guidelines also overlap with the home shopping process - particularly Rule #1, "Know What You Can Afford" - but they apply primarily to the mortgage finance portion of the transaction. The following five rules apply to anyone looking to obtain a mortgage to purchase a home or refinance an existing loan.

1 - Know what you can afford

Before you start either the home shopping or mortgage application process, you need to work out a budget and see what it's going to cost you to own a home. Many people make the mistake of only estimating their monthly mortgage payment when they start home shopping, and overlook other substantial costs such as insurance, and utilities.

Beyond that, you also need to be prepared for irregular expenses, such as routine and unexpected maintenance costs - such as pumping out the septic tank every few years, fixing a leaky pipe or replacing a furnace or hot water heater breaks down. Anticipate long-term housing and personal costs as well - will you have to replace the roof in five years or need to buy a new in a couple years? Having a long-term budget and maintaining a contingency fund to meet unexpected expenses can make the difference between comfortably making your mortgage payments and falling delinquent or even into foreclosure.

2 - Shop around

It's amazing how many people take the first loan that's offered to them by a lender or broker. Maybe they don't like dealing with the process of obtaining a mortgage and want to get it over with quickly and with a minimum of hassles. Or perhaps they assume that, mortgage lending being a competitive business, all offers are going to come in pretty much the same. Wrong. Even at the same interest rate, mortgages from different lenders can vary in costs by thousands of dollars due to various fees or other costs that can be built into the loan. A mortgage broker can offer convenience, by doing you shopping for you, obtaining loan quotes from a variety of lenders, but will still charge a premium over what you'd pay if you'd contacted the lender directly. Whether you use a broker or not depends in large part on whether you're willing to invest the time to research and compare offers from various lenders yourself - otherwise, a mortgage broker can simplify the process for you, but for a fee.

3 - Understand pricing and fees

Mortgage loans typically come packaged with a variety of fees and pricing options. The interest rate, discount points and fees can all come together in different combinations to make a big difference in the end cost of what appear to be similar loan offers. Keep an eye on what the end cost will be, both in terms of the monthly mortgage payment and total cost over the lifetime of the loan. Comparing offers from several lenders is your best way to find the best deal.

4 - Understand the pros and cons of different types of mortgages

Different types of mortgages will offer certain advantages and disadvantages. One may require a smaller down payment; another may offer lower monthly payments for the first several years, another may guarantee that your payments and interest rate will never increase. But with each of these advantages, there are also downsides to consider with different types of loans.

Although adjustable rate mortgages (ARMs) and zero-down payment mortgages are far less common than they were a few years ago, they are still available in some circumstances - these typically offer lower monthly payments up front, but at the risk of increasing dramatically a few years down the road. Fixed-rate mortgages offer stable monthly payments, but even here, consumers may wish to consider the differences between a 15- and 30- year mortgage - the former is paid off more quickly and costs less overall, but requires a significantly larger monthly commitment.

5 - Get advice from someone you trust

When shopping for a mortgage, it helps to talk with someone who's been there before. Check with friends and family who've bought a house or refinanced and see what their experiences have been, and what sort of recommendations they have - ask what they might have done differently if they were to go through the process again.

You can also get low-cost professional assistance from a housing counselor endorsed by the U.S. Department of Housing and Urban Development (HUD) - search for "HUD housing counselors" in your community online.

Also, it's not a bad idea to hire an attorney to review the mortgage documents before you sign them - an attorney can also pick up on certain financial or legal consequences of the mortgage you may not have been aware of and which you might wish to renegotiate or try to eliminate entirely.

Published on August 3, 2009