Ask people to share their home-buying fears, and you might get a second-hand narrative about a mortgage myth.
And, it’s totally understandable. You’re about to make a major life decision. Not to mention putting your own personal finances at stake. The point is: this type of investment comes with a list of mounting pressures and insecurities.
So what do you do? More than likely you’ll turn to those closest to you, friends or family — especially if they own a home. Unfortunately, just like your mother’s unsolicited advice about who you should date — it’s usually bad. Granted, with good intentions. But still bad.
Luckily, we aren’t your mother. But, we do want to support you and your major life decision to buy a home. So, in order to better your home-buying experience, we’ve provided a list in order to dispel a few common mortgage myths.
Mortgage Myth No. 1: I Need Perfect Credit
Most industry experts and novices can agree: A good credit score — generally 700 or higher — is favorable when looking into buying a house. Although favorable, it isn’t necessary for home loan approval.
The majority of Americans have a misconception of the actual factors of credit qualifications when applying for a mortgage loan. This was determined by the big cheeses at Fannie Mae. In 2015, nearly 4,000 Americans were surveyed as part of a research study to pinpoint where the lines of communication lagged.
One of the findings reveals, on average, most people have misinformation about the required score. In actuality, the majority actually admitted to not knowing their current score. Even so, when asked if their current estimated score would meet the requirements for a loan, the majority answered “no.” Altogether, the median score averaged 652, higher than Fannie Mae’s requirement of 620. Of those surveyed, only 13 percent picked the correct “620 – 679” choice bucket.
The lack of understanding could be not knowing the difference between a credit report and a credit score. Nearly all lenders determine your credit worthiness based on your Fair Isaac Corporation (FICO) Score. Ranging anywhere from 350 to 850, the score provides an analysis based on reports from the three major credit bureaus. The computer generated formula provides a snapshot of your creditworthiness, predicting how likely you are to repay your debts.
In simple terms: most lenders know you don’t possess the means to put the money up front. However, they do want to know you’ll pay them back in a timely manner. By simply knowing your credit, or FICO score is an easy way to remain ahead of the competition.
Either way, buying a home with bad credit is not impossible. Borrowers can qualify for government loan programs with a FICO score as low as 580. Government loan programs, such as FHA allow those with bad credit scores—even under 600—to qualify. Keep in mind, though, that FHA loans may look great at first, but they definitely aren’t for everyone.
Generally, better financing terms are available for those with higher credit scores. Buyers with lower credit scores will pay higher interest rates for mortgages. The difference between a score of 620 and 760 often means savings in the tens of thousands of dollars.
Mortgage Myth No. 2: I Make Enough Income to Qualify
There is a key indicator many lenders use approval. And, for many buyers, it’s prioritized behind credit scores and down payments.
Your debt-to-income ratio serves as a direct indication of whether you can afford to repay what you’re asking to borrow. So, even if you are sitting pretty in a high-paying career, if splurging on life’s “finer things” has you in constant debt, you’re unattractive to potential lenders.
Don’t believe me? Ask the experts.
According to a 2014 survey by credit-score giant FICO it heeds power over credit scores, down payments and even how many bucks you have in the bank. During the study, researchers asked a representative what single factor makes them most hesitant to fund a loan request. In other words, what’s most likely to prompt them to say “no.” Nearly 60 percent of risk managers in the FICO study rated excessive DTIs as the number one concern factor.
And notice it is “DTIs” plural. This is because there are two variables lenders look at.
The first measures your gross income from all sources before taxes against your proposed monthly housing expenses. This generally includes the principal, interest, taxes and insurance that you’d be paying if the lender granted the mortgage.
The second, called the back-end ratio, measures your income against all your recurring monthly debts. These include housing expenses, credit cards, student loans, personal loan payments and others.
While mortgage lenders typically look at both types of DTI, the back-end ratio often holds more sway. This is because it takes into account your entire debt load.
Lenders tend to focus on the back-end ratio for conventional mortgages. That is, loans banks or online mortgage lenders offer rather than a government program. When applying for a non-conventional mortgage, lenders will look at both ratios.
Mortgage Myth No. 3: I Need 20 Percent Down Payment
The average American spends about three years scraping together the funds for a down payment. And, although most financial planners recommend putting down a 20 percent down payment, it’s not a requirement.
Four in 10 recently surveyed Americans believe you need at least 20 percent down payment to purchase a home. This was the finding of the National Association of REALTORS®’ 2017 National Housing Pulse Survey. And, a common barrier to homeownership isn’t being able to afford the monthly mortgage payment. It’s being able to save for the down payment.
The reality is that the median down payment for first-time buyers is about 6 percent. Likewise, repeat buyers tend to put down about 14 percent. A growing number of lenders are also requiring much less. Many lenders will be glad to offer up home loans with 10 or 5 percent down. That is, as long as you’re willing to foot the monthly bill for Private Mortgage Insurance.
Government-backed programs, including the Federal Housing Administration requires a down payment of only 3.5 percent.
And while many of these programs are geared toward low-income home buyers, you don’t have to be destitute. There are lots of different ways you can qualify for help on the local or federal level. Depending on your credit score and income, you could qualify for one of over 2,200 programs offered nationwide. The majority of which focus on home buyers with low-interest loans, grants, and tax credits.
Keep in mind that there are some drawbacks. For one, the amount of money you’re borrowing will obviously be larger. This means you’ll have to make larger monthly mortgage payments. Loans with down payments under 20 percent typically come with higher interest rates. But the idea that you can’t buy a home without 20 percent down is a mortgage myth.
Mortgage Myth No. 4: A 30-Year is my Best Option
Most people opt for 30-year fixed-rate mortgages. Looking at monthly costs, the idea of a longer fixed-rate mortgage is more appealing than its 15-year counterpart. But, in reality, this is often not the case.
The shorter term makes the loan cheaper on several fronts. Over the full life of a loan, a 30-year-mortgage will end up costing more than double the 15-year option. This is because you’re borrowing the same amount of money for twice as long — at a higher interest rate. The primary culprit behind higher costs is time.
Moreover, 15-year loans are less risky for banks. This is because it costs banks less to make shorter-term loans than longer-term loans. That is, consumers pay a lower interest rate on a 15-year mortgage. This could range anywhere from a quarter of a percent to a full percent less.
Long story short? The option for a 30-year mortgage is not wrong. But keep an open mind toward other loan plans , including an adjustable-rate mortgage. This can be an ideal mortgage for those not planning on staying for the long haul.
Mortgage Myth No. 5: Down Payment is the Only Up-Front Cost
These fundamentals will help get your foot in the door. However, you can’t pass “Go” until you’ve paid additional costs.
For one thing, the seller might determine you’re responsible for closing costs. This typically includes anywhere from 3 percent to 6 percent of the purchase price.
At the end of the day, the math that comes with the home buying process is very complex. Even though the emotions of large investments can be exhausting, remember it is only temporary. Because, you’re most likely to reap a bounty of benefits that could potentially last a lifetime.
But here is a fact: Making sacrificial trade-offs are a reality when going through the home buying process. It’s just a matter of determining actual needs versus wants. Take your time. Have a prepared list of requirements. These types of measure will help enhance your home buying experience.