Mortgage agreements can be complex documents, leaving many borrowers confused and misinformed. If you’re currently in the market to buy a home, here are five common mortgage myths that you should know about before you sign on the dotted line.
Pre-qualification and pre-approval are not the same thing
When searching for a home, pre-qualification can be a helpful first step to find out which homes will fit your price range. However, many people make the mistake of thinking that this back-of-the-envelope calculation actually means they have a loan on the line. To pre-qualify, a financial institution doesn’t double-check your financial records at all; the pre-qualification figure is based solely on your self-reported income and declared debt. Pre-approval, however, is a much more stringent process, requiring a credit check and a thorough look into your financial background. When it comes time to make an offer on a home, a pre-approval document will be invaluable, letting the owner know that you are a serious buyer.
Pre-approval and a mortgage offer are not the same thing
While getting pre-approved is a valuable step in the mortgage process, many buyers make the mistake of thinking that their pre-approval means they have a mortgage in the bag. But you need to keep in mind that after you make an offer, the lender will check your credit again. If anything has happened in the time since you got pre-approved, it could kill a potential mortgage offer. So it’s essential during the house-hunting phase to avoid doing anything that can kill your credit, like buying a new car, taking out extra credit cards, or failing to make payments on your current debt.
You need a 20 percent down payment
There was a time when a 20 percent down payment was an essential part of buying a new home. However, there are a lot of options out there for would-be homeowners to help them lower this up-front cost. The Federal Housing Administration, for instance, insures many loans, allowing you to put down as little as 3.5 percent.
Keep in mind that a lower down payment will likely also come with a requirement to pay for private mortgage insurance, which protects the lender should you default. So if you’re looking for the lowest monthly payment with the least fees, a 20 percent down payment is still often the best way to go.
Your income will determine your loan amount
Many people assume that a higher income means they can land a larger mortgage, but that isn’t always the case. Lenders take a number of different factors into account before making you an offer. Debt is the biggest factor that will affect your mortgage offer.
Many lenders follow the 28/36 rule: A borrower should spend no more than 28 percent of gross salary on housing, and no more than 36 percent for total debt. So if you’re carrying around a lot of extra debt, it will cause lenders to reduce how much they will offer you for a mortgage.
Self-employment is also considered a strike against you. Lenders are often less willing to make larger offers to the self-employed because their salaries can be more erratic than those that get a steady paycheck from an employer.
Adjustable rate mortgages are always a bad bet
Many people steer clear of adjustable rate mortgages because they think they are unstable and can leave a borrower with a much higher rate down the road. While this is often true, an ARM isn’t always a bad bet. For many people, it can be a great way to get a low interest rate in the short term. Military families, for instance, who move frequently, can benefit from a short-term low interest loan, knowing that they’ll likely be out by the time the higher interest rates kick in.